INTERMEDIATE

GROUP-2
PAPER-6 AUDITING AND ASSURANCE
RTPs, MTPs AND PAST PAPERS

1. Nature,Objective and Scope of Audit ....................................................................... 1-17

2. Audit Strategy, Audit Planning and Audit Programme .............................................. 18-27

3. Audit Documentation and Audit Evidence ................................................................ 28-42

4. Risk Assessment and Internal Control .................................................................... 43-59

5. Fraud and Responsibilities of the Auditor in this Regard ....................................... 60-70

6. Audit in an Automated Environment ....................................................................... 71-75

7. Audit Sampling ....................................................................................................... 76-81

8. Analytical Procedures ............................................................................................ 82-88

9. Audit of Items of Financial Statements ................................................................... 89-102

10. The Company Audit ................................................................................................ 103-121

11. Audit Report .......................................................................................................... 122-129

12. Bank Audit .............................................................................................................. 130-135

13. Audit of Different Types of Entities ....................................................................... 136-148

 C H A PT E R- 1
NATUR E,OBJ E CT IV E AND SCOPE O F AUDIT

Q-1 “An audit is independent examination of financial information of any entity, whether profit orientedor
not, and irrespective of its size or legal form, when such an examination is conducted with a view to
expressing an opinion thereon.”
Explain stating clearly how the person conducting this task should take care to ensure that financial
statements would not mislead anybody. [MTP-Oct’19,4 Marks]
Ans. “An audit is independent examination of financial information of any entity, whether profit oriented
or not, and irrespective of its size or legal form, when such an examination is conducted with a view to
expressing an opinion thereon.”
Analysis of the Definition
1. Audit is Independent examination of Financial information.
2. of any entity – that entity may be profit oriented or not and irrespective of its size or legal form.
For example – Profit oriented – Audit of Listed company engaged in business. On the other hand,
Audit of NGO – not profit oriented.
3. The objective of the audit is to express an opinion on the financial statements.
The person conducting this task should take care to ensure that financial statements would not
mislead anybody. This he can do honestly by satisfying himself that:
(i) the accounts have been drawn up with reference to entries in the books of account;
(ii) the entries in the books of account are adequately supported by sufficient and appropriate
evidence;
(iii) none of the entries in the books of account has been omitted in the process of compilation
and nothing which is not in the books of account has found place in the statements;
(iv) the information conveyed by the statements is clear and unambiguous;
(v) the financial sta tement amounts are properly classifi ed, described and disclosed in
conformitywith accounting standards; and
(vi) the statement of accounts present a true and fair picture of the operational results and of
the assets and liabilities.
Q-2 The relationship between auditing and law is very close one. [MTP-Oct’19, 4 Marks, RTP-Nov’18]
Ans. The relationship between au diting and law: The relationship between auditing and law is very close
one. Auditing involves examination of various transactions from the view point of whether or not
these have been properly entered into. It necessitates that an auditor should have a good knowledge
of business laws affecting the entity. He should be familiar with the law of contracts, negotiable
instruments, etc. The knowledge of taxation laws is also inevitable as entity is required to prepare

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 their financial statements taking into account various provisions affected by various tax laws. In analysing
the impact of various transactions particularly from the accounting aspect, an auditor ought to have a
good knowledge about the direct as well as indirect tax laws.
Q-3 The firm’s system of quality control should include policies and procedures addressing each and every
element of system of quality control. State those elements. [MTP-Oct’19,3 Marks, RTP-Nov’18]
Ans. ELEMENTS OF A SYSTEM OF QUALITY CONTROL: The firm’s system of quality control should include
policies and procedures addressing each of the following elements:
(a) Leadership responsibilities for quality within the firm.
(b) Ethical requirements.
(c) Acceptance and continuance of client relationships and specific engagements.
(d) Human resources.
(e) Engagement performance.
(f) Monitoring.
Q-4 SWM is proprietorship firm engaged in the manufacturing of different kind of yarns. It sells its finished
products both in the domestic as well as in the international market. The company is making total
turnover of Rs. 30 crores. It has also availed cash credit limit of Rs.. 3 crores from Dena Bank. In the year
2018-19. Proprietor of the firm is worried about the financial position of the company and is under the
impression that since he is out of India, therefore firm might not run well. He approaches an Internal
Auditor about as to what would be covered in Audit. Advise regarding principal aspects (any four) to be
covered in getting accounts audited. [MTP-March’19,4 Marks]
Ans. The principal aspect to be covered in an audit concerning final statements of account are the following:
(i) An examination of the system of accounting and internal control to ascertain whether itis
appropriate for the business and helps in properly recording all transactions.
(ii) Reviewing the system and procedures to find out whether they are adequate and comprehensive
and incidentally whether material inadequacies and weaknesses exist to allow frauds and errors
going unnoticed.
(iii) Checking of the arithmetical accuracy of the books of account by the verification of postings,
balances, etc.
(iv) Verification of the authenticity and validity of transaction entered into by making an examination
of the entries in the books of accounts with the relevant supporting documents.
(v) Ascertaining that a proper distinction has been made between items of capital and of revenue
nature and that the amounts of various items of income and expenditure adjusted in the accounts
corresponding to the accounting period.
(vi) Comparison of the balance sheet and profit and loss account or other statements with the
underlying record in order to see that they are in accordance therewith.
(vii) Verification of the title, existence and value of the assets appearing in the balance sheet.
(viii) Verification of the liabilities stated in the balance sheet.
(ix) Checking the result shown by the profit and loss and to see whether the results shown are true
and fair.
(x) Where audit is of a corporate body, confirming that the statutory requirements have been complied
with.
(xi) Reporting to the appropriate person/body whether the statements of account examined do reveal
a true and fair view of the state of affairs and of the profit and loss of the organisation.
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Q-5 The a udi tor sha ll comply w i th re l eva n t ethica l re quire me nts, i ncludi ng those pe rt ai ni ng to
independence, relating to financial statement audit engagements. [MTP-April’19,3 Marks, RTP-May’19]
Ans. Ethical Requirements Relating to an Audit of F inancial Statements: The auditor shall comply with
relevant ethical requirements, including those pertaining to independence, rela ting to financial
statement audit engagements. Relevant ethical requirements ordinarily comprise the Code of Ethics
for Professional Accountants (IESBA Code) related to an audit of financial statements.
The Code establishes the following as the fundamental principles of professional ethics relevant to
the auditor when conducting an audit of financial statements :
(a) Integrity; (b) Objectivity;
(c) Professional competence and due care; (d) Confidentiality; and
(e) Professional behavior.
Q-6 Briefly discuss the limitations of Internal Control. [MTP-April’19,4 Marks]
Ans. Limitations of Internal Control:
(i) Internal control can provide only reasonable assurance: Internal control, no matter how effective,
can provide an enti ty with only reasonable assurance about achieving the entity’s financial
reporting objectives. The likelihood of their achievement is affected by inherent limitations of
internal control.
(ii) Human judgment in decision-making: Realities that human judgment in decision-making can be
faulty and that breakdowns in internal control can occur because of human error.
(iii) Lack of understanding the purpose: Equally, the operation of a control may not be effective, such
as where information produced for the purposes of internal control (for example, an exception
report) is not effectively used because the individual responsible for reviewing the information
does not understand its purpose or fails to take appropriate action.
(iv) Collusion among People: Additionally, controls can be circumvented by the collusion of two or
more people or inappropriate management override of internal control. For example, management
may enter into side agreements with customers that alter the terms and conditions of the entity’s
standard sales contracts, which may result in improper revenue recognition. Also, edit checks in
a software program that are designed to identify and report transactions that exceed specified
credit limits may be overridden or disabled.
(v) Judgements by Management: Further, in designing and implementing controls, management
may make judgments on the nature and extent of the controls it chooses to implement, and the
nature and extent of the risks it chooses to assume.
(vi) Limitations in case of Small Entities: Smaller entities often have fewer employees due to which
segregation of duties is not practicable. However, in a small owner-managed entity, the owner-
manager may be able to exercise more effective oversight than in a larger entity. This oversight
may compensate for the generally more limited opportunities for segregation of duties.
On the other hand, the owner-manager may be more able to override controls because the
system of internal control is less structured. This is taken into account by the auditor when
identifying the risks of material misstatement due to fraud.
Q-7 RAG is proprietorship firm engaged in the manufacturing of textile and handloom products. It sells its
finished products both in the domestic as well as in the international market. The company is making
total turnover of ` 30 crores. It has also availed cash credit limit of ` 5 crores from Canara Bank. In the
year 2017-18, proprietor of the firm is worried about the financial position of the company and is under
the impression that since he is out of India, therefore firm might run into losses. He approaches a CA

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 about advantages of getting his accounts audited throughout the year so that he may not suffer due to
accounting weaknesses. Advise regarding advantages of getting accounts audited.
[MTP-March’18,5 Marks, MTP -Oct-18, RTP-Nov’18]
Ans. The chief utility of audit lies in reliable financial statements on the basis of which the state of affairs
may be easy to understand. Apart from this obvious utility, there are other advantages of audit. Some
or all of these are of considerable value even to those enterprises and organisations where audit is not
compulsory, these advantages are given below:
(a) It safeguards the financial interest of persons who are not associated with the management of
the entity, whether they are partners or shareholders,bankers, FI’s, public at large etc.
(b) It acts as a moral check on the employees from committing defalcations or embezzlement.
(c) Audited statements of account are helpful in settling liability for taxes, negotiating loans and for
determining the purchase consideration for a business.
(d) These are also useful for settling trade disputes for higher wages or bonus as well as claims in
respect of damage suffered by property, by fire or some other calamity.
(e) An audit can also help in the detection of wastages and losses to show the different ways by
which these might be checked, especially those that occur due to the absence or inadequacy of
internal checks or internal control measures.
(f) Audit ascertains whether the necessary books of account and allied records have been properly
kept and helps the client in making good deficiencies or inadequacies in this respect.
(g) As an appraisal function, audit reviews the existence and operations of various controls in the
organisations and reports weaknesses, inadequacies, etc., in them.
(h) Audited accounts are of great help in the settlement of accounts at the time of admission or death
of partner.
(i) Government may require audited and certified statement before it gives assistance or issues a
license for a particular trade.
Q-8 The objective of the IAASB is to serve the public interest by setting high quality auditing standards and
by facilitating the convergence of international and national standards, thereby enhancing the quality
and uniformity of practice throughout the world and strengthening public confide nce in the global
auditing and assurance profession. Advise how this objective would be accomplished.
[MTP-March’18,5 Marks, RTP-May’19]
Ans. The objective of the IAASB is to serve the public interest by setting high quality auditing standards and
by facilitating the convergence of international and national standards, thereby enhancing the quality
and uniformity of practice throughout the world and strengthening public confidence in the global
auditing and assurance profession. The IAASB achieves this objective by:
• Establishing high quality auditing standards and guidance for financial statement audits that are
generally accepted and recognized by investors, auditors, governments, banking regula tors,
securities regulators and other key stakeholders across the world;
• Establishing high quality standards and guidance for other types of assurance services on both
financial and non-financial matters;
• Establishing high quality standards and guidance for other related services;
• Establishing high quality standards for quality control covering the scope of services addressed by
the IAASB; and

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 • Publishing other pronouncements on auditing and assurance matters, thereby advancing public
understanding of the roles and responsibility of professional auditors and assurance service
providers.
Q-9 As per SA 220, the engagement partner shall take responsibility for the overall quality on each audit
engagement to which that partner is assigned. While taking responsibility for the overall quality on
each audit engagement, analyse and explain the emphasis of the actions of the engagement partner
and appropriate messages to the other members of the engagement team . Also define engagement
partner. [Sugg. Nov’19, MTP-Aug’18,5 Marks]
Ans. As per SA 220 “Quality Control for an Audit of Financial Statements”, the engagement partner shall
take responsibility for the overall quality on each audit engagement to which that partner is assigned.
The actions of the engagement partner and appropriate messages to the other members of the
engagement team, in taking responsibility for the overall quality on each audit engagement, emphasise:
(a) The importance to audit quality of:
(i) Performing work that compli es wi th professional standards and regulatory and l egal
requirements;
(ii) Complying with the firm’s quality control policies and procedures as applicable;
(iii) Issuing auditor’s reports that are appropriate in the circumstances; and
(iv) The engagement team’s ability to raise concerns without fear of reprisals; and
(b) The fact that quality is essential in performing audit engagements.
Engagement partner defined
Engagement partner refers to the partner or other person in the firm who is responsible for the
audit engagement and its performance, and for the auditor’s report that is issued on behalf of the
firm, and who, where required, has the appropriate authority from a professional, legal or
regulatory body.
Q-10 The Code of Ethics for Professional Accountants, prepared by the Interna tional Federa tion of
Accountants (IFAC) identifies five types of threats. Explain.[MTP-Aug’18,5 Marks, MTP-OCT’18,7 Marks]
Ans. The Code of Ethics for Professional Accountants, prepared by the Interna tional Federa tion of
Accountants (IFAC) identifies five types of threats. These are:
1. Self-interest threats, which occur when an auditing firm, its partner or associate could benefit
from a financial interest in an audit client. Examples include (i) direct financial interest or materially
significant indirect financial interest in a client, (ii) loan or guarantee to or from the concerned
client, (iii) undue dependence on a client’s fees and, hence, concerns about losing the engagement,
(iv) close business relationship with an audit client, (v) potential employment with the client,
and (vi) contingent fees for the audit engagement.
2. Self-review threats, which occur when during a review of any judgement or conclusion reached in
a previous audit or non-audit engagement (Non audit services include any professional services
provided to an entity by an auditor, other than audit or review of the financial statements. These
i nclud e ma nag em en t services, i nt ern al a udi t, investm en t a dvisory se rvice, design and
implementation of information technology systems etc.), or when a member of the audit team
was previously a director or senior employee of the client. Instances where such threats come
into play are (i) when an auditor having recently been a director or senior officer of the company,
and (ii) when auditors perform services that are themselves subject matters of audit.
3. Advocacy threats, which occur when the auditor promotes, or is perceived to promote, a client’s
opinion to a point where people may believe that objectivity is getting compromised, e.g. when

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 an auditor deals with shares or securities of the audited company, or becomes the client ’s advocate
in litigation and third party disputes.
4. Familiarity threats are self-evident, and occur when auditors form relationships with the client
where they end up being too sympathetic to the client ’s interests. This can occur in many ways: (i)
close relative of the audit team working in a senior position in the client company, (ii) former
partner of the audit firm being a director or senior employee of the client, (iii) long association
between specific auditors and their specific client counterparts, and (iv) acceptance of significant
gifts or hospitality from the client company, its directors or employees.
5. Intimidation threats, which occur when auditors are deterred from acting objectively with an
adequate degree of professional skepticism. Basically, these could happen because of threat of
replacement over disagreements with the application of accounting principles, or pressure to
disproportionately reduce work in response to reduced audit fees.
Q-11 An auditor who, before the completion of the engagement, is requested to change the engagement to
one which provides a lower level of assurance, should consider the appropriateness of doing so.
Explain stating the factors based on which client can request the auditor to change the engagement.
[RTP-Nov’19]
Ans. An auditor who, before the completion of the engagement, is requested to change the engagement to
one which provides a lower level of assurance, should consider the appropriateness of doing so.
A request from the client for the auditor to change the engagement may result from-
1. a change in circumstances affecting the need for the service,
2. a misunderstanding as to the nature of an audit or related service originally requested.
3. a restriction on the scope of the engagement, whether imposed by management or caused by
circumstances.
Q-12 The firm should establish policies and procedures designed to provide it with reasonable assurance
that the policies and procedures relating to the system of quality control are relevant, adequate,
operating effectively and complied with in practice. Such policies and procedures should include an
ongoing consideration and evaluation of the firm’s system of quality control, including a periodic
inspection of a selection of completed engagements. Explain in the above context the purpose of
monitoring compliance with quality control policies and procedures. [RTP-Nov’19]
Ans. The firm should establish policies and procedures designed to provide it with reasonable assurance
that the policies and procedures relating to the system of quality control are relevant, adequate,
operating effectively and complied with in practice. Such policies and procedures should include an
ongoing consideration and evaluation of the firm’s system of quality control, including a periodic
inspection of a selection of completed engagements.
The purpose of monitoring compliance with quality control policies and procedures is to provide an
evaluation of:
(a) Adherence to professional standards and regulatory and legal requirements;
(b) Whether the quality control system has been appropriately designed and effectively implemented;
and
(c) Whether the firm’s quality control policies and procedures have been appropriately applied, so
tha t reports tha t are issued by the firm or engage ment partners are appropria t e in the
circumstances.
Follow-up by appropriate firm personnel so that necessary modifications are promptly made to
the quality control policies and procedures.

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Q-13 The Chartered Accountant has a responsibility to remain independent by taking into account the context
in which they practice, the threats to independence and the safeguards available to eliminate the
threats.
In the above context, explain the guiding principles. [RTP-Nov’19]
Ans. The Chartered Accountant has a responsibility to remain independent by taking into account the context
in which they practice, the threats to independence and the safeguards available to eliminate the
threats.
The following are the guiding principles in this regard: -
1. For the public to have confidence in the quality of audit, it is essential that auditors should always
be and appears to be independent of the entities that they are auditing.

2. In the case of audit, the key fundamental principles are integrity, objectivity and professional
skepticism, which necessarily require the auditor to be independent.
3. Before taking on any work, an auditor must conscientiously consider whether it involves threats
to his independence.
4. When such threats exist, the auditor should either desist from the task or put in place safeguards
that eliminate them.
5. If the auditor is unable to fully implement credible and adequate safeguards, then he must not
accept the work.
Q-14 Write a note on “Self-review threats” [RTP-Nov’19]
Ans. Self-review threats, which occur when during a review of any judgement or conclusion reached in a
previous audit or non-audit engagement (Non audit services include any professional services provided
to an entity by an auditor, other than audit or review of the financial statements. These include
management services, internal audit, investment advisory service, design and implementation of
information technology systems etc.), or when a member of the audit team was previously a director
or senior employee of the client. Instances where such threats come into play are (i) when an auditor
having recently been a director or senior officer of the company, and (ii) when auditors perform services
that are themselves subject matters of audit.
Q-15 Explain the overall objective of the auditor as contained in SA 200. [RTP-May’19]
Ans. As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an audit of financial
statements, the overall objectives of the auditor are:
(i) To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement; and
(ii) To report on the financial statements, and communicate as required by the SAs, in accordance
with the auditor’s findings.
Q-16 Lord Justice Lindley in the course of the judgment in the famous London & General Bank case had
succinctly summed up the overall view of what an auditor should be as regards the personal qualities.
Explain stating also the qualities of Auditor. [RTP-May’19]
Ans. It is not enough to realise what an auditor should be. He is concerned with the reporting on financial
matters of business and other institutions. Financial matters inherently are to be set with the problems
of human fallibility; errors and frauds are frequent. The qualities required, according to Dicksee, are
tact, caution, firmness, good temper, integri ty, discretion, industry, judgement, pa tience, cl ear
headedness and reliability. In short, all those personal qualities that go to make a good businessman

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 contribute to the making of a good auditor. In addition, he must have the shine of culture for attaining
a great height. He must have the highest degree of integrity backed by adequate independence. In
fact, Code of ethics mentions integri ty, objectivity and independence as one of the fundamental
principles of professional ethics.
He must have a thorough knowledge of the general principles of law which govern matters with which
he is likely to be in intimate contact. The Companies Act need special mention but mercantile law,
specially the law relating to contracts, is no less important. Needless to say, where undertakings are
governed by a special statute, its knowledge will be imperative; in addition, a sound knowledge of the
law and practice of taxation is unavoidable.
He must pursue an intensive programme of theoretical education in subjects like financial and
management accounting, general m anagement, business a nd corpora te laws, computers and
information systems, taxation, economics, etc. Both practical training and theoretical education are
equally necessary for the development of professional competence of an auditor for undertaking any
kind of audit assignment.
The auditor should be equipped not only with a sufficient knowledge of the way in which business
generally is conducted but also with an understanding of the special features peculiar to a particular
business whose accounts are under audit. The auditor, who holds a position of trust, must have the
basic human qualities apart from the technical requirement of professional training and education.
He is called upon constantly to critically review financial statements and it is obviously useless for him
to attempt that task unless his own knowledge is that of an expert. An exhaustive knowledge of
accounting in all its branches is the sine qua non of the practice of auditing. He must know thoroughly
all accounting principles and techniques.
Lord Justice Lindley in the course of the judgment in the famous London & General Bank case had
succinctly summed up the overall view of what an auditor should be as regards the personal qualities.
He said, “an auditor must be honest that is, he must not certify what he does not believe to be true and
must take reasonable care and skill before he believes that what he certifies is true”.
Q-17 The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain
absolute assurance that the financial statements are free from material misstatement due to fraud or
error. This is because there are inherent limitations of an audit. Explain [RTP-Nov’18]
Ans. The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain
absolute assurance that the financial statements are free from material misstatement due to fraud or
error. This is because there are inherent limitations of an audit. The inherent limitations of an audit
arise from:
(i) The Nature of Financial Reporting: The preparation of financial statements involves judgment by
management in applying the requirements of the entity’s applicable financial reporting framework
to the facts and circumstances of the entity. In addition, many financial statement items involve
subjective decisions or assessments or a degree of uncertainty, and there may be a range of
acceptable interpretations or judgments that may be made.
(ii) The Nature of Audit Procedures: There are practical and legal limitations onthe auditor’s ability to
obtain audit evidence. For example:
1. There is the possibili ty tha t management or others may not provide,intentionally or
uni nt en ti on al ly, th e compl e te i nforma ti on th a t is re l eva nt to th e prep ara t ion and
presentation of the financial statements or that has been requested by the auditor.
2. Fraud may involve sophisticated and carefully organised schemes designed to conceal it.
Therefore, audit procedures used to gather audit evidence may be ineffective for detecting
an intentional misstatement that involves, for example, collusion to falsify documentation

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 which may cause the auditor to believe that audit evidence is valid when it is not. The
auditor is neither trained as nor expected to be an expert in the authentication of documents.
3. An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is
not given specific legal powers, such as the power of search, which may be necessary for
such an investigation.
(iii) Timeliness of Financial Reporting and the Balance between Benefit and Cost: The matter of
difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an audit
procedure for which there is no alternative. Appropriate planning assists in making sufficient
time and resources available for the conduct of the audit. Notwithstanding this, the relevance of
information, and thereby its value, tends to diminish over time, and there is a balance to be struck
between the reliability of information and its cost.
(iv) Other Matters that Affect the Limitations of an Audit: In the case of certain subject matters,
limitations on the auditor’s ability to detect material misstatements are particularly significant.
Such assertions or subject matters include:
• Fraud, particularly fraud involving senior management or collusion.
• The existence and completeness of related party relationships and transactions.
• The occurrence of non-compliance with laws and regulations.
• Future events or conditions that may cause an entity to cease to continue as a going concern.
Q-18 As per SA 220, “Quali ty Control for an Audit of F inancial Statements” the audi tor should obtain
information considered necessary in the circumstances before accepting an engagement with a new
client, when deciding whether to continue an existing engagement and when considering acceptance
of a new engagement with an existing client. Explain
[Sugg.Nov’19-5 Marks, RTP-May’18-Sugg.-May’19,3 Marks]
Ans. Information which assist the Auditor in accepting and continuing of relationship with Client: As per SA
220, “Quality Control for an Audit of F inancial Statements” the auditor should obtain information
considered necessary in the circumstances before accepting an engagement with a new client, when
deciding whether to continue an existing engagement and when considering acceptance of a new
engagement with an existing client. The following information would assist the auditor in accepting
and continuing of relationship with the client:
(i) The integrity of the principal owners, key management and those charged withgovernance of the
enti ty;
(ii) Whether the engagement team is competent to perform the audi t engagementand has the
necessary capabilities, including time and resources;
(iii) Whether the firm and the engagement team can comply with relevant ethical requirements; and
(iv) Significant matters that have arisen during the current or previous audit engagement, and their
implications for continuing the relationship.
Q-19 GST & Co., a firm of Chartered Accountants has been appointed to audit the accountsof XYZ Ltd. The
partner wanted to cover principal aspects while conducting its auditof financial statements. Advise
those principal aspects. [RTP-May’18-Sugg.-May’18,5 Marks]

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Ans. The principal aspects to be covered in an audit concerning final statements of account are the following:

(i) An examination of the system of accounting and internal control to ascertain whether it is
appropriate for the business and helps in properly recording all transactions.
(ii) Reviewing the system and procedures to find out whether they are adequate and comprehensive
and incidentally whether material inadequacies and weaknesses exist to allow frauds and errors
going unnoticed.
(iii) Checking of the arithmetical accuracy of the books of account by the verification of postings,
balances, etc.
(iv) Verification of the authenticity and validity of transaction entered into by making an examination
of the entries in the books of accounts with the relevant supporting documents.
(v) Ascertaining that a proper distinction has been made between items of capital and of revenue
nature and that the amounts of various items of income and expenditure adjusted in the accounts
corresponding to the accounting period.
(vi) Comparison of the balance sheet and profit and loss account or other statements with the
underlying record in order to see that they are in accordance therewith.
(vii) Verification of the title, existence and value of the assets appearing in the balance sheet.
Assertions about account balances at the period end:
(i) Existence—assets, liabilities, and equity interests exist.
(ii) Rights and obligations—the entity holds or controls the rights to assets, andliabilities are the
obligations of the entity.
(iii) Completeness—all assets, liabilities and equity interests that should have been recorded have
been recorded.
(iv) Valuation and allocation—assets, liabilities, and equity interests are included in the financial
statements at appropriate amounts and any resulting valuation or allocation adjustments are
appropriately recorded.

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 (viii) Verification of the liabilities stated in the balance sheet.
(ix) Checking the result shown by the profit and loss and to see whether the results shown are true
and fair.
(x) Where audit is of a corporate body, confirming that the statutory requirementshave been complied
with.
(xi) Reporting to the appropriate person/body whether the statements of account examined do reveal
a true and fair view of the state of affairs and of the profit and loss of the organisation.
Q-20 The matter of difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an
audit procedure for which there is no alternative or to be satisfied with audit evidence that is less than
persuasive. Explain. [RTP-May’18]
Ans. Timeliness of Financial Reporting and the Balance between Benefit and Cost: The matter of difficulty,
time, or cost involved is not in itself a valid basis for the auditor to omit an audit procedure for which
there is no alternative or to be satisfied with audit evidence that is less than persuasive. Appropriate
planning assists in making suffici ent time and resources available for the conduct of the audi t.
Notwithstanding this, the relevance of information, and thereby its value, tends to diminish over
time, and there is a balance to be struck between the reliability of information and its cost. There is an
expectation by users of financial statements that the auditor will form an opinion on the financial
sta tements wi thin a reasonabl e period of time and at a reasonabl e cost, recognising tha t i t is
impracticable to address all information that may exist or to pursue every matter exhaustively on the
assumption that information is in error or fraudulent until proved otherwise.
Q-21 “An auditor who before the completion of the engagement is requested to change the engagement to
one which provides a lower level of assurance should consider the appropriateness of doing so.”
Discuss. [RTP-May’18]
Ans. Acceptance of a Change in Engagement: An auditor who, before the completion of the engagement, is
requested to change the engagement to one which provides a lower level of assurance, should consider
the appropriateness of doing so. A request from the client for the auditor to change the engagement
may result from a change in circumstances affecting the need for the service, a misunderstanding as to
the nature of an audit or related service originally requested or a restriction on the scope of the
engagement, whether imposed by management or caused by circumstances. The auditor would consider
carefully the reason given for the request, particularly the implications of a restriction on the scope of
the engagement, especially any legal or contractual implications. If the auditor concludes that there is
reasonable justification to change the engagement and if the audit work performed complied with the
SAs applicable to the changed engagement, the report issued would be appropriate for the revised
terms of engagement. In order to avoid confusion, the report would not include reference to-
(i) the original engagement; or
(ii) any procedures that may have been performed in the original engagement,except where the
engagement is changed to an engagement to undertake agreed-upon procedures and thus
reference to the procedures performed is a normal part of the report. The auditor should not
agree to a change of engagement where there is no reasonable justification for doing so.
If the terms of the audit engagement are changed, the auditor and management shall agree on
and record the new terms of the engagement in an engagement letter or other suitable form of
written agreement. If the audi tor is unable to agree to a change of the terms of the audit
engagement and is not permitted by management to continue the original audit engagement,
the auditor shall-

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 (i) Withdraw from the audit engagement where possible under applicable law orregulation; and
(ii) Determine whether there is any obligation, ei ther contractual or otherwise, to report the
circumstances to other parties, such as those charged with governance, owners or regulators.
Q-22 “Independence of mind and independence in appearance are interlinked perspectives of Independence
of auditors.” Explain. [Sugg.-May’19,3 Marks]
Ans. Independence” implies that the judgment of a person is not subordinate to the wishes or direction of
another person who might have engaged him. The auditor should be independent of the entity subject
to the audit. There are two interlinked perspective of independence of auditors, one independence of
mind and two, independence in appearance. The Code of Ethics for Professional Accountants issued by
International Federation of Accountants (IFAC) defines the term “Independence” as comprising both-
(a) Independence of mind – the state of mind that permits the provision of an opinion without being
affected by influences allowing an individual to act with integrity, and exercise objectivity and
professional skepticism; and

(b) Independence in appearance – the avoidance of facts and circumstances that are so significant
that a third party would reasonably conclude an auditor’s integrity, objectivity or professional
skepticism had been compromised.” Independence of the auditor has not only to exist in fact, but
also appear to so exist to all reasonable persons.
Q-23 “Professional judgment is essential to the proper conduct of an audit.” Discuss. [Sugg.-Nov’18, 5 Marks]
Ans. Professional judgment is essential to the proper conduct of an audit. This is because interpretation of
relevant ethical requirements and the SAs and the informed decisions required throughout the audit
cannot be made without the application of relevant knowledge and experi ence to the facts and
circumstances. Professional judgment is necessary in particular regarding decisions about:
(i) Materiality and audit risk.
(ii) The nature, timing, and extent of audit procedures used to meet the requirements of the SAs and
gather audit evidence.
(iii) Evaluating whether sufficient appropriate audit evidence has been obtained, and whether more
needs to be done to achieve the objectives of the SAs and thereby, the overall objectives of the
auditor.
(iv) The evaluation of management’s judgments in applying the entity’s applicable financial reporting
framework.
(v) The drawing of conclusions based on the audit evidence obtained, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.
Q-24 “CA. NM who is rendering management consultancy service to LA Ltd. wants to accept offer letter for
appointment as an auditor of the LA Ltd. for the next financial year.” Discuss with reference to the
provision of the Companies Act, 2013. [Sugg.-Nov’18, 5 Marks]
Ans. Section 141(3)(i) of the Companies Act, 2013 disqualifies a person for appointment as an auditor of a
company who is engaged as on the date of appointment in management consultancy service as provided
in section 144. Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by
the auditor which are as under:
(i) Accounting and book keeping services
(ii) Internal audit.
(iii) Design and implementation of any financially information system.

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 (iv) Actuarial services
(v) Investment advisory services.
(vi) Investment banking services.
(vii) Rendering of outsourced financial services
(viii) Management services and
(ix) Any other kind of services as may be prescribed
Therefore, CA. NM is advised not to accept the assignment of auditing as the management
consultancy service is specifically notified in the list of services not to be rendered by him as per
section 141(3)(i) read with section 144 of the Companies Act, 2013.
Q-25 (a) The person conducting audit should take care to ensure that financial statements would not mislead
anybody. Explain stating clearly the meaning of Auditing.
(b) Explain the objectives of an Audit as per SA 200. [RTP-May’2020]
Ans.(a) “An audit is independent examination of financial information of any entity, whether profit oriented
or not, and irrespective of its size or legal form, when such an examination is conducted with a view to
expressing an opinion thereon.”
Analysis of the Definition
1. Audit is Independent examination of Financial information.
2. of any entity – that entity may be profit oriented or not and irrespective of its size or legal form.
For example – Profit oriented – Audit of Listed company engaged in business. On the other hand,
Audit of NGO – not profit oriented.
3. The objective of the audit is to express an opinion on the financial statements.
The person conducting this task should take care to ensure that financial statements would not mislead
anybody. This he can do honestly by satisfying himself that:
(i) the accounts have been drawn up with reference to entries in the books of account;
(ii) the entries in the books of account are adequately supported by sufficient and appropriate
evidence;
(iii) none of the entries in the books of account has been omitted in the process of compilation and
nothing which is not in the books of account has found place in the statements;
(iv) the information conveyed by the statements is clear and unambiguous;
(v) the financial statement amounts are properly classified, described and disclosed in conformity
with accounting standards; and
(vi) the statement of accounts present a true and fair picture of the operational results and of the
assets and liabilities.
(b) As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an audit of financial
statements, the overall objectives of the auditor are:
(a) To obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement; and
(b) To report on the financial statements, and communicate as required by the SAs, in accordance
with the auditor’s findings.
Q-26 (a) There are practical and legal limitations on the auditor’s ability to obtain audit evidence. Explain with
examples.

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 (b) In case of certain subject matters, limitations on the auditor’s ability to detect material misstatements
are particularly significant. Explain such assertions or subject matters. [RTP-May’2020]
Ans.(a) The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s ability to
obtain audit evidence. For example:
1. The re is th e possibi li ty tha t m an age m en t or o th e rs ma y not provi d e, i n te n ti ona lly or
unintentionally, the complete information that is relevant to the preparation and presentation of
the financial statements or that has been requested by the auditor.
2. Fraud may involve sophistica ted and carefully organised schemes designed to conceal it.
Therefore, audit procedures used to gather audit evidence may be ineffective for detecting an
intentional misstatement that involves, for example, collusion to falsify documentation which
may cause the auditor to believe that audit evidence is valid when it is not. The auditor is neither
trained as nor expected to be an expert in the authentication of documents.
3. An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not
given specific legal powers, such as the power of search, which may be necessary for such an
investigation.
(b) Other Matters that Affect the Limitations of an Audit: In the case of certain subject matters, limitations
on the auditor’s ability to detect material misstatements are particularly significant. Such assertions or
subject matters include:
- Fraud, particularly fraud involving senior management or collusion.
- The existence and completeness of related party relationships and transactions.
- The occurrence of non-compliance with laws and regulations.
- Future events or conditions that may cause an entity to cease to continue as a going concern.
Q-27 The auditor of MARUT Ltd, engaged in manufacturing of Smart Motor Bikes, obtains anunderstanding of
the control environment. As part of obtaining this understanding, the auditor evaluates whether:
(i) Management has created and maintained a culture of honesty and ethical behavior; and
(ii) The strengths in the control environment elements collectively provide an appropriatefoundation
for the other components of internal control.
Advise what is included in control environment. Also explain the elements of control environment.
[MTP-Aug.18,5 Marks]
Ans. Control Environment – Component of Internal Control: The auditor shall obtain an understanding of
the control environment. As part of obtaining this understanding, the auditor shall evaluate whether:
(i) Management has created and maintained a culture of honesty and ethical behavior; and
(ii) The strengths in the control environment elements collectively provide an appropriate foundation
for the other components of internal control.
What is included in Control Environment?
The control environment includes:
(i) the governance and management functions and
(ii) the attitudes, awareness, and actions of those charged with governance and management.
(iii) The control environment sets the tone of an organization, influencing the control consciousness
of its people.
Elements of the Control Environment : Elements of the control environment that may be relevant
when obtaining an understanding of the control environment include the following:

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 (a) Communication and enforcement of integrity and ethical values – These are essential elements
that influence the effectiveness of the design, administration and monitoring of controls.
(b) Commitment to competence – Matters such as management’s consideration of the competence
levels for particular jobs and how those levels translate into requisite skills and knowledge.
• Their independence from management.
• Their experience and stature.
• The extent of their involvement and the informa tion they receive, and the scrutiny of
activities.
• The appropriateness of their actions, including the degree to which difficult questions are
raised and pursued wi th management, and their interaction with internal and external
auditors.
• Approach to taking and managing business risks.
• Attitudes and actions toward financial reporting.
• Attitudes toward information processing and accounting functions and personnel.
(c) Participation by those charged with governance – Attributes of those charged with governance
such as:
(d) Management’s philosophy and operating style – Characteristics such as management ’s:
(e) Organisational structure – The framework within which an entity’s activities for achieving its
objectives are planned, executed, controlled, and reviewed.
(f) Assignment of authority and responsibility - Matters such as how authority and responsibility for
operating activities are assigned and how reporting relationships and authorisation hierarchies
are established.
(g) Human resource policies and practices – Policies and practices that relate to, for exampl e,
recrui tment, ori enta tion, training, evalua tion, counselling, promotion, compensation, and
remedial actions.
Q-2 The auditor shall plan and perform an audit with professional skepticism recognizing that circumstances
may exist that cause the financial statements to be materially misstated. Discuss any four examples of
professional skepticism. [Sugg.-Nov’19,4 Marks]
Ans. Professional skepticism includes being alert to, for example:
(i) Audit evidence that contradicts other audit evidence obtained.
(ii) Information that brings into question the reliability of documents and responses to inquiries to
be used as audit evidence.
(iii) Conditions that may indicate possible fraud.
(iv) Circumstances that suggest the need for audit procedures in addition to those required by the
SAs.
(v) Maintaining professional skepticism throughout the audit is necessary if the auditor is to reduce
the risks of:
(a) Overlooking unusual circumstances.
(b) Over generalising when drawing conclusions from audit observations.
(c) Using inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the results thereof.

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MULTIPLE CHOICE QUESTIONS

1. Most of the auditor’s work in forming the auditor’s opinion consists of :

(a) obtaining audit evidence. (b) evaluating audit evidence.
(c) obtaining or evaluating audit evidence. (d) obtaining and evaluating audit evidence.
[MTP-Oct’19]
2. Professional skepticism is necessary to the critical assessment of
(a) audit documentation (b) audit evidence.
(c) audit procedures (d) All of the above [MTP-Oct’19]
3. According to SA 210 “Agreeing the Terms of Audit Engagements”, The auditor shall agree the terms of
the audit engagement with :
(a) management
(b) those charged with governance
(c) management or those charged with governance, as appropriate.
(d) Audit committee [MTP-Oct’19]
4. The matter of difficulty, time, or cost involved is :
(a) not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative.
(b) in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative.
(c) not in itself a valid basis for the auditor to omit an audit procedure for which alternative exists.
(d) not in itself a valid basis for the auditor to omit an audit procedure. [MTP-March’19]
5. _____are self-evident, and occur when auditors form relationships with the client where they end up
being too sympathetic to the client’s interests.
(a) Self-review threats (b) Familiarity threats
(c) Intimidation threats (d) Advocacy threats [MTP-March’19]
6. The type of errors, existence of which becomes apparent in the process of compilation of accounts is
known as-
(a) Self-revealing errors. (b) Intentional errors.
(c) Concealed errors. (d) Unconcealed errors. [MTP-March’19]
7. If the auditor concludes that there is reasonable justification to change the engagement and if the
auditwork performed complied with the SAs applicable to the changed engagement, the report issued
wouldbe appropriate for the revised terms of engagement. In order to avoid confusion, the report
would not include reference to:
(a) the original engagement; or any procedures that may have been performed in the original
engagement.
(b) the original engagement;
(c) any procedures that may have been performed in the original engagement
(d) the origi na l e ngag em e nt and a ny proce dures tha t m ay hav e b ee n p e rf orm ed in th e
originalengagement. [MTP-April’19]
8. Which of the following is correct :

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 (a) The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore
obtainabsolute assurance that the financial statements are free from material misstatement due
to fraudor error.
(b) Th e audi tor is expecte d to and can reduce audi t risk to zero and can th erefore ob ta in
absoluteassurance.
(c) The auditor is not expected to, and cannot, reduce audi t risk to zero and cannot therefore
obtainreasonable assurance that the financial statements are free from material misstatement
due tofraud or error.
(d) Th e audi tor is expecte d to and can reduce audi t risk to zero and can th erefore ob ta in
reasonableassurance that the financial statements are free from material misstatement due to
fraud or error. [MTP-April’19]
9. Determining a percentage to be applied to a chosen benchmark (in relation to materiality) involves
theexercise of ___________
(a) Independence (b) Professional Judgement
(c) Professional skepticism (d) All of the above [MTP-April’19]
10. An important factor in determining the form, content and extent of audit documentation of significant
matters is the extent of _________exercised in performing the work and evaluating the results.
(a) professional skepticism (b) professional integrity
(c) professional judgment (d) Professional sincerity [RTP-Nov’19]

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 C H A PT E R- 2
A U D I T S T R A T E G Y , A U D I T P L A NNING A N D A U D I T
PRO GRAM M E

Q-1 Auditors of M/s Tender India (P) Ltd. were changed for the accounting year 2016-17. The closing inventory
of the company as on 31.3.2016 amounting to Rs. 100 lacs continued as it is and became closing inventory
as on 31.3.2017. The auditors of the company propose to exclude from their audit programme the audit
of closing inventory of Rs. 100 lacs on the understanding that it pertains to the preceding year which
was audited by another auditor. [MTP-Oct’19,4 Marks]
Ans. Verification of Inventory: As per SA 510 “Initial Audit Engagements – Opening Balances”, in conducting
an initial audit engagement, the objective of the auditor with respect to opening balances is to obtain
sufficient appropriate audit evidence about whether-
(i) Ope ning b al a nces con ta i n m issta t em en ts tha t m a te ri a lly a f fect th e curre nt pe ri od’s
financialstatements; and
(ii) Appropriate accounting policies reflected in the opening balances have been consistently applied
in the current period’s financial statements, or changes thereto are properly accounted for and
adequa tely presented and disclosed in accordance wi th the applicabl e financial reporting
framework.
When the financial statements for the preceding period were audited by predecessor auditor,
the current auditor may be able to obtain sufficient appropriate audit evidence regarding opening
balances by perusing the copies of the audited financial statements including the other relevant
documents relating to the prior period financial statements such as supporting schedules to the
audited financial statements. Ordinarily, the current auditor can place reliance on the closing
balances contained in the financial statements for the preceding period, except when during the
performance of audit procedures for the current period the possibility of misstatements in opening
balances is indicated.
General principles governing verification of assets require that the auditor should confirm that
assets have been correctly valued as on the Balance Sheet date. The contention of the management
that the inventory has not undergone any change cannot be accepted, it forms part of normal
duties of auditor to ensure that the figures on which he is expressing opinion are correct and
properly valued. Moreover, it is also quite likely that the inventory lying as it is might have
deteriorated and the same need to be examined. The auditor is advised not to exclude the audit
of closing inventory from his audit programme.
Q-2 “The auditor should plan his work to enable him to conduct an effective audit in an efficient and timely
manner. Plans should be based on knowledge of the client’s business” Discuss stating clearly the broad
points you would be covering in framing plan to conduct audit in an efficient and effective manner.
[MTP-March’19,4 Marks-MTP-March’18,5 Marks-MTP-Oct’18,5 Marks-
RTP-Nov’19,RTP-Nov’18]

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Ans. “The auditor should plan his work to enable him to conduct an effective audit in an efficient and timely
manner. Plans should be based on knowledge of the client ’s business”.
Plans should be made to cover, among other things:
(a) acquiring knowledge of the client’s accounting systems, policies and internal control procedures;
(b) establishing the expected degree of reliance to be placed on internal control;
(c) determining and programming the nature, timing, and extent of the audit procedures to be
performed; and
(d) coordinating the work to be performed.
Plans should be further developed and revised as necessary during the course of the audit. SA-
300, “Planning an Audit of Financial Statements” further expounds this principle. According to it,
planning is not a discrete phase of an audit, but rather a continual and iterative process that often
begins shortly after (or in connection with) the completion of the previous audit and continues
until the completion of the current audit engagement. The auditor shall establish an overall audit
strategy that sets the scope, timing and direction of the audit, and that guides the development
of the audit plan.
Q-3 The establishment of the overall audit strategy and the detailed audit plan are closely inter-related.
Explain [MTP-March’19,3 Marks]
Ans. Once the overall audit strategy has been established, an audit plan can be developed to address the
various matters identified in the overall audit strategy, taking into account the need to achieve the
audit objectives through the efficient use of the auditor’s resources. The establishment of the overall
audit strategy and the detailed audit plan are not necessarily discrete or sequential processes, but are
closely inter-related since changes in one may result in consequential changes to the other.
Q-4 The engagement partner of AST AND ASSOCIATES, firm of Chartered Accountants appointed as auditor
of Fabric India Ltd is considering as to management of key resources to be empl oyed to conduct audit.
Discuss how overall audit strategy would assist the auditor.
[MTP-March’18,5 Marks-MTP-Oct’18,5 Marks-RTP-Nov’18-Sugg.-May’19,4 Marks-RTP-May’2020]
Ans. The auditor shall establish an overall audit strategy that sets the scope, timing and direction of the
audit, and that guides the development of the audit plan.
The process of establishing the overall audit strategy assists the auditor to determine, subject to the
completion of the auditor’s risk assessment procedures, such matters as:
1. The resources to deploy for specific audit areas, such as the use of appropriately experienced
team members for high risk areas or the involvement of experts on complex matters;
2. The amount of resources to allocate to specific audit areas, such as the number of team members
assigned to observe the inventory count at material locations, the extent of review of other
auditors’ work in the case of group audits, or the audit budget in hours to allocate to high risk
areas;
3. When these resources are to be deployed, such as whether at an interim audit stage or at key cut-
off dates; and
4. How such resources are managed, directed and supervised, such as when team briefing and
debriefing meetings are expected to be held, how engagement partner and manager reviews are
expected to take place (for example, on-site or off-site), and whether to complete engagement
quality control reviews.

