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Question BankStandard On Auditing

C.A. FINALEDITION - 4

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COMPLITE YOUR CA FINAL AUDIT IN 18 DAYSBY CA SURENDRA AGRAWAL(M.COM,LLB,ACA)PH-9313336776

INDEX OF STANDARDS ON AUDITING (SA)

100-199 Introductory Matters200-299 General Principles and ResponsibilitiesSA 200 Overall Objectives of the Independent Auditor and the Conduct

of an Audit in Accordance with Standards on Auditing200.1-.2

SA 210 Agreeing the Terms of Audit Engagements 210.1SA 220 Quality Control for an Audit of Financial Statements 220.1SA 230 Audit Documentation 230.1SA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of

FS240.1

SA 250 Consideration of Laws and Regulations in an Audit of FS 250.1SA 260 Communication with Those Charged with Governance 260.1SA 265 Communicating Deficiencies in IC to TCWG and Management 265.1SA 299 Responsibility of Joint Auditors 299.1300-499 Risk Assessment and Response to Assessed RisksSA 300 Planning an Audit of Financial Statements 300.1SA 315 Identifying and Assessing the Risks of Material Misstatement

throughUnderstanding the Entity and Its Environment

315.1

SA 320 Materiality in Planning and Performing an Audit 320.1SA 330 The Auditor’s Responses to Assessed Risks 330.1SA 402 Audit Considerations Relating to an Entity Using Service

Organisation402.1

SA 450 Evaluation of Misstatements Identified During the Audit 450.1500-599 Audit EvidenceSA 500 Audit Evidence 500.1SA 501 Audit Evidence—Specific Considerations for Selected Items 501.1SA 505 External Confirmations 505.1SA 510 Initial Audit Engagements – Opening Balances 510.1SA 520 Analytical Procedures 520.1SA 530 Audit Sampling 530.1SA 540 Auditing Accounting Estimates, Including Fair Value

Accounting Estimates, and Related Disclosures540.1

SA 550 Related Parties 550.1SA 560 Subsequent Events 560.1SA 570 Going Concern 570.1SA 580 Written Representations 580.1600-699 Using Work of OthersSA 600 Using the Work of Another Auditor 600.1SA 610 Using The Work of Internal Auditors 610.1

COMPLITE YOUR CA FINAL AUDIT IN 18 DAYSBY CA SURENDRA AGRAWAL(M.COM,LLB,ACA)PH-9313336776

SA 620 Using the Work of an Auditor’s Expert 620.1700-799 Audit Conclusions and ReportingSA 700 Forming an Opinion and Reporting on Financial Statements 700.1SA 705 Modifications to the Opinion in the Independent Auditor’s

Report705.1

SA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs inthe Independent Auditor’s Report

706.1

SA 710 Comparative Information - Corresponding Figures andComparative Financial Statements

710.1

SA 720 The Auditor’s Responsibility in Relation to Other Information inDocuments Containing Audited Financial Statements

720.1

800-899 Specialized AreasSA 800 Audits of Financial Statements Prepared in Accordance with

Special Purpose Frameworks800.1

SA 805 Special Considerations - Audits of Single Financial Statementsand Specific Elements, Accounts or Items of a FinancialStatement

805.1

SA 810 Engagements to Report on Summary Financial Statements 810.12000-2699 Standards on Review Engagements (SREs)SRE 2400 Engagements to Review Financial Statements 2400.1SRE 2410 Review of Interim Financial Information Performed by the

Independent Auditor of the Entity2410.1

Engagements Other Than Audits or Reviews of HistoricalFinancial Information

SAE 3400 The Examination of Prospective Financial Information 3400.1SAE 3402 Assurance Reports on Controls At a Service Organisation 3402.1SAE 3420 Engagements to Report on the Compilation of Pro Forma

Financial Information2420.1

4000-4699 Standards on Related Services (SRSs)SRS 4400 Engagements to Perform Agreed-upon Procedures Regarding

Financial Information4400.1

SRS 4410 Engagements to Compile Financial Information 4410.1Standards on Quality Control (SQCs)

SQC 1 QC for Firms that Perform Audit and Reviews of HistoricalFinancial Information, & other Assurance & Related ServicesEngagements

SQC.1

200.1

SA – 200 (Revised)“Overall Objectives of the Independent Auditor and Conduct of Audit in accordance with SAs

Question-1 Enumerate (in brief) the basic principles governing an audit.

Answer-The basic principles which govern the auditor’s professional responsibilities and which shouldbe complied with wherever an audit is carried are described below:(i) Integrity, Objectivity andIndependence:

The auditor should be straightforward, honest andsincere in his approach to his professional work.

(ii) Confidentiality: The auditor should respect the confidentiality ofinformation acquired in the course of his work andshould not disclose any such information to a third partywithout specific authority or unless there is a legal orprofessional duty to disclose.

(iii) Skills and Competence: The audit should be performed and the report preparedwith due professional care by persons who haveadequate training, experience and competence inauditing.

(iv) Work performed by others: When the auditor delegates work to assistants or useswork performed by other auditor and experts, he willcontinue to be responsible for forming and expressing hisopinion on the financial information. However, he will beentitled to rely on work performed by others, providedhe exercises adequate skill and care and is not aware ofany reason to believe that he should not have so relied.

(v) Documentation: The auditor should document matters which areimportant in providing evidence that the audit wascarried out in accordance with the basic principles.

(vi) Planning: The auditor should plan his work to enable him toconduct an effective audit in an efficient and timelymanner. Plans should be based on knowledge of theclient’s business.

(vii) Audit evidence: The auditor should obtain sufficient appropriate auditevidence through the performance of compliance andsubstantive procedures to enable him to draw reasonableconclusions therefrom on which to base his opinion onthe financial information.

(viii) Accounting System andInternal Control:

The auditor should gain an understanding of theaccounting system and related controls and should studyand evaluate the operation of those internal controlsupon which he wishes to rely in determining the nature,timing and extent of other audit procedures.

(ix) Audit conclusions andreporting:

The auditor should review and assess the conclusionsdrawn from the audit evidence obtain and from hisknowledge of business of the entity as the basis for theexpression of his opinion on the financial information.

200.2

Question-2Comment on the following:M/s XYZ & Co., auditors of Goodwill Education Foundation, a recognised nonprofitorganisation feels that the standards on auditing need not be applied as Goodwill EducationFoundation is a non-profit making concern.(May 2010)

Answer-(a) The Preface to Standards on Auditing gives the scope of the Standards on Auditing.(b) As per the Preface, the SAs will apply whenever an independent audit is carried out; that is,in the independent examination of financial statements/information of any entity; whetherprofit-oriented or not and irrespective of its size, or legal form (unless specified otherwise)when such an examination is conducted with a view to expressing an opinion thereon.(c) Further on discharging their attest function; it is the duty of the Chartered Accountant toensure that SAs are followed in the audit of financial information covered by their auditreports.(d) In the given case, even though the client is a non-profit oriented entity the SAs shall applyand the auditor shall be guilty of professional misconduct for failing to discharge his duty in caseof non-compliance with SAs.

210.1

SA 210 (REVISED)AGREEING THE TERMS OF AUDIT ENGAGEMENTS

Question1

R&Co., a firm of Chartered Accountants have not revised the terms of engagements andobtained confirmation from the clients, for last 5years despite changes in business andprofessional environment. Please elucidate the circumstances that may warrant therevision in terms of engagement.

Answer-As per SA210 on “Agreeing the Terms of Audit Engagements”, the auditor may decide not tosend a new audit engagement letter or other written agreement each period. However, thefollowing factors may make it appropriate to revise the terms of the audit engagement or toremind the entity of existing terms:(i) Any indication that the entity misunderstands the objective and scope of the audit.(ii) Any revised or special terms of the audit engagement.(iii) A recent change of senior management.(iv) A significant change in ownership.(v) A significant change in nature or size of the entity’s business.(vi) A change in legal or regulatory requirements.(vii) A change in the financial reporting framework adopted in the Preparation of the financialstatements.(viii) A change in other reporting requirements.

Question2

M/s. PQR & Company, Chartered Accountants have been appointed Statutory Auditors ofa listed Company for the year ended 31st March, 2008. Draft an appropriate engagementletter to be sent to the Board of Directors for the same.

To, the Board of Directors of .................. (name of the Entity)(Address)

Dear Sirs, I/ We refer to the letter dated _________ informing me / us about my / our (re) appointment/ratification

as the auditors of the Company. You have requested that I / we audit the financial statements of theCompany as defined in Section 2(40) of the Companies Act, 2013 (‘2013 Act’), for the financial year(s)beginning April 1, 20XX and ending March 31, 20YY2 . The financial statements of the Company include,where applicable, consolidated financial statements of the Company and of all its subsidiaries, associatecompanies and joint ventures.

I am / We are pleased to confirm my / our acceptance and my / our understanding of this auditengagement by means of this letter.My / Our audit will be conducted with the objective of me / our expressing an opinion if the aforesaidfinancial statements give the information required by the 2013 Act in the manner so required, and give atrue and fair view in conformity with the applicable accounting principles generally accepted in India, ofthe state of affairs of the Company as at 31st March, 20YY, and its profit/loss and its cash flows for the

210.2

year ended on that date which, inter alia, includes reporting in conjunction whether the Company has anadequate internal financial controls system over financial reporting in place and the operatingeffectiveness of such controls. In forming my / our opinion on the financial statements, I / we will rely onthe work of branch auditors appointed by the Company and my / our report would expressly state thefact of such reliance.I / We will conduct my / our audit in accordance with the Standards on Auditing (SAs), issued by theInstitute of Chartered Accountants of India (ICAI) and deemed to be prescribed by the CentralGovernment in accordance with Section 143(10) of the 2013 Act. Those Standards require that I / wecomply with ethical requirements and plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free from material misstatements. An audit involves performingprocedures to obtain audit evidence about the amounts and the disclosures in the financial statements.The procedures selected depend on the auditor’s judgment, including the assessment of the risks ofmaterial misstatement of the financial statements, whether due to fraud or error. In making those riskassessments, the auditor considers internal financial control relevant to the Company’s preparation of thefinancial statements that give a true and fair view in order to design audit procedures that areappropriate in the circumstances. The terms of reference for my / our audit of internal financial controlsover financial reporting carried out in conjunction with our audit of the Company’s financial statementswill be as stated in the separate engagement letter for conducting such audit and should be read inconjunction with this letter. An audit also includes evaluating the appropriateness of the accountingpolicies used and the reasonableness of accounting estimates made by the Management, as well asevaluating the overall presentation of the financial statements. Because of the inherent limitations of anaudit, including the possibility of collusion or improper management override of controls, there is anunavoidable risk that material misstatements due to fraud or error may occur and not be detected, eventhough the audit is properly planned and performed in accordance with the SAs. Also, projections of anyevaluation of the internal financial controls over financial reporting to future periods are subject to therisk that the internal financial control over financial reporting may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

