INTERMEDIATE – AUDIT

Chapter: Nature Objective and Scope of Audit, Audit Strategy Audit Planning and
Programming, Risk Assessment and Internal Control, Audit Evidence, Audit
Documentation, Completion and Review, Ethics and Terms of Audit Engagement

Paper: Auditing and Assurance Marks: 50

SPC Receipt No: Model Answer
Test ID: 02552 Time Allowed :1.5 Hour

PART A

MULTIPLE CHOICE QUESTIONS (10 X 1 Mark each)

1) An auditor finds during course of an audit that the entity has entered into many related party transactions.
Which of the following statements is true?
(a) The risk that management may override controls in respect of related party transactions is lower.
(b) The risk that management may override controls in respect of related party transactions is higher.
(c) There is no effect on the risk that management may override controls in respect of related party
transactions.
(d) Risk of overriding of controls by management has no relationship at all with related party
transactions.

2) Which of the following is not an objective of a company’s policies for ensuring “internal financial controls”?
(a) Efficient conduct of business
(b) Safeguarding of assets
(c) Prevention and detection of frauds and errors
(d) Assessing audit risk

3) Which of the following statement is appropriately suited to preparation of audit documentation?

(a) Audit documentation has to be prepared simultaneously as audit progresses.
(b) Audit documentation has to be prepared 60 days after date of audit report.
(c) Audit documentation has to be prepared when information is required by regulator.
(d) Audit documentation has to be prepared 60 days after completion of audit work.

4) Which of the following is false in relation to audit documentation when an external auditor relies upon
work of internal auditor?
(a) Evaluation of objectivity and competence of internal auditor has to be documented.
(b) Nature of work used and reason for relying upon work used forms part of documentation.
(c) Documentation on whether quality control is exercised in internal audit work forms part of audit
 documentation.
(d) Documentation on what specific recommendations were given by internal auditor for risk assessment
to external auditor forms part of audit documentation.

5) Written representations are: -

(a) Necessary audit evidence
(b) Sufficient appropriate audit evidence
(c) Not audit evidence
(d) Audit evidence depending upon auditor’s professional judgment

6) Which of the following is not an example of events or conditions that may cast significant doubt on the
entity’s ability to continue as a going concern?
(a) Adverse key financial ratios
(b) Inability to invest in modernisation of plant
(c) Inability to pay creditors on time
(d) Inability to pay salary of staff

7) Which of the following is TRUE about Engagement Standards?

(a) Engagement standards ensure proper rights to practitioners in course of performance of their duties.
(b) Engagement standards ensure preparation and presentation of financial statements in a standardized
manner.
(c) Engagement standards ensure uniformity by practitioners in course of performance of their duties.
(d) Engagement standards ensure savings in resources of clients.

8) Which of the following is not included in an audit programme normally?

(a) Extent of checking
(b) Date of checking
(c) Nature or type of procedure
(d) Planning of risk assessment procedures

9) Which of the following is not an example of “General IT controls”?

(a) Controls pertaining to Disaster recovery plan
(b) Controls pertaining to batch preparation
(c) Controls pertaining to data security
(d) Controls pertaining to validation of input data in an application

10) Which of the following is not necessary to establish preconditions for an audit?
(a) Acceptability of financial reporting framework.
(b) Acknowledgment of cooperation from management in designing audit procedures.
(c) Acknowledgment from management of providing access to persons within company.
(d) Acknowledgment of management in understanding its responsibility for preparation of financial
statements.

Answer
1) B
2) D
3) A
4) D
5) A
6) B
7) C
8) D
9) D
10) B

State with reasons (in short) whether the following statements are correct or incorrect: (5 X 1 Mark)
1) The objective of stratification is to increase the variability of items within each stratum and therefore allow
sample size to be reduced without increasing sampling risk.
2) Mr. A is a statutory auditor of ABC Ltd. The branch of ABC Ltd. is audited by Mr. B, another Chartered
Accountant. Mr. A requests for the photocopies of the audit documentation of Mr. B pertaining to the branch
audit.
3) The basic objective of audit does not change with reference to nature, size or form of an entity.
4) Planning is a discrete phase of an audit.
5) The audit engagement letter is sent by the client to auditor.

Answer
1) Incorrect: 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.
2) Incorrect: SA 230 issued by ICAI on Audit Documentation, and “Standard on Quality Control (SQC) 1,
provides that, unless otherwise specified by law or regulation, audit documentation is the property of the
auditor. He may at his discretion, make portions of, or extracts from, audit documentation available to clients,
provided such disclosure does not undermine the validity of the work performed, or, in the case of assurance
engagements, the independence of the auditor or of his personnel.
3) Correct: An audit is an independent examination of financial information of any entity, whether profit
oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view
to expressing an opinion thereon. It is clear that the basic objective of auditing, i.e., expression of opinion on
financial statements does not change with reference to nature, size or form of an entity.
4) Incorrect. Planning is not a discrete phase of an audit, but rather a continual and iterative process that
often begin 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.
5) Incorrect: As per SA 210 “Agreeing the Terms of Audit Engagements”, the Audit engagement letter is sent
by the auditor to his client.