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Q-5 As a result of unexpected events, changes in conditions, or the audit evidence obtained from the
results of audit procedures, the auditor may need to modify the overall audit strategy and audit plan.
Explain. [RTP-Nov’19-RTP-Nov’18]
Ans. The auditor shall update and change the overall audit strategy and the audit plan as necessary during
the course of the audit. As a result of unexpected events, changes in conditions, or the audit evidence
obtained from the results of audit procedures, the auditor may need to modify the overall audit
strategy and audit plan and thereby the resulting planned nature, timing and extent of further audit
procedures, based on the revised consideration of assessed risks. This may be the case when information
comes to the auditor’s attention that differs significantly from the information available when the
auditor planned the audit procedures. For example, audit evidence obtained through the performance
of substantive procedures may contradict the audit evidence obtained through tests of controls.
Q-6 Engagement partner of Audit F irm MKC AND COMPANY thinks that Planning an audit would involve
establishing the overall audit strategy for the engagement and developing an audit plan. Also, Adequate
planning would benefit the audit of financial statements in several ways. Analyse explaining the
benefits of adequate planning. [RTP-Nov’19-RTP-May’19-RTP-May’18-Sugg.-May’19,5 Marks]
Ans. Planning an audit involves establishing the overall audit strategy for the engagement and developing
an audit plan. Adequate planning benefits the audit of financial statements in several ways, including
the following:
1. Helping the auditor to devote appropriate attention to important areas of the audit.
2. Helping the auditor identify and resolve potential problems on a timely basis.
3. Helping the auditor properly organize and manage the audit engagement so that it is performed
in an effective and efficient manner.
4. Assisting in the selection of engagement team members with appropriate levels of capabilities
and competence to respond to anticipated risks, and the proper assignment of work to them.
5. Facilitating the direction and supervision of engagement team members and the review of their
work.
6. Assisting, where applicable, in coordination of work done by auditors of components and experts.
Q-7 Planning is not a discrete phase of an audit, but rather a continual and iterative process that often
begins shortly after the completion of the previous audit and continues until the completion of the
current audit engagement. Analyse and Explain. [RTP-Nov’19-Sugg.-Nov’18,5 Marks]
Ans. Planning is not a discrete phase of an audit, but rather a continual and iterative process that often
begins shortly after (or in connection with) the completion of the previous audit and continues until
the completion of the current audit engagement. Planning, however, includes consideration of the
timing of certain activities and audit procedures that need to be completed prior to the performance of
further audit procedures. For example, planning includes the need to consider, prior to the auditor’s
identification and assessment of the risks of material misstatement, such matters as:
1. The analytical procedures to be applied as risk assessment procedures.
2. Obtaining a general understanding of the legal and regulatory framework applicable to the entity
and how the entity is complying with that framework.
3. The determination of materiality.
4. The involvement of experts.
5. The performance of other risk assessment procedures.

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Q-8 Evolving one audit programme applicable to all business under all circumstances is not practicable.
Explain [RTP-May’19-RTP-MaY’18]
Ans. Businesses vary in nature, size and composition; work which is suitable to one business may not be
suitable to others; efficiency and operation of internal controls and the exact nature of the service to
be rendered by the auditor are the other factors that vary from assignment to assignment. On account
of such variations, evolving one audit programme applicable to all business under all circumstances is
not practicable. However, it becomes a necessity to specify in detail in the audit programme the nature
of work to be done so that no time will be wasted on matters not pertinent to the engagement and any
special matter or any specific situation can be taken care of.
Q-9 The utility of the audit programme can be retained and enhanced only by keeping the programme as
also the cli ent ’s operations and internal control under periodic review so tha t inadequaci es or
redundancies of the programme may be removed. Explain [RTP-May’19]
Ans. Periodic Review of The Audit Programme : There should be periodic review of the audit programme to
assess whether the same continues to be adequate for obtaining requisite knowledge and evidence
about the transactions. Unless this is done, any change in the business policy of the client may not be
adequately known, and consequently, audit work may be carried on, on the basis of an obsolete
programme and, for this negligence, the whole audit may be held as negligently conducted and the
auditor may have to face legal consequences.
Example- if the audit programme for the audit of a branch of a financing house, drawn up a number of
years ago, fails to take into consideration that the previous policy of financing of a vehicle has been
changed to financing of real estate acquisition, the whole audit conducted thereunder would be entirely
misdirected and may even result into nothing more than a farce. [Pacific Acceptance Corporation Ltd. v.
Forsyth and Others.]
The utility of the audit programme can be retained and enhanced only by keeping the programme as
also the cli ent ’s operations and internal control under periodic review so tha t inadequaci es or
redundancies of the programme may be removed. However, as a basic feature, audit programme not
only lists the tasks to be carried out but also contains a few relevant instructions, like the extent of
checking, the sampling plan, etc. So long as the programme is not officially changed by the principal,
every assist-ant deputed on the job should unfailingly carry out the detailed work according to the
instructions governing the work. Many persons believe that this brings an element of rigidity in the
audit programme. This is not true provided the periodic review is undertaken to keep the programme
as up-to-date as possible and by encouraging the assistants on the job to observe all salient features of
the various accounting functions of the client.
Q-10 Explain the significant points auditor would consider while developing an audit programme.
[RTP-May’19]
Ans. Developing the Audit Programme :
1. Written Audit Programme: The auditor should prepare a written audit programme setting forth
the procedures that are needed to implement the audit plan.
2. Audit objective and instruction to assistants: The programme may also contain the audit objectives
for each area and should have sufficient details to serve as a set of instructions to the assistants
involved in the audit and as a means to control the proper execution of the work.
3. Reliance on Internal Controls: In preparing the audi t programme, the audi tor, having an
understanding of the accounting system and related internal controls, may wish to rely on certain
internal controls in determining the nature, timing and extent of required auditing procedures.
The auditor may conclude that relying on certain internal controls is an effective and efficient way

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 to conduct his audit. However, the auditor may decide not to rely on internal controls when there
are other more efficient ways of obtaining sufficient appropriate audit evidence. The auditor
should also consider the timing of the procedures, the coordination of any assistance expected
from the client, the availability of assistants, and the involvement of other auditors or experts.
4. Timings of performance of audit procedures: The auditor normally has flexibility in deciding
when to perform audit procedures. However, in some cases, the auditor may have no discretion
as to timing, for example, when observing the taking of inventories by client personnel or verifying
the securities and cash balances at the year-end.
5. Audit planning: The audit planning ideally commences at the conclusion of the previous year’s
audit, and along with the related programme, it should be reconsidered for modification as the
audit progresses. Such consideration is based on the auditor’s review of the internal control, his
preliminary evaluation thereof, and the results of his compliance and substantive procedures.
Q-11 The auditor shall document the overall audit strategy, the audit plan and any significant changes made
during the audit engagement to the overall audit strategy or the audit plan, and the reasons for such
changes. Explain [RTP-Nov’18]
Ans. The auditor shall document :
(a) the overall audit strategy;
(b) the audit plan; and
(c) any significant changes made during the audit engagement to the overall auditstrategy or the
audit plan, and the reasons for such changes.
The documentation of the overall audit strategy is a record of the key decisions considered
necessary to properly plan the audit and to communicate significant matters to the engagement
team.
For example, the auditor may summarize the overall audit strategy in the form of a memorandum
that contains key decisions regarding the overall scope, timing and conduct of the audit.
The documentation of the audit plan is a record of the planned nature, timing and extent of risk
assessment procedures and further audit procedures at the assertion level in response to the
assessed risks. It also serves as a record of the proper planning of the audit procedures that can be
reviewed and approved prior to their performance. The auditor may use standard audit programs
and/or audit completion checklists, tailored as needed to reflect the particular engagement
circumstances. A record of the significant changes to the overall audit strategy and the audit plan,
and resulting changes to the planned nature, timing and extent of audit procedures, explains why
the significant changes were made, and the overall strategy and audit plan finally adopted for the
audit. It also reflects the appropriate response to the significant changes occurring during the
audit.
For instanceThe following things should form part of auditor’s documentation :
• A summary of discussions with the entity’s key decision makers
• Documentation of audit committee pre-approval of services, where required
• Audit documentation access letters
• Other communications or agreements with management or those charged with governance
regarding the scope, or changes in scope, of our services
• auditor’s report on the entity’s financial statements.
• Other reports as specified in the engagement agreement (e.g., debt covenant compliance
letter)

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Q-12 Determining materiality involves the exercise of professional judgment. A percentage is often applied
to a chosen benchmark as a starting point in determining materiality for the financial statements as a
whole. Discuss stating the factors that may affect the identification of an appropriate benchmark.
[RTP-May’18]
Ans. Determining materiality involves the exercise of professional judgment. A percentage is often applied
to a chosen benchmark as a starting point in determining materiality for the financial statements as a
whole. Factors that may affect the identification of an appropriate benchmark include the following:
• The elements of the financial statements
Example - assets, liabilities, equity, revenue, expenses;
• Whether there are items on which the attention of the users of the particular entity’s financial
statements tends to be focused
Example - for the purpose of evaluating financial performance users may tend to focus on profit,
revenue or net assets.
• The nature of the entity, where the entity is at in its life cycle, and the industry and economic
environment in which the entity operates;
The entity’s ownership structure and the way it is financed and
Example- if an entity is financed solely by debt rather than equity, users may put more emphasis
on assets, and claims on them, than on the entity’s earnings);
The relative volatility of the benchmark
Q-13 Arpana Hospitals Ltd having Gross Professional Charges of ` 50 crores is engaged in providing healthcare
services. STP & Co., a firm of auditors is appointed as its auditors.
Advise what special points to be kept in mind for the purpose of construction of an Audit programme.
Explain. [Sugg.Nov’19,RTP-May’18-Sugg.-May’19,3 Marks]
Ans. For the purpose of programme construction, the following points should be kept in mind
(1) Stay within the scope and limitation of the assignment.
(2) Determine the evidence reasonably available and identify the best evidence for deriving the
necessary satisfaction.
(3) Apply only those steps and procedures which are useful in accomplishing the verification purpose
in the specific situation.
(4) Consider all possibilities of error.
(5) Co-ordinate the procedures to be applied to related items.
Q-14 Briefly mention the matters that are relevant in planning attendance at physical inventory counting.
[Sugg.-Nov’18,5 Marks]
Ans. Matters relevant in planning attendance at physical inventory counting:Matters relevant in planning
attendance at physical inventory counting include, for example :
(i) Nature of inventory.
(ii) Stages of completion of work in progress.
(iii) The risks of material misstatement related to inventory.
(iv) The nature of the internal control related to inventory.
(v) Whether adequate procedures are expected to be established and proper instructions issued for
physical inventory counting.

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 (vi) The timing of physical inventory counting.
(vii) Whether the entity maintains a perpetual inventory system.
(viii) The locations at which inventory is held, including the materiality of the inventory and the risks of
material missta tement at different loca tions, in deciding at which locations a ttendance is
appropriate
(ix) Whether the assistance of an auditor’s expert is needed.
Q-15 M & Co. was appointed as auditor of IGI Ltd.. As an auditor what are the factors that would be considered
in the development of overall audit plan? [sugg.-May’18,5 Marks]
Ans. Development of an Overall Plan: The auditor should consider the following matters in developing his
overall plan for the expected scope and conduct of the audit-
• The terms of his engagement and any statutory responsibilities.
• The nature and timing of reports or other communication.
• The applicable legal or statutory requirements.
• The accounting policies adopted by the client and changes in those policies.
• The effect of new accounting or auditing pronouncements on the audit.
• The identification of significant audit areas.
• The setting of materiality levels for audit purposes.
• Conditions requiring special attention, such as the possibility of material error or fraud or the
involvement of parties in whom directors or persons who are substantial owners of the entity are
interested and with whom transactions are likely.
• The degree of reliance he expects to be able to place on accounting system and internal control.
• Possible rotation of emphasis on specific audit areas.
• The nature and extent of audit evidence to be obtained.
• The work of internal auditors and the extent of their involvement, if any, in the audit.
• The involvement of other auditors in the audit of subsidiaries or branches of the client.
• The involvement of experts.
• The allocation of work to be undertaken between joint auditors and the procedures for its control
and review.
• Establishing and coordinating staffing requirements.
Q-16 Plans should be further developed and revised as necessary during the course of the audit. Explain.
[RTP-May’2020]
Ans. Plans should be further developed and revised as necessary during the course of the audit.
SA-300, “Planning an Audit of Financial Statements” further expounds this principle. According to it,
planning is not a discrete phase of an audit, but rather a continual and iterative process that often
begins shortly after (or in connection with) the completion of the previous audit and continues until
the completion of the current audit engagement. The auditor shall establish an overall audit strategy
that sets the scope, timing and direction of the audit, and that guides the development of the audit
plan.
Q-17 (a) Knowledge of the Client’s business is one of the important principles in developing an overall audit
plan. In fact without adequate knowledge of client’s business, a proper audit is not possible. As per SA-
315, “Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity

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 and Its Environment”, the auditor shall obtain an understanding of the relevant industry, regulatory
and other external factors including the applicable financial reporting framework. Substantiate with
the help of examples.
(b) Evidence is the very basis for formulation of opinion and an audit programme is designed to provide
for that by prescribing procedures and techniques.
Analyse and explain with the help of example of evidence in respect of Sales. [RTP-May’2020]
Ans.(a) Examples are :
• The competitive environment, including demand, capacity, product and price competition as well
as cyclical or seasonal activity.
• Supplier and customer relationships, such as types of suppliers and customers (e.g., related parties,
unified buying groups) and the related contracts with those entities.
• Technological developments, such as those related to the entity’s products, energy supply and
cost.
• The effect of regulation on entity operations.
(b) Evidence is the very basis for formulation of opinion and an audit programme is designed to provide
for that by prescribing procedures and techniques. What is best evidence for testing the accuracy of
any assertion is a matter of expert knowledge and experience. This is the primary task before the
audi tor when he draws up the audi t programme. Transactions are vari ed in nature and impact;
procedures to be prescribed depend on prior knowledge of what evidence is reasonably available in
respect of each transaction.
Example
Sales are evidenced by:
(i) invoices raised by the client;
(ii) price list;
(iii) forwarding notes to client;
(iv) inventory-issue records;
(v) sales managers’ advice to the inventory section;
(vi) acknowledgements of the receipt of goods by the customers; and
(vii) collection of money against sales by the client.
Q-18 “Even when information to be used as audit evidence is obtained from sources external to the entity,
circumstances may exist that could affect its reliability”. Explain. Also state clearly generalisati ons
about the reliability of audit evidence. [RTP-May’18]
Ans. Reliability of Audit Evidence: SA 500 on “Audit Evidence” provides that the reliability of information to
be used as audit evidence, and therefore of the audit evidence itself, is influenced by its source and its
nature, and the circumstances under which it is obtained, including the controls over its preparation
and maintenance where relevant. Therefore, generalisations about the reliability of various kinds of
audit evidence are subject to important exceptions. Even when information to be used as audit evidence
is obtained from sources external to the entity, circumstances may exist that could affect its reliability.
For example, information obtained from an independent external source may not be reliable if the
source is not knowledgeable, or a management ’s expert may lack objectivity. While recognising that
exceptions may exist, the following generalisations about the reliability of audit evidence may be
useful:

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 (1) The reliabili ty of audit evidence is increased when it is obtained from independent sources
outside the entity.
(2) The reliability of audit evidence that is generated internally is increased when the related controls,
including those over its preparation and maintenance, imposed by the entity are effective.
(3) Audit evidence obtained directly by the auditor (for example, observation of the application of a
control) is more reliable than audit evidence obtained indirectly or by inference (for example,
inquiry about the application of a control).
(4) Audit evidence in documentary form, whether paper, electronic, or other medium, is more reliable
than evidence obtained orally (for example, a contemporaneously written record of a meeting is
more reliable than a subsequent oral representation of the matters discussed).
(5) Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies or facsimiles, or documents that have been filmed, digitized or otherwise transformed
into electronic form, the reliability of which may depend on the controls over their preparation
and maintenance.
Q-19 In establishing overall audi t strategy, the auditor shall ascertain the reporting objectives of the
engagement to plan the timing of the audit and the nature of the communications required. Elucidate
those cases by which auditor can ascertain the reporting objectives of the engagement.
[Sugg.-Nov’19,4 Marks]
Ans. In establishing the overall audit strategy, auditor shall ascertain the reporting objectives of the
engagement to plan the timing of the audit and the nature of the communications required. The cases
by which auditor can ascertain the reporting objectives of the engagement are:
(i) The entity’s timetable for reporting, such as at interim and final stages.
(ii) The organization of meetings with management and those charged with governance to discuss
the nature, timing and extent of the audit work.
(iii) The discussion with management and those charged with governance regarding the expected
type and timing of reports to be issued and other communications, both written and oral, including
the auditor’s report, management letters and communications to those charged with governance.
(iv) The discussion with management regarding the expected communications on the status of audit
work throughout the engagement.

MULTIPLE CHOICE QUESTIONS

1. Planning an audit involves

(a) establishing the overall audit strategy for the engagement and developing an audit plan.
(b) establishing the overall audit plan for the engagement and developing an audit strategy.
(c) establishing the overall audit plan for the engagement
(d) developing an audit strategy. [MTP-Oct’19]
2. According to SA 300,
(a) planning is not a continual and iterative phase of an audit, but rather a discrete process
(b) planning is not a discrete phase of an audit, but rather a continual and iterative process
(c) planning is not continual and iterative process
(d) planning is not a discrete phase of an audit [MTP-Oct’19]

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3. SA 320 on “Materiality in Planning and Performing an Audit” requires that an auditor
(a) should not consider materiality and its relationship with audit risk while conducting an audit.
(b) should consider materiality and its relationship with audit risk while conducting an audit.
(c) should not consider materiality but should consider its relationship with audit risk while conducting
an audit.
(d) should consider materiality but need not consider its relationship with audit risk while conducting
an audit. [MTP-March’19]
4. When planning the audit,
(a) the auditor considers what would make the financial information materially misstated.
(b) the auditor need not consider what would make the financial information materially misstated.
(c) the auditor need not consider what would make the financial information materially misstated at
planning stage
(d) the auditor needs to consider what would make the financial information materially misstated
while conducting audit only [MTP-March’19]
5. CA. Bobby is a recently qualified Chartered Accountant. He is appointed as an auditor of Droopy Ltd. for
the current Financial Year 2017-18. He is quite conservative in nature which is also replicated in his
professional work. CA. Bobby is of the view that he shall record all the matters related to audit, audit
procedures to be performed, audit evidence obtained and conclusions reached. Thus, he maintained a
file and recorded each and every of his findings during the audit. His audit file, besides other thing,
includes audit programmes, notes reflecting preliminary thinking, letters of confirmation, e-mails
concerning significant matters, etc. State which of the following need not be included in the audit
documentation?
(a) Audit programmes. (b) Notes reflecting preliminary thinking.
(c) Letters of confirmation. (d) E-mails concerning significant matters.
[RTP-May’19]

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 C H A PT E R- 3
AUDIT D O CUM ENT A T ION AND AUDIT E VID E NC E

Q-1 The auditors should consider the effect of subsequent events on the financial statement and on
auditor’s report”– Comment according to SA 560. [MTP-Oct’19,4 Marks]
Ans. Effect of Subsequent Events: SA 560 “Subsequent Events”, establishes standards on the auditor’s
responsibility regarding subsequent events.
According to it, ‘subsequent events’ refer to those events which occur between the date of financial
statements and the date of the auditor’s report, and facts that become known to the auditor after the
date of the auditor’s report. It lays down the standard that the auditor should consider the effect of
subsequent events on the financial statements and on the auditor’s report.
The auditor should obtain sufficient appropriate evidence that all events upto the date of the auditor’s
report requiring adjustment or disclosure have been identified and to identify such events , the auditor
should-
(i) obt a in an unde rst a ndi ng of any procedures m a nag em en t h as est a bl ish e d to ensure
thatsubsequent events are identified.
(ii) inquire of management and, where appropriate, those charged with governance as to whetherany
subsequent events have occurred which might affect the financial statements.
Examples of inquiries of management on specific matters are:
• Whether new commitments, borrowings or guarantees have been entered into.
• Whether sales or acquisitions of assets have occurred or are planned.
• Whether there have been increases in capital or issuance of debt instruments, such as the
issue of new shares or debentures, or an agreement to merge or liquidate has been made or
is planned.
• Whether there have been any developments regarding contingencies.
• Whether there have been any developments regarding risk areas and contingencies.
• Whether any unusual accounting adjustments have been made or are contemplated.
• Whether any events have occurred or are likely to occur which will bring into question the
appropriateness of accounting policies used in the financial statements as would be the
case, for exampl e, if such events call into question the validity of the going concern
assumption.
• Whether any events have occurred that are relevant to the measurement of estimates or
provisions made in the financial statements.
• Whether any events have occurred that are relevant to the recoverability of assets.

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 (iii) Read minutes, if any, of the meetings, of the entity’s owners, management and those charged
with governance, that have been held after the date of the financial statements and inquiring
about matters discussed at any such meetings for which minutes are not yet available.
(iv) Read the entity’s latest subsequent interim financial statements, if any.
(v) Read the en t i ty ’s l a test ava i l a bl e budg ets, cash f l ow forecasts and o the r rel a ted
managementreports for periods after the date of the financial statements.
(vi) Inquire, or extend previous oral or written inquiries, of the entity’s legal counsel concerning
litigation and claims.
(vii) Consider whether wri tten representa tions covering particular subsequent events may be
necessary to support other audit evidence and thereby obtain suffici ent appropriate audit
evidence.
When the auditor identifies events that require adjustment of, or disclosure in, the financial
statements, the auditor shall determine whether each such event is appropriately reflected in
those financial statements. If such events have not been considered by the management and
which in the opinion of the auditor are material, the auditor shall modify his report accordingly.
Q-2 The auditor shall assemble the audit documentation in an audit file and complete the administrative
process of assembling the final audit file on a timely basis after the date of the auditor’s report.
Discuss. [Sugg.-Nov’19,3 Marks, MTP-March’19,4 Marks-MTP-March’18,5 Marks-
RTP-Nov’19-RTP-Nov’18]
Ans. The auditor shall assemble the audit documentation in an audit file and complete the administrative
process of assembling the final audit file on a timely basis after the date of the auditor’s report. SQC 1
“Quality Control for Firms that perform Audits and Review of Historical F inancial Information, and
other Assurance and related services”, requires firms to establish policies and procedures for the
timely completion of the assembly of audit files. An appropriate time limit within which to complete
the assembly of the final audit file is ordinarily not more than 60 days after the date of the auditor’s
report.
The completion of the assembly of the final audit file after the date of the auditor’s report is an
administrative process that does not involve the performance of new audit procedures or the drawing
of new conclusions. Changes may, however, be made to the audit documentation during the final
assembly process, if they are administrative in nature.
Examples of such changes include:
• Deleting or discarding superseded documentation.
• Sorting, collating and cross referencing working papers.
• Signing off on completion checklists relating to the file assembly process.
• Documenting audit evidence that the auditor has obtained, discussed and agreed with the relevant
members of the engagement team before the date of the auditor’s report.
After the assembly of the final audit file has been completed, the auditor shall not delete or discard
audit documentation of any nature before the end of its retention period.
SQ C 1 requi res f irms to esta bl ish pol ici es and proce dures f or th e re ten ti on of e ngage me nt
documentation. The retention period for audit engagements ordinarily is no shorter than seven years
from the date of the auditor’s report, or, if later, the date of the group auditor’s report.
Q-3 The auditor shall document the overall audit strategy, the audit plan, and any significant changes made
during the audit engagement to the overall audit strategy or the audit plan, and the reasons for such
changes. Explain. [MTP-Aug’18,5 Marks]

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Ans. The auditor shall document :
(a) the overall audit strategy;
(b) the audit plan; and
(c) any significant changes made during the audit engagement to the overall audit strategy or the
audit plan, and the reasons for such changes.
The documentation of the overall audit strategy is a record of the key decisions considered necessary
to properly plan the audit and to communicate significant matters to the engagement team.
For example, the auditor may summarize the overall audit strategy in the form of a memorandum that
contains key decisions regarding the overall scope, timing and conduct of the audit.
The documentation of the audit plan is a record of the planned nature, timing and extent of risk
assessment procedures and further audit procedures at the assertion level in response to the assessed
risks. It also serves as a record of the proper planning of the audit procedures that can be reviewed and
approved prior to their performance. The auditor may use standard audit programs and/or audit
completion checklists, tailored as needed to reflect the particular engagement circumstances.
A record of the significant changes to the overall audit strategy and the audit plan, and resulting
changes to the planned nature, timing and extent of audit procedures, explains why the significant
changes were made, and the overall strategy and audit plan finally adopted for the audit. It also
reflects the appropriate response to the significant changes occurring during the audit.
For instance-
The following things should form part of auditor’s documentation:
• A summary of discussions with the entity’s key decision makers
• Documentation of audit committee pre-approval of services, where required
• Audit documentation access letters
• Other communications or agreements with management or those charged with governance
regarding the scope, or changes in scope, of our services
• auditor’s report on the entity’s financial statements.
• Other reports as specified in the engagement agreement (e.g., debt covenant compliance letter)
Q-4 Audit documentation provides evidence of the auditor’s basis for a conclusion about the achievement
of the overall objectives of the auditor and evidence that the audit was planned and performed in
accordance with SAs and applicable legal and regulatory requirements. Explain stating clearly purpose
of audit documentation. [MTP-Aug’18,5 Marks-MTP-Oct’18,5 Marks-RTP-May’19]
Ans. Nature of Audit Documentation
Audit documentation provides:
(a) evidence of the auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor; and
(b) evidence that the audit was planned and performed in accordance with SAs and applicable legal
and regulatory requirements.
Purpose of Audit Documentation
The following are the purpose of Audit documentation:
1. Assisting the engagement team to plan and perform the audit.
2. Assisting members of the engagement team to direct and supervise the audit work, and to discharge
their review responsibilities.

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 3. Enabling the engagement team to be accountable for its work.
4. Retaining a record of matters of continuing significance to future audits.
5. Enabling the conduct of quality control reviews and inspections.
6. Enabling the conduct of external inspections in accordance with applicable legal, regulatory or
other requirements.
Q-5 Auditing is a logical process. An auditor is called upon to assess the actualities of the situation, review
the statements of account and give an expert opinion about the truth and fairness of such accounts.
This he cannot do unless he has examined the financial statements objectively. He needs evidence to
obtain information for arriving at his judgment. Discuss explaining clearly the detailed meaning of
audit evidence. [RTP-Nov’19, RTP-May’18]
Ans. Auditing is a logical process. An auditor is called upon to assess the actualities of the situation, review
the statements of account and give an expert opinion about the truth and fairness of such accounts.
This he cannot do unless he has examined the financial statements objectively.
Objective examination connotes critical examination and scrutiny of the accounting statements of the
undertaking with a view to assessing how far the statements present the actual state of affairs in the
correct context and whether they give a true and fair view about the financial results and state of
affairs. An opinion founded on a rather reckless and negligent examination and evaluation may expose
the auditor to legal action with consequential loss of professional standing and prestige.
He needs evidence to obtain information for arriving at his judgment.
Audit evidence may be defined as the information used by the auditor in arriving at the conclusions on
which the auditor ’s opinion is based. Audit evidence includes both information contained in the
accounting records underlying the financial statements and other information.
Explaining this further, audit evidence includes:-
(1) Information contained in the accounting records: Accounting records include the records of initial
accounting entries and supporting records, such as checks and records of electronic fund transfers;
invoices; contracts; the general and subsidiary ledgers, journal entries and other adjustments to
the financial statements that are not reflected in journal entries; and records such as work sheets
and spreadsheets supporting cost allocations, computations, reconciliations and disclosures.
(2) Other information that authenticates the accounting records and also supports the auditor’s
rationale behind the true and fair presentation of the financial statements: Other information
which the auditor may use as audit evidence includes, for example minutes of the meetings,
written confirmations from trade receivables and trade payables, manuals containing details of
internal control etc. A combination of tests of accounting records and other information is generally
used by the auditor to support his opinion on the financial statements.
Q-6 Audit evidence is necessary to support the auditor’s opinion and report. It is cumulative in nature and
is primarily obtained from audit procedures performed during the course of the audit. Most of the
auditor’s work in forming the auditor’s opinion consists of obtaining and evaluating audit evidence.
Explain [RTP-Nov’19, RTP-Nov’18]
Ans. Audit evidence is necessary to support the auditor’s opinion and report. It is cumulative in nature and
is primarily obtained from audit procedures performed during the course of the audit. It may, however,
also include information obtained from other sources such as previous audits. In addition to other
sources inside and outside the entity, the entity’s accounting records are an important source of audit
evidence. Also, information that may be used as audit evidence may have been prepared using the
work of a management ’s expert. Audi t evidence comprises both informa tion tha t supports and
corroborates management’s assertions, and any information that contradicts such assertions. In addition,
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 in some cases the absence of information (for example, management’s refusal to provide a requested
representation) is used by the auditor, and therefore, also constitutes audit evidence.
Most of the auditor’s work in forming the auditor’s opinion consists of obtaining and evaluating audit
evidence. Audit procedures to obtain audit evidence can include inspection, observation, confirmation,
recalculation, re-performance and analytical procedures, often in some combination, in addition to
inquiry. Although inquiry may provide important audit evidence, and may even produce evidence of a
misstatement, inquiry alone ordinarily does not provide sufficient audit evidence of the absence of a
material misstatement at the assertion level, nor of the operating effectiveness of controls.
As explained in SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Audi ting ”, reasonable assurance is obtained when the auditor has
obtained sufficient appropriate audit evidence to reduce audit risk (i.e., the risk that the auditor
expresses an inappropriate opinion when the financial statements are materially misstated) to an
acceptably low level. The sufficiency and appropriateness of audit evidence are interrelated.
Q-7 When the use of the going concern basis of accounting is appropriate, assets and liabilities are recorded
on the basis that the entity will be able to realize its assets and discharge its liabilities in the normal
course of business. Explain stating also the objective of the auditor regarding going concern.
[RTP-Nov’19,RTP-May’19]
Ans. Under the going concern basis of accounting, the financial statements are prepared on the assumption
that the entity is a going concern and will continue its operations for the foreseeable future. When the
use of the going concern basis of accounting is appropriate, assets and liabilities are recorded on the
basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of
business.
Objectives of the auditor regarding going concern
The objectives of the auditor are:
(a) To obtain written representations from management and, where appropriate, those charged
with governance that they believe that they have fulfilled their responsibility for the preparation
of the financial statements and for the completeness of the information provided to the auditor;
(b) To support other audit evidence relevant to the financial statements or specific assertions in the
financial statements by means of written representations, if determined necessary by the auditor
or required by other SAs; and
(c) To respond appropria tely to wri tten representations provided by management and, where
appropriate, those charged with governance, or if management or, where appropriate, those
charged with governance do not provide the written representations requested by the auditor. .
Q-8 Discuss the meaning and nature of Audit Documentation. [RTP-Nov’19]
Ans. Audit documentation: SA 230 on “Audit Documentation”, audit documentation refers to the record of
audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached.
(terms such as “working papers” or “work papers” are also sometimes used.)
Nature of Audit Documentation
Audit documentation provides:
(a) evidence of the auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor; and
(b) evidence that the audit was planned and performed in accordance with SAs and applicable legal
and regulatory requirements.

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Q-9 Explain clearly objective of the auditor regarding written representation. [RTP-Nov’19,RTP-May’20]
Ans. The objectives of the auditor regarding written representation
The objectives of the auditor are:
(a) To obtain written representations
To obtain written representations from management. Also that management believes that it has
fulfilled its responsibility for the preparation of the financial statements and for the completeness
of the information provided to the auditor;
(b) To support other evidence
To support other audit evidence relevant to the financial statements or specific assertions in the
financial statements by means of written representations; and
(c) To respond appropriately
To respond appropriately to written representations provided by management or if management
does not provide the written representations requested by the auditor.
Q-10 Judging the significance of a matter requires an objective analysis of the facts and circumstances.
Documentation of the professional judgments made, where significant, serves to explain the auditor’s
conclusions and to reinforce the quality of the judgment. Explain with the help of examples.
[RTP-May’19]
Ans. Documentation of Significant Matters and Related Significant Professional Judgments
Judging the significance of a matter requires an objective analysis of the facts and circumstances.
Examples of significant matters include:
• Matters that give rise to significant risks.
• Results of audit procedures indica ting (a) tha t the financial statements could be materially
misstated, or (b) a need to revise the auditor’s previous assessment of the risks of material
misstatement and the auditor’s responses to those risks.
• Circumstances that cause the auditor significant difficulty in applying necessary audit procedures.
• Findings that could result in a modification to the audit opinion or the inclusion of an Emphasis of
Matter Paragraph in the auditor’s report.
An important factor in determining the form, content and extent of audit documentation of significant
matters is the extent of professional judgment exercised in performing the work and evaluating the
results.
Documentation of the professional judgments made, where significant, serves to explain the auditor’s
conclusions and to reinforce the quality of the judgment. Such matters are of particular interest to
those responsible for reviewing audit documentation, including those carrying out subsequent audits,
when reviewing matters of continuing significance (for example, when performing a retrospective
review of accounting estimates).
Some examples of circumstances in which it is appropriate to prepare audit documentation relating to
the use of professional judgment include, where the matters and judgments are significant:
• The rationale for the auditor’s conclusion when a requirement provides that the auditor ‘shall
consider’ certain information or factors, and that consideration is significant in the context of the
particular engagement.
• The basis for the auditor’s conclusion on the reasonableness of areas of subjective judgments (for
example, the reasonableness of significant accounting estimates).

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 • The basis for the auditor’s conclusions about the authentici ty of a document when further
investigation (such as making appropriate use of an expert or of confirmation procedures) is
undertaken in response to conditions identified during the audit that caused the auditor to believe
that the document may not be authentic.
Q-11 The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence
that all events occurring between the date of the financial statements and the date of the auditor’s
report that require adjustment of, or disclosure in, the financial statements have been identified.
Explain. [RTP-May’19]
Ans. Audit Procedure Regarding Events Occurring Between The Date Of The Financial Statements And The
Date Of The Auditor’s Report
The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence
that all events occurring between the date of the financial statements and the date of the auditor’s
report that require adjustment of, or disclosure in, the financial statements have been identified.
The auditor is not, however, expected to perform additional audit procedures on matters to which
previously applied audit procedures have provided satisfactory conclusions.
The auditor shall perform the procedures required above so that they cover the period from the date
of the financial statements to the date of the auditor’s report, or as near as practicable thereto. The
auditor shall take into account the auditor’s risk assessment which shall include the following:
(a) Obtaining an understanding of any procedures management has established to ensure that
subsequent events are identified.
(b) Inquiring of management and, where appropriate, those charged with governance as to whether
any subsequent events have occurred which might affect the financial statements.
(c) Reading minutes, if any, of the meetings, of the entity’s owners, management and those charged
with governance, that have been held after the date of the financial statements and inquiring
about matters discussed at any such meetings for which minutes are not yet available.
(d) Reading the entity’s latest subsequent interim financial statements, if any.
Q-12 There are specific accounting and disclosure requirements for related party relationships, transactions
and balances to enable users of the financial statements to understand their nature and effects on the
financial statements. Analyse and explain stating the responsibility of auditor in this regard.
[RTP-May’19]
Ans. Responsibilities of the Auditor
There are specific accounting and disclosure requirements for related party relationships, transactions
and balances to enable users of the financial statements to understand their nature and effects on the
financial statements.
The auditor has a responsibility to perform audit procedures to identify, assess and respond to the risks
of material misstatement arising from the entity’s failure to appropriately account for related party
relationships, transactions or balances.
The auditor needs to obtain an understanding of the entity’s related party relationships and transactions
sufficient to be able to conclude whether the financial statements, insofar as they are affected by
those relationships and transactions:
(a) Achieve a true and fair presentation; or
(b) Are not misleading (for compliance frameworks).
In addition, an understanding of the entity’s related party relationships and transactions is relevant to

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 the auditor’s evaluation of whether fraud risk factors are present as required by SA 240. This is because
fraud may be more easily committed through related parties.
Owing to the inherent limitations of an audi t, there is an unavoidabl e risk tha t 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. In the context of related parties, the potential
effects of inherent limitations on the auditor’s ability to detect material misstatements are greater for
such reasons as the following:
• Management may be unaware of the existence of all related party relationships.
• Related party relationships may present a greater opportunity for collusion, concealment or
manipulation by management.
• Planning and performing the audit with professional skepticism as required by SA 200 is therefore
particul arly import ant i n this con text, given the poten tial for undisclosed rela t ed pa rty
relationships and transactions. The requirements in this SA are designed to assist the auditor in
identifying and assessing the risks of material misstatement associated wi th related party
relationships and transactions, and in designing audit procedures to respond to the assessed
risks.
Q-13 The quantity of audi t evidence needed is affected by the audi tor ’s assessment of the risks of
misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and also
by the quality of such audit evidence (the higher the quality, the less may be required). Obtaining
more audit evidence, however, may not compensate for its poor quality. Analyse and Explain stating
clearly the factors affecting the auditor’s judgement as to sufficiency of audit evidence.
[RTP-May’19, RTP-May’18]
Ans. Sufficiency of Audit Evidence: Sufficiency is the measure of the quantity of audit evidence. The quantity
of audit evidence needed is affected by the auditor’s assessment of the risks of misstatement (the
higher the assessed risks, the more audit evidence is likely to be required) and also by the quality of
such audit evidence (the higher the quality, the less may be required). Obtaining more audit evidence,
however, may not compensate for its poor quality. Auditor’s judgment as to sufficiency may be affected
by the factors such as:
(i) Materiality
(ii) Risk of material misstatement
(iii) Size and characteristics of the population.
(i) Materiality may be defined as the significance of classes of transactions, account balances and
presentation and disclosures to the users of the financial statements. Less evidence would be
required in case assertions are less material to users of the financial statements. But on the other
hand if assertions are more material to the users of the financial statements, more evidence
would be required.
(ii) Risk of material misstatement may be defined as the risk tha t the financial statements are
materially misstated prior to audit. This consists of two components described as follows at the
assertion level (a) Inherent risk—The susceptibility of an assertion to a misstatement that could
be ma terial before consideration of any related controls. (b) Control risk—The risk tha t a
misstatement that could occur in an assertion that could be material will not be prevented or
detected and corrected on a timely basis by the entity’s internal control. Less evidence would be
required in case assertions that have a lower risk of material misstatement. But on the other hand
if assertions have a higher risk of material misstatement, more evidence would be required.