My / Our audit will be conducted on the basis that the Management and those charged with governance(Audit Committee / Board) acknowledge and understand that they have the responsibility: (a) For thepreparation of financial statements that give a true and fair view in accordance with the applicableFinancial Reporting Standards and other generally accepted accounting principles in India. This includes:Compliance with the applicable provisions of the 2013 Act; Proper maintenance of accounts and othermatters connected therewith; The responsibility for the preparation of the financial statements on agoing concern basis; The preparation of the annual accounts in accordance with, the applicableaccounting standards and providing proper explanation relating to any material departures from thoseaccounting standards; Selection of accounting policies and applying them consistently and makingjudgments and estimates that are reasonable and prudent so as to give a true and fair view of the stateof affairs of the Company at the end of the financial year and of the profit and loss of the Company forthat period; Taking proper and sufficient care for the maintenance of adequate accounting records inaccordance with the provisions of the 2013 Act for safeguarding the assets of the Company and forpreventing and detecting fraud and other irregularities; Laying down internal financial controls to befollowed by the Company and that such internal financial controls are adequate and were operatingeffectively; and Devising proper systems to ensure compliance with the provisions of all applicable lawsand that such systems were adequate and operating effectively. (b) Identifying and informing me / us offinancial transactions or matters that may have any adverse effect on the functioning of the Company. (c)Identifying and informing me / us of : All the pending litigations and confirming that the impact of the

210.3

pending litigations on the Company’s financial position has been disclosed in its financial statements; Allmaterial foreseeable losses, if any, on long term contracts including derivative contracts and the accrualfor such losses as required under any law or accounting standards; and Any delay in transferringamounts, required to be transferred, to the Investor Education and Protection Fund by the Company. (d)Informing me / us of facts that may affect the financial statements, of which Management may becomeaware during the period from the date of my / our report to the date the financial statements are issued.(e) Identifying and informing me / us as to whether any director is disqualified as on March 31, 20YY frombeing appointed as a director in terms of Section 164 (2) of the 2013 Act. This should be supported bywritten representations received from the directors as on March 31, 20YY and taken on record by theBoard of Directors. (f) To provide me / us, inter alia, with: (i) Access, at all times, to all information,including the books, accounts, vouchers and other records and documentation of the Company, whetherkept at the Head Office or elsewhere, of which the Management is aware that are relevant to thepreparation of the financial statements such as records, documentation and other matters. This willinclude books of account maintained in electronic mode; (ii) Access, at all times, to the records of all thesubsidiaries (including associate companies and joint ventures as per Explanation to Section 129(3) of the2013 Act) of the Company in so far as it relates to the consolidation of its financial statements, asenvisaged in the 2013 Act; (iii) Access to reports, if any, relating to internal reporting on frauds (e.g., vigilmechanism reports etc.), including those submitted by cost accountant or company secretary in practiceto the extent it relates to their reporting on frauds in accordance with the requirements of Section143(12) of the 2013 Act; (iv) Additional information that I / we may request from the Management for thepurposes of my / our audit; (v) Unrestricted access to persons within the Company from whom I / wedeem it necessary to obtain audit evidence. This includes my / our entitlement to require from theofficers of the Company such information and explanations as I / we may think necessary for theperformance of my / our duties as the auditors of the Company; and (vi) All the required support todischarge my / our duties as the statutory auditors as stipulated under the Companies Act, 2013/ ICAIstandards on auditing and applicable guidance. As part of my / our audit process, I / we will request fromthe Management written confirmation concerning representations made to me / us in connection withmy / our audit. My / Our report prepared in accordance with relevant provisions of the 2013 Act would beaddressed to the shareholders of the Company for adoption of the accounts at the Annual GeneralMeeting. In respect of other services, my / our report would be addressed to the Board of Directors. Theform and content of my / our report may need to be amended in the light of my / our audit findings. Inaccordance with the requirements of Section 143(12) of the 2013 Act, if in the course of performance ofmy / our duties as auditor, I / we have reason to believe that an offence involving fraud is being or hasbeen committed against the Company by officers or employees of the Company, I / we will be required toreport to the Central Government, in accordance with the rules prescribed in this regard which, inter alia,requires me / us to forward my / our report to the Board or Audit Committee, as the case may be, seekingtheir reply or observations, to enable me / us to forward the same to the Central Government. As statedabove, given that I am / we are required as per Section 143(12) of the Act to report on frauds, suchreporting will be made in good faith and, therefore, cannot be considered as breach of maintenance ofclient confidentiality requirements or be subject to any suit, prosecution or other legal proceeding since itis done in pursuance of the 2013 Act or of any rules or orders made there under. I / We also wish to inviteyour attention to the fact that our audit process is subject to 'peer review' / ‘quality review’ under theChartered Accountants Act, 1949. The reviewer(s) may inspect, examine or take abstract of my / ourworking papers during the course of the peer review/quality review. I / We may involve specialists andstaff from our affiliated network firms to perform certain specific audit procedures during the course ofmy / our audit. In terms of Standard on Auditing 720 – “The Auditor’s Responsibility in Relation to OtherInformation in Documents Containing Audited Financial Statements” issued by the ICAI and deemed to beprescribed by the Central Government in accordance with Section 143(10) of the 2013 Act , I / we request

210.4

you to provide to me / us a Draft of the Annual Report containing the audited financial statements so asto enable me / us to read the same and communicate material inconsistencies, if any, with the auditedfinancial statements, before issuing the auditor’s report on the financial statements {Insert Otherinformation, such as fee arrangements, billings and other specific terms, as appropriate.} This lettershould be read in conjunction with my / our letter dated ___ for the Audit of Internal Financial ControlsOver Financial Reporting under the 2013 Act, in respect of which separate fees have been fixed/will bemutually agreed.

I / We look forward to full cooperation from your staff during my / our audit. Please sign and return theattached copy of this letter to indicate your acknowledgement of, and agreement with, the arrangementsfor my / our audit of the financial statements including our respective responsibilities.

Yours faithfully,(signature)(Name of the Member)(Designation)(Name of the Firm)Date:

Place:Copy to: Chairman, Audit CommitteeAcknowledged on behalf of <>Name and Designation: _________________ Date: ______________

220.1

SA 220 - QUALITY CONTROL FOR AN AUDIT OF FS

Question-1

You are an audit senior working for the firm Kala & Company. You are currently carrying outthe audit of W Ltd., a manufacturer of waste paper bins. You are unhappy with W Ltd.'sinventory valuation policy and have raised the issue several times with the audit manager. Hehas dealt with the client for a number of years and does not see what you are making a fussabout. He has refused to meet you on site to discuss these issues.The former engagement partner to W Ltd. retired two months ago. As the audit manager haddealt with W Ltd. for so many years, the other partners have decided to leave the audit of WLtd. in his capable hands. Comment on the situation outlines above. (RTP)

Answer:Several quality control issues are raised in the scenario:

(1) Engagement Partner: An engagement partner is usually appointed to each auditengagement undertaken by the firm, to take responsibility for the engagement onbehalf of the firm.Assigning the audit to an experienced audit manager is not sufficient.

(2) The lack of an audit engagement partner also means that several of the requirements ofSA 220 directing, supervising and reviewing the audit are not in place.

(3) Conflicting Views: In this scenario the audit manager and senior have conflicting viewsabout the valuation of inventory. This does not appear to have been handled well, withthe manager refusing to discuss the issue with the senior.

(4) Resolving of Disputes: SA 220, requires that the audit engagement partner takesresponsibility for setting disputes in accordance with the firm's policy in respect ofresolution of difference of opinion required by SQC 1" Quality Control for Firms thatPerform Audits and Reviews of Historical Financial Information, and Other Assurance andRelated Services Engagements".

(5) Reasons for Failure to Resolve the Disputes: In this case, the lack of engagement partnermay have contributed to this failure to resolve the disputes. In any event, at best, thefailure to resolve the difference of opinion is a breach of the firm's policy under SQC 1. Atworst, it indicates that the firm does not have a suitable policy concerning suchdisputes required by SQC.l "Quality Control for Firms that Perform Audits and Reviews ofHistorical Financial Information, and Other Assurance and Related ServicesEngagements".

Question-2

"The work performed by each assistant needs to be reviewed by personnel of at least equalcompetence."(May 2011)

Answer:Reviewing the work performed by Assistant: As per SA 220 "Quality Control for an Audit ofFinancial Statements" the firm's review responsibility policies and procedures are determined onthe basis that work of less experienced team members is reviewed by more experienced teammembers.

220.2

EP is responsible for the engagement and its performance, and for the report that is issued onbehalf of the firm, and who, where required, has the appropriate authority from aprofessional, legal or regulatory body.

Engagement partner's satisfaction on or before the date of the auditor's report: The engagement partner shall ensure that reviews being performed are in accordance with

the firm's review policies and procedures. A review consists of consideration whether, forexample:

(1)The work has been performed in accordance with professional standards and regulatory andlegal requirements;

(2)Significant matters have been raised for further consideration;(3)Appropriate consultations have taken place and the resulting conclusions have been

documented and implemented;(4)There is a need to revise the nature, timing and extent of work performed;(5)The work performed supports the conclusions reached and is appropriately documented;(6)The evidence obtained is sufficient and appropriate to support the auditor's report; and(7)The objectives of the engagement procedures have been achieved.

Question-3

Importance of KYC Requirements for a Chartered Accountant's Practice. (Nov 2014)

AnswerAs per SA-220 (Revised) The practicing chartered accountant should obtain informationregarding the client, whether or not to undertake the assignment with the client. This may bedue to:a) Client doing an illegal activity.b) Client putting unnecessary pressure for completing the audit. The firm should establish policies and procedures for the acceptance and continuance of

client relationships and specific engagements, designed to provide it with reasonableassurance that it will undertake or continue relationships and engagements only where it:

a) Has considered the integrity of the client and does not have information that would lead it toconclude that the client lacks integrity;

b) Is competent to perform the engagement and has the capabilities, time and resources to doso; and

c) Can comply with the ethical requirements.d) The firm should obtain such information as it considers necessary in the circumstances before

accepting an engagement with a new client, when deciding whether to continue an existingengagement, and when considering acceptance of a new engagement with an existing client.

With regard to the integrity of a client matters that the firm considers include, for example:(1) The identity and business reputation of the client's principal owners, key management, related

parties and those charged with its governance.(2) The nature of the client's operations, including its business practices.(3) Information concerning the attitude of the client's principal owners, key management and

those charged with its governance towards such matters as aggressive interpretation ofaccounting standards and the internal control environment.

(4) Whether the client is aggressively concerned with maintaining the firm's fees as low aspossible.

(5) Indications of an inappropriate limitation in the scope of work.(6) Indications that the client might be involved in money laundering or other criminal activities.

220.3

Question-4M/s Sureshchandra & Co. has been appointed as an auditor of SC Ltd. for the financial year2014-15. CA. Suresh, one of the partners of M/s Sureshchandra & Co., completed entireroutine audit work by 29th May, 2015. Unfortunately, on the very next morning, while rovingtowards office of SC Ltd. to sign final audit report,he met with a road accident and died. CA.Chandra, another partner of M/s Sureshchandra & Co., therefore, signed the accounts of SCLtd., without reviewing the work performed by CA. Suresh. State with reasons whether CA.Chandra is right in expressing an opinion on financial statements the audit of which isperformed by another auditor.