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PART B – THEORY
(7 x 5 Marks each)
Q1) While applying the Substantive Analytical Procedures what techniques can be used by the statutory
auditor of a company to obtain sufficient and appropriate audit evidence?
Answer
While applying the Substantive Analytical Procedures the statutory auditor of a company may use the
following techniques to obtain sufficient and appropriate audit evidence
Trend analysis – Trend analysis is a commonly used technique. It 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.
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 applicable to income statement accounts and certain accrual or prepayment accounts. In other words
these tests are made by reviewing the relationship of certain account balances to other balances for
reasonableness of amounts.
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).
The statutory auditor may use any of the above mentioned techniques while applying substantive analytical
procedures depending upon the availability of data and requirements of the case.
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Q2) During the course of audit of a company, an issue arose relating to treatment of interest costs of
company on its restructured loans taken from a bank. This important matter was discussed with CFO of the
company and was properly resolved. Is it necessary for the auditor to include in its working papers?
Answer
The auditor shall document discussions of significant matters with management, those charged with
governance, and others, including the nature of the significant matters discussed and when and with whom
the discussions took place.
In the instant case, an important matter regarding treatment of interest costs of company on its restructured
loans taken from a bank directly impacting profits of the company was discussed. Although issue was
resolved, it is necessary to document the same by including detail of the person with whom discussions took
place along with date.
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Q3) The management of an entity feels that it is not necessary for it to give in writing explicitly to the auditor
that it understands its responsibilities for preparation of financial statements in accordance with applicable
financial reporting framework. Discuss, whether, it is necessary for the management to do so. In case
management refuses, why should an auditor not accept the proposed engagement?
Answer
It is necessary for management to give in writing explicitly to the auditor that it understands its
responsibilities for preparation of financial statements in accordance with applicable financial reporting
framework. It is a necessary precondition for an audit in accordance with SA 210.
If the preconditions for an audit are not present, the auditor shall discuss the matter with management.
Unless required by law or regulation to do so, the auditor shall not accept the proposed audit engagement: -
(a) If the auditor has determined that the financial reporting framework to be applied in the preparation
of the financial statements is unacceptable or
(b) If the agreement of management is not obtained on matters relating to understanding of
responsibility of management on preparation of financial statements, internal controls for preparation of
financial statements, providing access to all information to auditor and unrestricted access to persons within
the entity.
Unless required by law or regulation to do so, such a refusal on the part of auditor is necessary as
management is not willing to accept its responsibility for preparation of financial statements in accordance
with applicable financial reporting framework. An audit is conducted on this basic premise according to SA
210. When basic premise on which audit is conducted is not fulfilled, refusal by auditor is necessary.
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Q4) You are nearing completion of audit of a company. On going through your working papers, it is noticed
that finished goods inventory was overvalued by Rs. 2 crore. It has also been noticed that freight of Rs.10 lacs
paid on import of machinery was charged to statement of profit and loss.
Discuss, how you should, proceed and communicate in above situation before signing audit report.
Answer
The instances highlighted in above situation are examples of misstatements identified during the audit. Over
valuation of inventory of finished goods by Rs. 2 crore and wrongly charging freight of Rs. 10 lacs paid on
machinery to statement of profit and loss instead of capitalizing are examples of misstatements.
The auditor should communicate above identified misstatements to those charged with governance and
request for correction of these misstatements. In case, these are not corrected, understand the reasons for
not making the corrections and reassess materiality. It should also be considered whether uncorrected
statements are material individually or in aggregate. Effect of uncorrected misstatements on the opinion in
auditor’s report should be communicated to those charged with governance.
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Q5) Explain clearly the examples of matters relevant in planning attendance at physical inventory counting.
Answer
Matters relevant in planning attendance at physical inventory counting include, for example:
(a) Nature of inventory.
(b) Stages of completion of work in progress.
(c) The risks of material misstatement related to inventory.
(d) The nature of the internal control related to inventory.
(e) Whether adequate procedures are expected to be established and proper instructions issued for
physical inventory counting.
(f) The timing of physical inventory counting.
(g) Whether the entity maintains a perpetual inventory system.
(h) The locations at which inventory is held, including the materiality of the inventory and the risks of
material misstatement at different locations, in deciding at which locations attendance is appropriate
(i) Whether the assistance of an auditor’s expert is needed.
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Q6) CA Chandni Khanna is going to complete audit of a company within next few days. She has performed
necessary audit procedures like inquiry of management personnel, reading minutes of meetings held after
date of financial statements, going through books of accounts after date of financial statements to make
sure that all subsequent events before signing audit report have been considered by her. Still, she wants to
be certain that no such events have been left out. What she should do in such a situation? Also, discuss the
rationale of doing so.
Answer
She has already performed necessary audit procedures like inquiry of management personnel, reading
minutes of meetings after date of financial statements and going through books after date of financial
statements.
Now, she should request management and, where appropriate, those charged with governance, to provide a
written representation in accordance with SA 580, “Written Representations” that all events occurring
subsequent to the date of the financial statements and for which the applicable financial reporting
framework requires adjustment or disclosure have been adjusted or disclosed.
The rationale of obtaining written representations is that even after performing abovesaid procedures, she
may not come to know all subsequent events. Therefore, it is necessary from an auditor’s point of view to
obtain acknowledgment from management in the form of Written representations that all such events for
which the applicable financial reporting framework requires adjustment or disclosure have been adjusted or
disclosed.
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Q7) 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.
Answer
Objectives of Internal Control
Internal control over safeguarding of assets against unauthorised acquisition, use, or disposition may include
controls relating to both financial reporting and operations objectives. The auditor’s consideration of such
controls is generally limited to those relevant to the reliability of financial 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 the
accounting period in which executed so as to permit preparation of financial information within 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.
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