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 (iii) Size of population refers to the number of items included in the population. Less evidence would
be required in case of smaller, more homogeneous population but on the other hand in case of
larger, more heterogeneous populations, more evidence would be required.
Q-14 The form, content and extent of audit documentation depend on factors such as the size and complexity
of the entity, the nature of the audit procedures to be performed etc. Explain in detail.[RTP-Nov’18]
Ans. The form, content and extent of audit documentation depend on factors such as:
1. The size and complexity of the entity.
2. The nature of the audit procedures to be performed.
3. The identified risks of material misstatement.
4. The significance of the audit evidence obtained.
5. The nature and extent of exceptions identified.
6. The need to document a conclusion or the basis for a conclusion not readily determinable from
the documentation of the work performed or audit evidence obtained.
7. The audit methodology and tools used.
Q-15 A higher level of assurance may be sought about the operating effectiveness of controls when the
approach adopted consists primarily of tests of controls, in particular where it is not possible or
practicable to obtain sufficient appropriate audit evidence only from substantive procedures. Explain.
[RTP-Nov’18]
Ans. Tests of controls: Test of controls may be defined as an audit procedure designed to evaluate the
operating effectiveness of controls in preventing, or detecting and correcting, material misstatements
at the assertion level. The auditor shall design and perform tests of controls to obtain sufficient
appropriate audit evidence as to the operating effectiveness of relevant controls when:
(a) The auditor’s assessment of risks of material misstatement at the assertion level includes an
expectation that the controls are operating effectively (i.e., the auditor intends to rely on the
operating effectiveness of controls in determining the nature, timing and extent of substantive
procedures); or
(b) Substantive procedures alone cannot provide sufficient appropriate auditevidence at the assertion
l evel.
A higher level of assurance may be sought about the operating effectiveness of controls when the
approach adopted consists primarily of tests of controls, in particular where it is not possible or
practicable to obtain sufficient appropriate audit evidence only from substantive procedures.
Q-16 Irrespective of the assessed risks of material misstatement, the auditor shall design and perform
substantive procedures for each material class of transactions, account balance, and disclosure. Analyse
and explain. [RTP-Nov’18, RTP-May’18]
Ans. Irrespective of the assessed risks of material misstatement, the auditor shall design and perform
substantive procedures for each material class of transactions, account balance, and disclosure.
1. This requirement reflects the facts that:
(i) the auditor’s assessment of risk is judgmental and so may not identify allrisks of material
misstatement; and
(ii) there are inherent limitations to internal control, including managementoverride.
2. Depending on the circumstances, the auditor may determine that:
• Performing only substantive analytical procedures will be sufficient to reduce audit risk to

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 an acceptably low level. For example, where the auditor’s assessment of risk is supported
by audit evidence from tests of controls.
• Only tests of details are appropriate.
• A combination of substantive analytical procedures and tests of details are most responsive
to the assessed risks.
3. Substantive analytical procedures are generally more applicable to large volumes of transactions
that tend to be predictable over time. SA 520, “Analytical Procedures” establishes requirements
and provides guidance on the application of analytical procedures during an audit.
4. The nature of the risk and assertion is relevant to the design of tests of details. For example, tests
of details related to the existence or occurrence assertion may involve selecting from items
contained in a financial statement amount and obtaining the relevant audit evidence. On the
other hand, tests of details related to the completeness assertion may involve selecting from
items that are expected to be included in the relevant financial statement amount and investigating
whether they are included.
5. Because the assessment of the risk of material misstatement takes account of internal control,
the extent of substantive procedures may need to be increased when the results from tests of
controls are unsatisfactory.
6. In designing tests of details, the extent of testing is ordinarily thought of in terms of the sample
size. However, other matters are also relevant, including whether it is more effective to use other
selective means of testing.
Q-17 External confirmation procedures frequently are relevant when addressing assertions associated with
account balances and their elements, but need not be restricted to these items. Analyse and Explain.
[RTP-Nov’18]
Ans. External confirmation procedures frequently are relevant when addressing assertions associated with
account balances and their elements, but need not be restricted to these items. For example, the
auditor may request external confirmation of the terms of agreements, contracts, or transactions
between an entity and other parties. External confirmation procedures also may be performed to
obtain audit evidence about the absence of certain conditions. For example, a request may specifically
seek confirmation that no “side agreement” exists that may be relevant to an entity’s revenue cut-off
assertion. Other situa tions where external confirmation procedures may provide relevant audit
evidence in responding to assessed risks of material misstatement include:
• Bank balances and other information relevant to banking relationships.
• Accounts receivable balances and terms.
• Inventories held by third parties at bonded warehouses for processing or on consignment.
• Property title deeds held by lawyers or financiers for safe custody or as security.
• Investments held for safekeeping by third parties, or purchased from stockbrokers but not
delivered at the balance sheet date.
• Amounts due to lenders, including relevant terms of repayment and restrictive covenants.
• Accounts payable balances and terms.
Q-18 State the significant difficulties encountered during audit with reference to SA-260 (communication
with those charged with governance). [RTP-May’18]
Ans. Significant Difficulties Encountered During the Audit: As per SA 260 “Communication with Those Charged
with Governance”, significant difficulties encountered during the audit may include such matters as:

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 • Significant delays in management providing required information.
• An unnecessarily brief time within which to complete the audit.
• Extensive unexpected effort required to obtain sufficient appropriate audit evidence.
• The unavailability of expected information.
• Restrictions imposed on the auditor by management.
• Management’s unwillingness to make or extend its assessment of the entity’s ability to continue
as a going concern when requested.
Q-19 Evaluating responses to inquiries is an integral part of the inquiry process. Explain . [RTP-May’18]
Ans. Inquiry – Audit Procedure to obtain Audit Evidence: Inquiry consists of seeking information of
knowledgeable persons, both financial and non- financial, within the entity or outside the entity.
Inquiry is used extensively throughout the audit in addition to other audit procedures. Inquiries may
range from formal written inquiries to informal oral inquiries. Evaluating responses to inquiries is an
integral part of the inquiry process.
Responses to inquiries may provide the auditor with information not previously possessed or with
corrobora tive audi t evidence. Al terna tively, responses might provide informa t ion tha t differs
significantly from other information that the auditor has obtained, for example, information regarding
the possibility of management override of controls. In some cases, responses to inquiries provide a
basis for the auditor to modify or perform additional audit procedures.
Although corroboration of evidence obtained through inquiry is often of particular importance, in the
case of inquiries about management intent, the information available to support management’s intent
may be limited. In these cases, understanding management’s past history of carrying out its stated
intentions, management’s stated reasons for choosing a particular course of action, and management’s
ability to pursue a specific course of action may provide relevant information to corroborate the evidence
obtained through inquiry. In respect of some matters, the auditor may consider it necessary to obtain
written representations from management and, where appropriate, those charged with governance to
confirm responses to oral inquiries.
Q-20 The auditor P of PAR and Co., a firm of Chartered Accountants is conducting audit of AB Industries Ltd.
The auditor requests management to provide Banker’s certificate in support of Fixed deposits whereas
management provides only written representation on the matter.
Analyse how would you deal as an auditor. [RTP-May’18]
Ans. Although written representations provide necessary audit evidence, they do not provide sufficient
appropriate audit evidence on their own about any of the matters with which they deal. Furthermore,
the fact that management has provided reliable written representations does not affect the nature or
extent of other audit evidence that the auditor obtains about the fulfillment of management ’s
responsibilities, or about specific assertions.
Applying the above to the given problem, the auditor would further request the management to
provide him with the Banker’s certificate in support of fixed deposits held by the company.
Q-21 “Completion Memorandum” is helpful as part of the audit documentation. Explain.
[Sugg.-May’19,3 Marks]
Ans. Completion Memorandum or Audit Documentation Summary.
The auditor may consider it helpful to prepare and retain as part of the audit documentation a summary
(sometimes known as a completion memorandum) that describes-
(i) the significant matters identified during the audit.
(ii) how they were addressed.
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 Such a summary may facili ta te effective and effici ent revi ew and inspection of the audi t
documentation, particularly for large and complex audits. Further, the preparation of such a
summary may assist auditor’s consideration of the significant matters. It may also help the auditor
to consider whether there is any individual relevant SA objective that the auditor cannot achieve
that would prevent the auditor from achieving the overall objectives of the auditor.
Q-22 The auditor has no obligation to perform any audit procedures regarding the financial statements after
the date of the auditor’s report. However, when, after the date of the auditor’s report but before the
date the financial statements are issued, a fact becomes known to the auditor that, had it been known
to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s
report. Explain the auditor’s obligation in the above situation. [RTP-May’2020]
Ans. The auditor has no obligation to perform any audit procedures regarding the financial statements after
the date of the auditor’s report. However, when, after the date of the auditor’s report but before the
date the financial statements are issued, a fact becomes known to the auditor that, had it been known
to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s
report, the auditor shall:
(a) Discuss the matter with management and, where appropriate, those charged with governance.
(b) Determine whether the financial statements need amendment and, if so,
(c) Inquire how management intends to address the matter in the financial statements.
Q-23 (a) The nature of related party relationships and transactions may, in some circumstances, give rise to
higher risks of material misstatement of the financial statements than transactions with unrelated
parties. Explain with the help of at least three examples.
(b) When using external confirmation procedures, the auditor shall maintain control over external
confirmation requests including sending the requests, including follow-up requests when applicable,
to the confirming party. Explain the other points as to when using external confirmation procedures,
the auditor would be required to maintain control over external confirmation requests.[RTP-May’2020]
Ans.(a) Many related party transactions are in the normal course of business. In such circumstances, they may
carry no higher risk of material misstatement of the financial statements than similar transactions with
unrelated parties. However, the nature of related party relationships and transactions may, in some
circumstances, give rise to higher risks of material misstatement of the financial statements than
transactions with unrelated parties.
Example
• Related parties may operate through an extensive and complex range of relationships and
structures, with a corresponding increase in the complexity of related party transactions.
• Information systems may be ineffective at identifying or summarising transactions and outstanding
balances between an entity and its related parties.
• Related party transactions may not be conducted under normal market terms and conditions; for
example, some related party transactions may be conducted with no exchange of consideration.
(b) When using external confirmation procedures, the auditor shall maintain control over external
confirmation requests, including:
(a) Determining the information to be confirmed or requested;
(b) Selecting the appropriate confirming party;
(c) Designing the confirmation requests, including determining that requests are properly addressed
and contain return information for responses to be sent directly to the auditor; and
(d) Sending the requests, including follow-up requests when applicable, to the confirming party.

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Q-24 (a)Define the following :
(i) Positive confirmation request
(ii) Negative confirmation request
(iii) Non-response
(iv) Exception [RTP-May’2020]
Ans.(a) Positive confirmation request – A request that the confirming party respond directly to the auditor
indicating whether the confirming party agrees or disagrees with the information in the request, or
providing the requested information.
Negative confirmation request – A request that the confirming party respond directly to the auditor
only if the confirming party disagrees with the information provided in the request.
Non-response – A failure of the confirming party to respond, or fully respond, to a positive confirmation
request, or a confirmation request returned undelivered.
Exception – A response that indicates a difference between information requested to be confirmed, or
contained in the entity’s records, and information provided by the confirming party.
Q-25 While planning the audit of S Ltd. you want to apply sampling techniques. What are the risk factors you
should keep in mind? [MTP-April’19,3 Marks]
Ans. Risk Factors while applying Sampling Techniques: As per SA 530 “Audit Sampling”, sampling risk is the
risk that the auditor’s conclusion based on a sample may be different from the conclusion if the entire
population were subjected to the same audit procedure. Sampling risk can lead to two types of erroneous
conclusions-
(i) In the case of a test of controls, that controls are more effective than they actually are, or in the
case of tests of details, that a material misstatement does not exists when in fact it does. The
auditor is primarily concerned with this type of erroneous conclusion because it affects audit
effectiveness and is more likely to lead to an inappropriate audit opinion.
(ii) In the case of test of controls, the controls are less effective than they actually are, or in the case
of tests of details, that a material misstatements exists when in fact it does not. This type of
erroneous conclusion affects audit efficiency as it would usually lead to additional work to establish
that initial conclusions were incorrect.

MULTIPLE CHOICE QUESTIONS

1. Which of the following is correct :

(a) The auditor shall assemble the audit documentation in an audit file and complete the
administrativeprocess of assembling the final audit file on a timely basis after the date of the
auditor’s report.
(b) The auditor shall assembl e the audi t documentation in an audit file and shall not complete
theadministrative process of assembling the final audit file.
(c) Th e audi tor sh al l assembl e th e audi t docume nta ti on in a n a udi t fi l e and compl ete the
administrativeprocess of assembling the final audit file on a timely basis before the date of the
auditor’s report.
(d) The auditor shall not assemble the audit documentation in an audit file.
[MTP-Oct’19-MTP-April’19]

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2. Standard on Quality Control (SQC) 1 provides that,
(a) unless otherwise specified by law or regulation, audit documentation is the property of the
management.
(b) unl ess otherwise specifi ed by law or regula tion, audi t documenta tion is the property of
thosecharged with governance.
(c) unl ess otherwise specifi ed by law or regula tion, audi t documenta tion is the property of
themanagement or those charged with governance.
(d) unless otherwise specified by law or regulation, audit documentation is the property of the
auditor. [MTP-Oct’19]
3. Audit evidence includes
(a) information contained in the accounting records underlying the financial statements
(b) both information contained in the accounting records underlying the financial statements and
otherinformation.
(c) other information.
(d) informa tion containe d in the accoun ting records und erlying the fin ancial sta tements or
otherinformation. [MTP-Oct’19-MTP-APRIL-2019]
4. Audit evidence is necessary to support the auditor’s opinion and report. It is_____in nature and is
primarily obtained from audit procedures performed during the course of the audit.
(a) cumulative (b) regressive (c) selective (d) objective [MTP-Oct’19]
5. Audit documentation provides:
(a) evidence of the auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor; or evidence that the audit was planned and performed in accordance with SAs and
applicable legal and regulatory requirements.
(b) evidence of the auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor; and evidence that the audit was planned and performed in accordance with SAs
and applicable legal and regulatory requirements.

(c) evidence of the auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor
(d) evidence that the audit was planned and performed in accordance with SAs and applicable legal
and regulatory requirements. [MTP-March’19]
6. Which of the following is not an example of audit documentation:
(a) Audit programmes (b) Summaries of significant matters
(c) Audit file (d) Checklists. [MTP-March’19]
7. SA 315 establishes requirements and provides guidance on identifying and assessing the risks of material
misstatement -
(a) at the financial statement levels only.
(b) at the assertion levels only.
(c) at the financial statement and assertion levels.
(d) at the financial statement or assertion levels. [MTP-March’19]

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8. which of the following is incorrect :
(a) Inquiry consists of seeking information of unknown persons, both financial and non- financial,
within the entity or outside the entity.
(b) Inquiry is used extensively throughout the audit in addition to other audit procedures.
(c) Inquiries may range from formal written inquiries to informal oral inquiries. Evaluating responses
to inquiries is an integral part of the inquiry process.
(d) Responses to inquiries may provide the auditor with information not previously possessed or
with corroborative audit evidence. [MTP-March’19]
9. Which of the following is incorrect :
(a) Written representations are necessary information that the auditor requires in connection with
the audit of the entity’s financial statements.
(b) Similar to responses to inquiries, written representations are audit evidence.
(c) Wri tte n represen ta ti ons are re quested from those responsibl e for the prepara ti on a nd
presentation of the financial statements.
(d) Written representations provide necessary audit evidence and also they provide sufficient
appropriate audit evidence on their own about any of the matters with which they deal.
[MTP-March’19]
10. With reference to SA 300, the auditor shall document:
(a) The overall audit strategy (b) The audit plan
(c) Any significant changes made during the audit engagement to the overall audit strategy or the
audit plan, and the reasons for such changes.
(d) All of the above [MTP-April’19]
11. The auditor has no obligation to perform any audit procedures regarding the financial statements after
the date of the auditor’s report. However, when, after the date of the auditor’s report but before the
date the financial statements are issued, a fact becomes known to the auditor that, had it been known
to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s
report, the auditor shall:
(a) Discuss the matter with management and, where appropriate, those charged with governance.
(b) Determine whether the financial statements need amendment.
(c) Inquire how management intends to address the matter in the financial statements.
(d) All of the above [MTP-April’19]
12. Risk of material misstatement may be defined as the risk
(a) that the financial statements are materially misstated after audit.
(b) that the financial statements are materially misstated during audit.
(c) that the financial statements are materially misstated prior to audit.
(d) All of the above [MTP-April’19-MTP-Oct’19]


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 C H A PT E R- 4
RISK ASSESSM ENT AND INT E RNAL C ONT R OL

Q-1 Materiality for the financial statements as a whole may need to be revised as a result of a change in
circumstances that occurred during the audit. Explain with the help of example. [MTP-Oct’19,3 Marks]
Ans. Revision in Materiality level as the Audit Progresses: Materiality for the financial statements as a
whole (and, if applicable, the materiality level or levels for particular classes of transactions, account
balances or disclosures) may need to be revised as a result of a change in circumstances that occurred
during the audit (for example, a decision to dispose of a major part of the entity’s business), new
information, or a change in the auditor’s understanding of the entity and its operations as a result of
performing further audit procedures.
Example
If during the audit it appears as though actual financial results are likely to be substantially different
from the anticipated period end financial results that were used initially to determine materiality for
the financial statements as a whole, the auditor revises that materiality.
If the auditor concludes that a lower materiality for the financial sta tements as a whole (and, if
applicabl e, ma teriali ty level or l evels for particular classes of transactions, account balances or
disclosures) than that initially determined is appropriate, the auditor shall determine whether it is
necessary to revise performance materiality, and whether the nature, timing and extent of the further
audit procedures remain appropriate.
Q-2 In performing an audit of financial statements, the auditor should have or obtain knowledge of
thebusiness. Explain in the light of SA 315 “Identifying and Assessing the Risks of Material Misstatement
through Understanding the Entity and its Environment”. [MTP-Oct’19,4 Marks]
Ans. Obtaining Knowledge of the Business: The auditor needs to obtain a level of knowledge of the client’s
business that will enable him to identify the events, transactions and practices that, in his judgment,
may have significant effect on the financial information among other things.
As per SA 315 – “Identifying and Assessing the Risk of Material Misstatement Through Understanding
the Entity and its Environment”,the auditor shall obtain an understanding of the following:
(a) Relevant industry, regulatory, and other external factors including the applicable financial reporting
framework
(b) The nature of the entity, including:
(i) its operations;
(ii) its ownership and governance structures;
(iii) the types of investments that the entity is making and plans to make, including investments
in special-purpose entities; and
(iv) the way tha t the enti ty is structured and how it is financed; to enabl e the auditor to
understand the classes of transactions, account balances, and disclosures to be expected in
the financial statements.

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 (c) The entity’s selection and application of accounting policies, including the reasons for changes
thereto. The auditor shall evaluate whether the entity’s accounting polic ies are appropriate for
its business and consistent with the applicable financial reporting framework and accounting
policies used in the relevant industry.
(d) The entity’s objectives and strategies, and those related business risks that may result in risks of
material misstatement.
(e) The measurement and review of the entity’s financial performance.
In addition to the importance of knowledge of the client ’s business in establishing the overall
audit plan, such knowledge helps the auditor to identify areas of special audit consideration, to
evaluate the reasonableness both of accounting estimates and management representations,
and to make judgement regarding the appropriateness of accounting policies and disclosures.
Q-3 The auditor of XYZ Ltd, engaged in FMCG (Fast Moving Consumable Goods) obtains an understanding of
the control environment. As part of obtaining this understanding, the auditor evaluates whether:
(i) Management has created and maintained a culture of honesty and ethical behavior; and
(ii) The strengths in the control environment elements collectively provide an appropriate foundation
for the other components of internal control.
Advise what is included in control environment. Also explain the elements of control environment.
[MTP-March’19,6 Marks-MTP-Aug.18,5 Marks, RTP-Nov’19,RTP-May’18]
Ans. Control Environment – Component of Internal Control: The auditor shall obtain an understanding of
the control environment. As part of obtaining this understanding, the auditor shall evaluate whether:
(i) Management has created and maintained a culture of honesty and ethical behavior; and
(ii) The strengths in the control environment elements collectively provide an appropriatefoundation
for the other components of internal control.
What is included in Control Environment?
The control environment includes:
(i) the governance and management functions and
(ii) the attitudes, awareness, and actions of those charged with governance and management.
(iii) The control environment sets the tone of an organization, influencing the control consciousness
of its people.
Elements of the Control Environment: Elements of the control environment that may be relevant
when obtaining an understanding of the control environment include the following:
(a) Communication and enforcement of integrity and ethical values – These are essential elements
that influence the effectiveness of the design, administration and monitoring of controls.
(b) Commitment to competence – Matters such as management’s consideration of the competence
levels for particular jobs and how those levels translate into requisite skills and knowledge.
(c) Participation by those charged with governance – Attributes of those charged with governance
such as:
• Their independence from management.
• Their experience and stature.
• The extent of their involvement and the informa tion they receive, and the scrutiny of
activities.
• The appropriateness of their actions, including the degree to which difficult questions are
raised and pursued wi th management, and their interaction with internal and external
auditors.
(d) Management’s philosophy and operating style – Characteristics such as management’s:

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 • Approach to taking and managing business risks.
• Attitudes and actions toward financial reporting.
• Attitudes toward information processing and accounting functions and personnel.
(e) Organisational structure – The framework within which an entity’s activities for achieving its
objectives are planned, executed, controlled, and reviewed.
(f) Assignment of authority and responsibility - Matters such as how authority and responsibility for
operating activities are assigned and how reporting relationships and authorisation hierarchies
are established.
(g) Human resource policies and practices – Policies and practices that relate to, for example,
recrui tment, ori enta tion, training, evalua tion, counselling, promotion, compensation, and
remedial actions.
Q-4 ABC Ltd is engaged in manufacturing of different type of yarns. On going through its financial statements
for the past years, it is observed that inventory is material to the financial statements. You as an auditor
of the company wanted to obtain sufficient appropriate audit evidence regarding the existence and
condition of the inventory as appearing in the financial statements. Discuss, how would you proceed
as an auditor.
[MTP-March’19,4 Marks-MTP-March’18,5 Marks-MTP-Aug’18,5 Marks, MTP-Oct’18,5 Marks]
Ans. When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate
audit evidence regarding the existence and condition of inventory by:
(1) Attendance at physical inventory counting, unless impracticable, to:
(i) Evaluate management ’s instructions and procedures for recording and controlling theresults
of the entity’s physical inventory counting;
(ii) Observe the performance of management ’s count procedures;
(iii) Inspect the inventory; and
(iv) Perform test counts; and
(2) Performing audit procedures over the entity’s final inventory records to determine whether they
accurately reflect actual inventory count results.
Q-5 The assessment of risks is a matter of professional judgment. Explain stating clearly what is not
included in Audit Risk? [MTP-Aug’18,5 Marks]
Ans. Assessment of Risks - Matter of Professional Judgement
The assessment of risks is based on audit procedures to obtain information necessary for that purpose
and evidence obtained throughout the audit. The assessment of risks is a matter of professional
judgment, rather than a matter capable of precise measurement.
What is not included in Audit Risk ?
(i) Audit risk does not include the risk that the auditor might express an opinion that the financial
statements are materially misstated when they are not. This risk is ordinarily insignificant.
(ii) Further, audit risk is a technical term related to the process of auditing; it does not refer to the
auditor’s business risks such as loss from litigation, adverse publicity, or other events arising in
connection with the audit of financial statements.
Q-6 Based on the results of the tests of control, the auditor should evaluate whether the internal controls
are designed and operating as contemplated in the preliminary assessment of control risk. Analyse
and Explain. [RTP-Nov’19, RTP-Nov’18]

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Ans. While obtaining audit evidence about the effective operation of internal controls, the auditor considers
how they were applied, the consistency with which they were applied during the period and by whom
they were applied. The concept of effective operation recognises that some deviations may have
occurred. Deviations from prescribed controls may be caused by such factors as changes in key
personnel, significant seasonal fluctuations in volume of transactions and human error. When deviations
are detected the auditor makes specific inquiries regarding these matters, particularly, the timing of
staff changes in key internal control functions. The auditor then ensures that the tests of control
appropriately cover such a period of change or fluctuation.
Based on the results of the tests of control, the auditor should evaluate whether the internal controls
are designed and operating as contemplated in the preliminary assessment of control risk. The
evaluation of deviations may result in the auditor concluding that the assessed level of control risk
needs to be revised. In such cases, the auditor would modify the nature, timing and extent of planned
substantive procedures.
Before the conclusion of the audit, based on the results of substantive procedures and other audit
evidence obtained by the auditor, the auditor should consider whether the assessment of control risk
is confirmed. In case of deviations from the prescribed accounting and internal control systems, the
auditor would make specific inquiries to consider their implications. Where, on the basis of such
inquiries, the auditor concludes that the deviations are such that the preliminary assessment of control
risk is not supported, he would amend the same unless the audit evidence obtained from other tests
of control supports that assessment. Where the auditor concludes that the assessed level of control
risk needs to be revised, he would modify the nature, timing and extent of his planned substantive
procedures.
It has been suggested that actual operation of the internal control should be tested by the application
of procedural tests and examination in depth. Procedural tests simply mean testing of the compliance
with the procedures laid down by the management in respect of initiation, authorisation, recording
and documentation of transaction at each stage through which it flows.
Q-7 The extent and the nature of the audit programme is substantially influenced by the internal control
system in operation. Analyse and explain. [RTP-Nov’19]
Ans. The auditor can formulate his entire audit programme only after he has had a satisfactory understanding
of the internal control systems and their actual operation. If he does not care to study this aspect, it is
very likely that his audit programme may become unwieldy and unnecessarily heavy and the object of
the audit may be altogether lost in the mass of entries and vouchers. It is also important for him to
know whether the system is actually in operation. Often, after installation of a system, no proper
follow up is there by the management to ensure compliance. The auditor, in such circumstances, may
be led to believe that a system is in operation which in reality may not be altogether in operation or
may at best operate only partially. This state of affairs is probably the worst that an auditor may come
across and he would be in the midst of confusion, if he does not take care.
It would be better if the auditor can undertake the review of the internal control system of client. This
will give him enough time to assimilate the controls and implications and will enable him to be more
objective in the framing of the audit programme. He will also be in a position to bring to the notice of
the management the weaknesses of the system and to suggest measures for improvement. At a further
interim date or in the course of the audit, he may ascertain how far the weaknesses have been removed.
From the foregoing, it can be concluded that the extent and the nature of the audit programme is
substantially influenced by the internal control system in operation. In deciding upon a plan of test
checking, the existence and operation of internal control system is of great significance.
A proper understanding of the internal control system in its content and working also enables an
auditor to decide upon the appropriate audit procedure to be applied in different areas to be covered
in the audit programme.

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 In a situation where the internal controls are considered weak in some areas, the auditor might choose
an auditing procedure or test that otherwise might not be required; he might extend certain tests to
cover a large number of transactions or other items than he otherwise would examine and at times he
may perform additional tests to bring him the necessary satisfaction.
Q-8 The SAs do not ordinarily refer to inherent risk and control risk separately, but rather to a combined
assessment of the “risks of material misstatement ”. Explain. [RTP-Nov’19]
Ans. The SAs do not ordinarily refer to inherent risk and control risk separately, but rather to a combined
assessment of the “risks of material misstatement ”. However, the auditor may make separate or
combined assessments of inherent and control risk depending on preferred audit techniques or
methodologies and practical considerations. The assessment of the risks of material misstatement
may be expressed in quantitative terms, such as in percentages, or in non-quantitative terms. In any
case, the need for the auditor to make appropriate risk assessments is more important than the different
approaches by which they may be made.
It can be concluded from the above that- Risk of Material Misstatement= Inherent Risk x Control Risk
Q-9 Explain the meaning, objectives and scope of internal audit functions as per SA 610. Also discuss who
can be appointed as Internal Auditor? [Sugg.-Nov’19-3 Marks, RTP-May’19]
Ans. Who can be appointed as Internal Auditor? As per section 138, 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.
Internal audit function: A function of an entity that performs assurance and consulting activities designed
to evaluate and improve the effectiveness of the entity’s governance, risk management and internal
control processes.
The objectives and scope of internal audit functions: As per SA-610, “Using the Work of an Internal
Auditor”, the objectives of internal audit functions vary widely and depend on the size and structure of
the entity and the requirements of management and, where applicable, those charged with governance.
The objectives and scope of internal audit functions typically include assurance and consulting activities
designed to evalua te and improve the effectiveness of the enti ty’s governance processes, risk
management and internal control such as the following:

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 1. Activities Relating to Governance: The internal audit function may assess the governance process
in i ts accomplishment of objectives on ethics and values, performance management and
accountability, communicating risk and control information to appropriate areas of the organization
and effectiveness of communication among those charged with governance, external and internal
auditors, and management.
2. Activities Relating to Risk Management: The internal audit function may assist the entity by
identifying and evaluating significant exposures to risk and contributing to the improvement of
risk management and internal control (including effectiveness of the financial reporting process).
The internal audit function may perform procedures to assist the entity in the detection of fraud.
3. Activities Relating to Internal Control
(i) Evaluation of internal control. The internal audi t function may be assigned specific
responsibili ty for revi ewing controls, evalua ting their opera tion and recommending
improvements thereto. In doing so, the internal audit function provides assurance on the
control. For example, the internal audit function might plan and perform tests or other
procedures to provide assurance to management and those charged with governance
regarding the design, implementation and operating effectiveness of internal control,
including those controls that are relevant to the audit.
(ii) Examination of financial and operating information. The internal audit function may be
assigned to review the means used to identify, recognize, measure, classify and report
financial and operating information, and to make specific inquiry into individual items,
including detailed testing of transactions, balances and procedures.
(iii) Review of operating activities. The internal audit function may be assigned to review the
economy, efficiency and effectiveness of operating activities, including nonfinancial activities
of an entity.
(vi) Review of compliance with laws and regulations. The internal audit function may be assigned
to review compliance with laws, regulations and other external requirements, and with
management policies and directives and other internal requirements.
Q-10 IT poses specific risks to an entity’s internal control. Explain [RTP-May’19-Sugg.-May’19,4 Marks]
Ans. IT also poses specific risks to an entity’s internal control, including, for example:
• Reliance on systems or programs that are inaccurately processing data, processing inaccurate
data, or both.
• Unauthorised access to data that may result in destruction of data or improper changes to data,
including the recording of unauthorised or non-existent transactions, or inaccurate recording of
transactions. Particular risks may arise where multiple users access a common database.
• The possibility of IT personnel gaining access privileges beyond those necessary to perform their
assigned duties thereby breaking down segregation of duties.
• Unauthorised changes to data in master files.
• Unauthorised changes to systems or programs.
• Failure to make necessary changes to systems or programs.
• Inappropriate manual intervention.
• Potential loss of data or inability to access data as required.
Q-11 The existence of a satisfactory control environment can be a positive factor when the auditor assesses
the risks of material misstatement. Analyse and explain. [RTP-May’19-RTP-May’18]

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Ans. Satisfactory Control Environment - not an absolute deterrent to fraud: The existence of a satisfactory
control environment can be a posi tive factor when the audi tor assesses the risks of material
misstatement. However, although it may help reduce the risk of fraud, a satisfactory control environment
is not an absolute deterrent to fraud. Conversely, deficienci es in the control environment may
undermine the effectiveness of controls, in particular in relation to fraud. For example, management ’s
failure to commit sufficient resources to address IT security risks may adversely affect internal control
by allowing improper changes to be made to computer programs or to data, or unauthorized transactions
to be processed. As explained in SA 330, the control environment also influences the nature, timing,
and extent of the auditor’s further procedures.
The control environment in itself does not prevent, or detect and correct, a material misstatement. It
may, however, influence the auditor’s evaluation of the effectiveness of other controls (for example,
the monitoring of controls and the operation of specific control activities) and thereby, the auditor’s
assessment of the risks of material misstatement.
Q-12 So far as the auditor is concerned, the examination and evaluation of the internal control system is an
indispensable part of the overall audit programme. The auditor needs reasonable assurance that the
accounting system is adequate and that all the accounting information which should be recorded has in
fact been recorded. Internal control normally contributes to such assurance. Explain stating clearly the
benefits of evaluation of internal control to the auditor. [RTP-May’19]
Ans. So far as the auditor is concerned, the examination and evaluation of the internal control system is an
indispensable part of the overall audit programme. The auditor needs reasonable assurance that the
accounting system is adequate and that all the accounting information which should be recorded has in
fact been recorded. Internal control normally contributes to such assurance. The auditor should gain an
understanding of the accounting system and related internal controls and should study and evaluate
the operations of these internal controls upon which he wishes to rely in determining the nature,
timing and extent of other audit procedures.
Benefits of Evaluation of Internal Control to the Auditor
The review of internal controls will enable the auditor to know:
(i) whether errors and frauds are likely to be located in the ordinary course of operations of the
business;
(ii) whether an adequa te internal control system is in use and opera ting as planned by the
management;
(iii) whether an effective internal auditing department is operating;
(iv) whether any administrative control has a bearing on his work (for example, if the control over
worker recruitment and enrolment is weak, there is a likelihood of dummy names being included
in the wages sheet and this is relevant for the auditor);
(v) whether the controls adequately safeguard the assets;
(vi) how far and how adequately the management is discharging its function in so far as correct
recording of transactions is concerned;
(vii) how reliable the reports, records and the certificates to the management can be;
(viii) the extent and the depth of the examination that he needs to carry out in the different areas of
accounting;
(ix) what would be appropriate audit technique and the audit procedure in the given circumstances;
(x) what are the areas where control is weak and where it is excessive; and
(xi) whether some worthwhile suggestions can be given to improve the control system.

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Q-13 A Flow Chart is a graphic presentation of each part of the company’s system of internal control. Explain
elaborating each and every aspect about flow chart. [RTP-Nov’18]
Ans. A Flow Chart: It is a graphic presentation of each part of the company’s system of internal control. A
flow chart is considered to be the most concise way of recording the auditor’s review of the system. It
minimises the amount of narrative explanation and thereby achieves a consideration or presentation
not possible in any other form. It gives bird’s eye view of the system and the flow of transactions and
integration and in documentation, can be easily spotted and improvements can be suggested.
It is also necessary for the auditor to study the significant features of the business carried on by the
concern; the nature of its activities and various channels of goods and materials as well as cash, both
inward and outward; and also a comprehensive study of the entire process of manufacturing, trading
and administration. This will help him to understand and evaluate the internal controls in the correct
perspective.
Q-14 The auditor can formulate his entire audit programme only after he has had a satisfactory understanding
of the internal control systems and their actual operation. Analyse and explain. [RTP-Nov’18]
Ans. The auditor can formulate his entire audit programme only after he has had a satisfactory understanding
of the internal control systems and their actual operation.
If he does not care to study this aspect, it is very likely that his audit programme may become unwi eldy
and unnecessarily heavy and the object of the audit may be altogether lost in the mass of entries and
vouchers. It is also important for him to know whether the system is actually in operation. Often, after
installation of a system, no proper follow up is there by the management to ensure compliance. The
auditor, in such circumstances, may be led to believe that a system is in operation which in reality may
not be altogether in operation or may at best operate only partially. This state of affairs is probably the
worst that an auditor may come across and he would be in the midst of confusion, if he does not take
care.
It would be better if the auditor can undertake the review of the internal control system of client. This
will give him enough time to assimilate the controls and implications and will enable him to be more
objective in the framing of the audit programme. He will also be in a position to bring to the notice of
the management the weaknesses of the system and to suggest measures for improvement. At a further
interim date or in the course of the audit, he may ascertain how far the weaknesses have been removed.
From the foregoing, it can be concluded that the extent and the nature of the audit programme is
substantially influenced by the internal control system in operation. In deciding upon a plan of test
checking, the existence and operation of internal control system is of great significance.
A proper understanding of the internal control system in its content and working also enables an
auditor to decide upon the appropriate audit procedure to be applied in different areas to be covered
in the audit programme.
In a situation where the internal controls are considered weak in some areas, the auditor might choose
an auditing procedure or test that otherwise might not be required; he might extend certain tests to
cover a large number of transactions or other items than he otherwise would examine and at times he
may perform additional tests to bring him the necessary satisfaction.
Q-15 Auditor’s reporting on internal financial controls is a requirement specified in the Act and, therefore,
will apply only in case of reporting on financial statements prepared under the Act and reported under
Section 143. Explain stating clearly the auditor’s responsibility for reporting on internal financial controls
over financial reporting. [RTP-Nov’18]
Ans. Auditors’ Responsibility for Reporting on Internal Financial Controls over Financial Reporting in India
Clause (i) of Sub-section 3 of Section 143 of the Act requires the auditors’ report to state whether the
company has adequate internal financial controls system in place and the operating effectiveness of
such controls.

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 It may be noted that auditor’s reporting on internal financial controls is a requirement specified in the
Act and, therefore, will apply only in case of reporting on financial statements prepared under the Act
and reported under Section 143.
Accordingly, reporting on internal financial controls will not be applicable with respect to interim
financial statements, such as quarterly or half-yearly financial statements, unless such reporting is
required under any other law or regulation.
Objectives of an auditor in an audit of internal financial controls over financial reporting: The auditor’s
objective in an audit of internal financial controls over financial reporting is, “to express an opinion on
the effectiveness of the company’s internal financial controls over financial reporting.” It is carried out
along with an audit of the financial statements.
Reporting under Section 143(3)(i) is dependent on the underlying criteria for internal financial controls
over financial reporting adopted by the management. However, any system of internal controls provides
only a reasonable assurance on achievement of the objectives for which it has been established. Also,
the auditor shall use the concept of materiality in determining the extent of testing such controls.
Rule 8(5)(viii) of the Companies (Accounts) Rules, 2014 requires the board report of all companies to
state the details in respect of adequacy of internal financial controls with reference to the financial
statements.
The inclusion of the matters rela ting to internal financial controls in the directors responsibility
statement is in addition to the requirement of the directors stating that they have taken proper and
sufficient care for the maintenance of adequate accounting records in accordance with the provisions
of the 2013 Act for safeguarding the assets of the company and for preventing and detecting fraud and
other irregularities.
Q-16 As part of the risk assessment, the auditor shall determine whether any of the risks identified are, in
the auditor’s judgment, a significant risk. In exercising judgment as to which risks are significant risks,
state the factors which shall be considered by the auditor.
Explain the above in context of SA-315. [RTP-May’18]
Ans. Identification of Significant Risks: SA 315 “Identifying and Assessing the Risk of Material Misstatement
through understanding the Entity and its Environment” defines ‘significant risk’ as an identified and
assessed risk of ma terial missta tement tha t, in the audi tor ’s judgment, requires special audi t
consideration.
As part of the risk assessment, the auditor shall determine whether any of the risks identified are, in
the auditor’s judgment, a significant risk. In exercising this judgment, the auditor shall exclude the
effects of identified controls related to the risk. In exercising judgment as to which risks are significant
risks, the auditor shall consider at least the following-
(i) Whether the risk is a risk of fraud;
(ii) Whether the risk is related to recent significant economic, accounting or otherdevelopments like
changes in regulatory environment etc. and therefore requiresspecific attention;
(iii) The complexity of transactions;
(iv) Whether the risk involves significant transactions with related parties;
(v) The degree of subjectivi ty in the measurement of financial information related to the risk,
especially those measurements involving a wide range of measurement uncertainty; and
(vi) Whether the risk involves significant transactions that are outside the normal course of business
for the entity or that otherwise appear to be unusual.

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Q-17 Discuss what is included in risk assessment procedures to obtain audit evidenceabout the design and
implementation of relevant controls. [RTP-May’18]
Ans. Risk assessment procedures to obtain audit evidence about the design and implementation of relevant
controls may include-
• Inquiring of entity personnel.
• Observing the application of specific controls.
• Inspecting documents and reports.
• Tracing transactions through the information system relevant to financial reporting.
Q-18 “P India” Ltd. is a manufacturer of various sports products. The company is having several cases of
litigation pending in courts. The auditor wanted to identify litigation and claims, which may give rise to
risk of material misstatements. Suggest the audit procedures in the given case. [Sugg.-May’19,4 Marks]
Ans. The auditor shall design and perform audit procedures in order to identify litigation and claims involving
the entity which may give rise to a risk of material misstatement, including:
(i) Inquiry of management and, where applicable, others within the entity, including in-house legal
counsel;
(ii) Reviewing minutes of meetings of those charged with governance and correspondence between
the entity and its external legal counsel; and
(iii) Reviewing legal expense accounts.
If the auditor assesses a risk of material misstatement regarding litigation or claims that have been
identified, or when audit procedures performed indicate that other material litigation or claims may
exist, the auditor shall, in addition to the procedures required by other SAs, seek direct communication
with the entity’s external legal counsel.
Q-19 “A multinational co. wants to appoint you to carry the statutory audit.” Discuss with reference to SA 330
the substantive procedures to be performed to assess the risk of material misstatement.
[RTP-Nov’18,6 Marks]
Ans. Substantive procedures to be performed to assess the risk of material misstatement: Irrespective of
the assessed risks of material missta tement, the audi tor shall design and perform substantive
procedures for each material class of transactions, account balance, and disclosure.
1. This requirement reflects the facts that:
(i) the auditor’s assessment of risk is judgmental and so may not identify all risks of material
misstatement; and
(ii) there are inherent limitations to internal control, including management override.
2. Depending on the circumstances, the auditor may determine that:
• Performing only substantive analytical procedures will be sufficient to reduce audit risk to
an acceptably low level. For example, where the auditor’s assessment of risk is supported
by audit evidence from tests of controls.
• Only tests of details are appropriate.
• A combination of substantive analytical procedures and tests of details are most responsive
to the assessed risks.
3. Substantive analytical procedures are generally more applicable to large volumes of transactions
that tend to be predictable over time. SA 520, “Analytical Procedures” establishes requirements
and provides guidance on the application of analytical procedures during an audit.

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 4. The nature of the risk and assertion is relevant to the design of tests of details. For example, tests
of details related to the existence or occurrence assertion may involve selecting from items
contained in a financial statement amount and obtaining the relevant audit evidence. On the
other hand, tests of details related to the completeness assertion may involve selecting from
items that are expected to be included in the relevant financial statement amount and investigating
whether they are included.
5. Because the assessment of the risk of material misstatement takes account of internal control,
the extent of substantive procedures may need to be increased when the results from tests of
controls are unsatisfactory.
6. In designing tests of details, the extent of testing is ordinarily thought of in terms of the sample
size. However, other matters are also relevant, including whether it is more effective to use other
selective means of testing.
Q-20 Name the assertions for the following audit procedures:
(i) Year end inventory verification.
(ii) Depreciation has been properly charged on all assets.
(iii) The title deeds of the lands disclosed in the Balance Sheet are held in the name of the company.
(iv) All liabilities are properly recorded in the financial statements.
(v) Related party transactions are shown properly. [Sugg.-May’18,5 Marks]
Ans. (i) Year end inventory verification: Existence Assertion.
(ii) Depreciation has been properly charged on all assets: Valuation Assertion.
(iii) Title deed of lands disclosed in the Balance Sheet are held in the name of the Company: Rights &
Obligations Assertion.
(iv) All liabilities are properly recorded in the financial statements: Completeness.
(v) Related party transactions are shown properly: Presentation & Disclosure.
Q-21 What constitutes a ‘true and fair’ view, is the matter of an auditor’s judgement in the particular
circumstances of a case. In order to ensure ‘true and fair’ view, auditor has to review certain points.
Mention any such 5 (five) points in brief. [Sugg.-May’18,5 Marks]
Ans. True and Fair View: To ensure true and fair view, an auditor has to see:
(i) that the assets are neither undervalued or overvalued, according to the applicable accounting
principles,
(ii) no material asset is omitted;
(iii) the charge, if any, on assets are disclosed;
(iv) material liabilities should not be omitted;
(v) the profit and loss account and balance sheet discloses all the matters required to be disclosed;
(vi) accounting policies have been followed consistently; and
(vii) all unusual, exceptional or non-recurring items have been disclosed separately.
Q-22 Briefly discuss the limitations of Internal Control. [Sugg.-May’18,6 Marks]
Ans. Limitations of Internal Control:
(i) Internal control can provide only reasonable assurance: Internal control, no matter how effective,
can provide an enti ty with only reasonable assurance about achieving the entity’s financial
reporting objectives. The likelihood of their achievement is affected by inherent limitations of
internal control.

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 (ii) Human judgment in decision-making: Realities that human judgment in decision-making can be
faulty and that breakdowns in internal control can occur because of human error.
(iii) Lack of understanding the purpose: Equally, the operation of a control may not be effective, such
as where information produced for the purposes of internal control (for example, an exception
report) is not effectively used because the individual responsible for reviewing the information
does not understand its purpose or fails to take appropriate action.
(iv) Collusion among People: Additionally, controls can be circumvented by the collusion of two or
more people or inappropriate management override of internal control. For example, management
may enter into side agreements with customers that alter the terms and conditions of the entity’s
standard sales contracts, which may result in improper revenue recognition. Also, edit checks in
a software program that are designed to identify and report transactions that exceed specified
credit limits may be overridden or disabled.
(v) Judgements by Management: Further, in designing and implementing controls, management
may make judgments on the nature and extent of the controls it chooses to implement, and the
nature and extent of the risks it chooses to assume.
(vi) Limitations in case of Small Entities: Smaller entities often have fewer employees due to which
segregation of duties is not practicable. However, in a small owner-managed entity, the owner-
manager may be able to exercise more effective oversight than in a larger entity. This oversight
may compensate for the generally more limited opportunities for segregation of duties.
On the other hand, the owner-manager may be more able to override controls because the
system of internal control is less structured. This is taken into account by the auditor when
identifying the risks of material misstatement due to fraud.
Q-23 XYZ & Associates, Chartered Accountants, while evaluating the operating effectiveness of internal
controls, detects deviation from controls. In such a situation, state the specific inquiries to be made by
an auditor to understand these matters and their potential consequences. [Sugg.-May’18,5 Marks]
Ans. Evaluating the Operating Effectiveness of Controls: When evaluating the operating effectiveness of
relevant controls, the auditor shall evaluate whether misstatements that have been detected by
substa nt iv e procedures indica te tha t controls are no t op era t ing ef fective ly. Th e abse nce of
misstatements detected by substantive procedures, however, does not provide audit evidence that
controls related to the assertion being tested are effective.
When deviations from controls upon which the auditor intends to rely are detected, the auditor shall
make specific inquiries to understand these matters and their potential consequences, and shall
determine whether:
(a) The tests of controls that have been performed provide an appropriate basis for reliance on the
controls;
(b) Additional tests of controls are necessary; or
(c) The potential risks of misstatement need to be addressed using substantive procedures.
A material misstatement detected by the auditor’s procedures is a strong indicator of the existence
of a significant deficiency in internal control.
Q-24(a) When auditor identifies deficiencies and report on internal controls, he determines the significant
financial statement assertions that are affected by the ineffective controls in order to evaluate th e
effect on control risk assessments and strategy for the audit of the financial statements. Explain.
(b) Obtaining an understanding of the entity and its environment, including the entity’s internal control,
is a continuous, dynamic process of gathering, updating and analysing information throughout the
audit. Analyse and explain giving examples. [ RTP-May’2020]

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Ans.(a) Control risk assessment when control deficiencies are identified: When auditor identifies deficiencies
and report on internal controls, he determines the significant financial statement assertions that are
affected by the ineffective controls in order to evaluate the effect on control risk assessments and
strategy for the audit of the financial statements.
When control deficiencies are identified and auditor identifies and tests more than one control for
each relevant assertion, he evaluates control risk considering all of the controls he has tested. If
auditor determines that they support a ‘rely on controls’ risk assessment, or if compensating controls
are identified, tested and evaluated to be effective, he may conclude that the ‘rely on controls’ is still
appropriate. Otherwise we change our control risk assessment to ‘not rely on controls.’
When a deficiency relates to an ineffective control that is the only control identified for an assertion,
he revises risk assessment to ‘not rely on controls’ for associated assertions, as no other controls have
been identified that mitigate the risk related to the assertion. If the deficiency relates to one WCGW
(what can go wrong) out of several WCGW’s, he can ‘rely on controls’ but performs additional substantive
procedures to adequately address the risks related to the deficiency.
(b) Obtaining an understanding of the entity and its environment, including the entity’s internal control,
is a continuous, dynamic process of gathering, updating and analysing information throughout the
audit. The understanding establishes a frame of reference within which the auditor plans the audit and
exercises professional judgment throughout the audit, for example, when:
• Assessing risks of material misstatement of the financial statements;
• Determining materiality in accordance with SA 320;
• Considering the appropriateness of the selection and application of accounting policies;
• Identifying areas where special audit consideration may be necessary, for example, related party
transactions, the appropriateness of management ’s use of the going concern assumption, or
considering the business purpose of transactions;
• Developing expectations for use when performing analytical procedures;
• Eva lua t ing the suffici ency a nd a ppropria t eness of audi t evidence obtain ed, such as the
appropriateness of assumptions and of management ’s oral and written representations.
Q-25(a) Internal control over safeguarding of assets against unauthorised acquisition, use, or disposition may
include controls relating to both financial reporting and operations objectives. Explain stating clearly
the objectives of Internal Control.
(b) It has been suggested that actual operation of the internal control should be tested by the application
of procedural tests and examination in depth. Explain with the help of example in respect of the
procedure for sales. [ RTP-May’2020]
Ans.(a) Objectives of Internal Control
Internal control over safeguarding of assets against unauthorised acquisition, use, or disposition may
includ e controls rela ting to both fin ancial reporting and opera tions objectives. The audi tor ’s
considera tion of such controls is generally limited to those relevant to the reliability of financia l
reporting. For example, use of access controls, such as passwords, that limit access to the data and
programs that process cash disbursements may be relevant to a financial statement audit. Conversely,
safeguarding controls relating to operations objectives, such as controls to prevent the excessive use
of materials in production, generally are not relevant to a financial statement audit.
Objectives of Internal Control are :
(i) transactions are executed in accordance with managements general or specific authorization;
(ii) all transactions are promptly recorded in the correct amount in the appropriate accounts and in

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 the accounting period in which executed so as to permit preparation of financial information
wi thin a framework of recognized accounting policies and practices and relevant statutory
requirements, if any, and to maintain accountability for assets;
(iii) assets are safeguarded from unauthorised access, use or disposition; and
(iv) the recorded assets are compared with the existing assets at reasonable intervals and appropriate
action is taken with regard to any differences.
(b) It has been suggested that actual operation of the internal control should be tested by the application
of procedural tests and examination in depth. Procedural tests simply mean testing of the compliance
with the procedures laid down by the management in respect of initiation, authorisation, recording
and documentation of transaction at each stage through which it flows.
For example, the procedure for sales requires the following:
1. Before acceptance of any order the position of inventory of the relevant article should be known
to ascertain whether the order can be executed in time.
2. An advice under the authorisation of the sales manager should be sent to the party placing the
order, internal reference number, and the acceptance of the order. This advice should be prepared
on a standardised form and copy thereof should be forwarded to inventory section to enable it to
prepare for the execution of the order in time.
3. The credit period allowed to the party should be the normal credit period. For any special credit
period a special authorisation of the sales manager would be necessary.
4. The rate at which the order has been accepted and other terms about transport, insurance, etc.,
should be clearly specified.
5. Before deciding upon the credit period, a reference should be made to the credit section to know
the creditworthiness of the party and particularly whether the party has honoured its commitments
in the past.
Q-26 Discuss the various points which auditor needs to consider in determining whether it is appropriate to
use audit evidence about operating effectiveness of controls obtained in previous audit, and if so, the
length of the time period that may elapse before retesting. [Sugg.-Nov’19,4 Marks]
Ans. In determining whether it is appropriate to use audit evidence about the operating effectiveness of
controls obtained in previous audits, and, if so, the length of the time period that may elapse before
retesting a control, the auditor shall consider the following:
i. The effectiveness of other elements of internal control, including the control environment, the
entity’s monitoring of controls, and the entity’s risk assessment process;
ii. The risks arising from the characteristics of the control, including whether i t is manual or
automated;
iii. The effectiveness of general IT-controls;
iv. The effectiveness of the control and its application by the entity, including the nature and extent
of deviations in the application of the control noted in previous audits, and whether there have
been personnel changes that significantly affects the application of the control;
v. Whether the lack of a change in a particular control poses a risk due to changing circumstances;
and
vi. The risks of material misstatement and the extent of reliance on the control.