Answer-Relying on Work Performed by Another Auditor: As per SA 220 “Quality Control for an Audit ofFinancial Statements”, an engagement partner taking over an audit during the engagement mayapply the review procedures such as the work has been performed in accordance withprofessional standards and regulatory and legal requirements

The engagement partner shall take responsibility For reviews being performed in accordancewith the firm’s review policies and procedures On or before the date of the auditor’s report, Theengagement partner shall, be satisfied that sufficient appropriate audit evidence has beenobtained to support the conclusions and the auditor’s report.Further, one of the basic principles, which govern the auditor’s professional responsibilities andwhich should be complied with wherever an audit is carried, is that when the auditor delegateswork to assistants or uses work performed by other auditor and experts, he will continue to beresponsible for forming and expressing his opinion on the financial information. However, he willbe entitled to rely on work performed by others, provided he exercises adequate skill and care isnot aware of any reason to believe that he should not have so relied. This is the fundamentalprinciple which is ethically required as per Code of Ethics.In the given case, all the auditing procedures before the moment of signing of final report havebeen performed by CA. Suresh. However, the report could not be signed by him due to hisunfortunate death. Later on, CA. Chandra signed the report relying on the work performed byCA. Suresh. Here, CA. Chandra is allowed to sign the audit report, though, will be responsible forexpressing the opinion. He may rely on the work performed by CA. Suresh provided he furtherexercises adequate skill and due care and review the work performed by him.

230.1

SA 230 - AUDIT DOCUMENTATION

Question-1

As an auditor how would you deal with the following: The statutory auditor of the holdingcompany demands for the working paper of the auditors of the subsidiary company, of whichyou are the auditor?

Answer:As per SA 230, “Audit Documentation” working papers are the property of the auditor. Theauditor may, at his discretion, make portion of or extracts of his working papers available to hisclient.SA 600 “Using the Work of Another Auditors” also states that an auditor should respect theconfidentiality of information acquired during the course of his audit work and should notdisclose such information unless there is a legal or professional duty to disclose.As per ICAI Guidelines, statutory auditor of an enterprise do not have right of access to the auditworking papers of the branch auditor. An auditor can rely on the work of another auditor,without having any right of access to the audit working papers of other auditor.Conclusion: Statutory auditor of Holding company cannot have access to audit working papers ofthe subsidiary company’s auditor. He can however, asks the auditor to answer certain questionsabout the manner in which the audit is conducted and certain other clarifications regarding audit

Question-2

What are Audit working papers and why should they be carefully preserved by auditor?

AnswerRecord of: Audit procedures performed Relevant audit evidence obtained, & Conclusions reachedPurposeincludes the following:(1)Assist in Planning and performance of Audit.(2)Direction, supervision & Review of work.(3)To fix accountability.(4)Record for future reference.(5)Quality control review and inspections(6)Conduct of external inspections.

Question-3

Discuss various contents of permanent audit file and current file. (Nov 2005, May 2007)?

Answer-(I) Permanent Audit file: It includes -

230.2

(1)Information concerning the legal and organisational structure of the entity. Example: MOA,AOA etc.

(2)Extracts or copies of important legal documents, agreements and minutes relevant to theaudit.

(3)A record of the study and evaluation of the internal controls related to the accounting system.(4)Copies of audited financial statements for previous years.(5)Analysis of significant ratios and trends.(6)Copies of management letters issued by the auditor, if any.(7)Record of communication with the retiring auditor, if any, before acceptance of the

appointment as auditor.(8)Notes regarding significant accounting policies.(9)Significant audit observations of earlier years.(II) Current Audit file:The current file normally includes:(1)Correspondence relating to acceptance of annual reappointment.(2)Extracts of important matters in the minutes of Board Meetings and General(3)Meetings, as are relevant to the audit.(4)Evidence of the planning process of the audit and audit programme.(5)Analysis of transactions and balances.(6)A record of the nature, timing and extent of auditing procedures performed and the results of

such procedures.(7)Evidence that the work performed by assistants was supervised and reviewed.(8)Copies of communications with other auditors, experts and other third parties.(9)Copies of letters or notes concerning audit matters communicated to or discussed with the

client, including the terms of the engagement and material weaknesses in relevant internalcontrols.

(10) Letters of representation or confirmation received from the client.(11) Conclusions reached by the auditor concerning significant aspects of the audit.(12) Copies of the financial information being reported on and the related audit reports.

Question-3

Mr. A, a practising Chartered Accountant, has been appointed as an auditor of True Pvt. Ltd.What factors would influence the amount of working papers required to be maintained for thepurpose of his audit?(Nov-15)

Answer(a) Factors Influencing the Amount of Working Papers: As per SA 230 “Audit Documentation”,which refers to the record of audit procedures performed, relevant audit evidence obtained andconclusions the auditor reached, the amount of audit working papers depend on factors such as-(i) The size and complexity of the entity.(ii) The nature of the audit procedures to be performed.(iii) The identified risks of material misstatement.(iv) Thesignificance of the audit evidence obtained.(v) The nature and extent of exceptions identified.

230.3

(vi) The need to document a conclusion or the basis for a conclusion not readily determinablefrom the documentation of the work performed or audit evidence obtained.(vii) The audit methodology and tools used.(viii) Timely preparation of Audit Documentation.

Question-4 Discuss the Auditor’s responsibility to provide access to his audit working papers toRegulators and third parties.Answer-Audit Working Paper:

1. The auditor should not provide access to working papers to any third party withoutspecific authority or unless there is a legal or professional duty to disclose.

2. Clause (1) of Part I of Second Schedule to the Chartered Accountants Act, 1949 statesthat a Chartered Accountant in practice shall be deemed to be guilty of professionalmisconduct if he discloses information acquired in the course of his professionalengagement to any person other than his client, without the consent of his client orotherwise than as required by law for the time being in force.

3. SA 200 on “Overall Objectives of the Independent Auditor and the conduct of an audit inaccordance with Standards on Auditing” also reiterates that, “the auditor should respectthe confidentiality of the information obtained and should not disclose any suchinformation to any third party without specific authority or unless there is a legal orprofessional duty to disclose”.If there is a request to provide access by the regulatorbased on the legal requirement,the same has to be complied with after informing theclient about the same.

4. Further, Standard on Quality Control (SQC) 1, “Quality Control for Firms that PerformAudits and Reviews of Historical Financial Information, and Other Assurance and RelatedServices Engagements”, provides that, unless otherwise specified by law or regulation,audit documentation is the property of the auditor. He may at his discretion, makeportions of, or extracts from, audit documentation available to clients, provided suchdisclosure does not undermine the validity of the work performed, or, in the case ofassurance engagements, the independence of the auditor or of his personnel.

5. As per SA 230, Audit documentation serves a number of additional purposes, includingthe enabling the conduct of external inspections in accordance with applicable legal,regulatory or other requirements.

Therefore, it is auditor’s responsibility to provide access to his audit working papers toRegulators whereas it’s at auditor’s discretion, to make portions of, or extract from hisworking paper to third parties.

240.1

SA 240 - THE AUDITOR’S RESPONSIBILITIES RELATING TO FRAUD IN AN AUDITOF FINANCIALSTATEMENTS

Question-1

The Managing Director of the Company has committed a “Teeming and Lading” Fraud. Theamount involved has been however subsequently after the year end deposited in the company.As a Statutory Auditor, how would you deal?

Answer

Fraud Committed by Managing Director: The Managing Director of the company has committed a“Teeming and Lading” fraud. The fact that the amount involved has been subsequently depositedafter the year end is not important because the auditor is required to perform his responsibilit iesas laid down in SA 240, “The Auditor’s responsibilities relating to Fraud in an Audit of FinancialStatements”. First of all, as per SA 240, the auditor needs to perform procedures whether thefinancial statements are materially misstated. Because an instance of fraud cannot be consideredas an isolated occurrence and it becomes important for the auditor to perform audit proceduresand revise the audit risk assessment. Secondly, the auditor needs to consider the impact of fraudon financial statements and its disclosure in the audit report. Thirdly, the auditor shouldcommunicate the matter to the Chairman and Board of Directors. Finally, in view of the fact thatthe fraud has been committed at the highest level of management, it affects the reliability of auditevidence previously obtained since there is a genuine doubt about representations ofmanagement.Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in thecourse of the performance of his duties as auditor, has reason to believe that an offenceinvolving fraud is being or has been committed against the company by officers or employees ofthe company, he shall immediately report the matter to the Central Government within 60 daysof his knowledge and after following the prescribed procedure.

Question-2

As a Statutory Auditor, how would you deal with the following?While auditing accounts of a public limited company for the year ended 31st March 2014, anauditor found out an error in the valuation of inventory, which affects the financial statementmaterially – Comment as per standards on auditing.

Answer

Errors in Valuation of Inventories and Auditor’s Responsibilities: SA 240, “The Auditor’sResponsibilities Relating Fraud in an Audit of Financial Statements”, requires that if circumstances

240.2

indicate the possible existence of fraud or error, the auditor should consider the potential effectof the suspected fraud or error on the financial information.If the auditor believes the suspected fraud or error could have a material effect on the financialinformation, he should perform such modified or additional procedures as he determines to beappropriate.SA 240 also requires that when the auditor identifies a misstatement, the auditor shall evaluatewhether such a misstatement is indicative of fraud.If there is such an indication, the auditor shall evaluate the implications of the misstatement inrelation to other aspects of the audit, particularly the reliability of management representations,recognizing that an instance of fraud is unlikely to be an isolated occurrence.The auditor should consider requesting the management to adjust the financial informationor consider extending his audit procedures. If the management refuses to adjust the financialinformation and the results of extended audit procedures do not enable the auditor to concludethat the aggregate of uncorrected misstatements is not material, the auditor should express aqualified or adverse opinion, as appropriate. In the instant case, the auditor has detected thematerial errors affecting the financial statements; the auditor should communicate his findings tothe management on a timely basis, consider the implications on true and fair view and also ensurethat appropriate disclosures have been made.

Question-3

M/s Honest Limited has entered into a transaction on 5th March, 2014, near year-end, wherebyit has agreed to pay ` 5 lakhs per month to Mr. Y as annual retainer-ship fee for "engineeringconsultation". No amount was actually paid, but ` 60 lakhs is provided in books of account as onMarch 31, 2014.Your inquiry elicits a response that need-based consultation was obtained round the year, butthere is no documentary or other evidence of receipt of the service. As the auditor of M/sHonest Limited, what would be your approach?

Answer

As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of FinancialStatements”, fraud can be committed by management overriding controls using suchtechniques as Recording fictitious journal entries, particularly close to the end of an accountingperiod, to manipulate operating results or achieve other objectives.Keeping in view the above, it is clear that Company has passed fictitious journal entries near yearend to manipulate the operating results. Also Auditor’s enquiry elicited a response thatneed-based consultation was obtained round the year, but there is no documentary or otherevidence of receipt of the service, is not acceptable.Accordingly, the auditor would adopt the following approach-

240.3

Consider whether such a misstatement is an indication of Fraud. If Fraud identified-

Further, as per section 143(12) of the Companies Act, 2013, if an auditor of acompany, inthe course of the performance of his duties as auditor, has reason to believe that an offenceinvolving fraud is being or has been committed against the company by officers or employees ofthe company, he shall immediately report the matter to the Central Government within 60days of his knowledge and after following the prescribed procedure.

Question-4

In the course of audit of K Ltd., its auditor Mr. 'N' observed that there was a special auditconducted at the instance of the management on a possible suspicion of a fraud and requestedfor a copy of the report to enable him to report on the fraud aspects. Despite many reminders itwas not provided.In absence of the special audit report, Mr. 'N' insisted that he be providedwith at least a written representation in respect of fraud on/by the company. For this requestalso, the management remained silent. Please guide Mr. 'N'.

Answer

Auditors Responsibilities Relating to Fraud: As per SA 240, “The Auditor’s Responsibilities relatingto Fraud in an Audit of Financial Statements”, the primary responsibility for the prevention anddetection of fraud rests with both those charged with governance of the entity and management.In addition an auditor conducting anaudit in accordance with SAs is responsible for obtainingreasonable assurance that the financial statements taken as a whole are free from materialmisstatement, whether caused by fraud or error.The risk of not detecting a material misstatement resulting from fraud is higher than the risk ofnot detecting one resulting from error. This is because fraud may involve sophisticated andcarefully organized schemes designed to conceal it, such as forgery, deliberate failure to recordtransactions, or intentional misrepresentations being made to the auditor.As per SA 580, “Written Representations”, if management modifies or does not provide therequested written representations, it may alert the auditor to the possibility that one or moresignificant issues may exist. Further, If management does not provide one or more of therequested written representations, the auditor shall discuss the matter with management; re-evaluate the integrity of management and evaluate the effect that this may have on the reliabilityof representations (oral or written) and audit evidence in general; and take appropriate actions,including determining the possible effect on the opinion in the auditor’s report.

Communicate to Mngt. &TCWG(and to Regulatory

and Enforcement authorities, if required by Law)

Auditor unable to complete

the engagement.Consider the Possibility of

withdrawingIf withdraw: Discuss with

Mngt& TCWG

240.4

In the instant case, in the course of audit of K Ltd., its auditor Mr. N observed that there was aspecial audit conducted at the instance of the management on a possible suspicion offraud. Therefore, the auditor requested for special audit report, which was not provided by themanagement despite of many reminders. Mr. N also insisted for written representation in respectof fraud on/by the company. For this request also management remained silent.Hence, the fact is required to be reported and the auditor should also disclaim an opinion on thefinancial statements.

Question-5

In the course of audit of A Ltd you suspect the management has indulged in fraudulentfinancial reporting? State the possible source of such fraudulent financial reporting.

Answer

As per SA 240, “”, Fraudulent financial reporting involves intentional misstatements oromissions of amounts or disclosures in financial statements to deceive financial statementusers. It may be accomplished by manipulation, falsification, or alteration of accounting records orsupporting documents from which the financial statements are prepared or Misrepresentation in,or intentional omission from, the financial statements of events, etc.It often involves management override of controls, misappropriation of assets etc thatotherwise may appear to be operating effectively. Fraud can be committed by managementoverriding controls using such techniques as:(1) Recording fictitious journal entries, particularly close to the end of an accounting period, to

manipulate operating results or achieve other objectives.(2) Inappropriately adjusting assumptions and changing judgments used to estimate account

balances.(3) Omitting, advancing or delaying recognition in the financial statements of events and

transactions that have occurred during the reporting period.(4) Concealing, or not disclosing, facts that could affect the amounts recorded in the

financial statements.(5) Engaging in complex transactions that are structured to misrepresent the financial

position or financial performance of the entity.(6) Altering records and terms related to significant and unusual transactions.(7) Embezzling receipts (for example, misappropriating collections on accounts receivable or

diverting receipts in respect of written-off accounts to personal bank accounts).(8) Stealing physical assets or intellectual property (for example, stealing inventory for

personal use or for sale, stealing scrap for resale, colluding with a competitor bydisclosing technological data in return for payment).

(9) Causing an entity to pay for goods and services not received (for example, payments tofictitious vendors, kickbacks paid by vendors to the entity’s purchasing agents in return forinflating prices, payments to fictitious employees).

Question-6

240.5

Explain briefly duties and responsibilities of an auditor in case of material misstatementresulting from Management Fraud.Answer

As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of FinancialStatements”, the primary responsibility for the prevention and detection of fraud rests with boththose charged with governance of the entity and management.The auditor, conducting an audit, is responsible for obtaining reasonable assurance that thefinancial statements taken as a whole are free from material misstatement, whether caused byfraud or error.Owing to the inherent limitations of an audit, there is an unavoidable risk that some materialmisstatements of the financial statements may not be detected, even though the audit is properlyplanned and performed in accordance with the SAs.The risk of not detecting a material misstatement resulting from fraud is higher than the risk ofnot detecting one resulting from error. This is because fraud may involve sophisticated andcarefully organized schemes designed to conceal it, such as forgery, deliberate failure to recordtransactions, or intentional misrepresentations being made to the auditor. Such attempts atconcealment may be even more difficult to detect when accompanied by collusion. Collusion maycause the auditor to believe that audit evidence is persuasive when it is, in fact, false.Furthermore, the risk of the auditor not detecting a material misstatement resulting frommanagement fraud is greater than for employee fraud, because management is frequently in aposition to directly or indirectly manipulate accounting records, present fraudulent financialinformation or override control procedures designed to prevent similar frauds by otheremployees.When obtaining reasonable assurance, the auditor is responsible for maintaining professionalskepticism throughout the audit, considering the potential for management override ofcontrolsand recognizing the fact that audit procedures that are effective for detecting error maynot be effective in detecting fraud.

Question-7

Comment on the following: While conducting statutory Audit of ABC Ltd., you come across IOUsamounting to Rs. 2 crores as against a cash balance shown in books of Rs. 2.10 crores. You alsoobserve that despite similar high balances throughout the year, small amounts of Rs. 50,000 arewithdrawn from the bank to meet day-to-day expenses. [May 09 - New (5 marks)]

Answer

According to SA 240 "Auditors responsibilities relating to Fraud in an audit of financialstatements", when the auditor comes across such circumstances indicating the possiblemisstatements resulting from entity's procedure, the auditor shall evaluate whether such amisstatement is indicative of fraud.

240.6

In this case, the circumstances indicate the possibility of fraud and accordingly, the] auditor mustinvestigate further to consider effect on financial statements.The Guidance Note on Audit of Cash and Bank balances also mentions that if the entity ismaintaining an unduly large balance of cash, he should carry out surprise verification of cash morefrequently to ascertain whether it agrees. If cash in hand is not in agreement with the bookbalance, he should seek explanations and if the same are not satisfactory, he should state this factappropriately in his Audit Report.

Question-8

You notice a misstatement resulting from fraud or suspected fraud during the audit andconclude that it is not possible to continue the performance of audit. As a Statutory Auditor,how would you deal?

Answer

Impossibility to continue the performance of audit:According to SA 240 “The Auditor’sResponsibilities Relating to Fraud in an Audit of Financial Statements”, if, as a result of amisstatement resulting from fraud or suspected fraud, the auditor encounters exceptionalcircumstances that bring into question the auditor’s ability to continue performing the audit, theauditor shall:

1. Determine the professional and legal responsibilities applicable in the circumstances, includingwhether there is a requirement for the auditor to report to the person or persons who madethe audit appointment or, in some cases, to regulatory authorities;

2. Consider whether it is appropriate to withdraw from the engagement, where withdrawal fromthe engagement is legally permitted; and

3. If the auditor withdraws:

a. 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

b. Determine whether there is a professional or legal requirement to report to the personor persons who made the audit appointment or, in some cases, to regulatory authorities, theauditor’s withdrawal from the engagement and the reasons for the withdrawal.

Question-9

As a Statutory Auditor, How would you deal with the following?"While auditing accounts of a public limited company for the year ended 31st march 2012, anauditor found out an error in the valuation of inventory, which affects the financial Statementmaterially - comment as per standards on auditing." (RTP Nov 2013)

Answer

(1)SA 240 requires that if circumstances indicate the possible existence of fraud or error, theauditor should consider the potential effect of the suspected fraud or error on the financialinformation.

240.7

(2)If the auditor believes the suspected fraud or error could have a material effect on the financialinformation, he should perform such modified or additional procedures as he determines to beappropriate.

(3)SA 240 also requires that whence auditor identifies a misstatement, the auditor shall evaluatewhether such a misstatement is indicative of fraud.

(4)If there is such an indication, the auditor shall evaluate the implications of the misstatement inrelation to other aspects of the audit, particularly the reliability of managementrepresentations, recognising that an instance of fraud is unlikely to be an isolated occurrence.

(5)Further, SA 320 Materiality in Planning and Performing an Audit, also requires that in suchcircumstances, the auditor should consider requesting the management to adjust the financialinformation or consider extending his audit procedures.

(6)If the management refuses to adjust the financial information and the results of extended auditprocedures do not enable the auditor to conclude that the aggregate of uncorrectedmisstatements is not material, the auditor should express a qualified or adverse opinion, asappropriate.

(7)In the instant case, the auditor has detected the material errors affecting the financialstatements; the auditor should communicate his findings to the management on a timely basis,consider the implications on true and fair view and also ensure that appropriate disclosureshave been made.

Question-10

As a Statutory Auditor, how would you deal with a misstatement resulting from fraud orsuspected fraud during the audit and conclude that it is not possible to continue theperformance of audit. (RTP)

Question-11

Is it appropriate for the auditor to make inquires of management regarding management’s ownassessment of the risk of fraud and the controls in place to prevent and detect it? Discuss.

Answer

Auditor to make Inquiries regarding Management’s own Assessment of Risk of Fraud andControls: As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of FinancialStatements”, management accepts responsibility for the entity’s internal control and for thepreparation of the entity’s financial statements. Accordingly, it is appropriate for the auditor tomake inquiries of management regarding management’s own assessment of the risk of fraud andthe controls in place to prevent and detect it. The nature, extent and frequency of management’sassessment of such risk and controls may vary from entity to entity.

240.8

In some entities, management may make detailed assessments on an annual basis or as part ofcontinuous monitoring. In other entities, management’s assessment may be less structured andless frequent. The nature, extent and frequency of management’s assessment are relevant to theauditor’s understanding of the entity’s control environment. For example, the fact thatmanagement has not made an assessment of the risk of fraud may in some circumstances beindicative of the lack of importance that management places on internal control.The auditor’s inquiries of management may provide useful information concerning the risks ofmaterial misstatements in the financial statements resulting from employee fraud. However, suchinquiries are unlikely to provide useful information regarding the risks of material misstatement inthe financial statements resulting from management fraud.Management is often in the best position to perpetrate fraud. Accordingly, when evaluatingmanagement’s responses to inquiries with an attitude of professional skepticism, the auditor mayjudge it necessary to corroborate responses to inquiries with other information.