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MULTIPLE CHOICE QUESTIONS

1. A dif f erence be tw e en the amoun t, classi fica t ion, prese nt a t ion, or disclosure of a re porte d
financialstatement item and the amount, classification, presentation, or disclosure that is required for
the item tobe in accordance with the applicable financial reporting framework is :
(a) Misstatement (b) Error (c) fraud (d) Any [MTP-Oct’19]
2. The assessment of the risks of material misstatement may be expressed in
(a) quantitative terms, such as in percentages, or in non-quantitative terms.
(b) quantitative terms, such as in percentages.
(c) non-quantitative terms.
(d) None of the above [MTP-Oct’19]
3. SA 315 establishes requirements and provides guidance on identifying and assessing the risks ofmaterial
misstatement -
(a) at the financial statement levels only.
(b) at the assertion levels only.
(c) at the financial statement and assertion levels
(d) at the financial statement or assertion levels. [MTP-Oct’19]
4. The risks of material misstatement at the assertion level consist of two components:
(a) Inherent risk and detection risk (b) control risk and detection risk
(c) audit risk and detection risk (d) Inherent risk and control risk [MTP-March’19]
5. Audit risk is a function of the
(a) risks of material misstatement and detection risk.
(b) audit risk and detection risk.
(c) control risk and detection risk.
(d) inherent risk and detection risk. [MTP-April’19]
6. ____________refers to a difference between the amount, classification, presentation, or disclosure of
a reported financial statement item and the amount, classification, presentation, or disclosure that is
required for the item to be in accordance with the applicable financial reporting framework.
(a) Misstatement (b) Error (c) Fraud (d) Any of the above
[MTP-April’19]
7. A request that the confirming party respond directly to the auditor only if the confirming party disagrees
with the information provided in the request is-
(a) Positive confirmation request (b) Non-response
(c) Exception (d) Negative confirmation request [MTP-April’19]
8. The auditor shall design and perform audit procedures in order to identify litigation and claims involving
the entity which may give rise to a risk of material misstatement, including:
(a) Inquiry of management and, where applicable, others within the entity, including in-house legal
counsel.
(b) Reviewing minutes of meetings of those charged with governance and correspondence between
the entity and its external legal counsel.

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 (c) Reviewing legal expense accounts.
(d) All of the above [MTP-April’19]
9. One of your junior audit team members is confused with the term ‘material misstatement’. You explain
him that a material misstatement is untrue information in a financial statement that could affect the
financial decisions of one who relies on the statement. Which of the following would constitute material
misstatement?
(1) An error of ` 5,000 in relation to assets of ` 20 lakhs.
(2) A payroll fraud of ` 100 in a company where profit before tax is ` 11,000.
(3) Non-disclosure of a material uncertainty.
(4) Financial statements have been prepared on a going concern basis when the company is in the
process of being liquidated.
(a) 1 and 2 (b) 3 and 4 (c) 2 and 3 (d) 1 and 4
[MTP-April’19]
10. ______refer to the audit procedures performed to obtain an understanding of the entity and its
environment, including the entity’s internal control, to identify and assess the risks of ma terial
misstatement, whether due to fraud or error, at the financial statement and assertion levels.
(a) Audit assessment procedures (b) substantive procedures
(c) test of control (d) Risk assessment procedures [RTP-Nov’19]
11. When more persuasive audit evidence is needed regarding the effectiveness of a control,
(a) it may be appropriate to increase the extent of testing of the control and reduce the extent of the
degree of reliance on controls.
(b) it may be appropriate to decrease the extent of testing of the control as well as the degree of
reliance on controls.
(c) it may be appropriate to decrease the extent of testing of the control and increase the extent of
the degree of reliance on controls.
(d) it may be appropriate to increase the extent of testing of the control as well as the degree of
reliance on controls. [RTP-Nov’19]
12. When deviations from controls upon which the auditor intends to rely are detected,
(a) the auditor shall not make any inquiri es to understand these ma tters and their potential
consequences
(b) the auditor shall make specific inquiries to understand these matters and their potential
consequences
(c) the audi tor shall make general inquiri es to understand these ma tters and their potential
consequences
(d) the auditor shall make both general as well as specific inquiries to understand these matters and
their potential consequences [RTP-Nov’19]
13. A failure of the confirming party to respond, or fully respond, to a positive confirmation request, or a
confirmation request returned undelivered is called-
(a) Negative confirmation request (b) Non-response
(c) Exception (d) Positive confirmation request [RTP-Nov’19]

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14. Coyote Ltd. is dealing in trading of electronic goods. Huge inventory (60% approximately) of the
company is lying on consignment (i.e. under the custody of third party). CA. Star, the auditor of the
company, wants to obtain sufficient appropriate audit evidence regarding the existence and condition
of the inventory lying on consignment. Thus, he requested & obtained confirmation from the third
party as to the quantities and condition of inventory held on behalf of the entity, however, it raised
doubts about the integrity and objectivity of the third party. Which of the following other audit
procedures may be performed by CA. Star to obtain sufficient appropriate audit evidence regarding
the existence and condition of the inventory under the custody of third party?
(a) Attend third party’s physical counting of inventory.
(b) Arrange for another auditor to attend third party’s physical counting of inventory.
(c) Inspect warehouse receipts regarding inventory held by third parties.
(d) All of the above. [RTP-Nov’19]

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 C H A PT E R- 5
F RAUD AND R ESPONSIBILI T I ES O F T H E AUDI T O R IN
T HIS R E GARD

Q-1 “Fraudulent financial reporting involves intentional misstatements including omissions of amounts or
disclosures in financial statements to deceive financial statement users.” Discuss.
[MTP-Oct’19,3 Marks]
Ans. Fraudulent Financial Reporting: Fraudulent financial reporting involves intentional misstatements
including omissions of amounts or disclosures in financial statements to deceive financial statement
users. It can be caused by the efforts of management to manage earnings in order to deceive financial
statement users by influencing their perceptions as to the entity’s performance and profitability. Such
earnings management may start out with small actions or inappropriate adjustment of assumptions
and changes in judgments by management. Pressures and incentives may lead these actions to increase
to the extent that they result in fraudulent financial reporting.
In some entities, management may be motivated to reduce earnings by a material amount to minimize
tax or to inflate earnings to secure bank financing.
Fraudulent financial reporting may be accomplished by the following:
(i) M ani pula t ion, f alsif ica ti on (incl udi ng f orge ry), or a l te ra t ion of accoun t ing records or
supportingdocumentation from which the financial statements are prepared.
(ii) Misrepresentation in or intentional omission from, the financial statements of events,transactions
or other significant information.
(iii) Intentional misapplication of accounting principles relating to amounts, classification, manner of
presentation, or disclosure.
Fraudulent financial reporting often involves management override of controls that otherwise
may appear to be operating effectively.
Q-2 Fraud, whether fraudulent financial reporting or misappropriation of assets, involves incentive or
pressure to commit fraud, a perceived opportunity to do so and some rationalization of the act. Explain
with examples
[MTP-March’19,3 Marks, MTP-April’18,5 Marks, MTP-Aug’18,5 Marks, MTP-Oct’18,5 Marks]
Ans. Fraud, whether fraudulent financial reporting or misappropriation of assets, involves incentive or
pressure to commit fraud, a perceived opportunity to do so and some rationalization of the act. For
exampl e:
• Incentive or pressure to commit fraudulent financial reporting may exist when management is
under pressure, from sources outside or inside the entity, to achieve an expected (and perhaps
unrealistic) earnings target or financial outcome.
• A perceived opportunity to commit fraud may exist when an individual believes internal control
can be overridden, for example, because the individual is in a position of trust or has knowledge
of specific deficiencies in internal control. Individuals may be able to rationalize committing a

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 fraudulent act. Some individuals possess an attitude, character or set of ethical values that allow
them knowingly and intentionally to commit a dishonest act. However, even otherwise honest
individuals can commit fraud in an environment that imposes sufficient pressure on them.
Q-3 Write the circumstances that indicate the possibility of fraud due to problematic or unusual relationship
between the auditor and management. [MTP-April’19,6 Marks]
Ans. Problematic or unusual relationships between the auditor and management, including:
1. Denial of access to records, facilities, certain employees, customers, vendors, or others from
whom audit evidence might be sought.
2. Undue time pressures imposed by management to resolve complex or contentious issues.
3. Complaints by management about the conduct of the audit or management intimidation of
engagement team members, particularly in connection with the auditor’s critical assessment of
audit evidence or in the resolution of potential disagreements with management.
4. Unusual delays by the entity in providing requested information.
5. Unwillingness to facilitate auditor access to key electronic files for testing through the use of
computer-assisted audit techniques.
6. Denial of access to key IT operations staff and facilities, including security, operations, and systems
development personnel.
7. An unwillingness to add or revise disclosures in the financial statements to make them more
complete and understandable.
8. An unwillingness to address identified deficiencies in internal control on a timely basis.
9. Unwillingness by management to permit the auditor to meet privately with those charged with
governance
10. Accounting Policy that appears to be variance with industry norms
11. Frequent changes in accounting estimates that do not appear to result from changed circumstances
12. Tolerance of variations in the entity’s code of conduct
Q-4 The auditor of XYZ Ltd, engaged in FMCG (Fast Moving Consumable Goods) obtains anunderstanding of
the control environment. As part of obtaining this understanding, the auditor evaluates whether:
(i) Management has created and maintained a culture of honesty and ethical behavior; and
(ii) The strengths in the control environment elements collectively provide an appropriate foundation
for the other components of internal control.
Advise what is included in control environment. Also explain the elements of control environment.
[MTP-March’18,6 Marks]
Ans. Control Environment – Component of Internal Control: The auditor shall obtain an understanding of
the control environment. As part of obtaining this understanding, the auditor shall evaluate whether:
(i) Management has created and maintained a culture of honesty and ethical behavior; and
(ii) The strengths in the control environment elements collectively provide an appropriate foundation
for the other components of internal control.
What is included in Control Environment?
The control environment includes:
(i) the governance and management functions and
(ii) the attitudes, awareness, and actions of those charged with governance and management.

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 (iii) The control environment sets the tone of an organization, influencing the control consciousness
of its people.
Elements of the Control Environment: Elements of the control environment that may be relevant
when obtaining an understanding of the control environment include the following:
(a) Communication and enforcement of integrity and ethical values – These are essential elements
that influence the effectiveness of the design, administration and monitoring of controls.
(b) Commitment to competence – Matters such as management’s consideration of the competence
levels for particular jobs and how those levels translate into requisite skills and knowledge.
(c) Participation by those charged with governance – Attributes of those charged with governance
such as:
• Their independence from management.
• Their experience and stature.
• The extent of their involvement and the informa tion they receive, and the scrutiny of
activities.
• The appropriateness of their actions, including the degree to which difficult questions are
raised and pursued wi th management, and their interaction with internal and external
auditors.
(d) Management’s philosophy and operating style – Characteristics such as management’s:
• Approach to taking and managing business risks.
• Attitudes and actions toward financial reporting.
• Attitudes toward information processing and accounting functions and personnel.
(e) Organisational structure – The framework within which an entity’s activities for achieving its
objectives are planned, executed, controlled, and reviewed.
(f) Assignment of authority and responsibility - Matters such as how authority and responsibility for
operating activities are assigned and how reporting relationships and authorisation hierarchies
are established.
(g) Human resource policies and practices – Policies and practices that relate to, for example,
recrui tment, ori enta tion, training, evalua tion, counselling, promotion, compensation, and
remedial actions.
Q-5 The scope of auditor’s inquiry under clause (x) of paragraph 3 of Companies (Auditor’s Report) Order,
2016 is restricted to frauds ‘noticed or reported’ during the year. Explain. [RTP May’18-RTP-Nov’19]
Ans. Reporting under Companies (Auditor’s Report) Order, 2016 [CARO, 2016]: The auditor is also required
to report under clause (x) of paragraph 3 of Companies (Auditor’s Report) Order, 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.
The scope of auditor’s inquiry under clause (x) of paragraph 3 of Companies (Auditor’s Report) Order,
2016 is restricted to frauds ‘noticed or reported’ during the year. 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
SA 240, “The Auditor’s Responsibility Relating to Fraud in an Audit of Financial Statements”.
Audit Procedures and Reporting under CARO:
(1) While planning the audit, the auditor should discuss with other members of the audit team, the

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 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.
(2) 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 auditor 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.
(3) 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) i t be li eves th e effects of those uncorrect ed missta tements i n financi al sta tem ents,
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
(a) disclosed to the auditor all significant facts relating to any frauds or suspected frauds
known to management that may have affected the entity; and
(b) 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.
(4) Because management is responsible for adjusting the financial statements to correct material
misstatements, it is important that the auditor obtains written representation from management
tha t any uncorrected missta tements resul ting from fraud are, in managem ent ’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
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].”
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. (5)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

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 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.
Q-6 Detection of manipulation of accounts with a view to presenting a false state of affairs is a task requiring
great tact and intelligence. Explain stating clearly how this type of fraud is generally committed.
[RTP-Nov’19]
Ans. Manipulation of Accounts: Detection of manipulation of accounts with a view to presenting a false
state of affairs is a task requiring great tact and intelligence because generally management personnel
in higher management cadre are associated with this type of fraud and this is perpetrated in methodical
way. This type of fraud is generally committed:
(a) to avoid incidence of income-tax or other taxes;
(b) for declaring a dividend when there are insufficient profits;
(c) to withhold declaration of dividend even when there is adequate profit (this is often done to
manipulate the value of shares in stock market to make it possible for selected persons to acquire
shares at a lower cost); and
(d) for receiving higher remuneration where managerial remuneration is payable by reference to
profits.
Q-7 Explain how would you deal as an auditor if, as a result of a misstatement resulting from fraud or
suspected fraud, you encounter exceptional circumstances that bring into question your ability to
continue performing the audit. [RTP-May’19]
Ans. 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:
(a) 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;
(b) Consider whether it is appropriate to withdraw from the engagement, where withdrawal is possible
under applicable law or regulation; and
(c) If the auditor withdraws:
(i) 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
(ii) 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.
(a) Determine the professional and l egal responsibili ties 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;
(b) Consider whether it is appropriate to withdraw from the engagement, where withdrawal is
possible under applicable law or regulation; and
(c) If the auditor withdraws:

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 (i) 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
(ii) 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.
Q-8 Discuss the different ways in which defalcation of cash may take place. [RTP-May’19]
Ans. Defalcation of Cash: Defalcation of cash has been found to perpetrate generally in the following ways:

(a) By inflating cash payments. Examples of inflation of payments:

(1) Making payments against fictitious vouchers.
(2) Making payments against vouchers, the amounts whereof have been inflated.
(3) Manipulating totals of wage rolls either by including therein names of dummy workers or by
inflating them in any other manner.
(4) Casting a larger totals for petty cash expenditure and adjusting the excess in the totals of the
detailed columns so that cross totals show agreement.
(b) By suppressing cash receipts. Few techniques of how receipts are suppressed are:
(1) Teeming and Lading: Amount received from a customer being misappropriated; also to
prevent i ts detection the money received from another customer subsequently being
credited to the account of the customer who has paid earlier. Similarly, moneys received
from the customer who has paid thereafter being credited to the account of the second
customer and such a practice is continued so that no one account is outstanding for payment
for any length of time, which may lead the management to either send out a statement of
account to him or communicate with him.
(2) Adjusting unauthorised or ficti tious reba tes, allowances, discounts, etc. to customer ’
accounts and misappropriating amount paid by them.
(3) Writing off as debts in respect of such balances against which cash has already been received
but has been misappropriated.
(4) Not accounting for cash sales fully.
(5) Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the
employees, etc.
(6) Writing down asset values in entirety, selling them subsequently and misappropriating the
proceeds.
(c) By casting wrong totals in the cash book.
Q-9 Misappropriation of Assets involves the theft of an entity’s assets and is often perpetrated by employees
in relatively small and immaterial amounts. However, it can also involve management who are usually

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 more able to disguise or conceal misappropriations in ways that are difficult to detect. Misappropriation
of assets can be accomplished in a variety of ways. Analyse and Explain. [RTP-Nov’18]
Ans. Misappropriation of Assets: It involves the theft of an entity’s assets and is often perpetrated by
employees in relatively small and immaterial amounts. However, it can also involve management who
are usually more able to disguise or conceal misappropriations in ways that are difficult to detect.
Misappropriation of assets can be accomplished in a variety of ways including:

• Embezzling receipts (for exampl e, misappropria tingcoll ections on accounts receivabl e or

divertingreceipts in respect of written-off accounts to personalbank accounts).
• Stealing physical assets or intellectual property (for example, stealing inventory for personal use
or for sale, stealing scrap for resale, colluding with a competitor by disclosing technological data
in return for payment).
• Causing an entity to pay for goods and services not received (for example, payments to fictitious
vendors, kickbacks paid by vendors to the entity’s purchasing agents in return for inflating prices,
payments to fictitious employees).
Example : Vineet is a manager in Zed Ex Ltd. He is having authority to sign cheques up to ` 10,000.
While performing the audit, Rajan, the auditor, noticed that there were many cheques of `9,999
which had been signed by Vineet. Further Vineet had split large payments (amounting to more
than `10,000 each, into two or more cheques less than `10,000 each so that he may authorize the
payments). This raised suspicion in the auditor.
The auditor found that the cheques of `9,999 were deposited in Vineet’s personal account i.e.
Vineet had misappropriated the amount.
Splitting the cheques into lower amounts involves manipulation of accounts.
The fraud was committed by an employee.
• Using an entity’s assets for personal use (for example, using the entity’s assets as collateral for a
personal loan or a loan to a related party).
Misappropriation of assets is often accompanied by false or misleading records or documents in
order to conceal the fact that the assets are missing or have been pledged wi thout proper
authorization.
Q-10 The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not
detecting one resulting from error. Explain [RTP-Nov’18]
Ans. The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not
detecting one resul ting from error. This is because fraud may involve sophisticated and carefully
organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or
intentional misrepresentations being made to the auditor. Such attempts at concealment may be even
more difficult to detect when accompanied by collusion. Collusion may cause the auditor to believe

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 that audit evidence is persuasive when it is, in fact, false. The auditor’s ability to detect a fraud depends
on factors such as the skillfulness of the perpetrator, the frequency and extent of manipulation, the
degree of collusion involved, the relative size of individual amounts manipulated, and the seniority of
those individuals involved. While the auditor may be able to identify potential opportunities for fraud
to be perpetrated, it is difficult for the auditor to determine whether misstatements in judgment areas
such as accounting estimates are caused by fraud or error.
Q-11 Saburi Yarns Ltd is engaged in manufacturing and trading of yarns of different types. Its huge amount is
locked up in account receivables. Moreover, Management of Saburi Yarns Ltd is worried about its
Internal Control system over receipts from account receivables and other receipts. Management wants
to understand from you as an auditor few techniques as to how receipts can be suppressed resulting
into frauds and finally incurring losses. [RTP-MAY’18]
Ans. Few Techniques of how receipts are suppressed are:
(1) Teeming and Lading: Amount received from a customer being misappropriated; also to prevent
its detection the money received from another customer subsequently being credited to the
account of the customer who has paid earlier. Similarly, moneys received from the customer who
has paid thereafter being credited to the account of the second customer and such a practice is
continued so that no one account is outstanding for payment for any length of time, which may
lead the management to either send out a statement of account to him or communicate with him.
(2) Adjusting unauthorised or fictitious rebates, allowances, discounts, etc. to customer’ accounts
and misappropriating amount paid by them.
(3) Writing off as debts in respect of such balances against which cash has already been received but
has been misappropriated.
(4) Not accounting for cash sales fully.
(5) Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the employees,
etc.
(6) Writing down asset values in entirety, selling them subsequently and misappropria ting the
proceeds.
Q-12 Although fraud is a broad legal concept, for the purposes of the SAs, the auditor is concerned with
fraud that causes a material misstatement in the financial statements. Explain. [RTP-MAY’18]
Ans. The Standard on Auditing (SA) 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements” defines the term ‘fraud’ as-
“an intentional act by one or more individuals among management, those charged with governance,
employees, or third parties, involving the use of deception to obtain an unjust or illegal advantage”.
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor is concerned with
fraud that causes a material misstatement in the financial statements.
Two types of intentional misstatements are relevant to the auditor–
• misstatements resulting from fraudulent financial reporting and
• misstatements resulting from misappropriation of assets.
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, the auditor
does not make legal determinations of whether fraud has actually occurred.
Q-13 Write any five circumstances of conflicting or missing evidence that indicate the possibility of fraud.
[Sugg.-Nov’19,5 Marks]
Ans. Conflicting or missing evidence, including:

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 (i) Missing documents.
(ii) Documents that appear to have been altered.
(iii) Significant unexplained items on reconciliations.
(iv) Unusual discrepancies between the entity’s records and confirmation replies.
(v) Large numbers of credit entries and other adjustments made to accounts receivable records.
(vi) Missing or non-existent cancelled cheques in circumstances where cancelled cheques are ordinarily
returned to the entity with the bank statement.
(vii) Missing inventory or physical assets of significant magnitude.
(viii) Unavai labl e or missing electronic evidence, inconsistent with the enti ty’s record retention
practices or policies.
Q-14 Mr. A is appointed as statutory auditor of a company for the F inancial Year ended 31st March, 2018.
During the course of audit, it was found that few doubtful transactions had been committed by finance
manager who retired in March, 2018. The fraud was going on since last 2-3 years and the total amount
misappropriated exceeding ` 100 lakhs. As a statutory auditor, what would be reporting responsibilities
of Mr. A? [Sugg.-May’18,5 Marks-RTP-May’2020]
Ans. Reporting to the Central Government- As per section 143(12) of the Companies Act, 2013 read with
Rule 13 of the Companies (Audit and Auditors) Rules, 2014, 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, which involves
or is expected to involve individually an amount of ` 1 crore or above, is being or has been committed
in the company by its officers or employees, the auditor shall report the matter to the Central
Government within such time and in such manner as prescribed.
The manner of reporting the matter to the Central Government is as follows:
(1) 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;
(2) 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;
(3) 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;
(4) 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;
(5) 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
(6) the report shall be in the form of a statement as specified in Form ADT-4.
The auditor is also required to report under clause (x) of paragraph 3 of Companies (Auditor’s
Report) Order, 2016 [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.
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Q-15 Discrepancies in the accounting records, including transactions that are not recorded in a complete or
timely manner or are improperly recorded as to amount, accounting period, classification, or entity
policy is one of the example of circumstances that indicate the possibility of fraud. Explain at least four
other such examples relating to discrepancies in the accounting records. [RTP-May’ 20]
Ans. Discrepancies in the accounting records, including:
• Transactions that are not recorded in a complete or timely manner or are improperly recorded as
to amount, accounting period, classification, or entity policy.
• Unsupported or unauthorized balances or transactions.
• Last-minute adjustments that significantly affect financial results.
• Evidence of employees’ access to systems and records inconsistent with that necessary to perform
their authorized duties.
• Tips or complaints to the auditor about alleged fraud.
Q-16 “If an accounting professional, whether in the course of internal or external audit or in the processof
institutional audit finds anything susceptible to be fraud or fraudulent activity or act of excess power
or smells any foul play in any transaction, he should refer the matter to the regulator. Any deliberate
failure on the part of the auditor should render himself liable for action”. Analyse and explain the
above RBI Circular regarding liability of accounting and auditing profession. [MTP-Oct’19,5 Marks]
Ans. The RBI issued a Circular relating to implementation of recommendations of Committee on Legal
Aspects of Bank Frauds applicable to all scheduled commercial banks (excluding Regional Rural Banks).
Regarding liability of accounting and auditing profession, the said circular provided as under: “If an
accounting professional, whether in the course of internal or external audit or in the process of
institutional audit finds anything susceptible to be fraud or fraudulent activity or act of excess power
or smell any foul play in any transaction, he should refer the matter to the regulator. Any deliberate
failure on the part of the auditor should render h imself liable for action”. As per the above requirement,
the member shall be required to report the kind of matters stated in the circular to RBI. Auditor should
also consider the provisions of SA 250, “Consideration of Laws and Regulations in an Audit of Financial
Statements”. The said Standard explains that the duty of confidentiality is over-ridden by statute, law
or by courts. SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements
“ states that 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. It must be noted that auditor is not expected to look into each and every
transaction but to evaluate the system as a whole. Therefore, if the auditor while performing his
normal duties comes across any instance, he should report the matter to the RBI in addition to Chairman/
Managing Director/Chief Executive of the concerned bank.
Duty to report on Frauds under the Companies Act, 2013 - 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.
Q-17 “Inadequate internal control over assets may increase the susceptibility of misappropriation of those
assets.” State any three examples of such occurrence of misappropriation of such assets.
[Sugg.-Nov’19,4 Marks]
Ans. Inadequate internal control over assets may increase the susceptibility of misappropriation of those
assets. For example, misappropriation of assets may occur because there is the following:

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 (i) Inadequate segregation of duties or independent checks.
(ii) Ina d equ a t e ove rsight of se ni or m an age m en t exp e ndi tures, such as trav e l and o the r
reimbursements
(iii) Inadequate record keeping with respect to assets.
(iv) Inadequate system of authorization and approval of transactions (for example, in purchasing).
(v) Inadequate physical safeguards over cash, investments, inventory, or fixed assets.
(vi) Lack of complete and timely reconciliations of assets.
(vii) Lack of timely and appropriate documentation of transactions, for example, credits for merchandise
returns.
(viii) Lack of mandatory vacations for employees performing key control functions.
(ix) Inadequate management understanding of information technology, which enables information
technology employees to perpetrate a misappropriation.
(x) Inadequate access controls over automated records, including controls over and review of computer
systems event logs.

MULTIPLE CHOICE QUESTIONS

1. Which of the following is an example of inflating cash payments?

(a) Making payments against purchase vouchers.
(b) Teeming and lading.
(c) Not accounting for cash sales fully.
(d) Making payments against inflated vouchers. [MTP-March’19]
2. In case of a fraud involving less than ‘ 1 crore, the auditor shall
(a) 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 prescribed.
(b) report the matter to the audit committee constituted under section 177 within such time and in
such manner as prescribed.
(c) report the matter to the Board within such time and in such manner as prescribed.
(d) report the matter to the audit committee constituted under section 177 and also to the Board
within such time and in such manner as prescribed. [MTP-March’19]
3. If, as a result of a misstatement resulting from fraud, the auditor encounters exceptional circumstances
that bring into question his ability to continue performing the audit, he shall-
(a) Withdraw from the engagement immediately.
(b) Report to Audit team regarding withdrawal.
(c) Determine the professional and legal responsibilities applicable in the circumstances.
(d) Ask the management for his withdrawal. [MTP-April’19]

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 C H A PT E R- 6
AUDIT IN AN AUT O MAT E D E NVIR ONM E NT

Q-1 Understanding the entity and its automated environment involves understanding how IT department
is organised, IT activities, the IT dependencies, relevant risks and controls.Explain stating the points
that an auditor should consider to obtain an understanding of the company’s automated environment.
[MTP-Oct’19,4 Marks-RTP-Nov’19-RTP-May’18]
Ans. Understanding and Documenting Automated Environment: Understanding the entity and its automated
environment involves understanding how IT department is organised, IT activities, the IT dependencies,
relevant risks and controls.
Given below are some of the points that an auditor should consider to obtain an understanding of the
company’s automated environment.
• Information systems being used (one or more application systems and what they are)
• their purpose (financial and non-financial)
• Location of IT systems - local vs global
• Architecture (desktop based, client-server, web application, cloud based)
• Version (functions and risks could vary in different versions of same application)
• Interfaces within systems (in case multiple systems exist)
• In-house vs Packaged
• Outsourced activities (IT maintenance and support)
• Key persons (CIO, CISO, Administrators)
Q-2 The fundamental principle of an automated environment is the ability to carry out business with less
manual intervention. Explain. [MTP-March’19,3 Marks]
Ans. The fundamental principle of an automated environment is the ability to carry out business with less
manual intervention and more system driven. The complexity of a business environment depends on
the level of automation i.e., if a business environment is more automated, it is likely to be more
complex.
For example, if a company uses an integrated enterprise resource planning system (ERP) viz., SAP,
Oracle etc., then it is considered more complex to audit. On the other hand, if a company is using an
off-the-shelf accounting software, then it is likely to be less automated and hence less complex
environment.
Similarly, there are several other aspects that an auditor should consider to determine the level of
automation and complexity of a business environment which we will look at in the following sections.
Q-3 In today’s digital age when companies rely on more and more on IT systems and networks to operate
business, the amount of data and information that exists in these systems is enormous. Explain stating
uses of Data analytics. [MTP-April’19,4 Marks, RTP-Nov’18, RTP-May’2020]
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Ans. In today’s digital age when companies rely on more and more on IT systems and networks to operate
business, the amount of data and information that exists in these systems is enormous. A famous
businessman recently said, “Data is the new Oil”.
The combination of processes, tools and techniques that are used to tap vast amounts of electronic
data to obtain meaningful information is called data analytics. While it is true that companies can
benefit immensely from the use of data analytics in terms of increased profitability, better customer
service, gaining competitive advantage, more efficient operations, etc., even auditors can make use of
similar tools and techniques in the audit process and obtain good results. The tools and techniques
that auditors use in applying the principles of data analytics are known as Computer Assisted Auditing
Techniques or CAATs in short.
Data analytics can be used in testing of el ectronic records and data residing in IT systems using
spreadsheets and specialised audit tools viz., IDEA and ACL to perform the following,
• check completeness of data and population that is used in either test of controls or substantive
audit tests
• selection of audit samples – random sampling, systematic sampling
• re-computation of balances – reconstruction of trial balance from transaction data
• reperformance of mathematical calculations – depreciation, bank interest calculation.
• analysis of journal entries as required by SA 240
• fraud investigation
• evaluating impact of control deficiencies
Q-4 Discuss the different ways testing is performed in an automated environment
[MTP-March’18,5 Marks-MTP-Oct’18,5 Marks, RTP-May’2020]
Ans. The following are different ways testing is performed in an automated environment :
There are basically four types of audit tests that should be used. They are inquiry, observation, inspection
and reperformance. As shown in the illustration below, Inquiry is the most efficient audit test but it is
also gives the least audit evidence. Hence, inquiry should always be used in combination with any one
of the other audit testing methods. Inquiry alone is not sufficient.
Reperformance is most effective as an audit test and gives the best audit evidence. However, testing
by reperformance could be very time consuming and least efficient most of the time.
Generally, applying inquiry in combination with inspection gives the most effective and efficient audit
evidence. However, which audit test to use, when and in what combination is a matter of professional
judgement and will vary depending on several factors including risk assessment, control environment,
desired level of evidence required, history of errors/misstatements, complexity of business, assertions
being addressed, etc. The auditor should document the nature of test (or combination of tests) applied
along with the judgements in the audit file as required by SA 230.
When testing in an automated environment, some of the more common methods are as follows:
• Obtain an understanding of how an automated transaction is processed by doing a walkthrough of
one end-to-end transaction using a combination of inquiry, observation and inspection.
• Observe how a user processes transactions under different scenarios.
• Inspect the configuration defined in an application
Q-5 Having obtained an understanding of the IT systems and the automated environment of a company,
the auditor should consider the risks that arise from the use of IT systems. Explain.
[MTP-Aug’18,5 Marks, RTP-Nov’19-Sugg,.May’18,5 Marks]

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Ans. Having obtained an understanding of the IT systems and the automated environment of a company,
the auditor should now understand the risks that arise from the use of IT systems.
Given below are some such risks that should be considered,
• Inaccurate processing of data, processing inaccurate data, or both
• Unauthorized access to data
• Direct data changes (backend changes)
• Excessive access / Privileged access (super users)
• Lack of adequate segregation of duties
• Unauthorized changes to systems or programs
• Failure to make necessary changes to systems or programs
• Loss of data
Q-6 Explain the meaning of automa ted environment. Also discuss the key fea tures of an automated
environment. [RTP-May’19]
Ans. An automated environment basically refers to a business environment where the processes, operations,
accounting and even decisions are carried out by using computer systems – also known as Information
Systems (IS) or Information Technology (IT) systems. Nowadays, it is very common to see computer
systems being used in almost every type of business. For example, think about how banking transactions
are carried out using ATMs (Automated T eller Machines), or how tickets can be purchased using “apps”
on mobile phones, etc. In these examples, you can see how these computer systems enable us to
transact business at any time and any day. Some of the key features of an automated environment are
as follows:
Key features of an Automated Environment
• Enables faster business operations
• Accuracy in data processing and computation
• Ability to process large volumes of transactions
• Integration between business operations
• Better security and controls
• Less prone to human errors
• Provides latest information
• Connectivity and Networking capability
The fundamental principle of an automated environment is the ability to carry out business with less
manual intervention and more system driven. The complexity of a business environment depends on
the level of automation i.e., if a business environment is more automated, it is likely to be more
complex.
For example, if a company uses an integrated enterprise resource planning system (ERP) viz., SAP,
Oracle etc., then it is considered more complex to audit. On the other hand, if a company is using an
off-the-shelf accounting software, then it is likely to be less automated and hence less complex
environment.
Similarly, there are several other aspects that an auditor should consider to determine the level of
automation and complexity of a business environment which we will look at in the following sections.

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Q-7 Discuss the situations in which IT will be relevant to an audit. [Sugg, Nov.’19-5 Marks, RTP-May’19]
Ans. Given below are some situations in which IT will be relevant to and audit,
• Increased use of Systems and Application software in Business (for example, use of ERPs)
• Complexity of transactions has increased (multiple systems, network of systems)
• Hi-tech nature of business (Telecom, e-Commerce)
• Volume of transactions are high (Insurance, Banking, Railways ticketing)
• Company Policy (Compliance)
• Regulatory requirements - Companies Act 2013 IFC, IT Act 2008
• Required by Indian and International Standards - ISO, PCI-DSS, SA 315, SOC, ISAE
• Increases efficiency and effectiveness of audit
Q-8 When a business operates in a more automated environment it is likely that we will see several
business functions and activities happening within the systems. Explain stating the points that an
auditor should consider to substantiate the above. [RTP-Nov’18]
Ans. When a business operates in a more automated environment it is likely that we will see several
business functions and activities happening within the systems. Consider the following aspects,
• Computa ti on and Calcula tions are automa tica lly carri ed out (for exampl e, bank interest
computation and inventory valuation)
• Accounting entries are posted automatically (for example, sub-ledger to GL postings are automatic)
• Business policies and procedures, including internal controls, are applied automatically (for
example, delegation of authority for journal approvals, customer credit limit checks are performed
automatically)
• Reports used in business are produced from systems. Management and other stakeholders rely
on these reports and information produced (for example, debtors ageing report)
• User access and security are controlled by assigning system roles to users (for example, segregation
of duties can be enforced effectively)
Q-9 Discuss the impact of IT related risks on Substantive Audit, Controls and Reporting. [RTP-May’18]
Ans. Impact of IT related risks i.e. on Substantive Audit, Controls and Reporting: The above risks, if not
mitigated, could have an impact on audit in different ways. Let us understand how:

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 • First, we may not be able to rely on the data obtained from systems where such risks exist. This
means, all forms of data, information or reports that we obtain from systems for the purpose of
audit has to be thoroughly tested and corroborated for completeness and accuracy.
• Second, we will not be able to rely on automated controls, calculations, accounting procedures
that are built into the applications. Additional audit work may be required in this case.
• Third, due to the regulatory requirement of auditors to report on internal financial controls of a
company, the audit report also may have to be modified in some instances.
In all the above scenarios, it is likely that the auditor will be required to obtain more audit
evidence and perform additional audit work. The auditor should also be able to demonstrate how
the risks were identified and what audit evidence was obtained and validated to address these IT
risks.
Here, we should remember that as the complexity, automation and dependence of business
operations on IT systems increases, the severity and impact of IT risks too increases accordingly.
The auditor should apply professional judgement in determining and assessing such risks and
plan the audit response appropriately.
Q-10 With respect to audit in an automated environment, explain the following:
(i) CAATs (ii) Data Analytics (iii) Database (iv) Information Systems
(v) Privileged access [Sugg.-Nov’18,5 Marks]
Ans.(i) CAATs: Short form for Computer Assisted Audit Techniques, are a collection of computer based tools
and techniques that are used in an audit for analysing data in electronic form to obtain audit evidence.
(ii) Data Analytics: A combination of processes, tools and techniques that are used to tap vast amounts of
electronic data to obtain meaningful information
(iii) Database: A logical subsystem within a larger information system where electronic data is stored in a
predefined form and retrieved for use.
(iv) Information Systems: Refers to a collection of electronic hardware, software, networks and processes
that are used in a business to carry out operations and transactions.
(v) Privileged access: A type of super user access to information systems that enforces less or no limits on
using that system.
Q-11 List any five points that an auditor should consider to obtain an understanding of the Company’s
automated environment. [Sugg.-Nov’18,5 Marks]
Ans. Understanding of the Company’s Automated Environment: Given below are some of the points that an
auditor should consider to obtain an understanding of the company’s automated environment
• Information systems being used (one or more application systems and what they are)
• their purpose (financial and non-financial)
• Location of IT systems - local vs global
• Architecture (desktop based, client-server, web application, cloud based)
• Version (functions and risks could vary in different versions of same application)
• Interfaces within systems (in case multiple systems exist)
• In-house vs Packaged
• Outsourced activities (IT maintenance and support)
• Key persons (CIO, CISO, Administrators)

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 C H A PT E R- 7
AUDIT SAMPLING

Q-1 XYZ Ltd is engaged in trading of electronic goods and having huge accounts receivables. For analysing
the whol e accounts receivabl es, audi tor wanted to use sampling technique. In considering the
characteristics of the population from which the sample will be drawn, the auditor determines that
stratification or value-weighted selection technique is appropriate. SA 530 provides guidance to the
auditor on the use of stratification and value-weighted sampling techniques. Advise the auditor in
accordance with SA 530. [MTP-Oct’19,4 Marks, RTP-Nov’18]
Ans. Stratification and Value-Weighted Selection: In considering the characteristics of the population from
which the sample will be drawn, the auditor may determine that stratification or value-weighted
selection technique is appropriate. SA 530 provides guidance to the auditor on the use of stratification
and value-weighted sampling techniques.
Stratification: Audit efficiency may be improved if the auditor stratifies a population by dividing it into
discrete sub-populations which have an identifying characteristic. The objective of stratification is to
reduce the variability of items within each stratum and therefore allow sample size to be reduced
without increasing sampling risk.
When performing tests of details, the population is often stratified by monetary value. This allows
greater audit effort to be directed to the larger value items, as these items may contain the greatest
potential misstatement in terms of overstatement. Similarly, a population may be stratified according
to a particular characteristic that indicates a higher risk of misstatement, for example, when testing the
allowance for doubtful accounts in the valuation of accounts receivable, balances may be stratified by
age.
The results of audit procedures applied to a sample of items within a stratum can only be projected to
the items that make up that stratum. To draw a conclusion on the entire population, the auditor will
need to consider the risk of material misstatement in relation to whatever other strata make up the
entire population.
For example, 20% of the items in a population may make up 90% of the value of an account balance. The
auditor may decide to examine a sample of these items. The auditor evaluates the results of this
sample and reaches a conclusion on the 90% of value separately from the remaining 10% (on which a
further sample or other means of gathering audit evidence will be used, or which may be considered
immaterial).
If a class of transactions or account balance has been divided into strata, the misstatement is projected
for each stratum separately. Projected misstatements for each stratum are then combined when
considering the possible effect of misstatements on the total class of transactions or account balance.
Value-Weighted Selection: When performing tests of details it may be efficient to identify the sampling
unit as the individual monetary units that make up the population. Having selected specific monetary
units from within the population, for example, the accounts receivable balance, the auditor may then

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 examine the particular items, for example, individual balances, that contain those monetary units.
One benefit of this approach to defining the sampling unit is that audit effort is directed to the larger
value items because they have a greater chance of selection, and can result in smaller sample sizes.
This approach may be used in conjunction with the systematic method of sample selection and is most
efficient when selecting items using random selection.
Q-2 The sample size can be determined by the application of a statistically-based formula or through the
exercise of professional judgment. When circumstances are similar, the effect on sample size of factors
will be similar regardless of whether a statistical or non-statistical approach is chosen.
Explain stating the examples of factors (any four) that the auditor may consider when determining the
sample size for tests of controls.[MTP-March’19,4 Marks, MTP-March’18,5 Marks, MTP-Oct’18,5 Marks]
Ans. The level of sampling risk that the auditor is willing to accept affects the sample size required. The
lower the risk the auditor is willing to accept, the greater the sample size will need to be.
The sample size can be determined by the application of a statistically-based formula or through the
exercise of professional judgment. When circumstances are similar, the effect on sample size of factors
will be similar regardless of whether a statistical or non-statistical approach is chosen.
Examples of Factors Influencing Sample Size for Tests of Controls: The following are factors that the
auditor may consider when determining the sample size for tests of controls. These factors, which
need to be considered together, assume the auditor does not modify the nature or timing of tests of
controls or otherwise modify the approach to substantive procedures in response to assessed risks.
• When there is an increase in the extent to which the auditor’s risk assessment takes into account
re l eva nt con trols.The more assurance th e audi tor inte nds to obtain from the ope ra ti ng
effectiveness of controls, the lower the auditor’s assessment of the risk of material misstatement
will be, and the larger the sample size will need to be. When the auditor’s assessment of the risk
of ma terial misstatement a t the assertion l evel includes an expecta tion of the opera ting
effectiveness of controls, the auditor is required to perform tests of controls. Other things being
equal, the greater the reliance the auditor places on the operating effectiveness of controls in the
risk assessment, the greater is the extent of the auditor’s tests of controls (and therefore, the
sample size is increased).Thus, sample size will increase.
• If there is an increase in the tolerable rate of deviation. Then sample size will decrease, as lower
the tolerable rate of deviation, larger the sample size needs to be.
• When there is an increase in the expected rate of deviation of the population to be tested
thensample size will increase, as higher the expected rate of deviation, larger the sample size
needs to be so that the auditor is in a position to make a reasonable estimate of the actual rate of
deviation. Factors relevant to the auditor’s consideration of the expected rate of deviation include
the auditor’s understanding of the business (in particular, risk assessment procedures undertaken
to obtain an understanding of internal control), changes in personnel or in internal control, the
results of audit procedures applied in prior periods and the results of other audit procedures.
High expected control deviation rates ordinarily warrant little, if any, reduction of the assessed
risk of material misstatement.
• An increase in the auditor’s desired level of assurance that the tolerable rate of deviation is not
exceeded by the actual rate of deviation in the population will increase the sample size.
Thus, the greater the level of assurance that the auditor desires that the results of the sample are
in fact indicative of the actual incidence of deviation in the population, the larger the sample size
needs to be.