Question 12The Managing Director of the Company has committed a “Teeming and Lading” Fraud. Theamount involved has been however subsequently after the year end deposited in the company.As a Statutory Auditor, how would you deal?Answer-Fraud Committed by Managing Director: The Managing Director of the company hascommitted a “Teeming and Lading” fraud. The fact that the amount involved has beensubsequently deposited after the year end is not important because the auditor is required toperform his responsibilities as laid down in SA 240, “The Auditor’s responsibilities relating to Fraudin an Audit of Financial Statements”. First of all, as per SA 240, the auditor needs to performprocedures whether the financial statements are materially misstated. Because aninstance of fraud cannot be considered as an isolated occurrence and it becomes important forthe auditor to perform audit procedures and revise the audit risk assessment. Secondly, theauditor needs to consider the impact of fraud on financial statements and its disclosure inthe audit report. Thirdly, the auditor should communicate the matter to the Chairman andBoard of Directors. Finally, in view of the fact that the fraud has been committed at the highestlevel of management, it affects the reliability of audit evidence previously obtained since thereis agenuine doubt about representations of management. Further, as per section 143(12) of theCompanies Act, 2013, if an auditor of a company, in the course of the performance of his duties asauditor, has reason to believe that an offence involving fraud is being or has been committedagainst the company by officers or employees of the company, he shall immediately report thematter to the Central Government (in case amount of fraud is 1 crore or above)or AuditCommittee or Board in other cases (in case the amount of fraud involved in less than 1 crore)within such time and in such manner as may be prescribed.The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016,Whether any fraud by the company or any fraud on the company by its officers or employeeshas been noticed or reported during the year; If yes, the nature and the amount involved is tobe indicated.

Question 13

240.9

In the course of audit of A Ltd. you suspect the management has indulged in fraudulentfinancial reporting. State the possible source of such fraudulent financial reporting.AnswerPossible Sources of Fraudulent Financial Reporting: As per SA 240, “The Auditor’s responsibilitiesrelating to Fraud in an Audit of Financial Statements”, fraudulent financial reporting involvesintentional misstatements or omissions of amounts or disclosures in financial statements todeceive financial statement users. It may be accomplished by manipulation, falsification, oralteration of accounting records or supporting documents from which the financial statements areprepared or Misrepresentation in, or intentional omission from, the financial statements ofevents, transactions or other significant information or intentional misstatements involveintentional misapplication of accounting principles relating to measurement, recognition,classification, presentation, or disclosure etc.It often involves management override of controls,misappropriation of assets etc that otherwise may appear to be operating effectively. Fraud canbe committed by management overriding controls using such techniques as:(i) Recording fictitious journal entries, particularly close to the end of an accounting period,to manipulate operating results or achieve other objectives.(ii) Inappropriately adjusting assumptions and changing judgments used to estimate accountbalances.(iii) Omitting, advancing or delaying recognition in the financial statements of events andtransactions that have occurred during the reporting period.(iv) Concealing, or not disclosing, facts that could affect the amounts recorded in the financialstatements.(v) Engaging in complex transactions that are structured to misrepresent the financial position orfinancial performance of the entity.(vi) Altering records and terms related to significant and unusual transactions.(vii) Embezzling receipts (for example, misappropriating collections on accounts receivable ordiverting receipts in respect of written-off accounts to personal bank accounts).(viii) Stealing physical assets or intellectual property (for example, stealing inventory for personaluse or for sale, stealing scrap for resale, colluding with a competitor by disclosing technologicaldata in return for payment).(ix) 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 returnfor inflating prices, payments to fictitious employees).(x) Using an entity’s assets for personal use (for example, using the entity’s assets as collateral fora personal loan or a loan to a related party).

Question-14You are appointed as an auditor of Global Ltd. Explain the risk factors relating to misstatementsarising from misappropriation of assets.Answer(a) Risk Factors Relating to Misstatements Arising from Misappropriation of Assets:As per SA 240, “The Auditor’s Responsibilities Relating to Fraud in audit of Financial Statements”,misappropriation of assets involves the theft of an entity’s assets and is often perpetrated by

240.10

employees in relatively small and immaterial amounts. However, it can also involve managementwho are usually more able to disguise or conceal misappropriations in ways that are difficult todetect. Risk factors that relate to misstatements arising from misappropriation of assets areclassified according to the three conditions generally present when fraud exists:incentives/pressures, opportunities, and attitudes/rationalization. The following are examples ofrisk factors related to misstatements arising from misappropriation of assets:Incentives/Pressures: Personal financial obligations may create pressure on management oremployees with access to cash or other assets susceptible to theft to misappropriate those assets.Adverse relationships between the entity and employees with access to cash or other assetssusceptible to theft may motivate those employees to misappropriate those assets. For example,adverse relationships may be created by the following:1. Known or anticipated future employee layoffs.2. Recent or anticipated changes to employee compensation or benefit plans.3. Promotions, compensation or other rewards inconsistent with expectations. Opportunities:Certain characteristics or circumstances may increase the susceptibility of assets tomisappropriation. For example, opportunities to misappropriate assets increase when there arethe following: Inventory items that are small in size, of high value, or in high demand. Fixed assets which are small in size, marketable, or lacking observable identification of

ownership. Inadequate internal control over assets may increase the susceptibility of misappropriation

of those assets. Inadequate segregation of duties or independent checks.

Attitudes/Rationalizations Disregard for the need for monitoring or reducing risks related to misappropriations of

assets. Disregard for internal control over misappropriation of assets by overriding existing

controls or by failing to take appropriate remedial action on known deficiencies in internalcontrol.

Behavior indicating displeasure or dissatisfaction with the entity or its treatment of theemployee.

Changes in behavior or lifestyle that may indicate assets have been misappropriated.

250.1

SA 250 - CONSIDERATIONS OF LAW AND REGULATIONS IN AN AUDIT OFFINANCIALSTATEMENTS

Question-1

As a statutory auditor of a company, comment on the following:While verifying the employee records in a company, it was found that a major portion of theLabour employed was child labour. On questioning the management, the auditor was told thatit was outside his scope of the financial audit to look into the compliance with other laws.

Question-2

State the reporting responsibility of an auditor in the context of non-compliance of LawandRegulation in an audit of Financial Statement.

Answer

Reporting responsibility of an auditor in the context of non-compliance of Law andRegulation: According to SA 250 “Consideration of Laws and Regulations in an Audit ofFinancial Statements”, the reporting responsibilities of an Auditor may be divided into thefollowing categories-

Reporting Non-Compliance to Those Charged with Governance: Unless all of thosecharged with governance are involved in management of the entity, and therefore are aware ofmatters involving identified or suspected non-compliance already communicated by theauditor, the auditor shall communicate with those charged with governance matters involvingnon-compliance with laws and regulations that come to the auditor’s attention duringthe course of the audit, other than when the matters are clearly inconsequential.

If, in the auditor’s judgment, the non-compliance referred above is believed to be intentionaland material, the auditor shall communicate the matter to those charged with governance assoon as practicable.

If the auditor suspects that management or those charged with governance are involved innon-compliance, the auditor shall communicate the matter to the next higher level of authorityat the entity, if it exists, such as an audit committee or supervisory board. Where no higherauthority exists, or if the auditor believes that the communication may not be acted upon or isunsure as to the person to whom to report, the auditor shall consider the need to obtain legaladvice.

Reporting Non-Compliance in the Auditor’s Report on the Financial Statements: If the auditorconcludes that the non-compliance has a material effect on the financial statements, and hasnot been adequately reflected in the financial statements, the auditor shall, in accordance withSA 705 express a qualified or adverse opinion on the financial statements.

250.2

If the auditor is precluded by management or those charged with governance from obtainingsufficient appropriate audit evidence to evaluate whether non-compliance that may be materialto the financial statements has, or is likely to have, occurred, the auditor shall express aqualified opinion or disclaim an opinion on the financial statements on the basis of a limitationon the scope of the audit in accordance with SA 705.

If the auditor is unable to determine whether non-compliance has occurred because oflimitations imposed by the circumstances rather than by management or those charged withgovernance, the auditor shall evaluate the effect on the auditor’s opinion in accordance with SA705.

Reporting Non-Compliance to Regulatory and Enforcement Authorities: If the auditor hasidentified or suspects non-compliance with laws and regulations, the auditor shall determinewhether the auditor has a responsibility to report the identified or suspected non-complianceto parties outside the entity.

Question-3

R & M Co. wants to be alert on the possibility of non-compliance with 5 Laws and Regulations duringthe course of audit of SRS Ltd, R &. M Co. seeks your guidance for identifying the indications of noncompliance with Laws and Regulations.(May-16)

AnswerAs per SA 250, “Consideration of Laws and Regulations, the auditor shall perform the auditprocedures to help identify instances of non-compliance with other laws and regulations thatmay have a material effect on the financial statements by inquiring of management and, whereappropriate, those charged with governance, as to whether the entity is in compliance withsuch laws and regulations; and Inspecting correspondence, if any, with the relevant licensing orregulatory authorities.However, when the auditor becomes aware of the existence of, or information about, thefollowing matters, it may also be an indication of non-compliance with laws and regulations:

(i) Investigations by regulatory organisations and government departments or payment offines or penalties.

(ii) Payments for unspecified services or loans to consultants, related parties, employees orgovernment employees.

(iii) Sales commissions or agent’s fees that appear excessive in relation to those ordinarilypaid by the entity or in its industry or to the services actually received.

(iv) Purchasing at prices significantly above or below market price.(v) Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer

or transfers to numbered bank accounts.(vi) Unusual payments towards legal and retainership fees.

(vii) Unusual transactions with companies registered in tax havens.(viii)Payments for goods or services made other than to the country from which the goods or

services originated.(ix) Payments without proper exchange control documentation.(x) Existence of an information system which fails, whether by design or by accident, to

provide an adequate audit trail or sufficient evidence.

250.3

(xi) Unauthorised transactions or improperly recorded transactions.(xii)Adverse media comment.

260.1

Standard on Auditing (SA) 260 (Revised)Communication with Those Charged with Governance

Question-1

“The auditors should communicate audit matters of governance interest arising from the auditof financial statements with those charged with the governance of an entity”. Briefly state thematters to be included in such Communication.

Answer

Communications of audit matters with those charged with governance: As per SA 260“Communication with those Charged with Governance”, the auditor shall communicate withthose charged with governance, the responsibilities of the auditor in relation to the financialstatement audit, including that:(i) The auditor is responsible for forming and expressing an opinion on the financial

statements that have been prepared by management with the oversight of those chargedwith governance; and

(ii)The audit of the financial statements does not relieve management or those charged withgovernance of their responsibilities.

The auditor shall communicate with those charged with governance the following:a) The auditor’s views about significant qualitative aspects of the entity’s accounting

practices, including accounting policies, accounting estimates and financial statementdisclosures. When applicable, the auditor shall explain to those charged with governance whythe auditor considers a significant accounting practice, that is acceptable under the applicablefinancial reporting framework, not to be most appropriate to the particular circumstancesof the entity;

b) Significant difficulties, if any, encountered during the audit;c) Unless all of those charged with governance are involved in managing the entity:(i) Significant matters, if any, arising from the audit that were discussed, or subject to

correspondence with management; and(ii)Written representations the auditor is requesting; andd) Other matters, if any, arising from the audits that, in the auditor’s professional judgment, are

significant to the oversight of the financial reporting process.

Question-2

Write short notes on the following: (Nov 2010)Factors governing modes of communication of auditor with those charged with governance.Applicable Standard: SA 260, "Communication with Those Charge with Governance"

Answer:

260.2

As per SA 260, the auditor may decide whether to communicate orally or in writing, the extent ofdetail or summarization in the communication, and whether to communicate in a structured orunstructured manner) may be affected by such factors as: Size, operating structure, control environment, & legal structure of entity. In the case of an audit of special purpose F.S., whether the auditor also audits the entity’s

general purpose F. S. Requirements of respective law specifying written communication with TCWG in a prescribed

form. Expectations of TCWG, including arrangements made for periodic meetings or

communications with the auditor. The amount of ongoing contract and dialogue the auditor has with TCWG. Significant changes in the membership of a governing body.

265.1

SA 265COMMUNICATING DEFICIENCIES IN INTERNAL CONTROL TO THOSE CHARGED WITH

GOVERNANCE (TCWG) & MANAGEMENT

Question-1

Indicate the precise nature of auditor's liability in the following situations and support yourviews with authority, if any:Certain weaknesses in the internal control procedure in the payment of wages in a largeconstruction company were noticed by the statutory auditor who in turn brought the sameto the knowledge of the Managing Director of the company. In the subsequent year hugedefalcation came to the notice of the management. The origin of the same was traced tothe earlier year. The management wants to sue the auditor for negligence and also plans tofile a complaint with the InstituteIn the given case, certain weaknesses in the internal control procedure in the payment ofwages in a large construction company were noticed by the statutory auditor and broughtthe same to the knowledge of the Managing Director of the company. In the subsequentyear, a huge defalcation took place, the ramification of which stretched to the earlier year.The management of the company wants to sue the statutory auditor for negligence. Theprecise nature of auditor's liability in the case can be ascertained on the basis of the undernoted considerations:(a) Whether the/ defalcation emanated from the weaknesses noticed by the statutoryauditor, the information regarding which was passed on to the management; and(b) Whether the statutory auditor properly and adequately extended the audit programmeof the previous year having regard to the weaknesses noticed.(RTP Nov 2014)

Answer

As per SA 265, the auditor shall determine whether, on the basis of the audit workperformed, the auditor has identified one or more deficiencies in internal control. If the auditor has identified one or more deficiencies in internal control, the auditor shall

determine, on the basis of the audit work performed, whether, individually or incombination, they constitute significant deficiencies. The auditor shall communicate inwriting significant deficiencies in internal control identified during the audit to thosecharged with governance on a timely basis.

The auditor shall also communicate to management at an appropriate level ofresponsibility on a timely basis". The fact, however, remains that, weaknesses in the designof the internal control system and non-compliance with identified control proceduresincrease the risk of fraud or error.

If circumstances indicate the possible existence of fraud or error, the auditor shouldconsider the potential effect of the suspected fraud or error on the financial information. Ifthe auditor believes the suspected fraud or error could have a material effect on thefinancial information, he should perform such modified or additional procedures as hedetermines to be appropriate. Thus, normally speaking, as long as the auditor took duecare in performing the audit work, he cannot be held liable.

299.1

SA-299 (Responsibility of joint Auditors)

Question-1

Write a short note on Responsibility of Joint Auditors.

Answer

Responsibility of Joint Auditors: SA 299on, “Responsibility of Joint Auditors” deals with theprofessional responsibilities, which the auditors undertake in accepting such appointments asjoint auditors. Main features of the said SA are discussed below:

Two or more practicing units are appointed to conduct audit of an entity.Division of Work

• mutual discussion• Divide the audit work among themselves Period Functional area Components of financial statements Geographical location• Documentation• The division of work should be adequately documented• Reliance• Each joint auditor rely on other joint auditor, no need to review work done by other

Coordination• If one auditor comes to know a matter relevant for other, he should communicate it

immediately in writing to other joint auditor before submission of report.Responsibilities of Joint Auditors

• Separate responsibility of each joint auditor• For work allocated to him• For drafting audit program• For keeping documentation

Joint and several responsibility of all joint auditors• in respect of the audit work which is not divided among the joint auditors decisions taken

by all the joint auditors concerning the nature, timing or extent of the audit proceduresto be performed by any of the joint auditors

• in respect of matters which are brought to the notice of the joint auditors by any one ofthem and on which there is an agreement among the joint auditors for examining thatthe financial statements of the entity comply with the disclosure requirements of therelevant statute for ensuring that the audit report complies with the requirements of therelevant statute.

299.2

Question-2

ABC & Co. and DEF & Co., Chartered Accountant Firms were appointed as joint auditors ofGood Health Care Limited for 2009-10. A special audit was conducted u/s 233A of theCompanies Act, 1956 during March 2011 and observed gross understatement of revenue.The revenue aspects were look after by DEF & Co., but there was no documentation for thedivision of work between the joint auditors.

Answer

(1) As per SA 299 "Responsibilities of Joint Auditor" where joint auditors are appointed, theyshould, by mutual discussion, divide the work among themselves.

(2) Further the work so divided should be adequately documented and preferablecommunicated to the entity.

(3) In respect of audit work divided among the joint auditors, each joint auditor is responsibleonly for the work

(4) Allocated to him, whether or not he has prepared a separate report on the workperformed by him.

(5) However for the work not divided, all the joint auditors are jointly and severallyresponsible.

(6) Each joint auditor is entitled to assume that joint auditor have performed their part ofwork as per generally accepted audit procedure. It is not necessary for them to review theother joint auditor's work

(7) In the present case, though the revenue aspects were looked after by DEF & Co., but asthere is no documentation for division of the work between them, ABC & Co, has notreviewed the work as they have puttheir reliance on the work performed by DEF & Co.

(8) There is a violation of SA 299 as the division of work has not been documented, normallyDEF & Co. Will be held liable for negligence, if DEF & Co refuses to accept soleresponsibility for fault then ABC & Co will have to prove by other ways and means ofevidences that the particular area of audit was exclusively done by DEF & Co. only.

Question-3

P Limited is a listed company and its business activities are divided into three regions. Thecompany appointed PY & Co., KL & Co. and MK & Co., Chartered Accountants to conduct aJoint Audit and report on the financial statements for the Financial Year 2014-15. Explainthe relationship among the joint auditors for the audit of the financial statements for theyear 2014-15.

SA 299 “Responsibility of Joint Auditors” deals with the professional responsibilities which theauditors undertake in accepting appointments as joint auditors.

1. joint auditors arejointly and severallyresponsible in respectof the audit conductedby them as under:

1. in respect of the audit work which is not dividedamong the joint auditors and is carried out byall of them;

2. in respect of decisions taken by all the jointauditors concerning the nature, timing or extentof the audit procedures to be performed by anyof the joint auditors.

3. in respect of matters which are brought to thenotice of the joint auditors by any one of themand on which there is an agreement among thejoint auditors;

4. for examining that the financial statements ofthe entity comply with the disclosure

299.3

requirements of the relevant statute; and5. (v) for ensuring that the audit report complies

with the requirements of the relevant statute.separate and specificresponsibility

1. Each joint auditor to study and evaluate theprevailing system of internal control relating tothe work allocated to him, the extent ofenquiries to be made in the course of his audit.

2. The responsibility of obtaining and evaluatinginformation and explanation from themanagement is generally a joint responsibilityof all the auditors.

3. Each joint auditor is entitled to assure that theother joint auditors have carried out their partof work in accordance with the generallyaccepted audit procedures and therefore itwould not be necessary for joint auditor toreview the work performed by other jointauditors.

Question-4

KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditorsto conduct auditing for the financial year 2014-15. For the valuation of gratuity scheme ofthe company, Mr. X, Mr. Y and Mr. Z wanted to refer their own known Actuaries. Due todifference of opinion, all the joint auditors consulted their respective Actuaries.Subsequently, major difference was found in the actuary reports. However, Mr. X agreedto Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuaryreport shall be considered in audit report due to majority of votes. Now, Mr. Z is indilemma.(I) You are required to briefly explain the responsibilities of auditors when they are

jointly and severally responsible in respect of audit conducted by them and also guideMr. Z in such situation.

(II) Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on,found faulty.

(a) Difference of Opinion among Joint Auditors: SA 299 on, “Responsibility of Joint Auditors”deals with the professional responsibilities, which the auditors undertake in accepting suchappointments as joint auditors. In respect of the work divided amongst the joint auditors, eachjoint auditor is responsible only for the work allocated to him, whether or not he has made aseparate report on the work performed by him. On the other hand the joint auditors are jointlyand severally responsible in respect of the audit conducted by them as under:

(i) in respect of the audit work which is not divided among the joint auditors and is carried outby all of them;

(ii) in respect of decisions taken by all the joint auditors concerning the nature, timing or extentof the audit procedures to be performed by any of the joint auditors;

(iii) in respect of matters which are brought to the notice of the joint auditors by any one ofthem and on which there is an agreement among the joint auditors;

(iv) for examining that the financial statements of the entity comply with the disclosurerequirements of the relevant statute;

(v) for ensuring that the audit report complies with the requirements of the relevant statute;

299.4

(vi) it is the separate and specific responsibility of each joint auditor to study and evaluate theprevailing system of internal control relating to the work allocated to him, the extent ofenquiries to be made in the course of his audit;

(vii) the responsibility of obtaining and evaluating information and explanation from themanagement is generally a joint responsibility of all the auditors;

Normally, the joint auditors are able to arrive at an agreed report. However where the jointauditors are in disagreement with regard to any matters to be covered by the report, eachone of them should express their own opinion through a separate report. A joint auditor isnot bound by the views of majority of joint auditors regarding matters to be covered in thereport and should express his opinion in a separate report in case of a disagreement.In the instant case, there are three auditors, namely, Mr. X, Mr. Y and Mr. Z, jointlyappointed as an auditor of KRP Ltd. For the valuation of gratuity scheme of the Companythey referred their own known Actuaries. Mr. Z (one of the joint auditor) is not satisfiedwith the report submitted by Mr. Y’s referred actuary. He is not agreed with the matters tobe covered by the report whereas Mr. X agreed with the same.Hence, as per SA 299, Mr. Z is suggested to express his own opinion through a separatereport whereas Mr. X and Mr. Y may provide their joint report for the same.

(II) Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’sExpert”, the expertise of an expert may be required in the actuarial calculation of liabilitiesassociated with insurance contracts or employee benefit plans etc., however, the auditorhas sole responsibility for the audit opinion expressed, and that responsibility is notreduced by the auditor’s use of the work of an auditor’s expert.The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’spurposes, including the relevance and reasonableness of that expert’s findings orconclusions, and their consistency with other audit evidence as per SA 500.Further, in view of SA 620, if the expert’s work involves use of significant assumptions andmethods, then the relevance and reasonableness of those assumptions and methods mustbe ensured by the auditor and if the expert’s work involves the use of source data that issignificant to that expert’s work, the relevance, completeness, and accuracy of that sourcedata in the circumstances must be verified by the auditor.

In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuationreport of Actuary, to ensure the relevance and reasonableness of assumptions andmethods used. They were also required to examine the relevance, completeness andaccuracy of source data used for such report before expressing their opinion.Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty reportwithout examining the adequacy of expert actuary’s work whereas Mr. Z will not be heldliable for the same due to separate opinion expressed by him.

300.1

SA 300- PLANNING AN AUDIT OF FINANCIAL STATEMENTS

Question 1

Briefly discuss the following statements in view of SA 300 “Planning an Audit of FinancialStatements”:(a) For an initial audit, the auditor may need to expand the planning activities.

(b) Audit planning is not a discrete phase but a continuous phase.