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 • In case of large populations, the actual size of the population has little, if any, effect on sample
size. For small populations however, audit sampling may not be as efficient as alternative means
of obtaining sufficient appropriate audit evidence. Therefore, there will be negligible effect on
sample size due to increase in the number of sampling units in the population.
Q-3 The auditor shall evaluate the results of the sample and whether the use of audit sampling has provided
a reasonable basis for conclusions about the population that has been tested. Analyse and explain.
[MTP-Aug’18,5 Marks, RTP-Nov’18]
Ans. The auditor shall evaluate-
(a) The results of the sample; and
(b) Whether the use of audit sampling has provided a reasonable basis for conclusions about the
population that has been tested.
For tests of controls, an unexpectedly high sample deviation rate may lead to an increase in the assessed
risk of material misstatement, unless further audit evidence substantiating the initial assessment is
obtained. For tests of details, an unexpectedly high misstatement amount in a sample may cause the
auditor to believe that a class of transactions or account balance is materially misstated, in the absence
of further audit evidence that no material misstatement exists.
In the case of tests of details, the projected misstatement plus anomalous misstatement, if any, is the
auditor’s best estimate of misstatement in the population. When the projected misstatement plus
anomalous misstatement, if any, exceeds tolerable misstatement, the sample does not provide a
reasonable basis for conclusions about the population that has been tested. The closer the projected
misstatement plus anomalous misstatement is to tolerable misstatement, the more likely that actual
misstatement in the population may exceed tolerable misstatement. Also if the projected misstatement
is greater than the auditor’s expectations of misstatement used to determine the sample size, the
auditor may conclude that there is an unacceptable sampling risk that the actual misstatement in the
population exceeds the tolerable misstatement. Considering the results of other audit procedures
helps the auditor to assess the risk that actual misstatement in the population exceeds tolerable
misstatement, and the risk may be reduced if additional audit evidence is obtained.
In case the auditor concludes that audit sampling has not provided a reasonable basis for conclusions
about the population that has been tested, the auditor may request management to investigate
misstatements that have been identified and the potential for further misstatements and to make any
necessary adjustments; or tailor the nature, timing and extent of those further audit procedures to
best achieve the required assurance. For example, in the case of tests of controls, the auditor might
extend the sample size, test an alternative control or modify related substantive procedures.
Q-4 There is a growing realisation that the traditional approach to audit is economically wasteful because
all efforts are directed to check all transactions without exception. Explain [RTP-Nov’19]
Ans. No conscious effort in human society is divested of economic considerations and auditing is no
exception. There is a growing realisation that the traditional approach to audit is economically wasteful
because all efforts are directed to check all transactions without exception. This invariably leads to
more emphasis on routine checking, which often is not necessary in view of the time and the cost
involved. With the shift in favour of formal internal controls in the management of affairs of
organisations, the possibilities of routine errors and frauds have greatly diminished and auditors often
find extensive routine checking as nothing more than a ritual because it seldom reveals anything
material. Now the approach to audit and the extent of checking are undergoing a progressive change in
favour of more attention towards the questions of principles and controls with a curtailment of non-
consequential routine checking. By routine checking we traditionally think of extensive checking and
vouching of all entries.

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Q-5 The extent of the checking to be undertaken is primarily a matter of judgment of the auditor.
It is in the interest of the auditor that if he decides to form his opinion on the basis of a part checking,
he should adopt standards and techniques which are widely followed Explain [RTP-Nov’19]
Ans. The extent of the checking to be undertaken is primarily a matter of judgment of the auditor, there is
nothing statutorily stated anywhere which specifies what work is to be done, how it is to be done and
to what extent. It is also not obligatory that the auditor must adopt the sampling technique. What he is
to do is to express his opinion and become bound by that.
To ensure good and reasonable standard of work, he should adopt standards and techniques that can
lead him to an informed professional opinion. On a consideration of this fact, it can be said that it is in
the interest of the auditor that if he decides to form his opinion on the basis of a part checking, he
should adopt standards and techniques which are widely followed and which have a recognised basis.
Since statistical theory of sampling is based on a scientific law, it can be relied upon to a greater extent
than any arbitrary technique which lacks in basis and acceptability.
Q-6 The auditor is required to project misstatements for the population to obtain a broad view of the scale
of misstatement. Explain [RTP-May’19, RTP-May’2020]
Ans. The auditor is required to project misstatements for the population to obtain a broad view of the scale
of misstatement but this projection may not be sufficient to determine an amount to be recorded.
When a misstatement has been established as an anomaly, it may be excluded when projecting
misstatements to the population. However, the effect of any such misstatement, if uncorrected, still
needs to be considered in addition to the projection of the non-anomalous misstatements.
For tests of details, the auditor shall project misstatements found in the sample to the population
whereas for tests of controls, no explicit projection of deviations is necessary since the sample deviation
rate is also the projected deviation rate for the population as a whole.
Q-7 Discuss the factors that should be considered for deciding upon the extent of checking on a sampling
plan. [RTP-May’19, Sugg.May’18,5 Marks]
Ans. The factors that should be considered for deciding upon the extent of checking on a sampling plan are
following:
(i) Size of the organisation under audit.
(ii) State of the internal control.
(iii) Adequacy and reliability of books and records.
(iv) Tolerable error range.
(v) Degree of the desired confidence.
Q-8 W ha teve r m ay b e the a pproach non-st a t ist ical or sta tist ica l sa mpl ing, th e sa mpl e must b e
representative. Discuss explaining Statistical and Non Statistical sampling approaches.
[RTP-Nov’18]
Ans. Audit sampling enables the auditor to obtain and evaluate audit evidence about some characteristic of
the items selected in order to form or assist in forming a conclusion concerning the population from
which the sample is drawn. Audit sampling can be applied using either non-statistical or statistical
sampling approaches.

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 Statistical sampling is an approach to sampling that has the random selection of the sample items; and
the use of probability theory to evaluate sample results, including measurement of sampling risk
characteristics. A sampling approach that does not have above characteristics is considered non-
statistical sampling.

The decision whether to use a statistical or non-statistical sampling approach is a matter for the auditor’s
judgment; however, sample size is not a valid criterion to distinguish between statistical and non-
statistical approaches.
Sample must be representative.
W ha teve r ma y be the a ppro ach non-sta tist ical or st a t ist ical sampl ing, the sampl e must be
representative. This means that it must be closely similar to the whole population although not
necessarily exactly the same. The sample must be large enough to provide statistically meaningful
results.
Q-9 Explain the sampling method which involves selection of a block(s) of contiguous items from within
the population. Also give example. [RTP-May’20]
Ans. Block Sampling: This method involves selection of a block(s) of contiguous items from within the
population. Block selection cannot ordinarily be used in audit sampling because most populations are
structured such that items in a sequence can be expected to have similar characteristics to each other,
but different characteristics from items elsewhere in the population. Although in some circumstances
it may be an appropriate audit procedure to examine a block of items, it would rarely be an appropriate
sampl e selection technique when the auditor intends to draw valid inferences about the entire
population based on the sample.
Example
Take the first 200 sales invoices from the sales day book in the month of September; alternatively take
any four blocks of 50 sales invoices. Therefore, once the first item in the block is selected, the rest of
the block follows items to the completion.

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MULTIPLE CHOICE QUESTIONS

1. In the case of tests of details

(a) the projected misstatement plus anomalous misstatement, if any, is the auditor’s best estimate
of misstatement in the population.
(b) the projected misstatement is the auditor’s best estimate of misstatement in the population.
(c) the anomalous misstatement is the auditor’s best estimate of misstatement in the population.
(d) the projected misstatement plus anomalous misstatement, if any, cannot be the auditor’s best
estimate of misstatement in the population. [MTP-March’19]
2. Which of the following is correct :
(a) When the projected misstatement exceeds tolerable misstatement, the sample does not provide
a reasonable basis for conclusions about the population that has been tested.
(b) When the projected misstatement plus anomalous misstatement, if any, exceeds tolerable
misstatement, the sample does not provide a reasonable basis for conclusions about the population
that has been tested.
(c) When the anomalous misstatement exceeds tolerable misstatement, the sample does not provide
a reasonable basis for conclusions about the population that has been tested.
(d) When the projected misstatement plus anomalous misstatement, if any, exceeds tol erable
misstatement, the sample provides a reasonable basis for conclusions about the population that
has been tested. [MTP-March’19]
3. It is a type of value-weighted selection in which sample size, sel ection and evaluation results in
aconclusion in monetary amounts :
(a) Haphazard sampling (b) Monetary Unit Sampling
(c) Stratified Sampling (d) Interval sampling [MTP-March’19]

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 C H A PT E R- 8
ANALYT ICAL PRO C E DUR ES

Q-1 Ratio analysis is useful for analysing asset and liability accounts as well as revenue and expense accounts.
An individual balance sheet account is difficult to predict on its own, but its relationship to another
account is often more predictable (e.g., the trade receivables balance related to sales).
Explain stating the techniques available as substantive analytical procedures.
[MTP-Oct’19,3 Marks-MTP-Aug’18,5 Marks-RTP-May’19, Sugg.-May’19,4 Marks, Sugg.-May’18,5 Marks]
Ans. procedure is limited only by the availability of reliable data and the experience and creativity of the
audit team. Substantive analytical procedures generally take one of the following forms:
• Trend analysis — A commonly used technique is the comparison of current data with the prior
period balance or with a trend in two or more prior period balances. We evaluate whether the
current balance of an account moves in line with the trend established with previous balances for
that account, or based on an understanding of factors that may cause the account to change.
• Ratio analysis — Ratio analysis is useful for analysing asset and liability accounts as well as revenue
and expense accounts. An individual balance sheet account is difficult to predict on its own, but
its relationship to another account is often more predictable (e.g., the trade receivables balance
related to sales). Ratios can also be compared over time or to the ratios of separate entities
within the group, or with the ratios of other companies in the same industry.
• For example, Financial ratios may include:
• Trade receivables or inventory turnover
• Freight expense as a percentage of sales revenue
• Reasonableness tests — Unlike trend analysis, this analytical procedure does not rely on events
of prior periods, but upon non-financial data for the audit period under consideration (e.g.,
occupancy ra tes to estimate rental income or interest rates to estimate interest income or
expense). These tests are generally more applicable to income statement accounts and certain
accrual or prepayment accounts.
• Structural modelling — A modelling tool constructs a statistical model from financial and/or non-
financial data of prior accounting periods to predict current account balances (e.g., linear
regression).
Q-2 Substantive analytical procedures are generally more applicable to large volumes of transactions that
tend to be predictable over time. Explain. [MTP-April’19,4 Marks-RTP-Nov’18]
Ans. Substantive Analytical Procedure: Substantive analytical procedures are generally more applicable to
large volumes of transactions that tend to be predictable over time. The application of planned analytical
procedures is based on the expectation that relationships among data exist and continue in the absence
of known conditions to the contrary. However, the suitability of a particular analytical procedure will
depend upon the auditor’s assessment of how effective it will be in detecting a misstatement that,
individually or when aggregated with other misstatements, may cause the financial statements to be
materially misstated.

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 In some cases, even an unsophisticated predictive model may be effective as an analytical procedure.
For example, where an entity has a known number of employees at fixed rates of pay throughout the
period, it may be possible for the auditor to use this data to estimate the total payroll costs for the
period with a high degree of accuracy, thereby providing audit evidence for a significant item in the
financial statements and reducing the need to perform tests of details on the payroll. The use of
widely recognised trade ratios (such as profit margins for different types of retail entities) can often be
used effectively in substantive analytical procedures to provide evidence to support the reasonableness
of recorded amounts.
Q-3 The reliability of data is influenced by its source and nature and is dependent on the circumstancesunder
which it is obtained. Accordingly, explain the factors that are relevant when determining whether data
is reliable for purposes of designing substantive analytical procedures.
[[Sugg.-Nov’19, 3 Marks, MTP-March’18,5 Marks,MTP-Oct’18,5 Marks]
Ans. The reliability of data is influenced by its source and nature and is dependent on the circumstances
under which it is obtained. Accordingly, the following are relevant when determining whether data is
reliable for purposes of designing substantive analytical procedures:
(i) Source of the information available. For example, information may be more reliable when it is
obtained from independent sources outside the entity;
(ii) Comparability of the information available. For example, broad industry data may need to be
supplemented to be comparable to that of an entity that produces and sells specialised products;
(iii) Nature and relevance of the information available. For example, whether budgets have been
established as results to be expected rather than as goals to be achieved; and
(iv) Controls over the preparation of the information that are designed to ensure its completeness,
accuracy and validity. For example, controls over the preparation, review and maintenance of
budgets.
The auditor may consider testing the operating effectiveness of controls, if any, over the entity’s
preparation of information used by the auditor in performing substantive analytical procedures in
response to assessed risks. When such controls are effective, the audi tor generally has greater
confidence in the reliability of the information and, therefore, in the results of analytical procedures.
The opera ting effectiveness of controls over non-financial information may often be tested in
conjunction with other tests of controls. For example, in establishing controls over the processing of
sales invoices, an entity may include controls over the recording of unit sales. In these circumstances,
the auditor may test the operating effectiveness of controls over the recording of unit sales in
conjunction with tests of the operating effectiveness of controls over the processing of sales invoices.
Alternatively, the auditor may consider whether the information was subjected to audit testing. SA 500
(Revised) establishes requirements and provides guidance in determining the audit procedures to be
performed on the information to be used for substantive analytical procedures.
Q-4 Routine checks cannot be depended upon to disclose all the mistakes or manipulation that may exist in
accounts, certain other procedures also have to be applied like trend and ratio analysis. Analyse and
Explain stating clearly the meaning of analytical procedures. [RTP-Nov’19]
Ans. Since routine checks cannot be depended upon to disclose all the mistakes or manipulation that may
exist in accounts, certain other procedures also have to be applied like trend and ratio analysis in
addition to reasonable tests. These collectively are known as overall tests. With the passage of tests,
analytical procedures have acquired lot of significance as substantive audit procedure. SA-520 on
Analytical Procedures discusses the application of analytical procedures during an audit.

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 Meaning of Analytical Procedures. As per the Standard on Auditing (SA) 520 “Analytical Procedures”,
the term “analytical procedures” means evalua tions of financial information through analysis of
plausibl e rela tionships among both financial and non-financial data. Analytical procedures also
encompass such investigation as is necessary of identified fluctuations or relationships tha t are
inconsistent with other relevant information or that differ from expected values by a significant amount.
Q-5 Give examples of Analytical Procedures having consideration of comparisons of the entity’s financial
information [RTP-Nov’19]
Ans. Examples of Analytical Procedures having consideration of comparisons of the entity’s financial
information with are:
• Comparable information for prior periods.
• Anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor, such
as an estimation of depreciation.
• Similar industry information, such as a comparison of the entity’s ratio of sales to accounts
receivable with industry averages or with other entities of comparable size in the same industry
Q-6 If analytical procedures performed in accordance with SA 520 identify fluctuations or relationships that
are inconsistent with other relevant information or that differ from expected values by a significant
amount, explain how would the auditor investigate such differences. [RTP-May’19]
Ans. If analytical procedures performed in accordance with SA 520 identify fluctuations or relationships that
are inconsistent with other relevant information or that differ from expected values by a significant
amount, the auditor shall investigate such differences by:
(i) Inquiring of management and obtaining appropriate audit evidence relevant to management’s
responses: Audit evidence relevant to management ’s responses may be obtained by evaluating
those responses taking into account the auditor’s understanding of the entity and its environment,
and with other audit evidence obtained during the course of the audit.
(ii) Performing other audit procedures as necessary in the circumstances: The need to perform other
audit procedures may arise when, for example, management is unable to provide an explanation,
or the explanation, together with the audit evidence obtained relevant to management’s response,
is not considered adequate.
Q-7 The relationships between individual financial statements items traditionally considered in the audit
of business entities may not always be relevant in the audit of governments or other non-business
public sector entities. Analyse and Explain.
Ans. The relationships between individual financial statements items traditionally considered in the audit
of business entities may not always be relevant in the audit of governments or other non-business
public sector entities; for example, in many public sector entities there may be little direct relationship
between revenue and expenditure. In addition, because expenditure on the acquisition of assets may
not be capitalized, there may be no relationship between expenditures on, for example, inventories
and fixed assets and the amount of those assets reported in the financial statements. Also, industry
data or statistics for comparative purposes may not be available in the public sector. However, other
relationships may be relevant, for example, variations in the cost per kilometer of road construction or
the number of vehicles acquired compared with vehicles retired.
Q-8 Analytical procedures use comparisons and relationships to assess whether account balances or other
data appear reasonable. Explain stating the purpose of analytical procedures with examples.
[RTP-Nov’18]
Ans. Purpose of Analytical Procedures : Analytical procedures use comparisons and relationships to assess

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 whether account balances or other data appear reasonable. Analytical procedures are used for the
following purposes:
(i) To obtain relevant and reliable audit evidence when using substantive analytical procedures; and
(ii) To design and perform analytical procedures near the end of the audit that assist the auditor
when forming an overall conclusion as to whether the financial statements are consistent with
the auditor’s understanding of the entity.
For instance, establishing the relationship that exists between certain balances included in the Balance
Sheet and the Statement of Profit and Loss and comparing them with those that existed between the
same set of balances in the previous year’s reconciling the physical balances of assets with the relevant
financial record; obtaining of account from the bankers, account receivables and account payables and
reconciling with relevant balances in books of account; confirming amounts of outstanding income and
expenses by preparing reconciliation statements, etc. These are helpful in the detection of unusual
state of affairs and mistakes in accounts.
Example: In XYZ Ltd., after applying analytical procedures as comparison of the gross profit ratio with
that of the previous year, it is discovered that there has been fall in the ratio. Therefore, it became
necessary for the auditor to make further enquiries as it may be due to pilferage of inventories/
misappropriation of a part of the sale proceeds/ a change in the cost of sales without a corresponding
increase in the sales price.
Likewise, on verifying the balances of sundry account receivables and account payables by obtaining
the confirmation of their statements of account, it will be possible for the auditor to find out whether
the discrepancy in the balance of an account receivable is due to the failure to debit his account with
the cost of goods supplied to him or is the result of non-adjustment of a remittance received from him.
Also whether in the case of account payable, the discrepancy is due to failure to afford him credit for
one or more consignments of goods supplied by him or failure to debit him wi th an amount of
remittance. Similarly, by taking inventories of raw materials and stores at the end of the year any
excesses or shortages therein shall be detected. The investigation of their causes might disclose that
the shortages were the result of a misappropriation of inventory or that the excess were due to
requisitions having been entered before the inventories were issued. In the same way, by reconciling
the amounts of interest and dividends collected with the amounts which had accrued due and that
which are outstanding for payment, the mistake, if any, in the adjustment of such an income would be
detected. The overall tests can be extended for making inter-firm and intra-firm comparison of trading
results. For example, if balances included in the Statement of Profit and Loss of an entity are compared
with those contained in the Statement of Profit and Loss for the same period of another entity engaged
in the same trade and working under similar circumstances, it would be possible to find out the cause
of the variation in the rate of profitability that exists. Similarly, it would also be possible to compare
the balances on the Statement of Profit and Loss with that of the previous period, it would be possible
to find out the reasons for increase or decrease in the amount of profits of those years. By setting up
certain expenses ratios on the basis of balances included in the Statement of Profit and Loss, for the
year under audit, comparing them with the same ratios for the previous year, it is possible to ascertain
the extent of increase or decrease in various items of expenditure in relation to sales and that of
trading profit in relation to sales. If differences are found to be material, the auditor would ascertain
the reasons thereof and assess whether the accounts have been manipulated to inflate or suppress
profits.
An abnormal fall in the cost of manufacture or that in the administrative cost, apart from economy in
expenses, there could be no provision or less provision for expenses incurred in the year. When it is
suspected, the auditor should compare the entries in the outstanding book with those in the previous
year. He must also check the vouchers for one month immediately before the close of the following

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 years. To verify that none of the expenses in the accounts under audit have been charged to the
accounts of the following years.
Often it is possible to independently verify the correctness of some of the items of expenses included
in the Statement of Profit and Loss. For instance the cost of importing goods which are subjected to an
ad valorem duty at uniform rate can be verified from the amount of duty paid. Similarly, a quantity of
sugar sold by sugar mill can be verified independently from the amount of excise duty paid. Similarly,
the amount of any income or expenses which has a direct relationship with the amount of profits or
that of sales can be verified independently, e.g., commission paid to a manager calculated on the basis
of net profits,commission paid to a selling agent as percentage of sales, etc. Such calculation of
ratios,trends and comparisons is also termed as analytical review.
Thus, it is important to note that Analytical procedures may help identify the existence of unusual
transactions or events, and amounts, ratios, and trends that might indicate matters that have audit
implica tions. Unusual or unexpected relationships that are identified may assist the auditor in
identifying risks of material misstatement, especially risks of material misstatement due to fraud.
Q-9 Ratio analysis is useful for analysing asset and liability accounts as well as revenue and expense accounts.
An individual balance sheet account is difficult to predict on its own, but its relationship to another
account is often more predictable (e.g., the trade receivables balance related to sales).
Explain stating the techniques available as substantive analytical procedures. [RTP-Nov’18]
Ans. Techniques available as substantive analytical procedures: The design of a substantive analytical
procedure is limited only by the availability of reliable data and the experience and creativity of the
audit team. Substantive analytical procedures generally take one of the following forms:
Trend analysis — A commonly used technique is the comparison of current data with the prior period
balance or with a trend in two or more prior period balances. We evaluate whether the current balance
of an account moves in line with the trend established with previous balances for that account, or
based on an understanding of factors that may cause the account to change.
Ratio analysis — Ratio analysis is useful for analysing asset and liability accounts as well as revenue and
expense accounts. An individual balance sheet account is difficult to predict on its own, but i ts
relationship to another account is often more predictable (e.g., the trade receivables balance related
to sales). Ratios can also be compared over time or to the ratios of separate entities within the group,
or with the ratios of other companies in the same industry.
For example, Financial ratios may include:
Trade receivables or inventory turnover
Freight expense as a percentage of sales revenue
Reasonableness tests — Unlike trend analysis, this analytical procedure does not rely on events of
prior periods, but upon non-financial data for the audit period under consideration (e.g., occupancy
rates to estimate rental income or interest rates to estimate interest income or expense). These tests
are generally more applicabl e to income sta tement accounts and certain accrual or prepayment
accounts.
Structural modelling — A modelling tool constructs a statistical model from financial and/or non-
financial data of prior accounting periods to predict current account balances (e.g., linear regression).
Q-10 Explain the commonly used technique in the comparison of current data with the prior period balance
or with a trend in two or more prior period balances. [RTP-May’20]
Ans. Trend analysis – A commonly used technique is the comparison of current data with the prior period
balance or with a trend in two or more prior period balances. We evaluate whether the current balance
of an account moves in line with the trend established with previous balances for that account, or
based on an understanding of factors that may cause the account to change.

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Q-11 When designing and performing substantive analytical procedures, either alone or in combination
with tests of details, as substantive procedures in accordance with SA 330, the auditor shall determine
the suitability of particular substantive analytical procedures for given assertions, taking account of
the assessed risks of material misstatement and tests of details, if any, for these assertions. Explain the
other relevant points in this context. [RTP-May’2020]
Ans. When designing and performing substantive analytical procedures, either alone or in combination
with tests of details, as substantive procedures in accordance with SA 330, the auditor shall:
(i) Determine the suitability of particular substantive analytical procedures for given assertions,
taking account of the assessed risks of material misstatement and tests of details, if any, for these
assertions;
(ii) Evaluate the reliability of data from which the auditor’s expectation of recorded amounts or
ratios is developed, taking account of source, comparabili ty, and na ture and relevance of
information available, and controls over preparation;
(iii) Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is
sufficiently precise to identify a misstatement that, individually or when aggregated with other
misstatements, may cause the financial statements to be materially misstated; and
(iv) Determine the amount of any difference of recorded amounts from expected values that is
acceptable without further investigation.
Q-12 Discuss the audit procedure to be considered by an auditor while performing analytical procedure to
obtain audit evidence as to overall reasonableness of purchase quantity and price.
[Sugg.-Nov’19,3 Marks]
Ans. Auditor needs to perform analytical procedures to obtain audit evidence as to overall reasonableness
of purchase quantity and price which may include:
(i) Consumption Analysis: Auditor should scrutinize raw material consumed as per manufacturing
account and compare the same with previous years with closing stock and ask for the reasons
from management if any significant variations found.
(ii) Stock Composition Analysis: Auditor to collect the reports from management for composition of
stock i.e. raw materials as a percentage of total stock and compare the same with compare the
same with previous years and ask for the reasons from management if any significant variations
found.
(iii) Ratios: Auditor should compare the creditors turnover ratios and stock turnover ratios of the
current year with previous years.
(iv) Auditor should review quantitative reconciliation of closing stocks with opening stock, purchases
and consumption.

MULTIPLE CHOICE QUESTIONS

1. Which of the following is not an analytical procedure?

(a) Tracing of purchases recurred in the purchase book to purchase invoices
(b) Comparing aggregate wages paid to number of employees
(c) Comparing the actual costs with standard costs
(d) All of them are analytical procedures [MTP-Oct’19]

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2. Which of the following is correct :
(a) different types of analytical procedures provide different levels of assurance.
(b) Different types of analytical procedures provide similar levels of assurance.
(c) Similar type of analytical procedures provide different levels of assurance.
(d) All are correct [MTP-Oct’19]
3. Which of the following is correct :
(a) As per the Standard on Auditing (SA) 520 “Analytical Procedure” ‘the term “analytical procedures”
means evaluations of financial information through analysis of financial data.
(b) As per the Standard on Auditing (SA) 520 “Analytical Procedure” ‘the term “analytical procedures”
means evaluations of financial information through analysis of non-financial data.
(c) As per the Standard on Auditing (SA) 520 “Analytical Procedure” ‘the term “analytical procedures”
means evaluations of financial information through analysis of plausible relationships among
both financial and non-financial data.
(d) As per the Standard on Auditing (SA) 520 “Analytical Procedure” ‘the term “analytical procedures”
means evaluations of financial information through ratio analysis. [MTP-Oct’19]
4. Which of the following statement is correct :
(a) Substantive analytical procedures are generally more applicable to large volumes of transactions
that tend to be predictable over time
(b) Substantive analytical procedures are generally less applicable to large volumes of transactions
that tend to be predictable over time
(c) Substantive analytical procedures are generally more applicable to small volumes of transactions
that tend to be predictable over time
(d) None of the above [MTP-Oct’19]
5. Marvin Ltd. is a renowned food chain supplier in a posh area providing restaurant facility along with
food delivering. CA. Felix was appointed as an auditor of the company for the Financial Year 2017-18.
While examining the books of account of the company, CA. Felix came to know about one of the major
expenses of the company i.e. rent expense of ` 1,20,000 per month, for which he applied substantive
analytical procedure for verification purpose. Explain, how would CA. Felix perform substantive
analytical procedure in the given scenario?
(a) CA. Felix would inspect every single rent invoice per month of ` 1,20,000 and verify other
elements appropriately.
(b) CA. Felix would compare the rental expense of the company with that of another nearby company
having corresponding dimensions, for high degree of accuracy.
(c) CA. Felix would select the first month rent invoice of ` 1,20,000 and appropriately verifying other
elements would predict that the rent for the whole year would be ` 14,40,000 (i.e. ` 1,20,000 * 12).
Thereafter, he would compare the actuals with his prediction and follow-up for any fluctuation.
(d) (a) and (b), both. [RTP-May’19]



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 C H A PT E R- 9
AUDIT O F IT E MS O F F INANCIAL ST A T E M E NTS

Q-1 What are the obvious assertions in the following items appearing in the Financial Statements?
(i) Statement of Profit and Loss
Travelling Expenditure Rs. 50,000
(ii) Balance Sheet
Trade receivable Rs. 2,00,000 [MTP-Oct’19]
Ans. (i) Travelling Expenditure Rs. 50,000
• Expenditure has been actually incurred for the purpose of travelling.
• Travelling has been undertaken during the year under consideration.
• Total amount of expenditure incurred is Rs. 50,000 during the year.
• It has been treated as revenue expenditure and charged to Statement of Profit and Loss.
(ii) Trade receivable Rs. 2,00,000
• These include all sales transaction occurred during the year.
• These have been recorded properly and occurred during the year.
• These constitute assets of the entity.
• These have been shown at proper value, i.e. after showing the deduction on account of provision
for bad and doubtful debts.
Q-2 The auditor A of ABC & Co.- firm of auditors is conducting the audit of XYZ Ltd and while performing
testing of additions wanted to verify that all PPE (Property Plant and Equipment) purchase invoices are
in the name of the entity he is auditing. For all additions to land, building in particular, the auditor
desires to have concrete evidence about ownership. The auditor is worried about whether the entity
has valid legal ownership rights over the PPE claimed to be held by the entity and recorded in the
financial statements. Advise the auditor. [MTP-Oct’19,3 Marks, RTP-Nov’19, RTP-May’18]
Ans. In addition to the procedures undertaken for verifying completeness of additions to PPE during th
period under audit, the auditor while performing testing of additions should also verify that all PPE
purchase invoices are in the name of the entity that entitles legal title of ownership to the respective
entity. For all additions to land, building in particular, the auditor should obtain copies of conveyance
deed/ sale deed to establish whether the entity is mentioned to be the legal and valid owner.
The auditor should insist and verify the original title deeds for all immoveable properties held as at the
balance sheet date. In case the entity has given such immoveable property as security for any borrowings
and the original title deeds are not available with the entity, the auditor should request the entity’s
management for obtaining a confirmation from the respective lenders that they are holding the original
title deeds of immoveable property as security. In addition, the auditor should also verify the register
of charges, available with the entity to assess the PPE that has been given as security to any third
parties.
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Q-3 State assertions that are implied in the extract of financial statement given below:
(` )
Plant & Machinery (at Cost) 4,00,000
Less: Depreciation:
Up to Previous year 1,40,000
For the year 26,000 1,66,000
2,34,000
(i) Indicate assertions in respect of transactions and events for the period relating to Fixed Assets.
(ii) State specific assertions relating to the above extract of financial statement.
[MTP-April’19,6 Marks]
Ans.(i) Assertions about transactions and events for the period relating to fixed assets :
(1) Occurrence—transactions and events relating to fixed assets have been recorded, have occurred
and pertain to the entity.
(2) Completeness—all transactions and events relating to fixed assets that should have been recorded
have been recorded.
(3) Accuracy—amounts and other data relating to recorded transactions and events have been
recorded appropriately.
(4) Cut-off—transactions and events have been recorded in the correct accounting period.
(5) Classification—transactions and events have been recorded in the proper accounts.
(ii) The specific assertions are as follows:
(1) the firm owns the plant and machinery;
(2) the historical cost of plant and machinery is Rs. 4 lacs;
(3) the plant and machinery physically exists;
(4) the asset is being utilised in the business of the company productively;
(5) total charge of depreciation on this asset is Rs. 1,66,000 to date on which Rs. 26,000 relates to the
year in respect of which the accounts are drawn up; and
(6) the amount of depreciation has been calculated on recognised basis and the calculation is correct
Q-4 Explain with examples the audit procedure to establish the existence of intangible fixed assets as at
the period- end. [MTP-Oct’19,3 Marks, RTP-Nov’19,RTP-Nov’18]
Ans Since an Intangible Asset is an identifiable non-monetary asset, without physical substance, for
establishing the existence of such assets, the auditor should verify whether such intangible asset is in
active use in the production or supply of goods or services, for rental to others, or for administrative
purposes.
Example- for verifying the existence of software, the auditor should verify whether such software is in
active use by the entity and for the purpose, the auditor should verify the sale of related services/
goods during the period under audit, in which such software has been used.
Example- For verifying the existence of design/ drawings, the auditor should verify the production
data to establish if such products for which the design/ drawings were purchased, are being produced
and sold by the entity.

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 In case any intangible asset is not in active use, deletion should have been recorded in the books of
account post approvals by the entity’s management and amortization charge should have ceased to be
charged beyond the date of deletion.
Q-5 Verification of liabilities is as important as that of assets, considering if any liability is omitt ed (or
understated) or overstated, the Balance Sheet would not show a true and fair view of the state of
affairs of the entity. Explain stating also criteria for a liability to be classified as current liability.
[MTP-April’19,3 Marks, RTP-Nov’18]
Ans. Liabilities in addition to borrowings (discussed above), include trade payables and other current
liabilities, deferred payment credits and provisions. Verification of liabilities is as important as that of
assets, considering if any liability is omitted (or understated) or overstated, the Balance Sheet would
not show a true and fair view of the state of affairs of the entity.
Further, a liability is classified as current if it satisfies any of the following criteria:
• It is expected to be settled in the entity’s normal operating cycle
• It is held primarily for the purpose of being traded
• It is due to be settled within twelve months after the reporting period
• The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period. Terms of a liability that could, at the option of the
counterparty, resul t in its settl ement by the issue of equity instruments does not affect i ts
classification.
Q-6 On going through the financial statements of PQR Ltd, its auditors Kamal Gagan and Associates observed
that company has taken Loans from banks and financial institutions. Further, the audit team discusses
the following about Liabilities:
“Liabilities are the financial obligations of an enterprise other than owners’ funds. Liabilities include
loans/ borrowings, trade payables and other current liabilities, deferred payment credits and provisions.
Verification of liabilities is as important as that of assets, for, if any liability is omitted (or understated)
or over stated, the Balance Sheet would not show a true and fair view of the state of affairs of the
company.”
Advise stating clearly the audit procedures generally required to be undertaken for verification of
existence of Borrowings [MTP-March’18,5 Marks-MTP-Oct’18,5 Marks]
Ans. Review board minutes for approval of new lending agreements. During review, make sure that any
new loan agreements or bond issuances are authorized. Ensure that significant debt commitments
should be approved by the board of directors
• Agree details of loans recorded (interest rate, nature and repayment terms) to the loan agreement.
Verify that borrowing limits imposed by agreements are not exceeded.
• Agree overdrafts and loans recorded to bank confirmation / confirmation to lenders.
• Agree details of leases and hire purchase creditors recorded to underlying agreement.
• Examine trust deed for terms and dates of redemption, borrowing restrictions and compliance
with covenants.
• When debt is retired, ensure that a discharge is received on assets securing the debt.
• If we become aware of significant transactions that are outside the normal course of business or
that otherwise appear to be unusual given our understanding of the entity and its environment,
perform the following procedures:

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 (a) Gain an understanding of the business rationale for such significant unusual transaction.
(b) Consider whether the transactions involve previously unidentified related parties or parties that
do not have the substance or the financial strength to support the transaction without assistance
from the entity we are auditing.
Q-7 “Until the invoice is paid, the invoice amount is recorded on the organization’s balance sheet as accounts
receivable. If balances are not recoverable, then these amounts will need to be written off as an
expense in the income statement/ profit and loss account.”
It is important to carry out compliance procedures in the sales audit as part of the debtors’ audit
procedure.
Verify to ensure that the system for receivables has the necessary features.
[MTP-March’18,5 Marks-MTP-Oct’18,5 Marks]
Ans. Trade receivable are an essential part of any organisation’s balance sheet. Often referred to as debtors,
these are monies which are owed to an organisation by a customer. The most common form of an
account receivable is a sale made on credit, via an invoice, to a customer. Typically, an invoice is raised
and issued to the customer with the invoice amount being recorded as a debtor balance. Until the
invoice is paid, the invoice amount is recorded on the organization’s balance sheet as accounts
receivable. If balances are not recoverable, then these amounts will need to be written off as an
expense in the income statement/ profit and loss account.
It is important to carry out compliance procedures in the sales audit as part of the debtors’ audit
procedure. In summary, check to ensure that the system for receivables has the following features:
• Only bona fide sales lead to receivables
• All such sales are to approved customers
• All such sales are recorded
• Once recorded, the debts can only be eliminated by receipt of cash or on the authority of a
responsible official
• Debts are collected promptly
• Balances are regularly reviewed and aged, a proper system of follow up exists and if necessary
adequate provision for bad debt exists
• Clear segregation of duties relating to identification of debt, receipt of income, reconciliations
and write off of debts
Q-8 Liabilities include trade payables and other current liabilities, deferred payment credits and provisions.
Verification of liabilities is as important as that of assets, considering if any liability is omitt ed (or
understated) or overstated, the Balance Sheet would not show a true and fair view of the state of
affairs of the entity. Advise stating clearly the audit procedure to establish the existence of trad e
payables and other current liabilities as at the period-end. [MTP-Aug’18,10 Marks]
Ans. Audit Procedure to establish the existence of trade payables and other current liabilities :
1. Check whether there are controls in place to ensure that the same purchase / expense invoice
cannot be recorded more than once and payable balances are automatically recorded in the
general ledger at the time of recording of expense.
2. To ensure that trade payable ledger reconciles to general ledger, ask for a period-end accounts
payable aging report and trace the grand total to the amount in the accounts payable account in
the general ledger.

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 3. Calculate the accounts payable report total. Add up the expense / liability items on the accounts
payable aging report to verify that the total traced to the general ledger is correct.
4. Investigate reconciling items. If there are journal entries in the accounts payable account in the
general ledger, review the justification for larger amounts. This implies that these journal entries
should be fully documented.
Direct confirmation procedures
5. An important audit activity is to contact vendors directly and ask them to confirm the amounts of
accounts payable as of the end of the reporting period under audit. This should necessarily be
done for all significant account payable balances as at the period- end and for parties from whom
material purchases have been made during the period under audit even if period- end balance of
such parties is not significant.
6. The auditor employs direct confirmation procedure with the consent of the entity under audit.
There may be situations where the management of the entity requests the auditor not to seek
confirmation from certain trade payables. In such cases, the auditor should consider whether
there are valid grounds for such a request. In appropriate cases, the auditor may also need to
reconsider the nature, timing and extent of his audit procedures including the degree of planned
reliance on management’s representations.
7. The trade creditors may be requested to confirm the balances either (a) as at the date of the
balance sheet, or (b) as at any other selected date which is reasonably close to the date of the
balance sheet. The date should be decided by the auditor in consultation with the Company.
8. The form of requesting confirmation from the trade creditor may be either (a) the ‘positive’ form
of request, wherein the trade creditor is requested to respond whether or not he is in agreement
with the balance shown, or (b) the ‘negative’ form of request wherein the trade creditor is
requested to respond only if he disagrees with the balance shown. The use of the positive form is
preferable when individual account balances are relatively large, or where the internal controls
are weak, or where the auditor has reasons to believe that there may be a substantial number of
accounts in dispute or inaccuracies or irregularities. The negative form is useful when internal
controls are considered to be effective, or when a large number of small balances are involved, or
when the auditor has no reason to believe that the trade creditors are unlikely to respond. If the
negative rather than the positive form of confirmation is used, the number of requests sent and
the extent of the other auditing procedures to be performed should normally be greater so as to
enable the auditor to obtain the same degree of assurance with respect to the trade payable
balances. In many situations, it may be appropriate to use the positive form for trade creditors
with large balances and the negative form for trade creditors with small balances
9. The method of selection of the trade creditors to be circularised should not be revealed to the
Company until the trial balance of the trade payables’ ledger is handed over to the auditor. A list
of trade creditors selected for confirmation should be given to the entity for preparing request
l etters for confirmation which should be properly addressed and auditor should insert an
identification mark, example- a team member inserting his initials in the letter (without informing
the Company) to enable the auditor to continue to maintain unpredictability in audit and to avoid
any wrong doing from management side. The auditor should maintain strict control to ensure the
correctness and proper despatch of request letters. In the alternative, the auditor may request
the client to furnish duly authorised confirmation letters and the auditor may fill in the names,
addresses and the amounts relating to trade creditors selected by him and mail the letters directly.
It should be ensured that confirmations as well as any undelivered letters are returned to the
auditor and not to the client.

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 10. Any discrepancies revealed by the confirmations received or by the additional tests carried out by
the auditor may have a bearing on other accounts not included in the original sample. The entity
should be asked to investigate and reconcile the discrepancies. In addition, the auditor should
also consider what further tests he can carry out in order to satisfy himself as to the correctness of
the amount of trade payables taken as a whole.
11. Where no reply is received, the auditor should perform additional testing regarding the balances.
This testing could include:
• Agreeing the balance to subsequent cash paid;
• Agreeing the detail of the respective balance to the underlying vendor invoices;
• Preparing a detailed analysis of the balance, ensuring it consists of identifiable transactions
and confirming that these purchases/ expense transactions actually occurred;
• Prepare a final summary of the results of the circularization and draw the final conclusion
12. Related party payables. If there are any related party payables, review whether they were properly
authorized and the value of such transactions were reasonable and at arm’s length.
13. Trend analysis. Review a trend line of purchases/ expenses and accounts payable, or a comparison
of the two over time, to see if there are any unusual trends. Make inquiries about reasons for
changes in trends from the management and document the same in audit work papers.
Q-9 State the matters to be included in the auditor’s report as per CARO, 2016 regarding-
(i) F ixed Assets
(ii) statutory dues. [MTP-Aug’18, 5 Marks, Sugg.-May’19,3 Marks, MTP-Oct’18,3 Marks]
Ans. Matters to be included in the Auditor’s Report under CARO, 2016: The auditor’s report on the accounts
of a company to which CARO applies shall include a statement on the following matters, namely-
(i) Fixed Assets -
(1) whether the company is maintaining proper records showing full particulars, including
quantitative details and situation of fixed assets;
(2) whether these fixed assets have been physically verified by the management at reasonable
intervals; whether any material discrepancies were noticed on such verification and if so,
whether the same have been properly dealt with in the books of account;
(3) whether the title deeds of immovable properties are held in the name of the company. If
not, provide the details thereof.
(ii) As per clause (vii) of CARO, 2016, reporting requirements in respect of statutory dues are :
(1) whether the company is regular in depositing undisputed statutory dues including provident
fund, employees’ state insurance, income-tax, sales-tax, service tax, duty of customs, duty
of excise, value added tax, cess and any other statutory dues to the appropriate authorities
and if not, the extent of the arrears of outstanding statutory dues as on the last day of the
financial year concerned for a period of more than six months from the date they became
payable, shall be indicated;
(2) where dues of income tax or sales tax or service tax or duty of customs or duty of excise or
value added tax have not been deposited on account of any dispute, then the amounts
involved and the forum where dispute is pending shall be mentioned. (A mere representation
to the concerned Department shall not be treated as a dispute).