(RTP May 17)

Answer

(a) Additional Considerations in Initial Audit Engagements: As per SA 300, Planning an Audit ofFinancial Statements, the purpose and objective of planning the audit are the same whether theaudit is an initial or recurring engagement. However, for an initial audit, the auditor may need toexpand the planning activities because the auditor does not ordinarily have the previousexperience with the entity that is considered when planning recurring engagements.For initial audits, additional matters the auditor may consider in establishing the overall auditstrategy and audit plan include the following:♦ Unless prohibited by law or regulation, arrangements to be made with the predecessorauditor, for example, to review the predecessor auditor’s working papers.♦ Any major issues (including the application of accounting principles or of auditing andreporting standards) discussed with management in connection with the initial selection asauditor, the communication of these matters to those charged with governance and how thesematters affect the overall audit strategy and audit plan.♦ The audit procedures necessary to obtain sufficient appropriate audit evidence regardingopening balances (as per SA 510 “Initial Audit Engagements– Opening Balances”).♦ Other procedures required by the firm’s system of quality control for initial audit engagements(for example, the firm’s system of quality control may require the involvement of anotherpartner or senior individual to review the overall audit strategy prior to commencing significantaudit procedures or to review reports prior to their issuance).(b) Audit Planning – a Continuous Process: As per SA 300, Planning an Audit of FinancialStatements, planning is not a discrete phase of an audit, but rather a continual and iterativeprocess that often begins shortly after (or in connection with) the completion of the previousaudit 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 becompleted prior to the performance of further audit procedures. For example, planning includesthe need to consider, prior to the auditor’s identification and assessment of the risks of materialmisstatement, such matters as-♦ The analytical procedures to be applied as risk assessment procedures.♦ Obtaining a general understanding of the legal and regulatory framework applicable to theentity and how the entity is complying with that framework.♦ The determination of materiality.♦ The involvement of experts.♦ The performance of other risk assessment procedures.The auditor may decide to discuss elements of planning with the entity’s management tofacilitate the conduct and management of the audit engagement (for example, to coordinate

300.2

some of the planned audit procedures with the work of the entity's personnel). Although thesediscussions often occur, the overall audit strategy and the audit plan remain the auditor'sresponsibility. When discussing matters included in the overall audit strategy or audit plan, careis required in order not to compromise the effectiveness of the audit. For example, discussingthe nature and timing of detailed audit procedures with management may compromise theeffectiveness of the audit by making the audit procedures too predictable.

315.1

SA 315 - IDENTIFYING AND ASSESSING THE RISK OF MATERIAL MISSTATEMENTTHROUGH UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT

Question -1

As a Statutory Auditor, how would you deal with the following?While commencing the statutory audit of B Company Limited, the auditor undertook the riskassessment and found that the detection risk relating to certain class of transactions cannot bereduced to acceptance level.

Answer

Assessment of Risk and Acceptable Level: SA 315 and SA 330 “Identifying and Assessingthe Risk of Material Misstatement Through Understanding the Entity and itsEnvironment” and “The Auditor’s Responses to Assessed Risks” establishes standards onthe procedures to be followed to obtain an understanding of the accounting andinternal control systems and on audit risk and its components: inherent risk, control riskand detection risk.

SA 315 and SA 330 require that the auditor should use professional judgement to assessaudit risk and to design audit procedures to ensure that it is reduced to anacceptably low level. “Detection risk” is the risk that an auditor’s substantiveprocedures will not detect a misstatement that exists in an account balance or class oftransactions that could be material. The higher the assessment of inherent and controlrisks, the more audit evidence the auditor should obtain from the performance ofsubstantive procedures.

When both inherent and control risks are assessed as high, the auditor needs toconsider whether substantive procedures can provide sufficient appropriate auditevidence to reduce detection risk, and therefore audit risk, to an acceptably low level.

The auditor should use his professional judgement to assess audit risk and to design auditprocedures to ensure that it is reduced to an acceptably low level. If it cannot be reducedto an acceptable level, the auditor should express a qualified opinion or a disclaimer ofopinion as may be appropriate.

Question -2

IT systems also pose specific risks to an entity's internal control? What are those risks?

Answer

Specific Risk to an Entity’s internal Control: As per SA 315 “Identifying and Assessing the RisksofMaterial Misstatement through Understanding the Entity and its Environment”, IT system alsoposes specific risks to an entity’s Internal Control. They are–(1)Reliance on systems or programs that are inaccurately processing data, processing inaccurate

data or both.(2)Unauthorised access to data that may result in destruction of data or improper changes

to data, including the recording of unauthorized or non-existent transactions, orinaccurate recording of transactions. Particular risk may arise when multiple users access acommon database.

315.2

(3)The possibility of IT personnel gaining access beyond those necessary to perform theirassigned duties thereby breaking down segregation of duties.

(4)Unauthorised changes to data in Master files.(5)Unauthorised changes to systems or programs.(6)Failure to make necessary changes to systems or programs.(7)In appropriate manual intervention.

Question -3

Z Ltd. has its entire operations including accounting computerised. As the audit partner youare concerned about inherent and control risk for material financial statement assertions.What could be the areas you look forward for deficiencies and risk identification? (May 2010)

Answer

The auditor in accordance with SA 315 should make an assessment of inherent and control riskfor material financial statement assertions. In a CIS environment the risk of a Material financialstatement ascertain being erroneously stated could arise from the deficiencies in the followingcase as1. Program Development and maintenance.2. System software support.3. Operations including processing of data.4. Physical CIS security.5. Control over access to specialised utility program.These deficiencies would tend to have a negative impact on all application systems that areprocessed through the computer.

Question -3

Amu & Co. was appointed as auditor of Great India Ltd. As the audit partner what are thepoints to be considered while evaluating the "Knowledge of the Business" in the conduct of anaudit? (RTP)

Answer

The Broad matters to be considered while obtaining knowledge of business for a new auditassignment are set out in SA 315 Identifying and Assessing the Risks of Material Misstatementthrough Understanding the Entity and its environment.1. Relevant industry, regulatory, economic and other external factors including the applicablefinancial reporting framework2. The nature of the entity, including:(a) Its operations;(b) Its ownership and governance structures;(c) The types of investments that the entity is making and plans to make, including investmentsin special-purpose entities; and(d) The way that the entity is structured and how it is financed; to enable the auditor tounderstand the classes of transactions, account balances, and disclosures to be expected in thefinancial statements.3. The entity's selection and application of accounting policies.

315.3

4. The entity's objectives and strategies, and those related business risks that may result in risksof material misstatement.5. The measurement and review of the entity's financial performance.Question-4

Comments on the following:

While carrying out the statutory audit of a large entity, what are the substantive procedures tobe performed to assess the risk of material misstatement?" Nov 2012

Answer-

SA 315/330-The risk assessment procedure shall include the following:(i) Inquiries of management and of others within the entity who in the auditor's judgment may

have information that is likely to assist in identifying risks of material misstatement due tofraud or error.

(ii) Analytical procedures.(iii) Observation and inspection.

Question-5

Explain briefly the Flow Chart technique for evaluation of the Internal Control system

Answer

It is a diagrammatical representation of the process, risk and internal control. A graphicpresentation of internal control in the organisation and is normally drawn up to show thecontrols in each section or sub-section, it provides most concise and comprehensive way forreviewing the internal controls and the evaluator's findings, brings the e control structure in amost condensed and meaningful manner.

Question-6

"Surprise Checks" help the auditors to ascertain whether the internal control system isoperating effectively in a Company or not". Discuss.

Answer

SA 315 & SA 330 prescribes that the auditor should obtain an understanding of the accountingand internal control systems sufficient to plan the audit and develop an effective audit approach,in this context, surprise checks intend to ascertain whether the system of internal control isoperating effectively and whether the accounting and other records are prepared concurrentlyand kept up-to-date. Surprise checks are a useful method of determining whether or not errorsexist and where they exist, of bringing the matter promptly to the attention of the managementso that corrective action is taken immediately. Consequently, surprise visits by the auditor canexercise a good moral check on the client's staff.Therefore Surprise Checks help the auditors to ascertain whether the internal control system isoperating effectively in a Company or not

Question-7

315.4

M/s Sodhi& Associates have been appointed as the auditor of Raheja Ltd. Engaged in thebusiness of manufacturing and export of handloom goods. The partner of the firm explains tothe audit team that the formulation of audit strategy shall form the basis of audit planning toachieve the audit objectives in the most effective and efficient manner. As head of the auditteam, narrate the steps involved in the formulation of audit strategy. RTP Nov 2013

Answer

Audit strategy is concerned with designing optimised audit approaches that seeks to achieve thenecessary audit assurance at the lowest cost within the constraints of the information available.The formulation of audit strategy as shall be evident from the process as explained in thefollowing paragraphs in fact shall form the basis of audit planning to achieve the audit objectivesin the most efficient and effective manner. Audit strategy generally involves the following steps:a) Knowledge of Businessb) Performing analytical proceduresc) Evaluating Inherent riskd) Evaluating Internal Control

Question-8

The auditor of S limited has just commenced the statutory audit. What should beconsiderations for thee ffectiveness of a system of internal check? Nov 2013

Answer

Internal Check System - Internal check system implies organization of the overall system ofbook-keeping and arrangement of Staff duties in such a way that no one person can carrythrough a transaction and record every aspect thereof. It is a part of overall control system andoperates basically as a built-in-device as far as organization and job-allocation aspects of thecontrols are concerned.The general condition pertaining to the internal check system may be summarized as under -(1)No single person should have complete control over any important aspect of the business

operation. Every employee's action should come under the review of another person.(2)Staff duties should be rotated from time to time so that members do not perform the same

function for a considerable length of time.(3)Every member of the staff should be encouraged to go on leave at least once a year.(4)Persons having physical custody of assets must not be permitted to have access to the books

of accounts.(5)There should exist an accounting control in respect of each class of assets, in addition, there

should be periodical inspection so as to establish their physical condition.(6)Mechanical devices should be used, where ever practicable to prevent loss or

misappropriation of cash.(7)Budgetary control should be exercised and wide deviations observed should be reconciled.(8)For stock taking, at the close of the year, trading activities should, if possible be suspended,

and it should be done by staff belonging to several sections of the organization.(9)The financial and administrative powers should be distributed very judiciously among

different officers and the manner in which those are actually exercised should be reviewedperiodically.

315.5

(10) Procedures should be laid down for periodical verification and testing of different sectionsof accounting records to ensure that they are accurate

Question-9

Objectives of Internal Check System (May 2014)The following are the objectives of the internal check system:(i) To detect error and frauds with ease.(ii) To avoid and minimize the possibility of commission of errors and fraud by any staff.(iii) To increase the efficiency of the staff working within the organization.(iv) To locate the responsibility area or the stages where actual fraud and error occurs.(v) To protect the integrity of the business by ensuring that accounts are always subject toproper scrutiny and check.(vi) To prevent and avoid the misappropriation or embezzlement of cash and falsification ofaccounts.