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Q-10 Explain the audit procedure to vouch/verify :
(i) Rent expenses (ii) Power and Fuel expenses [RTP-May’19]
Ans.(i) Rent expense- Obtain a month wise expense schedule along with the rent agreements. Verify if expense
has been recorded for all 12 months and whether the rent amount is as per the underlying agreement.
Specific consideration should be given to escalation clause in the agreement to verify if the rent was to
be increased/ adjusted during the period under audit. Also, verify if the agreement is in the name of
the entity and whether the expense pertains to premises used for running business operations of the
enti ty
(ii) Power and fuel expense- Obtain a month wise expense schedule along with the power bills. Verify if
expense has been recorded for all 12 months. Also, compile a month wise summary of power units
consumed and the applicable rate and check the arithmetical accuracy of the bill raised on monthly
basis. In relation to the units consumed, analyse the monthly power units consumed by linking it to
units of finished goods produced and investigate reasons for variance in monthly trends
Q-11 Reserves are amounts appropriated out of profits whereas on the contrary, provisions are amounts
charged against revenue. Discuss explaining the difference between the two and also explain clearly
revenue reserve and capital reserve. [RTP-May’19,MTP, March’19,3 Marks]
Ans. Reserves are amounts appropriated out of profits that are not intended to meet any liability, contingency,
commitment or diminution in the value of assets known to exist as at the date of the Balance Sheet.
On the contrary, provisions are amounts charged against revenue to provide for:
(i) Renewal or diminution in the value of assets; or
(ii) a known liability, the amount whereof could only be estimated and cannot be deter-mined with
accuracy; or
(iii) a claim which is disputed.
Amounts contributed or transferred from profits to make good the diminution in value of assets due to
the fact that some of them have been lost or destroyed as a result of some natural calamity or debts
have proved to be irrecoverable are also described as provisions. Provisions are normally charged to
the Statement of Profit and Loss before arriving at the amount of profit. Reserves are appropriations
out of profits.
Difference between Reserves and Provisions
The difference between the two is that provisions are amounts set aside to meet specific/ identified
liabilities or diminution in recoverable value of assets. These must be provided for regardless of the
fact whether the Company has earned profit or not.
Reserves on the other hand, represent amounts appropriated out of profits, held for equalising the
dividends of the company from one period to another or for financing the expansion of the company or
for generally strengthening the company financially.
If we examine the Balance Sheet of a company, at a given time, and deduct the total liabilities to
outside trade payables from the value of assets shown therein, the difference between the two figures
will represent the net worth of the company based on the book values of assets as on that date. The
same shall include the capital contributed by the shareholders as well as total undistributed profit
held either to the credit of the Statement of Profit and Loss or to reserves; the reserves again will be
segregated as revenue or capital reserves.
Revenue reserves represent profits that are available for distribution to shareholders held for the
time being or any one or more purpose.

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 Examples- to supplement divisible profits in lean years, to finance an extension of business, to augment
the working capital of the business or to generally strengthen the company’s financial position.
Capital Reserve, on the other hand represents a reserve which does not include any amount regarded
as free for distribution through the Statement of Profit and Loss
Examples- share premium, capital redemption reserve.
It may be noted tha t if a company appropria tes revenue profi t for being credited to the asset
replacement reserve with the objective that these are to be used for a capital purpose, such a reserve
shall also be in the nature of a capital reserve.
A capital reserve, generally, can be utilised for writing down fictitious assets or losses or (subject to
provisions in the Articles) for issuing bonus shares if it is realised. But the amount of share premium or
capital redemption reserve account can be utilised only for the purpose specified in Sections 52 and 55
respectively of the Companies Act, 2013.
Q-12 ABC Ltd. has issued shares for cash at a premium of ` 450, that is, at amount in excess of the nominal
value of the shares which is ` 10 for cash. Section 52 of the Companies Act, 2013 provides that a
Company shall transfer the amount received by it as securities premium to securities premium account.
Advise the means in which the amount in the account can be applied. [RTP-May’18]
Ans. Shares Issued at Premium: In case a company has issued shares at a premium, that is, at amount in
excess of the nominal value of the shares, whether for cash or otherwise, section 52 of the Companies
Act, 2013 provides that a Company shall transfer the amount received by it as securities premium to
securities premium account and state the means in which the amount in the account can be applied. As
per the section, where a company issues shares at a premium, whether for cash or otherwise, a sum
equal to the aggregate amount of the premium received on those shares shall be transferred to a
“securities premium account” and the provisions of this Act relating to reduction of share capital of a
company shall apply as if the securities premium account were the paid-up share capital of the company.
Application of securities premium account: The securities premium account may be applied by the
Company:
(a) towards the issue of unissued shares of the company to the members of the company as fully paid
bonus shares;
(b) in writing off the preliminary expenses of the Company;
(c) in writing off the expenses of, or the commission paid or discount allowed on, anyissue of shares
or debentures of the company;
(d) in providing for the premium payable on the redemption of any redeemable preferenceshares or
of any debentures of the company; or
(e) for the purchase of its own shares or other securities under section 68.
The auditor needs to verify whether the premium received on shares, if any, has been transferred
to a “securities premium account” and whether the application of any amount out of the said
“securities premium account” is only for the purposes mentioned above
Q-13 You are an auditor of PQR Ltd. which has spent ` 10 lakhs on Research activities of the product during
period under audit. Board of Directors want to recognize it as an internally generated intangible assets.
Advise and discuss the conditions necessary to be fulfilled to recognize the intangible assets in the
financial statements. [Sugg.-May’19,4 Marks]
Ans. No Intangible asset arising from research (or from the research phase of an internal project) shall be
recognised. Expenditure on research shall be recognised as an expense when it is incurred since in the
research phase of an internal project, an entity cannot demonstrate that an intangible asset exists that

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 will generate probable future economic benefits. Thus, board of directors of PQR Ltd cannot recognize
the expense as internally generated intangible asset.
An intangible asset shall be recognised if, and only if:
(i) the said asset is identifiable;
(ii) the entity controls the asset i.e. the entity has the power to obtain the future economic benefits
flowing from the underlying resource and to restrict the access of others to those benefits;
(iii) it is probable that future economic benefits associated with the asset will flow to the entity;
(iv) the cost of the item can be measured reliably.
Q-14 While reviewing Employee benefits expenses of a company, how you as an auditor you will evaluate
its hiring, appraisal and retirement process? [Sugg.-May’19,3 Marks]
Ans. While reviewing Employee Benefits expenses auditor needs to obtain a clear understanding about the
organisation and its hiring, appraisal and retirement process in the following manner:
(i) The auditor first tests the controls the company has set around the employee benefit payment
process to determine how strong and reliable they are. If they are strong, the auditor can minimize
the amount of transaction testing he must do. Common internal controls over the employee
benefit payment cycle includes maintaining of attendance records, authorisation and approval of
monthly payroll processing and disbursement.
(ii) The auditor selects a random sample of transactions and examines the related appointment
letters, appraisal letters, attendance records, HR policies, employee master etc.
(iii) The a udi tor p e rf orms Subst an t iv e a na lyt ica l proce dure consisti ng of monthly expe nse
reasonability, comparison with previous accounting period, any analysis auditor may findrelevant
and most important of all setting an expectation in relation to the expense incurred during the
period under audit and compare that with the client’s business operations and overall trend in
the industry.
Q-15 Write the audit procedures to be performed as an auditor for valuation (assertion) of following:
(i) Loans and Advances and other current assets.
(ii) Finished goods and goods for resale. [Sugg.-May’19,3 Marks]
Ans.(i) Audit procedure for valuation of Loans and Advances and other current assets
• Assess the allowance for doubtful accounts. Review the process followed by the Company to
derive an allowance for doubtful accounts. This will include a consistency comparison with the
method used in the last year, and a determination of whether the method is appropriate for the
underlying business environment.
• Obtain the ageing report of loans and advances, split between not currently due, 30 days old, 30-
60 days old, 60- 180 days old, 180- 365 days old and more than 365 days old. Also, obtain the list of
loans and advances under litigation and compare with previous year.
• Scrutinize the analysis and identify those loans and advances that appear doubtful; Discuss with
management their reasons, if any of these loans/ advances are not included in the provision for
bad recoverable; Perform further testing where any disputes exist; Reach a final conclusion
regarding the adequacy of the bad and doubtful loans/ advances provision.
• Assess bad loans/ advances write-offs. Prepare schedule of movements on Bad loans/ advances
– Provision Accounts and loans/ advances written off.
• Check that write-offs or other reductions in the recoverable balances have been approved by an
appropriate and authorised member of senior management, for example the financial controller
or finance director.

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 • Check that the restatement of foreign currency loans and advances/ other current assets has been
done properly.
(ii) Audit procedure for valuation of finished goods and goods for resale
- Enquire into what costs are included, how these have been established and ensure that the overheads
included have been determined based on normal costs and appear reasonable in relation to the
information disclosed in the draft financial statements.
• Ensure that inventories are valued at net realizable value if they are likely to fetch a value lower
than their cost. For any such items, also verify if the relevant semi/ partly processed inventories
(work in progress) and raw materials have also been written down.
• Follow up for items that are obsolete, damaged, slow moving and ascertain the possible realizable
value of such items. For the purpose, request the client to provide inventory ageing split between
less than 30 days, 30-60 days old, 60- 90 days old, 90- 180 days old, 180- 385 days old and more than
365 days old (refer screenshot below)
• Follow up any inventories which at time of observance of physical counting were noted as being
damaged or obsolete.
• Compare recorded costs with replacement costs. Examine vendor price lists to determine if
recorded cost is less than current prices.
• Calculate inventory turnover ratio. Obsolete inventory may be revealed if ratio is significantly
lower.
• In manufacturing environments, test overhead allocation rates and ensure that only direct labor,
direct material and overhead have been included.
• Verify the correct application of lower-of-cost-or-net realizable value principles.
Q-16 Expenses which are essentially of a revenue nature if incurred for creating an asset or adding to its
value for achieving higher productivity are regarded as expenses of a capital nature. Describe any five
such expenses. [Sugg.-May’18,5 Marks]

Ans. Expenses which are essentially of a Revenue Nature, if incurred for creating an asset or adding to its
value for achieving higher productivity, are regarded as expenditure of a capital nature. Examples of
capital expenditure are-
(i) Material and wages- capital expenditure when expended on the construction of a building or
erection of machinery.
(ii) Legal expenses- capital expenditure when incurred in connection with the purchase of land or
building.
(iii) Freight- capital expenditure when incurred in respect of purchase of plant and machinery.
(iv) Repair- Major repairs of a fixed asset that increases its productivity.
(v) Wages- Wages paid on installation costs incurred in Plant & machinery.
(vi) Interest- Interest paid for the qualification period as per AS-16 i.e. before the asset is constructed.
Whenever, therefore, a part of the expenditure, ostensibly of a revenue nature, is capitalised it is the
duty of the audi tor not only to examine the precise particulars of the expenditure but also the
considerations on which it has been capitalised.
Q-17 Mention any five attributes to be considered by an auditor while verifying for a depreciation and
amortisation expenses. [Sugg.-May’18,5 Marks]

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Ans. Depreciation and Amortisation Expenses: Auditor needs to consider the following attributes while
verifying for depreciation and amortisation expenses:
• Obtain the understanding of entity’s accounting policy related to depreciation and amortisation.
• Ensure that the Company’s policy for charging depreciation and amortisation is as per the relevant
provisions of Companies Act and applicable accounting standards.
• Whether the depreciation has been calculated after making adjustment of residual value from
the cost of the assets.
• Whether depreciation and amortisation charges are valid.
• Whether depreciation and amortisation charges are accurately calculated and recorded.
• Whether all depreciation and amortisation charges are recorded in the appropriate period.
• Ensure the parts (components) of each item of property, plant and equipment that are to be
depreciated separately has been properly identified.
• Whether the most appropriate depreciation method for each separately depreciable component
has been used.
Q-18 As sta tutory auditor of the company, list out audit procedures required to be undertaken for the
following:
(i) Interest income from fixed deposits.
(ii) Dividend income.
(iii) Gain/(loss) on sale of investment in Mutual funds.
Also indicate disclosure requirements of above as per Companies Act, 2013. [Sugg.-May’18,5 Marks]
Ans.(i) For verifying interest income on fixed deposits:
• Obtain a listing of fixed deposits opened during the period under audit along with the applicable
interest rate and the number of days for which the deposit was outstanding during the period.
Verify the arithmetical accuracy of the interest calculation made by the entity by multiplying the
deposit amount with the applicable rate and number of days during the period under audit.
• For deposits still outstanding as at the period- end, trace the same to the direct confirmation
obtained from the respective bank / financial institution.
• Obtain a confirmation of interest income from the bank and verify that the interest income as per
bank reconciles to the calculation shared by the entity.
• Also, obtain a copy of Form 26AS (TDS withholding by the bank/ financial institution) and reconcile
the interest reflected therein to the calculation shared by client.
(ii) Dividend Income: For Dividends, verify that the same are recognised in the statement of profit and loss
only when the entity’s right to receive payment of the dividend is established, provided it is probable
that the economic benefits associated with the dividend will flow to the entity and the amount of the
dividend can be measured reliably.
(iii) Gain/ (loss) on sale of investment in mutual funds: Verify that Gain/(loss) on sale of investment in
mutual funds is recorded as other income only on transfer of title from the entity and is determined as
the difference between the redemption price and carrying value of the investments. For the purpose,
obtain the mutual fund statement and trace the gain / loss as recorded in the books of account to the
gain/ loss as reflected in the statement.
Disclosure Requirements: Ensure whether the following disclosures as required under Ind AS compliant
Schedule III to Companies Act, 2013 have been made:

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 Whether ‘other income’’ has been classified as:
• Interest income
• Dividend income
• Other non-operating income (net of expenses directly attributable to such income)
Q-19 Companies prepare their financial statements in accordance with the framework of generally accepted
accounting principles (Indian GAAP), also commonly referred to as accounting standards (AS). In
preparing financial statements, Company’s management makes implici t or explici t claims (i.e.
assertions) regarding assets, liabilities, equity, income, expenses and disclosures in accordance with
the applicable accounting standards. Explain with example stating the relevant assertions involved in
this regard. Also explain financial statement audit. [RTP-May’20]
Ans. Companies prepare their financial statements in accordance with the framework of generally accepted
accounting principles (Indian GAAP), also commonly referred to as accounting standards (AS).
A financial sta tement audi t comprises the examina tion of an enti ty’s financial sta tements and
accompanying disclosures by an independent auditor. The result of this examination is a report by the
auditor, attesting to the truth and fairness of presentation of the financial statements and related
disclosures.
In preparing financial statements, Company’s management makes implicit or explicit claims (i.e.
assertions) regarding:
• completeness;
• cut-off;
• existence / occurrence;
• valuation/ measurement;
• rights and obligations; and
• presentation and disclosure
of assets, liabi lities, equity, income, expenses and disclosures in accordance with the applicable
accounting standards.
Example
If Company X’s balance sheet shows building with carrying amount of ‘ 50 lakh, the auditor shall assume
that the management has claimed/ asserted that:
• The building recognized in the balance sheet exists as at the period- end (existence assertion);
• Company X owns and controls such building (Rights and obligations assertion);
• The building has been valued accurately in accordance with the measurement principles (Valuation
assertion);
• All buildings owned and controlled by Company X are included within the carrying amount of ‘ 50
lakh (Completeness assertion).
Q-20 What does the Valuation assertion mean in respect of Assets, liabilities and equity balances? Explain
with the help of example in respect of Inventory. [RTP-May’20]
Ans. Meaning of Valuation Assertion– Assets, liabilities, and equity interests are included in the financial
statements a t appropria te amounts and any resul ting valua tion or alloca tion adjustments are
appropriately recorded.
Example of Inventory explaining the valuation assertion is given hereunder: Inventory has been
recognized at the lower of cost and net realizable value in accordance with AS 2 - Inventories. Any costs

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 that could not be reasonably allocated to the cost of production (e.g. general and administrative costs)
and any abnormal wastage have been excluded from the cost of inventory. An acceptable valuation
basis (eg. FIFO, Weighted average etc.) has been used to value inventory as at the period-end.
Q-21 Validity and consequence of issue of shares at discount, check with respect to the provisions of the
Companies Act, 2013. [Sugg.-Nov’19,4 Marks]
Ans. Shares issued at discount:
(i) As per section 53 of the Companies Act, 2013, a company shall not issue share at a discount, except
in the case of an issue of sweat equity shares given under section 54 of the Companies Act, 2013.
Any share issued by a company at a discounted price shall be void.
(ii) The auditor needs to verify that the company has not issued any of its shares at a discount by
reading the minutes of meeting of its directors and shareholders authorising issue of share capital
and the issue price.
(iii) Where a company contravenes the provisions of this section, the company shall be punishable
with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees:
and
(iv) every officer who is in default shall be punishable with imprisonment for a term which may
extend to six months or with fine which shall not be less than one lakh rupees, or with both.
Q-22 Explain the disclosure requirements of IND AS compliant Schedule III to Companies Act, 2013 for each
component of “Other Equity.” [Sugg.-Nov’19,3 Marks]
Ans. For each component of other equity, whether the company has disclosed the following (to the extent
applicable):
(i) Balance at the beginning of the reporting period
(ii) Changes in accounting policy or prior period error
(iii) Restated balance at the beginning of the reporting period
(iv) Total comprehensive income for the year end
(v) Dividends
(vi) Transfer to retained earnings
(vii) Any other change (to be specified)
(viii) Balance at the end of reporting period

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MULTIPLE CHOICE QUESTIONS

1. While auditing the books of accounts of QHMP Ltd., CA. Ranker, the statutory auditor of the company,
came to know that the management of the company has recognized internally generated goodwill as a
fixed asset. CA. Ranker discussed with the management that according to accounting standards,
internally generated goodwill is not recognized as an asset because it is not an identifiable resource
controlled by the enterprise that can be measured reliably at cost. However, the management is quite
rigid to the accounting treatment followed for internally generated goodwill and not paying attention
to the auditor. Thus, through an example, CA. Ranker explained which type of goodwill may be
recognized as a fixed asset for which the management got justified. State which of the following
examples the auditor must have given to the management?
(a) If an item meeting the definition of an intangible asset is acquired in a business combination, it
forms part of the goodwill to be recognized at the date of the amalgamation.
(b) Only those goodwill needs to be recognized as a fixed asset which can be touched like physical
assets, for example, land and buildings.
(c) Goodwill is recognised only when there is a contractual or other legal rights for a physical asset
which shall not be amortized over the period.
(d) All of the above. [RTP-May’19]

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 C H APT E R- 1 0
T H E CO MPANY AUDIT

Q-1 Discuss which class of companies are specifically exempt from the applicability of CARO 2016.
[MTP-Oct’19,3 Marks]
Ans. CARO 2016 specifically exempts the following class of companies:
(i) A banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949;
(ii) An insurance company as defined under the Insurance Act,1938;
(iii) A company licensed to operate under section 8 of the Companies Act;
(iv) A One Person Company as defined under clause (62) of section 2 of the Companies Act;
(v) A small company as defined under clause (85) of section 2 of the Companies Act; and
(vi) A private limited company, 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 Schedul ed III to the Compani es Act, 2013 (including revenue from
discontinuing operations) exceeding rupees ten crores during the financial year asper the financial
statements.
Q-2 CA. Donald was appointed as the auditor of PS Ltd. at the remuneration of Rs. 30,000. However, after 4
months of continuing his services, he could not continue to hold his office of the auditor as his wife got
a government job at a distant place and he needs to shift along with her to the new place. Thus, he
resigned from the company and did not perform his responsibilities relating to filing of statement to
the company and the registrar indicating the reasons and other facts as may be relevant with regard to
his resignation.
How much fine may he be punishable with under section 140(3) for non-compliance of section
140(2) of the Companies Act, 2013? [MTP-Oct’19,3 Marks, RTP-May’19]
Ans. Provisions and Explanation: For non-compliance of sub-section (2) of section 140 of the Companies Act,
2013, the auditor shall be punishable with fine, which shall not be less than fifty thousand rupees or
the remuneration of the auditor, whichever is less but which may extend to five lakh rupees, under
section 140(3) of the said Act.
Conclusion: Thus, the fine under section 140(3) of the Companies Act, 2013 shall not be less than Rs.
30,000 but which may extend to Rs. 5,00,000.
Q-3 “The remuneration of the auditor of a company shall be fixed in its general meeting or in suchmanner
as may be determined therein.” Explain with reference to provisions of the Companies Act,2013.
[MTP-Oct’19,3 Marks]

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Ans. As per section 142 of the Act, the remuneration of the auditor of a company shall be fixed in its general
meeting or in such manner as may be determined therein. However, board may fix remuneration of
the first auditor appointed by it.
Further, the remuneration, in addition to the fee payable to an auditor, includes the expenses, if any,
incurred by the auditor in connection with the audit of the company and any facility extended to him
but does not include any remuneration paid to him for any other service rendered by him at the
request of the company. Therefore, it has been clarified that the remuneration to Auditor shall also
include any facility provided to him.
Q-4 State the matters to be included in the auditor’s report as per CARO, 2016 regarding-
(i) Default in repayment of loans or borrowing to a financial institution, bank etc.
(ii) Fraud by the company or on the Company by its officers or employees.
[MTP-March’19, 4 Marks, MTP-March’18, 4 Marks, RTP-May’18]
Ans. of a company to which CARO applies shall include a statement on the following matters, namely-
(i) whether the company has defaulted in repayment of loans or borrowing to a financialinstitution,
bank, Government or dues to debenture holders? If yes, the period and the amount of default to
be reported (in case of defaults to banks, financial institutions, and Government, lender wise
details to be provided).
(ii) 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;
Q-5 Where a company is required to constitute an Audit Committee, all appointments of an auditor under
this section shall be made after taking into account the recommendations of such committee. Explain
stating also the class of companies required to constitute Audit Committee. [MTP-March’19,3 Marks]
Ans. Applicability of section 177 i.e. Constitution of Audit Committee: Where a company is required to
constitute an Audit Committee under section 177, all appointments, including the filling of a casual
vacancy of an auditor under this section shall be made after taking into account the recommendations
of such committee.
It is important to know that in addition to listed public companies, following classes of companies shall
constitute an Audit Committee -
(i) all public companies with a paid up capital of ten crore rupees or more;
(ii) all public companies having turnover of one hundred crore rupees or more;
(iii) all public companies, having in aggregate, outstanding loans or borrowings or debentures or
deposits exceeding fifty crore rupees or more.
Q-6 The first auditors of Bhartiya Petrol Ltd., a Government company, were appointed by the Board of
Directors. Analyse. [MTP-March’19,4 Marks, MTP-March’18,5 Marks]
Ans. A “Government company” is a 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
company of such a Government company.
Section 139(7) provides that in the case of a Government company or any other company owned or
controll ed, directly or indirectly, by the Central Government, or by any Sta te Government, or
Governments, or partly by the Central Government and partly by one or more State Governments, the
first auditor shall be appointed by the Comptroller and Auditor-General of India within 60 days from

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 the date of registration of the company.
In case the Comptroller and Auditor-General of India does not appoint such auditor within the above
said period, the Board of Directors of the company shall appoint such auditor within the next 30 days.
Further, in the case of failure of the Board to appoint such auditor within next 30 days, it shall inform
the members of the company who shall appoint such auditor within 60 days at an extraordinary general
meeting. Auditors shall hold office till the conclusion of the first annual general meeting.
Hence, in the case of Bhartiya Petrol Ltd., being a government company, the first auditor shall be
appointed by the Comptroller and Auditor General of India.
Conclusion: Thus, the appointment of first auditor made by the Board of Directors of Bhartiya Petrol
Ltd., is null and void.
Q-7 State the matters to be included in the auditor’s report as per CARO, 2016, regarding:
(i) Private Placement of Preferential Issues.
(ii) Utilisation of IPO and further public offer.
[MTP-April’19, 4 Marks-Sugg.-Nov’18,4 Marks,Sugg.May’18, 4 Marks]
Ans.(i) The auditor is required to report as per clause xiv of paragraph 3 of CARO 2016, 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;
(ii) It is duty of the auditor to report as per clause ix of paragraph 3 of CARO 2016, whether moneys raised
by way of initial public offer or further public offer (including debt instruments) and term loans were
applied for the purposes for which those are raised. If not, the details together with delays or default
and subsequent rectification, if any, as may be applicable, be reported.
Q-8 What are the provisions prescribed under Companies Act, 2013 in respect of ceiling on number of
audits in a company to be accepted by an auditor? [MTP-April’19,3 Marks]
Ans Ceiling on number of Audits:
1. Section 141(3)(g) of the Companies Act, 2013 prescribes that a person shall not be eligible for
appointment as an auditor of a company namely – a person who is in full time employment
elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or
partner is at the date of such appointment or reappointment holding appointment as auditor of
more than twenty companies other than one person companies, dormant companies, small
companies and private companies having paid-up share capital less than Rs. 100 crore.
2. In the case of a firm of auditors, it has been further provided that ‘specified number of companies’
shall be construed as the number of companies specified for every partner of the firm who is not
in full time employment elsewhere. This limit of 20 company audits is per person. In the case of
an audit firm having 3 partners, the overall ceiling will be 3 20 = 60 company audits.
3. Sometimes, a chartered accountant is a partner in a number of auditing firms. In such a case, all
the firms in which he is partner or proprietor will be together entitled to 20 company audits on his
account. Subject to the overall ceiling of company audits, how they allocate the 20 audits between
themselves is their affairs.
Q-9 M/s RM & Co. is an audit firm having partners CA. R and CA. M. The firm has been offered the appointment
as an auditor of Enn Ltd. for the Financial Year 2016-17. Mr. Bee, the relative of CA. R, is holding 5,000
shares (face value of Rs. 10 each) in Enn Ltd. having market value of ` 1,50,000. One of the shareholders,

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 complains that the appointment of RM & Co. as an auditor is invalid because it incurred disqualifica tion
u/s 141 of the Companies Act, 2013. Analyse and advise.
[MTP-March’18,5 Marks-RTP-May’18,Sugg.-May’18,5 Marks]
Ans. As per section 141(3)(d)(i), 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. However, as per proviso to
this section, the relative of the person may hold the securities or interest in the company of face value
not exceeding of ` 1,00,000. In the instant case, M /s RM & Co. is an audit firm having partners CA. R and
CA. M. Mr. Bee is a relative of CA. R and he is holding shares of Enn Ltd. of face value of ` 50,000 only
(5,000 shares x ` 10 per share). Therefore, M/s RM & Co. is not disqualified for appointment as an
auditors of Enn Ltd. as the relative of CA. R (i.e. partner of M/s RM & Co.) is holding the securities in Enn
Ltd. which is within the limit mentioned in proviso to section 141(3)(d)(i) of the Companies Act, 2013.
Q-10 The auditor is not required to report on the matters specified in sub-section (1) of Section 143 unless
he has any special comments to make on any of the items referred to therein. If he is satisfied as a
result of the inquiries, he has no further duty to report that he is so satisfied. Explain clearly stating the
matters for which the auditor has to perform his duty of inquiry under this section.
[MTP-Aug’18,5 Marks,RTP-Nov’18]
Ans. Sections 143 of the Companies Act, 2013 specifies the duties of an auditor of a company in a quite
comprehensive manner. It is noteworthy that scope of duties of an auditor has generally been extending
over all these years.
Section 143(1) - Duty of Auditor to Inquire on certain matters: It is the duty of auditor to inquire into the
following matters-
(a) whether loans and advances made by the company on the basis of security have been properly
secured and whether the terms on which they have been made are prejudicial to the interests of
the company or its members;
(b) whether transactions of the company which are represented merely by book entries are prejudicial
to the interests of the company;
(c) 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;
(d) whether loans and advances made by the company have been shown as deposits;
(e) whether personal expenses have been charged to revenue account;
(f) where it is stated in the books and 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 opinion of the Research Committee of the Institute of Chartered Accountants of India on section
143(1) is reproduced below:
“The auditor is not required to report on the matters specified in sub-section (1) unless he has any
special comments to make on any of the items referred to therein. If he is satisfied as a result of the
inquiries, he has no further duty to report that he is so satisfied. In such a case, the content of the
Auditor’s Report will remain exactly the same as the auditor has to inquire and apply his mind to the
information elicited by the enquiry, in deciding whether or not any reference needs to be made in his
report. In our opinion, it is in this light that the auditor has to consider his duties under section 143(1).”

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 Therefore, it could be said that the auditor should make a report to the members in case he finds
answer to any of these matters in adverse.
Q-11 The auditor CA Z appointed under section 139 was removed from his office before the expiry of his
term by an ordinary resolution of the company. Comment explaining clearly the procedure of removal
of auditor before expiry of term. [MTP-Oct’18,5 Marks]
Ans. Removal of Auditor before Expiry of Term: According to Section 140 (1) the auditor appointed under
section 139 may be removed from his office before the expiry of his term only by a special resolution
of the company, after obtaining the previous approval of the Central Government .
(1) The application to the Central Government for removal of auditor shall be made in Form ADT- 2
and shall be accompa ni ed wi th f ees as provided for this purpose under the Compani es
(Registration Offices and Fees) Rules, 2014.
(2) The application shall be made to the Central Government within thirty days of the resolution
passed by the Board.
(3) The company shall hold the general meeting within sixty days of receipt of approval of the Central
Government for passing the special resolution.
It may be noted that before taking any action for removal before expiry of terms, the auditor concerned
shall be given a reasonable opportunity of being heard.
By applying the above provisions, it may be concluded that the action of the company for removal of
the auditor CA Z before expiry of term is not justified and auditor may be removed from his office only
by following the above mentioned procedure.
Q-12 The practice of appointing Chartered Accountants as joint auditors is quite widespread in big companies
and corporations. Explain stating the advantages of the joint audit. [RTP-Nov’19]
Ans. Joint Audit: The practice of appointing Chartered Accountants as joint auditors is quite widespread in
big companies and corporations. Joint audit basically implies pooling together the resources and
expertise of more than one firm of auditors to render an expert job in a given time period which may
be difficult to accomplish acting individually. It essentially involves sharing of the total work. This is by
itself a great advantage.
In specific terms the advantages that flow may be the following:
(i) Sharing of expertise.
(ii) Advantage of mutual consultation.
(iii) Lower workload.
(iv) Better quality of performance.
(v) Improved service to the client.
(vi) Displacement of the auditor of the company taken over in a takeover often obviated.
(vii) In respect of multi-national companies, the work can be spread using the expertise of the local
firms which are in a better position to deal with detailed work and the local laws and regulations.
(viii) Lower staff development costs.
(ix) Lower costs to carry out the work.
(x) A sense of healthy competition towards a better performance
Q-13 According to Companies Act, 2013, the person appointed as an auditor of the company shall sign the
auditor’s report in accordance with the relevant provisions of the Act. Explain clearly the relevant
provisions relating to signing of report. [RTP-Nov’19]

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Ans. Duty to Sign the Audit Report: As per section 145 of the Companies Act, 2013, the person appointed as
an auditor of the company shall sign the auditor’s report or sign or certify any other document of the
company, in accordance with the provisions of section 141(2).
Section 141(2) of the Companies Act, 2013 states that where a firm including a limited liability partnership
is appointed as an auditor of a company, only the partners who are chartered accountants shall be
authorised to act and sign on behalf of the firm.
The qualifications, observations or comments on financial transactions or matters, which have any
adverse effect on the functioning of the company mentioned in the auditor’s report shall be read
before the company in general meeting.
Q-14 The auditor shall make a report to the members of the company on the accounts examined by him.
Explain with reference to relevant provisions of the Companies Act, 2013. [RTP-Nov’19,RTP-NOV’18]
Ans. Right to report to the members of the company on the accounts examined by him – The auditor shall
make a report to the members of the company on the accounts examined by him and on every financial
statements which are required by or under this Act to be laid before the company in general meeting
and the report shall after taking into account the provisions of this Act, the accounting and auditing
standards and matters which are required to be included in the audit report under the provisions of
this Act or any rules made there under or under any order made under this section and to the best of his
information and knowledge, the said accounts, financial statements give a true and fair view of the
state of the company’ s affairs as at the end of its financial year and profit or loss and cash flow for the
year and such other matters as may be prescribed.
Q-15 Under sub-section (3) of section 141 of the Companies Act, 2013 along with Rule 10 of the Companies
(Audit and Auditors) Rules, 2014, state the persons who shall not be eligible for appointment as an
auditor of a company [RTP-May’19]
Ans. Under sub-section (3) of section 141 along with Rule 10 of the Companies (Audit and Auditors) Rules,
2014 (hereinafter referred as CAAR), the following persons shall not be eligible for appointment as an
auditor of a company, namely-
(a) a body corporate other than a limited liability partnership registered under the Limited Liability
Partnership Act, 2008;
(b) an officer or employee of the company;
(c) a person who is a partner, or who is in the employment, of an officer or employee of the company;
(d) a person who, or his relative or partner -
(i) 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;
It may be noted that the relative may hold security or interest in the company of face value
not exceeding ` 1,00,000.
It may also be noted that the condition of ` 1,00,000 shall, wherever relevant, be also
applicable in the case of a company not having share capital or other securities.
It may also be noted that in the event of acquiring any security or interest by a relative,
above the threshold prescribed, the corrective action to maintain the limits as specified
above shall be taken by the auditor within 60 days of such acquisition or interest.
(ii) is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary
of such holding company, in excess of ` 5,00,000; or
(iii) has given a guarantee or provided any security in connection with the indebtedness of any
third person to the Company or its Subsidiary, or its Holding or Associate Company or a
Subsidiary of such Holding Company, in excess of ` 1,00,000.

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 (e) a person or a firm who, whether directly or indirectly has business relationship with the Company,
or its Subsidiary, or its Holding or Associate Company or Subsidiary of such holding company or
associate company, of such nature as may be prescribed;
(f) a person whose relative is a Director or is in the employment of the Company as a director or key
Managerial Personnel.
(g) a person who is in full time employment elsewhere or a person or a partner of a firm holding
appointment as its audi tor, if such person or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than twenty companies other than one
person companies, dormant companies, small companies and private companies having paid-up
share capital less than ` 100 crore.
(h) a person who has been convicted by a Court of an offence involving fraud and a period of ten years
has not elapsed from the date of such conviction.
(i) any person whose subsidiary or associate company or any other form of entity, is engaged as on
the date of appointment in consulting and specialized services as provided in section 144.
Q-16 Mr. A, a chartered accountant, has been appointed as an auditor of Laxman Ltd. in the Annual General
Meeting of the company held in September, 2016, which assignment he accepted. Subsequently in
January, 2017 he joined Mr. B, another chartered accountant, who is the Manager Finance of Laxman
Ltd., as partner. Analyse and explain. [RTP-May’19]
Ans. Provisions and Explanation: Section 141(3)(c) of the Companies Act, 2013 prescribes that any person
who is a partner or in employment of an officer or employee of the company will be disqualified to act
as an auditor of a company. Sub-section (4) of Section 141 provides that an auditor who becomes
subject, after his appointment, to any of the disqualifications specified in sub-sections (3) of Section
141, he shall be deemed to have vacated his office as an auditor.
Conclusion: In the present case, Mr. A, an auditor of Laxman Ltd., joined as partner with Mr. B, who is
Manager Finance of Laxman Limited. The given situation has attracted sub-section (3)(c) of Section 141
and, therefore, he shall be deemed to have vacated office of the auditor of Laxman Limited in accordance
with sub-section (4) of section 141.
Q-17 The first auditor of Bhartiya Petrol Ltd., a Government company, was appointed by the Board of Directors.
Analyse and Explain [RTP-May’19]
A-20 Provisions and Explanation: In the case of a Government Company, the appointment of first auditor is
governed by the provisions of Section 139(7) of the Companies Act, 2013 which states that in the case
of a Government company, the first auditor shall be appointed by the Comptroller and Auditor-General
of India within 60 days from the date of registration of the company. Hence, in the case of Bhartiya
Petrol Ltd., being a government company, the first auditor shall be appointed by the Comptroller and
Auditor General of India.
Conclusion: Thus, the appointment of first auditor made by the Board of Directors of Bhartiya Petrol
Ltd., is null and void.
Q-18 Explain the manner and procedure of selection and appointment of auditors as per Rule 3 of Companies
(Audit and Auditors) Rules, 2014 [RTP-May’19]
Ans. Manner and procedure of selection and appointment of auditors- Rule 3 of CAAR, 2014 prescribes the
following manner and procedure of selection and appointment of auditors-
(1) In case of a company that is required to constitute an Audit Committee under section 177, the
committee, and, in cases where such a committee is not required to be constituted, the Board,
shall take into consideration the qualifications and experience of the individual or the firm
proposed to be considered for appointment as audi tor and whether such qualifications and

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 experience are commensurate with the size and requirements of the company.
It may be noted that while considering the appointment, the Audit Committee or the Board, as
the case may be, shall have regard to any order or pending proceeding relating to professional
matters of conduct against the proposed auditor before the Institute of Chartered Accountants of
India or any competent authority or any Court.
(2) The Audit Committee or the Board, as the case may be, may call for such other information from
the proposed auditor as it may deem fit.
(3) Subject to the provisions of sub-rule (1), where a company is required to constitute the Audit
Committee, the committee shall recommend the name of an individual or a firm as auditor to the
Board for consideration and in other cases, the Board shall consider and recommend an individual
or a firm as auditor to the members in the annual general meeting for appointment.
(4) If the Board agrees with the recommendation of the Audit Committee, it shall further recommend
the appointment of an individual or a firm as auditor to the members in the annual general
meeting.
(5) If the Board disagrees with the recommendation of the Audit Committee, it shall refer back the
recommendation to the committee for reconsideration citing reasons for such disagreement.
(6) If the Audit Committee, after considering the reasons given by the Board, decides not to reconsider
its original recommendation, the Board shall record reasons for i ts disagreement with the
committee and send its own recommendation for consideration of the members in the annual
general meeting; and if the Board agrees with the recommendations of the Audit Committee, it
shall place the matter for consideration by members in the annual general meeting.
(7) The auditor appointed in the annual general meeting shall hold office from the conclusion of that
meeting till the conclusion of the sixth annual general meeting, with the meeting wherein such
appointment has been made being counted as the first meeting.
Q-19 When the accounts of the branch are audited by a person other than the company’s auditor, there is
need for a clear understanding of the role of such auditor and the company’s auditor in relation to the
audit of the accounts of the branch and the audit of the company as a whole. Explain [RTP-Nov’18]
Ans. Using the Work of another Auditor: When the accounts of the branch are audited by a person other
than the company’s auditor, there is need for a clear understanding of the role of such auditor and the
company’s auditor in relation to the audit of the accounts of the branch and the audit of the company
as a whole; also, there is great necessity for a proper rapport between these two auditors for the
purpose of an effective audit. In recognition of these needs, the Council of the Institute of Chartered
Accountants of India has dealt with these issues in SA 600, “Using the Work of another Auditor”. It
makes clear that in certain situations, the statute governing the entity may confer a right on the
principal auditor to visit a component and examine the books of account and other records of the said
component, if he thinks it necessary to do so. Where another auditor has been appointed for the
component, the principal auditor would normally be entitled to rely upon the work of such auditor
unless there are special circumstances to make it essential for him to visit the component and/or to
examine the books of account and other records of the said component. Further, it requires that the
principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the
work of the other auditor is adequate for the principal auditor’s purposes, in the context of the specific
assignment. When using the work of another auditor, the principal auditor should ordinarily perform
the following procedures:
(i) advise the other auditor of the use that is to be made of the other auditor’s work and report and
make sufficient arrangements for co-ordination of their efforts at the planning stage of the audit.
The principal auditor would inform the other auditor of matters such as areas requiring special
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 consideration, procedures for the identification of inter-component transactions that may require
disclosure and the time-table for completion of audit; and
(ii) advise the other auditor of the significant accounting, auditing and reportingrequirements and
obtain representation as to compliance with them. The principal auditor might discuss with the
other auditor the audit procedures applied or review a written summary of the other auditor’ s
procedures and findings which may be in the form of a completed questionnaire or check-list. The
principal audi tor may also wish to visit the other audi tor. The nature, timing and extent of
procedures will depend on the circumstances of the engagement and the principal auditor’s
knowledge of the professional competence of the other auditor. This knowledge may have been
enhanced from the review of the previous audit work of the other audit or.
Q-20 Why Central Government permission is required, when the auditors are to be removed before expiry
of their term, but the same is not needed when the auditors are changed after expiry of their term?
[RTP-Nov’18]
Ans. Permission of Central Government for Removal of Auditor Under Section 140(1) of the Companies Act,
2013: Removal of auditor before expiry of his term i.e. before he has submitted his report is a serious
matter and may adversely affect his independence.
Further, in case of conflict of interest the shareholders may remove the auditors in their own interest.
Therefore, law has provided this safeguard so that central government may know the reasons for such
an action and if not satisfied, may not accord approval. On the other hand if auditor has completed his
term i.e. has submitted his report and thereafter he is not re-appointed then the matter is not serious
enough for central government to call for its intervention.
In view of the above, the permission of the Central Government is required when auditors are removed
before expiry of their term and the same is not needed when they are not re-appointed after expiry of
their term.
Q-21 Examine “Section 139(1) of the Companies Act, 2013 provides that every company shall, atthe first
annual general meeting appoint an auditor who shall hold office till theconclusion of its sixth annual
general meeting”. [RTP-May’18]
Ans. Appointment of Subsequent Auditors in case of Non Government Companies: Section 139(1) of the
Companies Act, 2013 provides that every company shall, at the first annual general meeting appoint an
individual or a firm as an auditor who shall hold office from the conclusion of that meeting till the
conclusion of its sixth annual general meeting and thereafter till the conclusion of every sixth meeting.
The following points need to be noted in this regard-
(i) The company shall place the matter relating to such appointment of ratificationby member at
every Annual General Meeting.
(ii) Before such appointment is made, the written consent of the auditor to suchappointment, and a
certificate from him or it that the appointment, if made, shall be in accordance with the conditions
as may be prescribed, shall be obtained from the auditor.
(iii) The certificate shall also indicate whether the auditor satisfies the criteria provided in section
141.
(iv) The company shall inform the auditor concerned of his or its appointment, and also file a notice
of such appointment with the Registrar within 15 days of the meeting in which the auditor is
appointed.

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Q-22 Examine Filling of a casual vacancy of auditor in respect of a company audit. [RTP-May’18]
Ans.(i) In the case of a company other than a company whose accounts are subject to audit by an auditor
appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within
30 days.
If such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be
approved by the company at a general meeting convened within three months of the recommendation
of the Board and he shall hold the office till the conclusion of the next annual general meeting.
(ii) In the case of a company whose accounts are subject to audit by an auditor appointed by the Comptroller
and Auditor-General of India, be filled by the Comptroller and Auditor-General of India within 30 days.
It may be noted that in case the Comptroller and Auditor-General of India does not fill the vacancy
within the said period the Board of Directors shall fill the vacancy within next 30 days.

Casual Vacancy by Resignation: As per section 140(2) the auditor who has resigned from the company
shall file within a period of 30 days from the date of resignation, a statement in the prescribed Form
ADT–3 (as per Rule 8 of CAAR) with the company and the Registrar, and in case of the companies
referred to in section 139(5) i.e. Government company, the auditor shall also file such statement with
the Comptroller and Auditor-General of India, indicating the reasons and other facts as may be relevant
with regard to his resignation. In case of failure the auditor shall be punishable with fine which shall
not be less than fifty thousand rupees but which may extend to five lakh rupees as per section 140(3).
Q-23 Rano Pvt. Ltd. is a private limited Company, having paid up share capital of ` 45 crore but having public
borrowing from nationalized banks and financial institutions of ` 40 crore. Advise the company on the
applicability of rotation of auditors. [RTP-May’18]
Ans. Applicability of Section 139(2) Rotation of Auditor: As per rules prescribed in Companies (Audit and
Auditors) Rules, 2014, for applicability of section 139(2) the class of companies shall mean the following
classes of companies excluding one person companies and small companies-

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 (I) all unlisted public companies having paid up share capital of rupees ten crore ormore;
(II) all private limited companies having paid up share capital of rupees fifty crore or more;
(III) all companies having paid up share capital of below threshold limit mentioned above, but having
public borrowings from financial institutions, banks or public deposits of rupees fifty crores or
more.
From the above, it can be concluded that rotational provisions would not be applicable.
Q-24 Board of Directors of “XYZ Ltd.” found the auditors of the Company acted in a fraudulent manner, and
decided to remove the auditors in board’s meeting. Comment on the action of Board of Directors and
describe correct procedure to be followed for removal of auditors before expiry of their term.
[Sugg.-May’19,4 Marks]
Ans. Board of Directors of “XYZ Ltd” cannot remove the auditors in Board meeting. According to Section
140(1), the auditor appointed under section 139 may be removed from his office before the expiry of
his term only by a special resolution of the company, after obtaining the previous approval of the
Central Government in that behalf as per Rule 7 of CAAR, 2014-
i. The application to the Central Government for removal of auditor shall be made in Form ADT-
2and shall be accompanied with fees as provided for this purpose under the Companies (Registration
Offices and Fees) Rules, 2014.
ii. The application shall be made to the Central Government within 30 days of the resolution passed
by the Board.
iii. The company shall hold the general meeting within 60 days of receipt of approval of the Central
Government for passing the special resolution.
iv. It is important to note that before taking any action for removal before expiry of terms, the
auditor concerned shall be given a reasonable opportunity of being heard.
Q-25 Auditors have right to attend only those general meetings at which the accounts audited by them are
to be discussed. Comment. [Sugg.-May’19,4 Marks]
Ans. The auditors of a company are entitled to attend any general meeting of the company and the right is
not only restricted to those at which the accounts audited by them are to be discussed, he is also
entitled to receive all the notices and other communications relating to the general meetings, which

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 members are entitled to receive and to be heard at any general meeting in any part of the business of
the meeting which concerns them as auditors.
According to the section 146 of the Companies Act 2013,“all notices of, and other communications
relating to, any general meeting shall be forwarded to the auditor of the company, and the auditor
shall, unless otherwise exempted by the company, attend either by himself or through his authorised
representative, who shall also be qualified to be an auditor, any general meeting and shall have right
to be heard at such meeting on any part of the business which concerns him as the auditor.”
Thus, it is right of the auditor to receive notices and other communications relating to any general
meeting and to be heard at such meeting, relating to the matter of his concern, however, it is duty of
the auditor to attend the same or through his authorised representative unless otherwise exempted.
Q-26 M/s Pankaj & Associates, Chartered Accountants, have been appointed as an auditor of ABC Limited.
CA Pankaj did not apply any audit procedures regarding opening balances. He argued that since financial
statements were audited by the predecessor auditor therefore he is not required to verify them. Is CA
Pankaj correct in his approach? [Sugg.-Nov’18,5 Marks]
Ans. Initial audit engagement is an engagement in which either :
(i) The financial statements for the prior period were not audited; or
(ii) The financial statements for the prior period were audited by a predecessor auditor.
From the above, it is quite clear that CA Pankaj is not correct in his approach and therefore would
be required to follow the initial audit engagement and also apply audit procedures regarding
opening balances.
Audit Procedures regarding Opening Balances; The auditor shall read the most recent financial
statements, if any, and the predecessor auditor’s report thereon, if any, for information relevant to
opening balances, including disclosures.
The auditor shall obtain sufficient appropriate audit evidence about whether the opening balances
contain misstatements that materially affect the current period’s financial statements by:
(a) Determining whether the prior period’s closing balances have been correctly brought forward to
the current period or, when appropriate, any adjustments have been disclosed as prior period
items in the current year’s Statement of Profit and Loss;
(b) Determining whether the opening balances reflect the application of appropriate accounting
policies; and
(c) Performing one or more of the following:
(i) Where the prior year financial statements were audited, perusing the copies of the audited
financial statements including the other relevant documents relating to the prior period
financial statements;
(ii) Evaluating whether audit procedures performed in the current period provide evidence
relevant to the opening balances; or
(iii) Performing specific audit procedures to obtain evidence regarding the opening balances.
Q-27 “MMJ Ltd., an unlisted public company, did not appoint any internal auditor for the financial year
ending on 31st March, 2019. The company had paid up capital of ` 20 crores and reserves of ` 25 crores.
Its turnover for the preceeding 3 years were ` 75 crores for the year ended 31st March, 2018, ` 150
crores for March, 2017 and ` 190 crores for March, 2016. The company had availed term loan from the
bank of ` 130 crores. The outstanding balance of the term loan as on 31st March, 2018 is ` 90 crores.” As
an auditor of the company, how would you deal with the above? [Sugg.-Nov’18,5 Marks]
Ans. Every unlisted public company having-
(i) paid up share capital of fifty crore rupees or more during the preceding financial year; or

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 (ii) turnover of two hundred crore rupees or more during the preceding financial year; or
(iii) 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; or
(iv) outstanding deposits of twenty five crore rupees or more at any point of time during the preceding
financial year;
In view of above provisions, MMJ Ltd would have to appoint internal auditor for the financial year 31-
03-2019 because it had availed a term loan from the bank of ` 130 Crores. The outstanding balance of
term loan as on 31-03-2018 ` 90 crores would not make any difference because section is contemplating
outstanding at any point of time during the preceding financial year.
Q-28 “Mr. A is offered by ABC Ltd. for appointment as cost auditor and asked to certify certain requirements
before such appointment.” Discuss those requirements with reference to the provisions of the
Companies Act, 2013. [Sugg.-Nov’18,5 Marks]
Ans. Cost Auditor: Rule 6 of the Companies (Cost Records and audit) rules, 2014 required the companies
prescribed under the said rules to appoint an auditor within 180days of the commencement of every
financial year. However, before such appointment is made, the written consent of the cost auditor to
such appointment and a certificate from him or it shall be obtained.
The certificate to be obtained from the cost auditor shall certify that the-
(1) the individual or the firm, as the case may be, is eligible for appointment and is not disqualified
for appointment under the Companies Act, 2013, the Cost and Works Accountants Act, 1959 and
the rules or regulations made thereunder;
(2) the individual or the firm, as the case may be, satisfies the criteria provided in section 141 of the
Companies Act, 2013 so far as may be applicable;

(3) the proposed appointment is within the limits laid down by or under the authority of the Companies
Act, 2013; and
(4) the list of proceedings against the cost auditor or audit firm or any partner of the audit firm
pending with respect to professional matters of conduct, as disclosed in the certificate, is true
and correct.
Q-29 ABC Ltd is a company incorporated in India. It has branches within and outside India. Explain who can
be appointed as an auditor of these branches within and outside India. Also explain to whom branch
auditor is required to report. [RTP-May’2020]
Ans. Sub-section (8) of section 143 of the Companies Act, 2013, prescribes the duties and powers of the
company’s auditor with reference to the audit of the branch and the branch auditor. Where a company
has a branch office, the accounts of that office shall be audited either by the auditor appointed for the
company (herein referred to as the company’s auditor) under this Act or by any other person qualified
for appointment as an auditor of the company under this Act and appointed as such under section 139,
or where the branch office is situated in a country outside India, the accounts of the branch office shall
be audited either by the company’s auditor or by an accountant or by any other person duly qualified to
act as an auditor of the accounts of the branch office in accordance with the laws of that country and the
duties and powers of the company’ s auditor with reference to the audit of the branch and the branch
auditor, if any, shall be such as may be prescribed:
It may be noted that the branch auditor shall prepare a report on the accounts of the branch examined
by him and send it to the auditor of the company who shall deal with it in his report in such manner as
he considers necessary.

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 Further as per rule 12 of the Companies (Audit and Auditors) Rules, 2014, the branch auditor shall
submit his report to the company’s auditor and reporting of fraud by the auditor shall also extend to
such branch auditor to the extent it relates to the concerned branch.
Q-30 Before the commencement of the audit, the joint auditors should discuss and develop a joint audit
plan. In developing the joint audit plan, the joint auditors should identify division of audit areas and
common audit areas. Explain stating the other relevant considerations in this regard.
[Sugg.Nov’19, 4 Marks, RTP-May’2020]
Ans. Before the commencement of the audit, the joint auditors should discuss and develop a joint audit
plan. In developing the joint audit plan, the joint auditors should:
(a) identify division of audit areas and common audit areas;
(b) ascertain the reporting objectives of the engagement;
(c) consider and communicate among all joint auditors the factors that are significant
(d) in directing the engagement team’s efforts;
(e) consider the results of preliminary engagement activities, or similar engagements performed
earlier.
(f) ascertain the nature, timing and extent of resources necessary to accomplish the engagement.
Q-31 The head accountant of a company entered fake invoices of credit purchases in the books of account
aggregate of ` 50 lakh and cleared all the payments to such bogus creditor. How will you deal as an
auditor ? [RTP-May’2020]
Ans. Here, the auditor of the company is required to report the fraudulent activity to the Board or Audit
Committee (as the case may be) within 2 days of his knowledge of fraud. Further, the company is also
required to disclose the same in Board’s Report. It may be noted that the auditor need not to report the
central government as the amount of fraud involved is less than ‘ 1 crore, however, reporting under
CARO, 2016 is required.
Q-32 M Ltd. has given certain loans to related parties and also has accepted certain deposits. As an auditor,
how will you include the above items in paragraph 3 of CARO, 2016? [Sugg.-Nov’19,4 Marks]
Ans.
1. Clause (iii) of paragraph 3 of CARO, 2016 states
Whether the company has granted any loans, secured or unsecured to companies, firms, Limited Liability
Partnerships or other parties covered in the register maintained under section 189 of the Companies
Act, 2013. If so,
(i) Whether the terms and conditions of the grant of such loans are not prejudicial to the company’s
interest;
(ii) Whether the schedule of repayment of principal and payment of interest has been stipulated and
whether the repayments or receipts are regular;
(iii) if the amount is overdue, state the total amount overdue for more than ninety days, and whether
reasonable steps have been taken by the company for recovery of the principal and interest;
2. Further, Clause (v) of paragraph 3 of CARO, 2016 states in case the company has accepted deposits,
(i) whether the directives issued by the Reserve Bank of India and the provisions of sections 73 to 76
or any: ether relevant provisions of the Companies Act, 2013 and the rules framed there under,
where applicable, have been complied with? If not, the nature of such contraventions be stated;

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 (ii) If an order has been passed by Company Law Board or National Company Law Tribunal or Reserve
Bank of India or any court or any other tribunal, whether the same has been complied with or not?
In the given situation, M Ltd. has given certain loans to related parties and also has accepted certain
deposits. Thus, the auditor is required to report the same as per clause (iii) and (v) of Paragraph 3 of
CARO, 2016.

MULTIPLE CHOICE QUESTIONS

1. Under sub-section (3) of section 141 along with Rule 10 of the Companies (Audit and Auditors) Rules,2014
(hereinafter referred as CAAR), the following persons shall not be eligible for appointment as anauditor
of a company, namely-
(i) a limited liability partnership registered under the Limited Liability Partnership Act, 2008;
(ii) an officer or employee of the company;
(iii) a person who is a partner, or who is in the employment, of an officer or employee of the company;
(iv) a person 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. It may
be noted that the relative may hold security or interest in the company of face value not exceeding
Rs. 1,00,000.
Which of the above is incorrect :
(a) All statements are incorrect. (b) (i) and (ii)
(c) (i) only (d) (iv) only [MTP-Oct’19]
2. Which of the following is not an advantage of Joint Äudit :
(a) Sharing of expertise
(b) General superiority complexes of some auditors.
(c) Lower workload.
(d) Displacement of the auditor of the company taken over in a take - over often obviated.
[MTP-Oct’19]
3. Which of the following is correct as per section 143(10) of the Companies Act, 2013 :
(a) IFAC m ay prescri b e the sta nd a rds of a udi ti ng as recomm end ed by th e Inst i tut e of
Cha rte redAccoun ta n ts of Indi a, i n consul ta t ion w i th and a ft e r exa m in a ti on of th e
recommendations made by the National Financial Reporting Authority.
(b) The Int erna tion al Audi ti ng Stand ards Boa rd ma y prescribe the stand ards of audi ting as
recommended by the Institute of Chartered Accountants of India, in consultation with and after
examination of the recommendations made by the National F inancial Reporting Authority.
(c) the MCA may prescribe the standards of auditing as recommended by the Institute of Chartered
Accountants of India, in consultation with and after examination of the recommendations made
by the National Financial Reporting Authority.
(d) the Central Government may prescribe the standards of auditing as recommended by the
Instituteof Chartered Accountants of India, in consultation with and after examination of the
recommendations made by the National Financial Reporting Authority. [MTP-OCT’19]
4. Which of the following is not a duty of auditor to report under section 143 (1)
(a) whether loans and advances made by the company on the basis of security have been properly
secured and whether the terms on which they have been made are prejudicial to the interests of
the company or its members;

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 (b) whether transactions of the company which are represented merely by book entries are prejudicial
to the interests of the company;
(c) 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;
(d) 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 auditors has been sent to him under the proviso
to that sub-section and the manner in which he has dealt with it in preparing his report;
[MTP-OCT’19]
5. Section 139(7) provides that in the case of a Government company or any other company owned or
controll ed, directly or indirectly, by the Central Government, or by any Sta te Government, or
Governments, or partly by the Central Government and partly by one or more State Governments, the
first auditor shall be appointed by the Comptroller and Auditor-General of India ___________from the
date of registration of the company.
(a) within 60 days (b) within 30 days (c) within 90 days (d) within 45 days
[MTP-March’19,]
6. As per Section 139(8), any casual vacancy in the office of an auditor shall in the case of a company
other than a company whose accounts are subject to audit by an auditor appointed by the
Comptroller and Auditor-General of India,
(a) be filled by the Audit committee within 60 days.
(b) be filled by the Audit committee within 30 days.
(c) be filled by the Board of Directors within 60 days.
(d) be filled by the Board of Directors within 30 days. [MTP-March’19]
7. As per section 140(2) the auditor who has resigned from the company shall-
(a) file within a period of 60 days from the date of resignation, a statement in the prescribed Form
ADT–3 (as per Rule 8 of CAAR) with the company and the Registrar
(b) file within a period of 30 days from the date of resignation, a statement in the prescribed Form
ADT–3 (as per Rule 8 of CAAR) with the company and the Registrar
(c) file within a period of 30 days from the date of resignation, a statement in the prescribed Form
ADT–3 (as per Rule 8 of CAAR) with the company.
(d) file within a period of 60 days from the date of resignation, a statement in the prescribed Form
ADT–3 (as per Rule 8 of CAAR) with the company. [MTP-MARCH-2019]
8. Which of the following is correct :
(a) As per section 142 of the Act, the remuneration of the auditor of a company shall be fixed in its
general meeting or in such manner as may be determined therein.
(b) As per section 142 of the Act, the remuneration of the auditor of a company shall be fixed in its
general meeting.
(c) As per section 142 of the Act, the remuneration of the auditor of a company shall be fixed in its
extra ordinary general meeting.
(d) As per section 142 of the Act, the remuneration of the auditor of a company shall be fixed in its
Board meeting or in such manner as may be determined therein. [MTP-March’19]
9. Which of the following is incorrect :
(a) According to Section 140(1), the auditor appointed under section 139 may be removed from his
office before the expiry of his term only by a special resolution of the company, after obtaining
the previous approval of the Central Government in that behalf as per Rule 7 of CAAR, 2014-

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 (b) The application to the Central Government for removal of auditor shall be made in Form ADT-2
and shall be accompa ni ed wi th f ees as provided for this purpose under the Compani es
(Registration Offices and Fees) Rules, 2014.
(c) The application shall be made to the Central Government within 30 days of the resolution passed
by the Board.
(d) The company shall hold the general meeting within 30 days of receipt of approval of the Central
Government for passing the special resolution. [MTP-March’19]
10. Which of the following is correct :
(a) A firm whereof all the partners practising anywhere are qualified for appointment may be
appointed by its firm name to be auditor of a company.
(b) A firm whereof majority of partners practising anywhere are qualified for appointment may be
appointed by its firm name to be auditor of a company.
(c) A firm whereof all the partners practising in India are qualified for appointment may be appointed
by its firm name to be auditor of a company.
(d) A firm whereof majority of partners practising in India are qualified for appointment may be
appointed by its firm name to be auditor of a company. [MTP-April’19]
11. As per Section 139(6), the first auditor of a company, other than a Government company, shall be
appointed
(a) by the Board of Directors within 30 days from the date of registration of the company.
(b) by the audit committee within 30 days from the date of registration of the company.
(c) by the Managing Director within 30 days from the date of registration of the company.
(d) by the shareholders within 30 days from the date of registration of the company. [MTP-April’19]
12. Where a company is required to constitute an Audit Committee under section 177,
(a) all appointments, including the filling of a casual vacancy of an auditor under this section shall be
made after taking into account the recommendations of such committee.
(b) all appointments, excluding the filling of a casual vacancy of an auditor under this section shall be
made after taking into account the recommendations of such committee.
(c) appointment of first auditors shall be made after taking into account the recommendations of
such committee.
(d) appointment of subsequent auditors shall be made after taking into account the recommendations
of such committee. [MTP-April’19]
13. Springfield Hospital located in the rural area of Lonawala region is a government hospital run by the
local doctors who are appointed by the government. The hospital was registered on 1 October 2018.
Which of the following is correct in respect of the appointment of the first auditor for Springfield
Hospital?
(a) The Board of Directors of the hospital have appointed the first auditor on 5th November 2018.
(b) The Comptroller Auditor-General of India appointed the first auditor on 15th December 2018.
(c) Since the Comptroller Auditor-General of India did not appoint the first auditor, the Board of
Director appointed the first auditor on 15th December 2018.
(d) Since the Comptroller Auditor-General of India did not appoint the first auditor, the Board of
Director appointed the first auditor on 10th November 2018. [MTP-April’19]

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14. In case of a company that is required to constitute an Audit Committee under section 177, the committee,
and, in cases where such a committee is not required to be constituted, __________, shall take into
consideration the qualifications and experience of the individual or the firm proposed to be considered
for appointment as auditor and whether such qualifications and experience are commensurate with
the size and requirements of the company.
(a) the board (b) any director (c) Managing Director (d) Whole time director
[RTP-Nov’19]
15. Eeyore Pvt. Ltd. is incorporated on 1st July, 2017. During the Financial Year ending on 31st March,
2018, the company did not opt for any borrowing at any point of time and have a total revenue of `
60 Lakh. At the year end, it provides the following information regarding its paid-up capital and
reserve & surplus
Particulars Amount (in` )
Paid-up Capital
- Consideration received in cash for equity shares (including unpaid calls of ` 5,00,000)40,00,000
- Consideration received in cash for preference shares 25,00,000
- Bonus shares allotted 7,00,000
- Share application money received pending allotment 10,00,000
Sub-Total 82,00,000
Reserve & Surplus
- Balance in Statement of Profit and Loss 15,00,000
- Capital Reserves 10,00,000
Sub-Total 25,00,000
GRAND TOTAL 1,07,00,000
You are provided with the provisions regarding applicability of Companies (Auditor’s Report) Order,
2016, (CARO, 2016) issued under section 143(11) of the Companies Act, 2013 to a private limited company
that it specifically exempts a private limited company having a paid up capital and reserves and surplus
not more than `1 crore as on the Balance Sheet date and which does not have total borrowings exceeding
` 1 crore from any bank 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 exceeding ` 10 crore during the
financial year.
Considering the information given above, which of the following shall be considered as a reason
regarding applicability or non-applicability of CARO, 2016?
(a) Reporting under CARO, 2016 shall be applicable as the company is having a paid up capital and
reserves and surplus of ` 1.07 crore i.e. more than ` 1 crore as on the Balance Sheet date.
(b) Reporting under CARO, 2016 shall be applicable as the company is having a paid up capital and
reserves and surplus of ` 1.02 crore i.e. more than ` 1 crore as on the Balance Sheet date.
(c) Reporting under CARO, 2016 shall not be applicable as the company is having a paid up capital and
reserves and surplus of ` 0.92 crore i.e. not more than ` 1 crore as on the Balance Sheet date.
(d) Reporting under CARO, 2016 shall not be applicable as the company is having a paid up capital and
reserves and surplus of ` 0.82 crore i.e. not more than ` 1 crore as on the Balance Sheet date.
[RTP-MAY’19]

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16. CA. Daffy is the auditor of xBose Ltd. for the previous 2 years. However, due to certain unavoidable
circumstances, no Annual General Meeting (AGM) was held for the current F inancial Year ending on
31st M arch, 2018 within every possible time limit and thus, the ratification procedure for her
appointment in the AGM could not be performed. Whether she may continue to hold the office of the
auditor?
(a) CA. Daffy may continue to hold the office of the auditor for the current Financial Year only and
thereafter shall resign herself as the ratification procedure could not be completed.
(b) CA. Daffy shall continue to hold the office of the auditor and ask the Board to re-appoint her in a
private meeting.
(c) CA. Daffy shall continue to hold the office of the auditor as no such ratification provisions for
appointment by members at every AGM exist.
(d) CA. Daffy shall not continue to hold office of the auditor as the ratification procedure could not be
completed as per proviso to section 139(1) of the Companies Act, 2013.
[RTP-MAY’19]

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 C H APT E R- 1 1
AUDIT R EPO R T

Q-1 The auditor shall evaluate whether the financial statements are prepared in accordanc e with the
requirements of the applicable financial reporting framework.
This evaluation shall include consideration of the qualitative aspects of the entity’s accounting practices,
including indicators of possible bias in management ’s judgments.
Advise about qualitative aspects of the entity’s accounting practices, including indicators of possible
bias in management’s judgments. [MTP-Oct’19,4 Marks-MTP-March’19,MTP-March’18,5 Marks,
MTP-Oct’18,5 Marks,RTP-May’18,RTP-May’20]
Ans. Evaluations by the Auditor: The auditor shall evaluate whether the financial statements are prepared
in accordance with the requirements of the applicable financial reporting framework.
This evaluation shall include consideration of the qualitative aspects of the entity’s accounting practices,
including indicators of possible bias in management ’s judgments.
Qualitative Aspects of the Entity’s Accounting Practices
1. Management makes a number of judgments about the amounts and disclosures in the financial
statements.
2. SA 260 (Revised) contains a discussion of the qualitative aspects of accounting practices.
3. In considering the qualitative aspects of the entity’s accounting practices, the auditor may become
aware of possible bias in management’s judgments. The auditor may conclude that lack of neutrality
together wi th uncorrected misstatements causes the financial statements to be materially
misstated. Indicators of a lack of neutrality include the following:
(i) The sel ective correction of misstatements brought to management ’s a ttention during
theaudit
Example
• Correcting misstatements with the effect of increasing reported earnings, but not
correcting misstatements that have the effect of decreasing reported earnings.
• The combina tion of several deficiencies affecting the same significant account or
disclosure (or the same internal control component) could amount to a significant
deficiency (or material weakness if required to be communicated in the jurisdiction).
This evaluation requires judgment and involvement of audit executives.
(ii) Possible management bias in the making of accounting estimates.
4. SA 540 addresses possible management bias in making accounting estimates.Indicators of possible
management bias do not constitute misstatements for purposes ofdrawing conclusions on the
reasonabl eness of individual accounting estimates. They may, how ever, affect the auditor ’s
evaluation of whether the financial statements as a whole are free from material misstatement.

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Q-2 The auditor’s report shall include a section with a heading “Responsibilities of Management for the
F inancial Statements.” SA 200 explains the premise, relating to the responsibilities of management
and, where appropriate, those charged with governance, on which an audit in accordance with SAs is
conducted. Explain [MTP-April’19,RTP-Nov’18]
Ans. Responsibilities for the Financial Statements: The auditor’s report shall include a section with a heading
“Responsibilities of Management for the F inancial Statements.”
SA 200 explains the premise, relating to the responsibilities of management and, where appropriate,
those charged with governance, on which an audit in accordance with SAs is conducted. Management
and, where appropriate, those charged with governance accept responsibility for the preparation of
the financial sta tements. Management also accepts responsibility for such internal control as it
determines is necessary to enable the preparation of financial statements that are free from material
misstatement, whether due to fraud or error. The description of management’s responsibilities in the
auditor’s report includes reference to both responsibilities as it helps to explain to users the premise
on which an audit is conducted.
This section of the auditor’s report shall describe management’s responsibility for:
(a) Preparing the financial statements in accordance wi th the applicabl e financial reporting
framework, and for such internal control as management determines is necessary to enable the
preparation of financial statements that are free from material misstatement, whether due to
fraud or error;[because of the possible effects of fraud on other aspects of the audit, materiality
does not apply to management’s acknowledgement regarding its responsibility for the design,
implementation, and maintenance of internal control (or for establishing and maintaining effective
internal control over financial reporting) to prevent and detect fraud.] and
(b) Assessing the entity’s ability to continue as a going concern and whether the use of the going
concern basis of accounting is appropriate as well as disclosing, if applicable, matters relating to
going concern. The explanation of management’s responsibility for this assessment shall include
a description of when the use of the going concern basis of accounting is appropriate.
Q-3 In order to form the audit opinion as required by SA 700, the auditor shall conclude as to whetherthe
auditor has obtained reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error. Explain the conclusions that the auditor
shall take into account. Also explain the objective of auditor as per SA 700. [MTP-Aug’18,5 Marks]
Ans. The objectives of the auditor as per SA 700 (Revised), “Forming An Opinion And Reporting On Financial
Statements” are:
(a) To form an opinion on the financial statements based on an evaluation of the conclusions drawn
from the audit evidence obtained; and
(b) To express clearly that opinion through a written report.
The auditor shall form an opinion on whether the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework.
To form opinion - Auditor to obtain Reasonable assurance
In order to form that opinion, the auditor shall conclude as to whether the auditor has obtained
reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error.
That conclusion shall take into account:
(a) whether sufficient appropriate audit evidence has been obtained;
(b) whether uncorrected misstatements are material, individually or in aggregate;
(c) The evaluations

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Q-4 When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding
figures except in some circumstances. Explain those circumstances.
[Sugg.-Nov’19,4 Marks, MTP-Aug’18,5 Marks]
Ans. When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding
figures except in the following circumstances.
1. If the auditor’s report on the prior period, as previously issued, included a qualified opinion, a
disclaimer of opinion, or an adverse opinion and the matter which gave rise to the modification is
unresolved, the auditor shall modify the auditor ’s opinion on the current period’s financial
statements. In the Basis for Modification paragraph in the auditor’s report, the auditor shall
either:
(a) Refer to both the current period’s figures and the corresponding figures in the description of
the matter giving rise to the modification when the effects or possible effects of the matter
on the current period’s figures are material; or
(b) In other cases, explain that the audit opinion has been modified because of the effects or
possible effects of the unresolved matter on the comparability of the current period’s figures
and the corresponding figures.
2. If the auditor obtains audit evidence that a material misstatement exists in the prior period
financial statements on which an unmodified opinion has been previously issued, the auditor
shall verify whether the misstatement has been dealt with as required under the applicable
financial reporting framework and, if that is not the case, the auditor shall express a qualified
opinion or an adverse opinion in the auditor’s report on the current period financial statements,
modified.
3. Prior Period Financial Statements Not Audited- If the prior period financial statements were not
audited, the auditor shall state in an Other Matter paragraph in the auditor’s report that the
corresponding figures are unaudited. Such a statement does not, however, relieve the auditor of
the requirement to obtain sufficient appropriate audit evidence that the opening balances do not
contain misstatements that materially affect the current period’s financial statements
Q-5 In the case of a nationalised bank, the auditor is required to make a report to the Central Government.
The report of auditors of State Bank of India is also to be made to the Central Government and is almost
identical to the auditor’s report in the case of a nationalised bank.
Explain what would the auditor state in his report. [MTP-Oct’18,5 Marks]
Ans. In the case of a nationalised bank, the auditor is required to make a report to the Central Governmentin
which he has to state the following:
(a) whether, in his opinion, the balance sheet is a full and fair balance sheet containing all the
necessary particulars and is properly drawn up so as to exhibit a true and fair view of the affairs of
the bank, and in case he had called for any explanation or information, whether it has been given
and whether it is satisfactory;
(b) whether or not the transactions of the bank, which have come to his notice, have been within the
powers of that bank;
(c) whether or not the returns received from the offices and branches of the bank have been found
adequate for the purpose of his audit;
(d) whether the profit and loss account shows a true balance of profit or loss for the period covered
by such account; and
(e) any other matter which he considers should be brought to the notice of the Central Government.
The report of auditors of State Bank of India is also to be made to the Central Government and is
almost identical to the auditor’s report in the case of a nationalised bank.

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Q-6 Communicating Key Audit Matter is not a substitute for disclosure in the Financial Statements rather
Communicating key audit matters in the auditor’s report is in the context of the Auditor having formed
an opinion on the financial statements as a whole. Analyse. [RTP-Nov’19, RTP-May’18]
Ans. Communicating key audit matters in the auditor’s report is not:
(i) A substitute for disclosures in the financial statements that the applicable
Financial reporting framework requires management to make, or that are otherwise necessary to
achieve fair presentation;
(ii) A substitute for the auditor expressing a modified opinion when required by the circumstances of
a specific audit engagement in accordance with SA 705 (Revised);
(iii) A substitute for reporting in accordance with SA 570 when a material uncertainty exists relating to
events or conditions that may cast significant doubt on an entity’s ability to continue as a going
concern; or
(iv) A separate opinion on individual matters
Q-7 The auditor’s report shall include a section, directly following the Opinion section, with the heading
“Basis for Opinion”. Explain what is included in this “Basis for Opinion” section. [RTP-Nov’19]
Ans. Basis for Opinion: The auditor’s report shall include a section, directly following the Opinion section,
with the heading “Basis for Opinion”, that:
(a) States that the audit was conducted in accordance with Standards on Auditing;
(b) Refers to the section of the auditor’s report that describes the auditor’s responsibilities under
the SAs;
(c) Includes a statement that the auditor is independent of the entity in accordance with the relevant
e thical re quirem e nts re l a t ing to th e audi t a nd h as fulf i ll ed the audi tor ’s o th er ethica l
responsibilities in accordance with these requirements.
(d) States whether the auditor believes that the audit evidence the auditor has obtained is sufficient
and appropriate to provide a basis for the auditor’s opinion.
Q-8 The nature of the comparative information that is presented in an entity’s financial statements depends
on the requirements of the applicable financial reporting framework. There are two different broad
approaches to the auditor’s reporting responsibilities in respect of such comparative information:
corresponding figures and comparative financial statements. Explain clearly stating the essential audit
reporting differences between the approaches. Also define comparative informa tion and audi t
procedures regarding comparative information. [RTP-May’19]
Ans. The nature of the comparative information that is presented in an entity’s financial statements depends
on the requirements of the applicable financial reporting framework. There are two different broad
approaches to the auditor’s reporting responsibilities in respect of such comparative information:
corresponding figures and comparative financial statements. The approach to be adopted is often
specified by law or regulation but may also be specified in the terms of engagement.
The essential audit reporting differences between the approaches are:
(a) For corresponding figures, the auditor’s opinion on the financial statements refers to the current
period only; whereas
(b) For compara tive financial statements, the audi tor’s opinion refers to each period for which
financial statements are presented.
Definition of Comparative information – The amounts and disclosures included in the financial
statements in respect of one or more prior periods in accordance with the applicable financial
reporting framework.

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 Audit Procedures regarding comparative information
The auditor shall determine whether the financial statements include the comparative information
required by the applicable financial reporting framework and whether such informa tion is
appropriately classified. For this purpose, the auditor shall evaluate whether:
(a) The comparative information agrees with the amounts and other disclosures presented in
the prior period; and
(b) The accounting policies reflected in the comparative information are consistent with those
applied in the current period or, if there have been changes in accounting policies, whether
those changes have been properly accounted for and adequately presented and disclosed.
Q-9 Define Emphasis of Matter paragraph. When the auditor shall include an Emphasis of Matter paragraph
in the auditor’s report? Also explain how the auditor would include an Emphasis of Matter in the
auditor’s report? [RTP-May’19,Sugg.May’18,5 Marks]
Ans. Emphasis of Matter paragraph – A paragraph included in the auditor’s report that refers to a matter
appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of
such importance that it is fundamental to users’ understanding of the financial statements.
Emphasis of Matter Paragraphs in the Auditor’s Report
If the auditor considers it necessary to draw users’ attention to a matter presented or disclosed in the
financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to
users’ understanding of the financial statements, the auditor shall include an Emphasis of Matter
paragraph in the auditor’s report provided:
(a) The auditor would not be required to modify the opinion in accordance with SA 705 (Revised) as
a result of the matter; and
(b) When SA 701 appli es, the matter has not been determined to be a key audit ma tter to be
communicated in the auditor’s report.
Separate section for Emphasis of Matter paragraph
When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall:
(a) Include the paragraph within a separate section of the auditor’s report with an appropriate heading
that includes the term “Emphasis of Matter”;
(b) Include in the paragraph a clear reference to the matter being emphasized and to where relevant
disclosures that fully describe the matter can be found in the financial statements. The paragraph
shall refer only to information presented or disclosed in the financial statements; and
(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.
Q-10 Explain clearly the purpose of communicating key audit matters. [RTP-Nov’18]
Ans. Purpose of communicating key audit matters : As per SA 701, “Communicating Key Audit Matters in the
Auditor’s Report”, the purpose of communicating key audit matters is to enhance the communicative
value of the auditor’s report by providing greater transparency about the audit that was performed.
Communicating key audit matters provides additional information to intended users of the financial
statements to assist them in understanding those matters that, in the auditor’s professional judgment,
were of most significance in the audit of the financial statements of the current period. Communicating
key audit matters may also assist intended users in understanding the entity and areas of significant
management judgment in the audited financial statements.

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Q-11 “An auditor is required to make specific evaluations while forming an opinion in an audit report.” State
them. [Sugg.-Nov’18,5 Marks]
Ans. Specific Evaluations by the auditor: In particular, the auditor shall evaluate whether :
(i) The financial statements adequately disclose the significant accounting policies selected and
applied;
(ii) The accounting policies selected and applied are consistent with the applicable financial reporting
framework and are appropriate;
(iii) The accounting estimates made by management are reasonable;
(iv) The information presented in the financial statements is relevant, reliable, comparable, and
understandable;
(v) The financial statements provide adequate disclosures to enable the intended users to understand
the effect of material transactions and events on the information conveyed in the financial
statements; and
(vi) The terminology used in the financial statements, including the title of each financial statement,
is appropriate.
Q-12 The first section of the auditor’s report shall include the auditor’s opinion, and shall have the heading
“Opinion.” The Opinion section of the auditor’s report shall also Identify the entity whose financia l
statements have been audited. Apart from the above, explain the other relevant points to be included
in opinion section. [RTP-May’020]
Ans. The first section of the auditor’s report shall include the auditor’s opinion, and shall havethe heading
“Opinion
”The Opinion section of the auditor’s report shall also:
(a) Identify the entity whose financial statements have been audited;
(b) State that the financial statements have been audited;
(c) Identify the title of each statement comprising the financial statements;
(d) Refer to the notes, including the summary of significant accounting policies; and
(e) Specify the date of, or period covered by, each financial statement comprising the financial
statements.

MULTIPLE CHOICE QUESTIONS

1. A company did not disclose accounting policies required to be disclosed under Schedule III or any
otherprovisions of the Companies Act, 2013, the auditor should issue–
(a) a qualified opinion (b) an adverse opinion
(c) a disclaimer of opinion (d) emphasis of matter paragraph. [MTP-Oct’19]
2. An Audit report is :
(a) an opinion drawn on the entity’s financial statements to make sure that the records are true
andcorrect representation of the transactions they claim to represent.
(b) an opinion drawn on the entity’s books of accounts to make sure that the records are true and fair
representation of the transactions they claim to represent.
(c) an opinion drawn on the entity’s financial statements to make sure that the records are true
andfair representation of the transactions they claim to represent.
(d) an opinion drawn on the entity’s books of accounts to make sure that the records are true andcorrect
representation of the transactions they claim to represent. [MTP-Oct’19]

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3. If the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances,
(a) the auditor shall express a qualified opinion in accordance with SA 705.
(b) the auditor shall express a disclaimer of opinion in accordance with SA 705.
(c) the auditor shall express a qualified opinion or adverse opinion, as appropriate, in accordance
with SA 705.
(d) the auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate, in
accordance with SA 705. [MTP-Oct’19-MTP-April’19-RTP-Nov’19]
4. Which of the following is correct :
(a) The audi tor shall express a qualified opinion when the audi tor, having obtained suffici ent
appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are
both material and pervasive to the financial statements.
(b) The auditor shall express a disclaimer opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are
both material and pervasive to the financial statements.
(c) The auditor shall express an adverse opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are
both material and pervasive to the financial statements.
(d) The auditor shall express an adverse opinion when the auditor, having obtained suffici ent
appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are
material, but not pervasive, to the financial statements [MTP-Oct’19]
5. Most of the auditor’s work in forming the auditor’s opinion consists of :
(a) obtaining audit evidence. (b) evaluating audit evidence.
(c) obtaining or evaluating audit evidence. (d) obtaining and evaluating audit evidence.
[MTP-April’19]
6. Which of the following is correct :
(a) When reporting on prior period financial statements in connection with the current period’s
audit, if the auditor’s opinion on such prior period financial statements differs from the opinion
the auditor previously expressed, the auditor need not disclose the substantive reasons for the
different opinion.
(b) When reporting on prior period financial statements in connection with the current period’s
audit, if the auditor’s opinion on such prior period financial statements differs from the opinion
the auditor previously expressed, the auditor shall disclose the substantive reasons for the
different opinion in an Other Matter paragraph in accordance with SA 706.
(c) When reporting on prior period financial statements in connection with the current period’s
audit, if the auditor’s opinion on such prior period financial statements differs from the opinion
the audi tor previously expressed, the auditor shall disclose the substantive reasons for the
different opinion in an emphasis of Matter paragraph in accordance with SA 706.
(d) When reporting on prior period financial statements in connection with the current period’s
audit, if the auditor’s opinion on such prior period financial statements differs from the opinion
the audi tor previously expressed, the auditor shall disclose the substantive reasons for the
different opinion in an Other Matter paragraph or emphasis of matter paragraph in accordance
with SA 706. [MTP-April’19]

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7. Which of the following is incorrect :
(a) Communicating key audit matters in the auditor’s report is not a substitute for disclosures in the
financial statements that the applicable financial reporting framework requires management to
make, or that are otherwise necessary to achieve fair presentation;
(b) Communicating key audit matters in the auditor ’s report is not a substi tute for the audi tor
expressing a modified opinion when required by the circumstances of a specific audit engagement
in accordance with SA 705 (Revised);
(c) Communicating key audit ma tters in the auditor ’s report is not a substitute for reporting in
accordance with SA 570 when a material uncertainty exists relating to events or conditions that
may cast significant doubt on an entity’s ability to continue as a going concern;
(d) Communicating key audit matters in the auditor’s report is a substitute for the auditor expressing
a modified opinion when required by the circumstances of a specific audit engagement in
accordance with SA 705 (Revised); [MTP-April’19]
8. CA. Goofy has been appointed as an auditor for audit of a complete set of financial statements of Dippy
Ltd., a listed company. The financial statements of the company are prepared by the management in
accordance with the Accounting Standards prescribed under section 133 of the Companies Act, 2013.
However, the inventories are missta ted which is deemed to be material but not pervasive to the
financial statements. Based on the audit evidences obtained, CA. Goofy has concluded that a material
uncertainty does not exist related to events or conditions that may cast significant doubt on the entity’s
ability to continue as a going concern in accordance with SA 570. Further, CA. Goofy is also aware of the
fact that a qualified opinion would be appropriate due to a material misstatement of the F inancial
Statements. State what phrases should the auditor use while drafting such opinion paragraph?
(a) In our opinion and to the best of our information and according to the explanations given to us,
except for the effects of the matter described in the Basis for Qualified Opinion section of our
report, the aforesaid financial statements present fairly, in all material respects, or give a true
and fair view in conformity with the applicable financial reporting framework.
(b) In our opinion and to the best of our information and according to the explanations given to us,
with the foregoing explanation, the aforesaid financial statements present fairly, in all material
respects, or give a true and fair vi ew in conformity with the applicable financial reporting
framework.
(c) In our opinion and to the best of our information and according to the explanations given to us,
subject to the misstatement regarding inventories, the aforesaid financial statements present
fairly, in all material respects, or give a true and fair view in conformity with the applicable
financial reporting framework.
(d) In our opinion and to the best of our information and according to the explanations given to us,
with the explanation described in the Basis for Qualified Opinion section of our report, the
aforesaid financial statements present fairly, in all material respects, or give a true and fair view
in conformity with the applicable financial reporting framework. [RTP-May’19]

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 C H APT E R- 1 2
BANK AUDIT

Q-1 Your firm of Chartered Accountants has been appointed as the Auditor of two branches of OBC which
are located in the Industrial area. Considering that the location of the branches of bank in industrial
area, these would be “advances oriented branches and audit of advances would require the major
attention of the auditors. Advise how would you proceed to obtain evidence in respect of audit of
advances. [MTP-Oct’19,4 Marks, RTP-Nov’19, RTP-May’18]
Ans. Audit of Advances: Advances generally constitute the major part of the assets of the bank. There are
large number of borrowers to whom variety of advances are granted. The audit of advances requires
the major attention from the auditors.
In carrying out audit of advances, the auditor is primarily concerned with obtaining evidence about the
following:
a. Amounts included in balance sheet in respect of advances are outstanding at the date of the
balance sheet.
b. Advances represent amount due to the bank.
c. Amounts due to the bank are appropriately supported by Loan documents and other documents
as applicable to the nature of advances.
d. There are no unrecorded advances.
e. The stated basis of valuation of advances is appropria te and properly applied, and tha t the
recoverability of advances is recognised in their valuation.
f. The advances are disclosed, classified and described in accordance with recognised accounting
policies and practices and relevant statutory and regulatory requirements.
g. Appropriate provisions towards advances have been made as per the RBI norms, Accounting
Standards and generally accepted accounting practices.
The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation
of internal controls relating to advances, and by:
• examining the validity of the recorded amounts;
• examining loan documentation;
• reviewing the operation of the accounts;
• examining the existence, enforceability and valuation of the security;
• checking compliance with RBI norms including appropriate classification and provisioning; and
• carrying out appropriate analytical procedures.
In carrying out his substantive procedures, the auditor should examine all large advances while other
advances may be examined on a sampling basis. The accounts identified to be problem accounts
however need to be examined in detail unless the amount involved is insignificant.
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 Advances which are sanctioned during the year or which are adversely commented by RBI inspection
team, concurrent auditors, bank’s internal inspection, etc. should generally be included in the auditor’s
revi ew.
Q-2 The engagement team of FRN & Co.- Auditors of Bank of Baroda held discussions to gain better
understanding of the bank and its environment, including internal control, and also to assess the
potential for material misstatements of the financial statements.
The discussion between the members of the engagement team and the audit engagement partner are
being done on the susceptibility of the bank’s financial statements to material misstatements. These
discussions are ordinarily done at the planning stage of an audit.
Analyse and Advise the matters to be discussed in the engagement team discussion.
[Sugg.-Nov’19,3 Marks, MTP-March’19,MTP-March’18,5 Marks,Sugg.-May’19,4 Marks]
Ans. The engagement team should hold discussions to gain better understanding of the bank and its
environment, including internal control, and also to assess the potential for material misstatements of
the financial sta tements. All these discussions should be appropriately documented for future
reference. The discussion provides:
• An opportuni ty for more expe ri enced e ngag em en t t ea m me mb ers, incl uding the a udi t
engagement partner, to share their insights based on their knowl edge of the bank and i ts
environment.
• An opportunity for engagement team members to exchange information about the bank’s business
risks.
• An understanding amongst the engagement team members about effect of the results of the risk
assessment procedures on other aspects of the audit, including decisions about the nature, timing,
and extent of further audit procedures.
The discussion between the members of the engagement team and the audit engagement partner
should be done on the susceptibility of the bank’s financial statements to material misstatements.
These discussions are ordinarily done at the planning stage of an audit.
The engagement team discussion ordinarily includes a discussion of the following matters:
Errors that may be more likely to occur;
Errors which have been identified in prior years;
Method by which fraud might be perpetrated by bank personnel or others within particular account
balances and/or disclosures;
Audit responses to Engagement Risk, Pervasive Risks, and Specific Risks;
Need to maintain professional skepticism throughout the audit engagement;
Need to alert for information or other conditions that indicates that a material misstatement may have
occurred (e.g., the bank’s application of accounting policies in the given facts and circumstances).
Q-3 The auditor should examine the efficacy of various internal controls over advances in case of Banks to
determine the nature, timing and extent of his substantive procedures. Explain what is included in the
internal controls over advances. [MTP-April’19,4 Marks,RTP-May’19,RTP-Nov’18,RTP-May’2020]
Ans. Evaluation of Internal Controls over Advances: The auditor should examine the efficacy of various
internal controls over advances to determine the na ture, timing and extent of his substantive
procedures. In general, the internal controls over advances should include, inter alia , the following:
• The bank should make an advance only after satisfying itself as to the credit worthiness of the

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 borrower and after obtaining sanction from the appropriate authorities of the bank.
• A ll th e n ecessa ry docum en ts (e.g., agre e me n ts, d em a nd promissory no t es, l e tt ers of
hypothecation, etc.) should be executed by the parties before advances are made.
• The compliance with the terms of sanction and end use of funds should be ensured.
• Sufficient margin as specified in the sanction letter should be kept against securities taken so as
to cover for any decline in the value thereof. The availability of sufficient margin needs to be
ensured at regular intervals.
• If the securities taken are in the nature of shares, debentures, etc., the ownership of the same
should be transferred in the name of the bank and the effective control of such securities be
retained as a part of documentation.
• All securities requiring registration should be registered in the name of the bank or otherwise
accompanied by documents sufficient to give title to the bank.
• In the case of goods in the possession of the bank, contents of the packages should be test
checked at the time of receipt. The godowns should be frequently inspected by responsible
officers of the branch concerned, in addition to the inspectors of the bank.
• Drawing Pow er Register should be upda ted every month to record the value of securities
hypothecated. These entries should be checked by an officer.
• The accounts should be kept within both the drawing power and the sanctioned limit.
• All the accounts which exceed the sanctioned limit or drawing power or are otherwise irregular
should be brought to the notice of the controlling authority regularly.
• The operation of each advance account should be reviewed at least once a year, and at more
frequent intervals in the case of large advances.
Q-4 “Ramjilal & Co. had been allotted the branch audit of a nationalized bank for the year ended 31st
March, 2018. In the audit planning, the partner of Ramjilal & Co., observed that the allotted branches
are predominantly based in rural areas and major portion of the advances were for agricultural purpose.”
Now he needs your assistance on the following points so as to incorporate them in the audit plan:
(i) for determination of NPA norms for agricultural advances
(ii) for accounts where there is erosion in the value of security/frauds committed by the borrowers.
[Sugg.-Nov’18,5 Marks]
Ans.(i) NPA norms for Agricultural Advances: As per the guidelines, Agricultural Advances are of two types, (1)
Agricultural Advances for “long duration” crops and (2) Agricultural Advances for “short duration” crops
The “long duration” crops would be crops with crop season longer than one year and crops, which are
not “long duration” crops would be treated as “short duration” crops.
The crop season for each crop, which means the period up to harvesting of the crops raised, would be
as determined by the State Level Bankers’ Committee in each State.
The following NPA norms would apply to agricultural advances (including Crop Term Loans):
- A loan granted for short duration crops will be treated as NPA, if the instalment of principal or
interest thereon remains overdue for two crop seasons and,
- A loan granted for long duration crops will be treated as NPA, if the instalment of principal or
interest thereon remains overdue for one crop season.
(ii) Accounts where there is erosion in the value of security / frauds committed by borrowers
Not prudent to follow stages of asset classification. It should be straightaway classified as doubtful or

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 loss asset as appropriate.
(i) Erosion in the value of security can be reckoned as significant when the realisable value of the
security is less than 50 per cent of the value assessed by the bank or accepted by RBI at the time of
last inspection, as the case may be. Such NPAs may be straightaway classified under doubtful
category and provisioning should be made as applicable to doubtful assets.
(ii) If the realisable value of the security, as assessed by the bank/ approved valuers/ RBI is less than
10 per cent of the outstanding in the borrowal accounts, the existence of security should be
ignored and the asset should be straightaway classified as loss asset. It may be either written off
or fully provided for by the bank.
Q-5 At the AGM of HDB Pvt. Ltd., Mr. R was appointed as the statutory auditor. He, however, resigned after
3 months since he wanted to pursue his career in banking sector. The Board of Director has appointed
Mr. L as the statutory auditor in board meeting within 30 days. Comment on the matter with reference
to the provisions of Companies Act, 2013. [Sugg.-May’18,5 Marks]
Ans. Casual Vacancy by Resignation: As per Section 139(8), any casual vacancy in the office of an auditor shall
in the case of a company other than a company whose accounts are subject to audit by an auditor
appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within
30 days. If such casual vacancy is as a result of the resignation of an auditor, such appointment shall also
b e a pprov ed by th e comp any a t a g e ne ra l m e et i ng conv e ne d w i thin thre e months of th e
recommendation of the Board and he shall hold the office till the conclusion of the next annual general
meeting.
Further, as per section 140(2) the auditor who has resigned from the company shall file within a period
of 30 days from the date of resignation, a statement in the prescribed Form with the company and the
Registrar. In the instant case, R resigned after three months of his appointment as statutory auditor as
he wanted to pursue his career in banking sector.
Therefore, the board of director has appointed Mr. L as the statutory auditor with in 30 days is in order
subject to such appointment shall also be approved by the company at a general meeting convened
within three months of the recommendation of the Board. Further, it is also the duty of the auditor to
file, within a period of 30 days from the date of resignation, a statement in the prescribed Form with
the company and the Registrar in compliance with section 140(2) of the Companies Act, 2013.
Q-6 Mr. A approaches a bank for financial assistance for his upcoming project. The Bank Branch Manager,
after verifying the proposal, is agreeable to financing Mr. A, but asks for the security to be offered to
the bank. Discuss the nature of securities required to be offered to the bank. [Sugg.-May’18,5 Marks]
Ans. Nature of Security :
I. Primary security refers to the security offered by the borrower for bank finance or the one against
which credit has been extended by the bank. This security is the principal security for an advance.
II. Collateral security is an additional security. Security can be in any form i.e. tangible or intangible
asset, movable or immovable asset.
Examples of most common types of securities accepted by banks are the following.
• Personal Security of Guarantor • Goods / Stocks / Debtors / Trade Receivables
• Gold Ornaments and Bullion • Immovable Property
• Plantations (For Agricultural Advances)
• Third Party Guarantees • Banker’s General Lien
• Life Insurance Policies • Stock Exchange Securities and Other Instruments

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Q-7 In view of the significant uncertainty regarding ultimate collection of income arising in respect of non-
performing assets, the guidelines require that banks should not recognize income on non-performing
assets until it is actually realised. When a credit facility is classified as non-performing for the first
time, interest accrued and credited to the income account in the corresponding previous year which
has not been realized should be reversed or provided for. This will apply to Government guaranteed
accounts also. Analyse and Explain. [RTP-May’20]
Ans. Reversal of Income:
If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, the
entire interest accrued and credited to income account in the past periods, should be reversed or
provided for if the same is not realised. This will apply to Government guaranteed accounts also.
In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in
the current period and should be reversed or provided for with respect to past periods, if uncollected.
Further, in case of banks which have wrongly recognised income in the past should reverse the interest
if it was recognised as income during the current year or make a provision for an equivalent amount if
it was recognized as income in the previous year(s).
Furthermore, the auditor should enquire if there are any large debits in the Interest Income account
that have not been explained. It should be enquired whether there are any communications from
borrowers pointing out differences in interest charge and whether appropriate action has been taken
in this regard.
Q-8 ‘’There is no difference in provisioning of NPA as regards to categories of NPA, whether the debt is
secured or unsecured.” Critically evaluate the statement on the basis of provisioning norms of NPA of
nationalised bank. [Sugg.-Nov’19,4 Marks]
Ans. Classification as NPA should be based on the record of recovery. Availability of security or net worth of
borrower/guarantor is not to be taken into account for purpose of treating an advance as NPA or
otherwise. Further, asset classification would be borrower-wise and not facility-wise. All facilities
including investments in securities would be termed as NPA.
There are different provisioning requirements as regards to categories of NPA such as Sub-standards
assets, Doubtful assets and loss assets which are given below:
Categories of Non-Performing Assets: Provision required
• Substandard Assets: Would be one, which has 15%
remained NPA for a period less than or equal
to 12 months.
• Doubtful Assets: Would be one, which
has remained in the substandard
category for a period of 12 months. Secured+ Unsecured
• Sub-categories:
Doubtful up to 1 Year (D1) 25% + 100%
Doubtful 1 to 3 Years (D2) 40% + 100%
Doubtful more than 3 Years (D3) 100% + 100%
• Loss Assets: Would be one, where loss
has been identified by the bank or
internal or external auditors or the
RBI inspection but the amount has not
been written off wholly. 100%

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MULTIPLE CHOICE QUESTIONS

1. Which of the following is correct :

(a) Sub-section (1) of section 30 of the Banking Regulations Act, 1949 requires that the balance
sheetand profit and loss account of a banking company should be audited by a Firm of Chartered
Accountants only.
(b) Sub-section (1) of section 30 of the Banking Regulations Act, 1949 requires that the balance
sheetand profit and loss account of a banking company should be audited by a person duly
qualifiedunder any law for the time being in force to be an auditor of companies.
(c) Sub-section (1) of section 30 of the Banking Regulations Act, 1949 requires that the balance
sheetand profit and loss account of a banking company should be audited by a CAG Auditor only.
(d) Sub-section (1) of section 30 of the Banking Regulations Act, 1949 requires that the balance
sheetand profit and loss account of a banking company should be audited by a by a person duly
qualified under Banking Law. [MTP-Oct’19,2 Marks]
2. Which of the following is correct in case of Banks :
(a) The policy of income recognition should be subjective.
(b) The policy of income recognition should be objective and based on record of recovery rather than
on any subjective considerations.
(c) The policy of income recognition should be objective.
(d) The policy of income recognition may be objective or subjective. [MTP-March’19, 2 Marks]
3. You are at the planning stage for one of your firm’s client XYZ Bank for the year ended 31 March 2018.
The bank is a commercial bank that provides a number of products and services to the general public
and other segments of the economy in the area of South Mumbai. You are assigned the audit of one of
the branches of XYZ Bank. The audit engagement team was called to have a detailed discussion on the
following matters. Which one of the following should not be included in the discussion for the audit of
banks?
(a) Discuss on the error of last year in the application of accounting policies of the bank.
(b) Discuss on the method of fraud if any perpetrated by the bank employee within particular balances
and/or disclosures
(c) Discuss with the team the appointment and remuneration to be received on this bank audit.
(d) Discuss the effect of the results of the risk assessment procedures on other aspects to decide the
nature, timing and extent of further audit procedures. [MTP-April’19,2 Marks]

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 C H APT E R- 1 3
AUDIT O F DI F F E R ENT TYP ES O F ENT IT I ES

Q-1 Audit against the propriety seeks to ensure that expenditure confirms to certain principles. Explain
[MTP-Oct’19,4 Marks]
Ans. Audit against propriety: Audit against propriety seeks to ensure that expenditure conforms to these
principles which have been stated as follows:
(1) The expenditure should not be prima facie more than the occasion demands. Every public officer
is expected to exercise the same vigilance in respect of expenditure incurred from public moneys
as a person of ordinary prudence would exercise in respect of expenditure of his own money.
(2) No authority should exercise its powers of sanctioning expenditure to pass an order which will be
directly or indirectly to its own advantage.
(3) Public moneys should not be utilized for the benefit of a particular person or section of the
community unless:
(i) The amount of expenditure involved is insignificant; or
(ii) A claim for the amount could be enforced in a Court of law; or
(iii) The expenditure is in pursuance of a recognized policy or custom; and
(iv) The amount of allowances, such as travelling allowances, granted to meet expenditure of a
particular type should be so regulated that the allowances are not, on the whole, sources of
profit to the recipients.
Q-2 The general transactions of a hospital include patient treatment, collection of receipts, donations,
capital expenditures. You are required to mention special points of consideration while auditing such
transactions of a hospital? [MTP-Oct’19,4 Marks, MTP-Aug’18,5 Marks, RTP-Nov’18]
Ans. Special points of consideration while auditing certain transactions of a hospital are stated below-
(i) Register of Patients: Vouch the Register of patients with copies of bills issued to them. Verifybills
for a selected period with the patients’ attendance record to see that the bills have been correctly
prepared. Also see tha t bills have been issued to all pa tients from whom an amount was
recoverable according to the rules of the hospital.
(ii) Collection of Cash: Check cash collections as entered in the Cash Book with the receipts, counterfoils
and other evidence for example, copi es of pati ents bills, counterfoils of dividend and other
interest warrants, copies of rent bills, etc.
(iii) Legacies and Donations: Ascertain that legacies and donations received for a specific purpose
have been applied in the manner agreed upon.
(iv) Reconciliation of Subscriptions: Trace all collections of subscription and donations from the Cash
Book to the respective Registers. Reconcil e the total subscriptions due (as shown by the
Subscription Register and the amount collected and that still outstanding).

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 (v) Authorisation and Sanctions: Vouch all purchases and expenses and verify that the capital
expenditure was incurred only with the prior sanction of the Trustees or the Managing Committee
and that appointments and increments to staff have been duly authorised.
Q-3 An NGO operating in Delhi had collected large scale donations for Tsunami victims. The donations so
collected were sent to different NGOs operating in Tamil Nadu for relief operations. This NGO operating
in Delhi has appointed you to audit its accounts for the year in which it collected and remitted donations
for Tsunami victims. Draft audit programme for audit of receipts of donations and remittance of the
collected amount to different NGOs. Mention two points each, peculiar to the situation, which you will
like to incorporate in your audit programme for audit of said receipts and remittances of donations.
[MTP-March’19,4 Marks, MTP-March’18,5 Marks-MTP-Oct’18,5 Marks]
Ans. Receipt of Donations :
(i) Internal Control System: Existence of internal control system particularly with reference todivision
of responsibilities in respect of authorised collection of donations, custody of receipt books and
safe custody of money.
(ii) Custody of Receipt Books: Existence of system regarding issue of receipt books, whether unused
receipt books are returned and the same are verified physically including checking of number of
receipt books and sequence of numbering therein.
(iii) Receipt of Cheques: Receipt Book should have carbon copy for duplicate receipt and signed by a
responsible official. All details relating to date of cheque, bank’s name, date, amount, etc. should
be clearly stated.
(iv) Bank Reconciliation: Reconciliation of bank statements with reference to all cash deposits not
only with reference to date and amount but also with reference to receipt book.
(v) Cash Receipts: Register of cash donations to be vouched more extensively. If addresses are
available of donors who had given cash, the same may be cross-checked by asking entity to post
thank you letters mentioning amount, date and receipt number.
(vi) Foreign Contributions, if any, to receive special attention to compliance with applicable laws and
regulations.
Remittance of Donations to Different NGOs:
(i) Mode of Sending Remittance: All remittances are through account payee cheques.Remittances
through Demand Draft would also need to be scrutinised thoroughly withreference to recipient.
(ii) Confirming Receipt of Remittance: A ll re mi t ta nces a re supporte d by rece ip ts and
acknowledgements.
(iii) Identity: Recipient NGO is a genuine entity. Verify address, 80G Registration Number, etc.
(iv) Direct Confirmation Procedure: Send confirmation letters to entities to whom donations have
been paid.
(v) Donation Utilisation: Utilisation of donations for providing relief to Tsunami victims and notfor
any other purpose.
(vi) System of NGOs’ Selection: System for selecting NGO to whom donations have been sent.
Q-4 Advise any six special points in an audit of hospital. [MTP-March’19,MTP-March’18,
MTP-Oct’18, 6 Marks]
Ans. Audit of Hospital: The special steps involved in such an audit are stated below-
(1) Register of Patients: Vouch the Register of patients with copies of bills issued to them. Verify bills
for a selected period with the patients’ attendance record to see that the bills have been correctly
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 prepared. Also see tha t bills have been issued to all pa tients from whom an amount was
recoverable according to the rules of the hospital.
(2) Collection of Cash: Check cash collections as entered in the Cash Book with the receipts, counterfoils
and other evidence for example, copi es of pati ents bills, counterfoils of dividend and other
interest warrants, copies of rent bills, etc.
(3) Income from Investments, Rent etc: See by reference to the property and Investment Register
that all income that should have been received by way of rent on properties, dividends, and
interest on securities have been collected.
(4) Legacies and Donations: Ascertain that legacies and donations received for a specific purpose
have been applied in the manner agreed upon.
(5) Reconciliation of Subscriptions: Trace all collections of subscription and donations from the Cash
Book to the respective Registers. Reconcil e the total subscriptions due (as shown by the
Subscription Register and the amount collected and that still outstanding).
(6) Authorisation and Sanctions: Vouch all purchases and expenses and verify that the capital
expenditure was incurred only with the prior sanction of the Trustees or the Managing Committee
and that appointments and increments to staff have been duly authorised.
(7) Grants and TDS: Verify that grants, if any, received from Government or local authority has been
duly accounted for. Also, that refund in respect of taxes deducted at source has been claimed.
(8) Budgets: Compare the totals of various items of expendi ture and income wi th the amount
budgeted for them and report to the Trustees or the Managing Committee, significant variations
which have taken place.
(9) Internal Check: Examine the internal check as regards the receipt and issue of stores; medicines,
linen, apparatus, clothing, instruments, etc. so as to insure that purchases have been properly
recorded in the Inventory Register and that issues have been made only against proper
authorisation.
(10) Depreciation: See that depreciation has been written off against all the assets at the appropriate
rates.
(11) Registers: Inspect the bonds, share scrips, title deeds of properties and compare their particulars
with those entered in the property and Investment Registers.
(12) Inventories: Obtain inventories, especially of stocks and stores as at the end of the year and check
a percentage of the items physically; also compare their total values with respective ledger
balances.
(13) Management Representation and Certificate: Get proper Management Representation and
Certificate with respect to various aspects covered during the course of audit.
Q-5 Multi-State Co-operative Societies Act, 2002 states that a person who is a Chartered Accountantwithin
the meaning of the Chartered Accountants Act, 1949 can only be appointed as auditor ofMulti-State co-
operative society. Explain stating also the persons who are not eligible for appointment as auditors of
a Multi-State co-operative society. [Sugg, Nov ‘18,MTP-Aug’18,5 Marks]
Ans. Qualification of Auditors - Section 72 of the Multi-State Co-operative Societies Act, 2002 states that a
person who is a Chartered Accountant within the meaning of the Chartered Accountants Act, 1949 can
only be appointed as auditor of Multi-State co-operative society.
However, the following persons are not eligible for appointment as auditors of a Multi-State co-
operative society-
(a) A body corporate.

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 (b) An officer or employee of the Multi-State co-operative society.
(c) A person who is a member or who is in the employment, of an officer or employee of the Multi-
State co-operative society.
(d) A person who is indebted to the Multi-State co-operative society or who has given any guarantee
or provided any security in connection with the indebtedness of any third person to the Multi-
State co-operative society for an amount exceeding one thousand rupees.
If an auditor becomes subject, after his appointment, to any, of the disqualifications specified
above, he shall be deemed to have vacated his office as such.
Q-6 BPL Ltd. is running a “RAGHU PALACE CINEMA.” Your firm of Chartered Accountants has beenappointed
to get its accounts audited. Assistant appointed on the job to conduct audit asks theaudit in charge as
to how to go about conducting an audit and seeks your guidance on it. Keepingin view the above you
are required to explain to the assistant special steps (any five) involved in the Audit of Cinema.
[MTP-Aug’18,5 Marks]
Ans. The special steps involved in the audit of Cinema are stated below-
(1) Verify the internal control mechanism-
(a) that entrance to the cinema-hall during show is only through printed tickets;
(b) that they are serially numbered and bound into books;
(c) that the number of tickets issued for each show and class, are different though the numbers of
the same class for the show on the same day, each week, run serially;
(d) that for advance booking a separate series of tickets is issued; and
(e) that the inventory of tickets is kept in the custody of a responsible official.
(2) Confirm that at the end of show, a statement of tickets sold is prepared and cash collected is
agreed with it.
(3) Verify that a record is kept of the ‘free passes’ and that these are issued under proper authority.
(4) Reconcile the amount of Entertainment Tax collected with the total number of tickets issued for
each class and vouch and verify the entertainment tax returns filed each month.
(5) Vouch the entries in the Cash Book in respect of cash collected on sale of tickets for different
shows on a reference to Daily Statements which have been test checked as aforementioned with
record of tickets issued for the different shows held.
(6) Verify the charges collected for advertisement slides and shorts by reference to the Register of
Slides and Shorts Exhibited kept at the cinema as well with the agreements, entered into with
advertisers in this regard.
(7) Vouch the expenditure incurred on advertisement, repairs and maintenance. No part of such
expenditure should be capitalized.
(8) Confirm that depreciation on machinery and furniture has been charged at an appropriate rate.
(9) Vouch payments on account of film hire with bills of distributors and in the process, the agreements
concerned should be referred to.
(10) Examine unadjusted balance out of advance paid to the distributors against film hire contracts to
see that they are good and recoverable. If any film in respect of which an advance was paid has
already run, it should be enquired as to why the advance has not been adjusted. The management
should be asked to make a provision in respect of advances that are considered irrecoverable.

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 (11) The arrangement for collection of the share in the restaurant income should be enquired into
either a fixed sum or a fixed percentage of the taking may be receivable annually. In case the
restaurant is run by the Cinema, its accounts should be checked. The audit should cover sale of
various items of foodstuffs, purchase of foodstuffs, cold drink, etc. as in the case of club.
Q-7 Audit of government expenditure is one of the major components of government audit conducted by
the office of C&AG. The basic standards set for audit of expenditure are to ensure that there is provision
of funds authorised by competent authority fixing the limits within which expenditure can be incurred.
Explain those standards. [Sugg. Nov’18, RTP, May’18, Nov’19]
Ans. Government Expenditure Audit: Audit of government expenditure is one of the major components of
government audit conducted by the office of C&AG. The basic standards set for audit of expenditure
are to ensure that there is provision of funds authorised by competent authority fixing the limits
within which expenditure can be incurred. Briefly, these standards are explained below:
(i) Audit against Rules & Orders: The auditor has to see that the expenditureincurred conforms to
the relevant provisions of the statutory enactment and is in accordance with the financial rules
and regulations framed by the competent authority.
(ii) Audit of Sanctions: The auditor has to ensure that each item of expenditure is covered by a
sanction, ei ther general or special, accorded by the competent authority, authorising such
expenditure.
(iii) Audit against Provision of Funds: It contemplates that there is a provision of funds out of which
expendi ture can be i ncurred and th e a moun t of such expe ndi ture does not exce ed the
appropriations made.
(iv) Propriety Audit: It is required to be seen that the expenditure is incurred with due regard to
broad and general principles of financial propriety. The auditor aims to bring out cases of improper,
avoidable, or in fructuous expendi ture even though the expendi ture has been incurred in
conformity with the existing rules and regulations. Audit aims to secure a reasonably high standard
of public financial morality by looking into the wisdom, faithfulness and economy of transactions.
(v) Performance Audit: This involves that the various programmes, schemes and projects where
large financial expenditure has been incurred are being run economically and are yielding results
expected of them. Efficiency-cumperformance audit, wherever used, is an objective examination
of the financial and operational performance of an organisation, programme, authority or function
and is oriented towards identifying opportunities for greater economy, and effectiveness.
Q-8 Explain in detail the duties of Comptroller and Auditor General of India. [RTP-Nov’19, May ‘19, May’18]
Ans. Duties of C&AG: The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act,
1971 lays down duties of the C&AG as under-
(i) Compile and submit Accounts of Union and States - The C&AG shall be responsible for compiling
the accounts of the Union and of each State from the initial and subsidiary accounts rendered to
the audit and accounts offices under his control by treasuries, offices or departments responsible
for the keeping of such account.
(ii) General Provisions Relating to Audit - It shall be the duty of the C&AG –
(a) to audit and report on all expenditure from the Consolidated Fund of India and of each State
and of each Union Territory having a Legislative Assembly and to ascertain whether the
moneys shown in the accounts as having been disbursed were legally available for and
applicable to the service or purpose to which they have been applied or charged and whether
the expenditure conforms to the authority which governs it;

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 (b) to audit and report all transactions of the Union and of the States relatingto Contingency
Funds and Public Accounts;
(c) to audit and report on all trading, manufacturing profit and loss accounts and balance-sheets
and other subsidiary accounts kept in any department of the Union or of a State.
(iii) Audit of Receipts and Expenditure - Where any body or authority is substantially financed by
grants or loans from the Consolidated Fund of India or of any State or of any Union Territory having
a Legislative Assembly, the Comptroller and Auditor General shall, subject to the provisions of
any law for the time being in force applicable to the body or authority, as the case may be, audit
all receipts and expenditure of that body or authority and to report on the receipts and expenditure
audited by him.
(iv) Audit of Grants or Loans - Where any grant or loan is given for any specific purpose from the
Consolidated Fund of India or of any State or of any Union Territory having a Legislative Assembly
to any authority or body, not being a foreign State or international organisation, the Comptroller
and Auditor General shall scrutinise the procedures by which the sanctioning authority satisfies
itself as to the fulfillment of the conditions subject to which such grants or loans were given and
shall for this purpose have right of access, after giving reasonable previous notice, to the books
and accounts of that authority or body.
(v) Audit of Receipts of Union or States - It shall be the duty of the Comptrollerand Auditor General
to audit all receipts which are payable into the Consolidated
Fund of India and of each State and of each Union Territory having a Legislative Assembly and to
satisfy himself that the rules and procedures in that behalf are designed to secure an effective
check on the assessment, collection and proper allocation of revenue and are being duly observed
and to make this purpose such examination of the accounts as he thinks fit and report thereon.
(vi) Audit of Accounts of Stores and Inventory - The Comptroller and Auditor General shall have
authority to audi t and report on the accounts of stores and inventory kept in any office or
department of the Union or of a State.
(vii) Audit of Government Companies and Corporations - The duties and powers of the Comptroller
and Auditor General in relation to the audit of the accounts of government companies shall be
performed and exercised by him in accordance with the provisions of the Companies Act, 2013.
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.
Q-9 What are the special steps involved in conducting the audit of an Educational Institution?
[RTP-Nov’19, May ‘18]
Ans. The Special Steps Involved in the Audit of an Educational Institution are the following:
(i) Examine the Trust Deed, or Regulations in the case of school or college and note allthe provisions
affecting accounts. In the case of a university, refer to the Act ofLegislature and the Regulations
framed thereunder.
(ii) Read through the minutes of the meetings of the Managing Committee or Governing Body, noting
resolutions affecting accounts to see that these have been duly complied with, specially the
decisions as regards the operation of bank accounts and sanctioning of expenditure.
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 (iii) Check names entered in the Students’ Fee Register for each month or term, with the respective
class registers, showing names of students on rolls and test amount of fees charged; and verify
that there operates a system of internal check which ensures that demands against the students
are properly raised.
(iv) Check fees received by comparing counterfoils of receipts granted with entries in the cash book
and tracing the collections in the Fee Register to confirm that the revenue from this source has
been duly accounted for.
(v) Total up the various columns of the Fees Register for each month or term to ascertain that fees
paid in advance have been carried forward and the arrears that are irrecoverable have been
written off under the sanction of an appropriate authority.
(vi) Check admission fees with admission slips signed by the head of the institution and confirm that
the amount had been credited to a Capital Fund, unless the Managing Committee has taken a
decision to the contrary.
(vii) See that free studentship and concessions have been granted by a person authorised to do so,
having regard to the prescribed Rules.
(viii) Confirm that fines for late payment or absence, etc., have either been collected or remitted
under proper authority.
(ix) Confirm that hostel dues were recovered before students’ accounts were closed and their deposits
of caution money refunded.
(x) Verify rental income from landed property with the rent rolls, etc.
(xi) Vouch income from endowments and legacies, as well as interest and dividends from investment;
also inspect the securities in respect of investments held.
(xii) Verify any Government or local authority grant with the relevant papers of grant. If any expense
has been disallowed for purposes of grant, ascertain the reasons and compliance thereof.
(xiii) Report any old heavy arrears on account of fees, dormitory rents, etc, to the Managing Committee.
(xiv) Confirm that caution money and other deposits paid by students on admission have been shown
as liability in the balance sheet and not transferred to revenue.
(xv) See that the investments representing endowment funds for prizes are kept separate and any
income in excess of the prizes has been accumulated and invested along with the corpus.
(xvi) Verify that the Provident Fund money of the staff has been invested in appropriate securities.
(xvii) Vouch donations, if any, with the list published with the annual report. If some donations were
meant for any specific purpose, see that the money was utilised for the purpose.
(xviii)Vouch all capital expenditure in the usual way and verify the same with the sanction for the
Committee as contained in the minute book.
(xix)Vouch in the usual manner all establishment expenses and enquire into any unduly heavy
expenditure under any head.
(xx) See that increase in the salaries of the staff have been sanctioned and minuted by the Committee.
(xxi) Ascertain that the system ordering inspection on receipt and issue of provisions, foodstuffs,
clothing and other equipment is efficient and all bills are duly authorised and passed before
payment.
(xxii) Verify the inventories of furniture, stationery, clothing, provision and all equipment, etc. These
should be checked by reference to Inventory Register and values applied to various items should
be test checked.

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 (xxiii)Confirm that the refund of taxes deducted from the income from investment (interest on
securities, etc.) has been claimed and recovered since the institutions are generally exempted
from the payment of income-tax.
(xxiv)Verify the annual statements of accounts and while doing so see that separate statements of
account have been prepared as regards Poor Boys Fund, Games Fund, Hostel and Provident Fund
of Staff, etc.
Q-10 Discuss the matters which should be specially considered in the audit of accounts of a partnership.
[RTP-May’19, Sugg.-Nov’19,3 Marks]
Ans. Matters which should be specially considered in the audit of accounts of a partnership:
(i) Confirming that the letter of appointment, signed by a partner, duly authorised, clearly states the
nature and scope of audit contemplated by the partners, specially the limitation, if any, under
which the auditor shall have to function.
(ii) Studying the minute book, if any, maintained to record the policy decision taken by partners
specially the minutes relating to authorisation of extraordinary and capital expenditure, raising
of loans; purchase of assets, extraordinary contracts entered into and other such matters as are
not of a routine nature.
(iii) Verifying that the business in which the partnership is engaged is authorised by the partnership
agreement; or by any extension or modification thereof agreed to subsequently.
(iv) Examining whether books of account appear to be reasonable and are considered adequate in
relation to the nature of the business of the partnership.
(v) Verifying generally that the interest of no partner has suffered prejudicially by an activity engaged
in by the partnership which, it was not authorised to do under the partnership deed or by any
violation of a provision in the partnership agreements.
(vi) Confirming that a provision for the firm’s tax payable by the partnership has been made in the
accounts before arriving at the amount of profit divisible among the partners.
(vii) Verifying that the profits and losses have been divided among the partners in their agreed profit-
sharing ratio.
Q-11 You have been appointed as an audi tor of an NGO, briefly state the points on which you would
concentrate while planning the audit of such an organisation? [RTP-Nov’18]
Ans. While planning the audit of an NGO, the auditor may concentrate on the following:
(i) Knowledge of the NGO’s work, its mission and vision, areas of operations andenvironment in
which it operate.
(ii) Updating knowledge of relevant statutes especially with regard to recentamendments, circulars,
judicial decisions related to the statutes.
(iii) Reviewing the legal form of the Organisation and its Memorandum of Association, Articles of
Association, Rules and Regulations.
(iv) Reviewing the NGO’s Organisation chart, then Financial and Administrative Manuals, Project and
Programme Guidelines, Funding Agencies Requirements and formats, budgetary policies if any.
(v) Examination of minutes of the Board/Managing Committee /Governing Body/Management and
Committees thereof to ascertain the impact of any decisions on the financial records.
(vi) Study the accounting system, procedures, internal controls and internal checks existing for the
NGO and verify their applicability.
(vii) Setting of materiality levels for audit purposes.
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 (viii) The nature and timing of reports or other communications.
(ix) The involvement of experts and their reports.
(x) Review the previous year’s Audit Report.
Q-12 Define the different types of lease agreements as per Accounting Standard/Ind-AS.
[Sugg.-May’19,4 Marks]
Ans. AS-19/ Ind-AS 17 defines that lease arrangements could be of 2 types i.e.
(i) Finance Lease and
(ii) Operating Lease.
Finance Lease: An arrangement with the following attributes qualifies as a F inance Lease:
The lease arrangement transfers ownership of the asset to the lessee at the end of the lease term;
• The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower
than the fair value at the date the option becomes exercisable for it to be reasonably certain, at
the inception of the lease, that the option will be exercised;
• The lease term is for the major part of the economic life of the asset even if title is not transferred;
• At the inception of the lease, the present value of the minimum lease payments amounts to at
least substantially all of the fair value of the leased asset; and
• the leased assets are of such a specialized nature that only the lessee can use them without major
modifications Operating Lease.
An arrangement tha t does not transfer substantially all the risks and rewards incidental to
ownership qualifi es as an Opera ting Lease. In other words, an operating lease is a l ease
arrangement “Other than finance lease”.
Q-13 Central Govt. hold 55% of the paid up share Capital in Kisan Credit Co-operative Society, which is
incurring huge losses. Advise when the Central Government can direct Special Audit under Section 77
of the Multi State Co-operative Society Act.
[Sugg. May ‘19, 5 Marks]
Ans. Central Government shall order for special audit only if that Government or the State Government
either by itself or both hold fifty-one percent or more of the paid-up share capital in such Multi -State
co-operative society. Under section 77 of the Multi-State Co-operative Societies Act, 2002, where the
Central Government is of the opinion:
i. that the affairs of any Multi-State co-operative society are not being managed in accordance with
self-help and mutual deed and co-operative principles or prudent commercial practices or with
sound business principles; or
ii. that any Multi-State co-operative society is being managed in a manner likely to cause serious
injury or damage to the interests of the trade industry or business to which it pertains; or
iii. that the financial position of any Multi-State co-operative society is such as to endanger its solvency.
Thus, in the given case since Central Govt is holding 55% shares and financial position of Kisan
Credit co- operative society is in danger, Central government can direct for special audit.
Q-14 Discuss the power of C & AG in Government audit. [Sugg.-May’19,3 Marks]
Ans. Powers of C&AG
The C&AG Act gives the following powers to the C&AG in connection with the performance of his
duti es-

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 i. To inspect any office of accounts under the control of the Union or a State Government including
office responsible for the creation of the initial or subsidiary accounts.
ii. To require that any accounts, books, papers and other documents which deal with or are otherwise
relevant to the transactions under audit, be sent to specified places.
iii. To put such questions or make such observations as he may consider necessary to the person in
charge of the office and to call for such information as he may require for the preparation of any
account or report which is his duty to prepare.
iv. In carrying out the audit, the C&AG has the power to dispense with any part of detailed audit of
any accounts or class of transactions and to apply such limited checks in relation to such accounts
or transactions as he may determine.
Q-15 “While the auditor may choose to analyse the monthly trends for expenses like rent, power and fuel
but for other expenses, an auditor generally prefers to verify other attributes.” Mention those attributes.
[Sugg.-Nov’18,5 Marks]
Ans. While the auditor may choose to analyse the monthly trends for expenses like rent, power and fuel, an
auditor generally prefers to vouch for other expenses to verify following attributes:
(i) Whether the expenditure pertained to current period under audit;
(ii) Whether the expenditure qualified as a revenue and not capital expenditure;
(iii) Whether the expenditure had a valid supporting like travel tickets, insurance policy, third party
invoice etc.;
(iv) Whether the expenditure has been classified under the correct expense head;
(v) Whether the expenditure was authorised as per the delegation of authority matrix;
(vi) Whether the expenditure was in relation to the entity’s business and not a personal expenditure.
Q-16 Mr. M, has served as an auditor in the Co-Operative Department of a Government, is appointed as a
statutory auditor by a Co-Operative Society that has receipts over `3 crores during the financial year.
He is not a Chartered Accountant. Mr. D, Chartered Accountant is appointed to conduct tax audit of the
society under section 44AB of the Income Tax Act, 1961. Comment. [Sugg.-May’18,5 Marks]
Ans. Qualifications and Appointment of Auditors - Apart from a chartered accountant within the meaning of
the Chartered Accountants Act, 1949, some of the State Co-operative Acts have permitted persons
holding a government diploma in co-operative accounts or in co-operation and accountancy and also a
person who has served as an auditor in the co-operative department of a government to act as an
auditor.
An auditor of a co-operative society is appointed by the Registrar of Co-operative Societies and the
auditor so appointed conducts the audit on behalf of the Registrar and submits his report to him as also
to the society.
Thus, in view of above provisions, appointment of Mr. M as statutory auditor and Mr. D as tax auditor
under Section 44 AB is in order.
Q-17 State the objectives of audit of Local Bodies. [Sugg.-May’18,5 Marks]
Ans. Objective of Audit of Local Bodies: The external control of municipal expenditure is exercised by the
state governments through the appointment of auditors to examine municipal accounts. The municipal
corporations of Delhi, Mumbai and a few others have powers to appoint their own auditors for regular
external audit. The important objectives of audit are:
(i) reporting on the fairness of the content and presentation of financial statements;
(ii) reporting upon the strengths and weaknesses of systems of financial control;
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 (iii) reporting on the adherence to legal and/or administrative requirements;
(iv) reporting upon whether value is being fully received on money spent; and
(v) detection and prevention of error, fraud and misuse of resources.
Q-18 (a) As per Multi-state Co-operative Societies Act, 2002, the auditor shall make a report to the members of
the Multi-State co-operative society on the accounts examined by him and on every balance-sheet and
profit and loss account and on every other document required to be part of or annexed to the balance-
sheet or profit and loss account. Explain [RTP-May’20]
(b) Explain the powers and duties of auditors under the Multi-State Co-operative Societies Act, 2002.

Ans.(a) As per sub-section (3) & (4) of section 73 of Multi- state Co-operative Societies Act, 2002, the auditor
shall make a report to the members of the Multi-State co-operative society on the accounts examined
by him and on every balance-sheet and profit and loss account and on every other document required
to be part of or annexed to the balance-sheet or profit and loss account, which are laid before the
Multi-State co-operative society in general meeting during his tenure of office, and the report shall
state whether, in his opinion and to the best of his information and according to the explanation given
to him, the said account give the information required by this act in the manner so required, and give
a true and fair view:
(a) In the case of the balance-sheet, of the state of the Multi-State co-operative society’s affairs as at
the end of its financial year; and
(b) In the case of the profit and loss account, of the profit or loss for its financial year. The auditor’s
report shall also state:
(i) Whether he has obtained all the informa tion and explanation which to the best of his
knowledge and belief were necessary for the purpose of his audit.
(ii) Whether, in his opinion, proper books of account have been kept by the Multi- State co-
operative society so far as appears from his examination of these books and proper returns
adequate for the purpose of his audit have been received from branches or offices of the
Multi-State co-operative society not visited by him.
(iii) Whether the report on the accounts of any branch office audited by a person other than the
Multi-State co-operative society’s auditor has been forwarded to him and how he has dealt
with the same in preparing the auditor’s report.
(iv) Whether the Multi-State co-operative society’s balance sheet and profit and loss account
dealt with by the report are in agreement with the books of account and return.
Where any of the matters referred to in sub-section (3) or (4) is answered in the negative or with
a qualification, the auditor’s report shall state the reason for the answer.
(b) Section 73 of the Multi-State Co-operative Societies Act, 2002 discusses the powers and duties of
auditors. According to this, every auditor of a Multi-State co-operative society shall have a right of
access at all times to the books accounts and vouchers of the Multi-State co-operative society, whether
kept at the head office of the Multi-State co-operative society or elsewhere, and shall be entitled to
require from the officers or other employees of the Multi- State co-operative society such information
and explanation as the auditor may think necessary for the performance of his duties as an auditor.
As per section 73(2), the auditor shall make following inquiries:
(a) Whether loans and advances made by the Multi-State co-operative society on the basis of security
have been properly secured and whether the terms on which they have been made are not
prejudicial to the interests of the Multi-State co-operative society or its members,

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 (b) Whether transactions of the Multi-State co-operative society which are represented merely by
book entries are not prejudicial to the interests of the Multi-State co-operative society,
(c) Whether personal expenses have been charged to revenue account, and
(d) Where it is Stated in the books and papers of the Multi-State co-operative society 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 as correct regular and not misleading.
Q-19 In the case of audit of a charitable institution, what attentions should be paid by the auditor regarding
audit of expenditure items? [Sugg.-Nov’19,4 Marks]
Ans. Audit of Expenditure of Charitable Institution:
(i) Vouching payment of grants also verifying that the grants have been paid only for a charitable
purpose or purposes falling within the purview of the objects for which the charitable institution
has been set up and that no trustee, director or member of the management committee has
benefited there from either directly or indirectly.
(ii) Verifying the schedules of securities held, as well as inventories of properties both movable and
immovable by inspecting the securities and title deeds of property and by physical verification of
the movable properties on a test basis.
(iii) Check payment along with supporting documents in regard to salary and other expenses. Verify
that all payments are made after proper sanction by appropriate authority.
(iv) Ascertaining that any funds contributed for a special purpose have been utilised for the purpose.
(v) Verifying the cash and bank balances/payments.
Q-20 You have been appointed auditor of M/s. Divine Children Hospital. Discuss any four important points
that would attract your attention while audit. [Sugg.-Nov’19,4 Marks]
Ans. Audit of Hospital
The important points involved in such an audit are stated below-
(i) Register of patients: Vouch the Register of patients with copies of bills issued to them. Verify bills
for a selected period with the patients’ attendance record to see that the bills have been correctly
prepared. Also see tha t bills have been issued to all pa tients from whom an amount was
recoverable according to the rules of the hospital.
(ii) Collection of Cash: Check cash collections as entered in the Cash Book with the receipts, counterfoils
and other evidence. For eg. copies of patients bills, counterfoils of dividend and other interest
warrants, copies of rent bills etc.
(iii) Income from Investments, Rent etc.: See by reference to the property and Investment Register
that all income that should have been received by way of rent on properties, dividends and
interest on securities have been collected.
(iv) Legacies and Donations: Ascertain that legacies and donations received for a specific purpose
have been applied in the manner agreed upon.
(v) Reconciliation of Subscriptions: Trace all collections of subscription and donations from the Cash
Book to the respective Registers. Reconcil e the total subscriptions due (as shown by the
Subscription Register and the amount collected and that still outstanding).
(vi) Authorisation and sanctions: Vouch all purchases and expenses and verify that the capital
expenditure incurred only with the prior sanction of the trustees of the Managing Committee and
that appointments and increments to staff have been duly authorised.

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 (vii) Grants and TDS: Verify that grants, if any, received from Government or local authority has been
duly accounted for. Also, that refund in respect of taxes deducted at source has been claimed.
(viii) Budgets: Compare the totals of various items of expenditure and income with the amount
budgeted for them and report to the Trustees or the Managing Committee, significant variations
which have taken place.
(ix) Internal Check: Examine the internal check as regards the receipt and issue of stores, medicines,
linen, apparatus, clothing, instruments, etc. so as to ensure that purchases have been properly
recorded in the Inventory Register and that issues have been made only against proper
authorisation.
(x) Depreciation: See that depreciation has been written off against all the assets at the appropriate
rates.
(xi) Registers: Inspect the bonds, share scrips, title deeds of properties and compare their particulars
with those entered in the property and Investment Registers.
(xii) Inventories: Obtain inventories, especially of stocks and stores as at the end of the year and check
the percentage of the items physically, also compare their total values with respective ledger
balances.
(xiii) Management Representation and Certificate: Get proper Management Representation and
Certificate with respect to various aspects covered during the course of audit.

MULTIPLE CHOICE QUESTIONS

1. Which of the following is correct :

(a) Under section 128 of the Act, books of account of a company must be kept at the registered office.
(b) Under section 128 of the Act, books of account of a company must be kept at the corporate office
(c) Under section 128 of the Act, books of account of a company must be kept at the Head office ofthe
company.
(d) Under section 128 of the Act, books of account of a company must be kept at the usual place of
business. [MTP-OCT’19]
2. In July, 2018, M/s Tom & Co. entered into an agreement with M/s Jerry & Co. under which a machinery
would be let on hire and M /s Jerry & Co. would have the option to purchase the machinery in accordance
with the terms of the agreement. Thus, M/s Jerry & Co. agreed to pay M/s Tom & Co. a settled amount
in periodical instalments. The property in the goods shall be passed to M/s Jerry & Co. on the payment
of last of such instalments. While checking such hire-purchase transaction, what would the auditor
examine?
(a) That the periodical instalments paid are charged as an expenditure by M/s Jerry & Co.
(b) That the hire purchase agreement specifies clearly the hire-purchase price of the machinery to
which the agreement relates.
(c) That M/s Tom & Co. charges depreciation throughout the life of the machinery.
(d) All of the above. [RTP-MAY’19]

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