Question 10

You are the auditor of Vishakha Steel Pressing Limited, which manufactures small pressingfrom sheet-steel. The process generates scrap steel which is placed daily by the work force intoa bin kept for that purpose in the yard. Every Friday a lorry arrives from a small local scrapmerchant. The bin is loaded on to the lorry and replaced by an empty bin. The weight isobtained by the gatekeeper using the company weighbridge. He notes the weight in a bookkept for that purpose in the gate office. Each month a cheque is received through the postfrom the scrap merchant accompanied by a remittance advice stating the weight of scrapcollected the price and the amount of the cheque. The cheque is banked by the cashier and theremittance advice is filed. There are no other procedures in this area: You are required to:(a) Suggest major improvements to be made in the internal control in this area.(b) Suggest key audit procedures under these circumstances to mitigate audit risk. RTP Nov2014

Answer

Improvements to be made in the internal control in this area:(i) Ensure that all scrap have been put into the bin by the work force. This can be achieved by

documenting the scrap generated in every production lot/shift/day.(ii)Check should be available, that the merchant is paying the best prices for the scrap. This can

be achieved by getting a quote periodically from few dealers or getting market price andvalidation.

(iii)Ensure that quantity collected is paid for this can be achieved by company quantity lifted withthe amount paid/quantity for which payment is received.

(iv)An independent official should attend the weighing and the enter in the book. Key auditprocedures under these circumstances to mitigate audit risk:

Key audit procedures under these circumstances to mitigate audit risk:(i) Budget figures should be prepared for waste and compared to actual waste and variance

being investigated.(ii)Compare remittance advices/related quantity and reconcile with the quantity in gate keeper's

book.

315.6

(iii) Ensure all entries in the weight book are paid for.(iv) Ensure all remittance matching entries in the cash book.(v)Review the reasonableness of total scarp sold during the period by comparing with

manufacturing records of steel used in processing.

Question-11

What are the roles and responsibilities of the Statutory Auditors in relation to compliance withthe Laws and Regulations by the Entity?

Answer

Considerations of Auditor for Assessing the Risk of Material Misstatement: As per SA 315“Identifying and Assessing the Risk of Material Misstatement through understanding the Entityand its Environment”,the auditor shall identify and assess the risks of material misstatement at the financial statementlevel; and the assertion level for classes of transactions, account balances, and disclosures toprovide a basis for designing and performing further audit procedures. For this purpose, theauditor shall:1) Identify risks throughout the process of obtaining an understanding of the entity and its

environment, including relevant controls that relate to the risks, and by considering theclasses of transactions, account balances, and disclosures in the financial statements;

2) Assess the identified risks, and evaluate whether they relate more pervasively to thefinancial statements as a whole and potentially affect many assertions; Relate the identifiedrisks to what can go wrong at the assertion level, taking account of relevant controls that theauditor intends to test; and

3) Consider the likelihood of misstatement, including the possibility of multiple misstatements,and whether the potential misstatement is of a magnitude that could result in a materialmisstatement.

Question 12

While commencing the statutory audit of Alex Co. Ltd., what would you consider as an auditorto assess risk of material misstatement and responses to such risks?

Answer

Considerations of Auditor for Assessing the Risk of Material Misstatement: As per SA 315“Identifying and Assessing the Risk of Material Misstatement through understanding the Entityand its Environment”, the auditor shall identify and assess the risks of material misstatement atthe financial statement level; and the assertion level for classes of transactions, accountbalances, and disclosures to provide a basis for designing and performing further auditprocedures. For this purpose, the auditor shall:(i) Identify risks throughout the process of obtaining an understanding of the entity and itsenvironment, including relevant controls that relate to the risks, and by considering the classesof transactions, account balances, and disclosures in the financial statements;(ii) Assess the identified risks, and evaluate whether they relate more pervasively to the financialstatements as a whole and potentially affect many assertions;(iii) Relate the identified risks to what can go wrong at the assertion level, taking account ofrelevant controls that the auditor intends to test; and

315.7

(iv) Consider the likelihood of misstatement, including the possibility of multiple misstatements,and whether the potential misstatement is of a magnitude that could result in a materialmisstatement.Auditor’s Responses to the Assessed Risk of Material Misstatement: According to SA 330 “TheAuditor’s Responses to Assessed Risks”, the auditor shall design and implement overallresponses to address the assessed risks of material misstatement. In designing the auditprocedures to be performed, the auditor shall:(i) Consider the reasons for the assessment given to the risk of material misstatement at theassertion level for each class of transactions, account balance, and disclosure, including:(1) The likelihood of material misstatement due to the particular characteristics of the relevantclass of transactions, account balance, or disclosure; and(2) Whether the risk assessment takes into account the relevant controls, thereby requiring theauditor to obtain audit evidence to determine whether the controls are operating effectively;and(ii) Obtain more persuasive audit evidence the higher the auditor’s assessment of risk.

320.1

SA 320 - MATERIALITY IN PLANNING & PERFORMING AN AUDIT

Question -1

Mr. X was appointed as the auditor of M/s Easygo Ltd. and intends to apply the concept ofmateriality for the financial statements as a whole. Please guide him as to the factors that mayaffect the identification of an appropriate benchmark for this purpose.

Answer

SA 320 “Materiality in Planning and Performing an Audit” prescribes the useofBenchmarks in Determining Materiality for the Financial Statements as a Whole.Factors that may affect the identification of an appropriate benchmark include the following:(i) The elements of the financial statements (for example, assets, liabilities, equity, revenue,

expenses);(ii) Whether there are items on which the attention of the users of the particular entity’s

financial statements tends to be focused (for example, for the purpose of evaluating financialperformance users may tend to focus on profit, revenue or net assets);

(iii) The nature of the entity, where the entity is at in its life cycle, and the industry and economicenvironment in which the entity operates;

(iv) The entity’s ownership structure and the way it is financed (for example, if an entity isfinanced solely by debt rather than equity, users may put more emphasis on assets, andclaims on them, than on the entity’s earnings); and

(v) The relative volatility of the benchmark.

Question -2

As an Auditor of RST Ltd, Mr. P applied the concept of materiality for the Financial Statementsas a whole. On the basis of obtaining additional information of significant contractualarrangements that draw attention to a particular aspect of a Company’s business, he wants tore–evaluate the Materiality Concept. Please guide him.

Answer

As per SA 320 “Materiality in Planning and Performing an Audit”, while establishing the overallaudit strategy, the auditor shall determine materiality for the financial statements a whole.

The auditor shall revise materiality for the financial statements in the event of becoming awareof information during the auditthat would have caused the auditor to have determined adifferent amount (or amounts) initially.If the auditor concludes a lower materiality for the same, then he should consider the fact thatwhether it is necessary to revise performance materiality and whether the nature, timing andextent of the further audit procedures remain appropriate.Thus, Mr. P can re-evaluate the materiality concepts after considering the necessity of suchrevision.

330.1

1

SA 330 - THE AUDITOR’S RESPONSE TO ASSESSED RISKS

Question -1

In the course of audit of Z Ltd, its auditor wants to rely on audit evidence obtained inprevious audit in respect of effectiveness of internal controls instead of retesting the sameduring the current audit. As an advisor to the auditor kindly caution him about the factors thatmay warrant a re-test of controls

Answer

(a)As per SA 330 on “The Auditor’s Responses to Assessed Risks”, changes may affect the relevanceof the audit evidence obtained in previous audits such that there may no longer be a basis forcontinued reliance.The auditor’s decision on whether to rely on audit evidence obtained in previous audits forcontrol is a matter of professional judgment. In addition, the length of time between retestingsuch controls is also a matter of professional judgment.Factors that may warrant a re-test of controls are-

(i) A deficient control environment.(ii) Deficient monitoring of controls.(iii) A significant manual element to the relevant controls.(iv) Personnel changes that significantly affect the application of the control.(v) Changing circumstances that indicate the need for changes in the control. (vi) Deficient general

IT-controls.

Question -2

While carrying out the statutory audit of a large entity, what are the substantive procedures to beperformed to assess the risk of material misstatement?

Answer

Substantive Procedures to be performed to assess the risk of material misstatement: As per SA 330,“The Auditor’s Response to Assessed Risk”, substantive procedure is an audit procedure designed todetect material misstatements at the assertion level. They comprise tests of details and substantiveanalytical procedures.Test of Details: The nature of the risk and assertion is relevant to the design of tests of details. Forexample, tests of details related to the existence or occurrence assertion may involve selectingfrom items contained in a financial statement amount and obtaining the relevant auditevidence. On the other hand, tests of details related to the completeness assertion mayinvolve selecting from items that are expected to be included in the relevant financial statementamount and investigating whether they are included.In designing tests of details, the extent of testing is ordinarily thought of in terms of the sample size.

330.2

2

Substantive Analytical Procedure: Substantive analytical procedures are generally more applicableto large volumes of transactions that tend to be predictable over time. The application ofplanned analytical procedures is based on the expectation that relationships among data exist andcontinue in the absence of known conditions to the contrary. However, the suitability of a particularanalytical procedure will depend upon the auditor’s assessment of how effective it will be indetecting a misstatement that, individually or when aggregated with other misstatements, maycause the financial statements to be materially misstated.In some cases, even an unsophisticated predictive model may be effective as an analyticalprocedure. For example, where an entity has a known number of employees at fixed rates of paythroughout the period, it may be possible for the auditor to use this data to estimate the totalpayroll costs for the period with a high degree of accuracy, thereby providing audit evidencefor a significant item in the financial statements and reducing the need to perform tests of detailson the payroll. The use of widely recognised trade ratios (such as profit margins for differenttypes of retail entities) can often be used effectively in substantive analytical procedures toprovide evidence to support the reasonableness of recorded amounts.Alternative Solution:SA 330 ‘The Auditor’s Responses to Assessed Risks’ requires the auditor to design and performsubstantive procedures for each material class of transactions, account balance, and disclosure,irrespective of the assessed risks of material misstatement.This requirement reflects the facts that: The auditor’s assessment of risk is judgmental and so may not identify all risks of material

misstatement; and; There are inherent limitations to internal control, including management override. Depending on

the circumstances, the auditor may determine that: Performing only substantive analytical procedures will be sufficient to reduce the audit risk to an

acceptably low level; Only tests of detail are appropriate; A combination of substantive analytical procedures and tests of details are most responsive

to the assessed risks. Based on the above, the auditor’s substantive procedures would include the following audit

procedures related to the financial statement closing process: Agreeing or reconciling the financial statements with the underlying accounting records and Examining material journal entries and other adjustments made during the course of

preparing the financial statements.

Question-3

Procedure in case detection risk cannot be reduced to acceptance levelOR"While commencing the statutory audit of B Company Limited, the auditor undertook the riskassessment and found that the detection risk relating to certain class of transactions cannot bereduced to acceptance level." (RTP)

330.3

3

Answer

(1)SA 315 and SA 330 prescribe the procedures to be followed to obtain an understanding of theaccounting and internal control systems and on audit risk and its components: inherent risk,control risk and detection risk.

(2)These standards require that the auditor should use professional judgement to assess audit riskand to design audit procedures to ensure that it is reduced to an acceptably low level.

(3)"Detection risk" is the risk that an auditor's substantive procedures will not detect amisstatement that exists in an account balance or class of transactions that could be material.

(4)The higher the assessment of inherent and control risks, the more audit evidence the auditorshould obtain from the performance of substantive procedures. /

(5)When both inherent and control risks are assessed as high, the auditor needs to considerwhether substantive procedures can provide sufficient appropriate audit evidence to reducedetection risk, and therefore audit risk, to an acceptably low level.

(6)The auditor should use his professional judgement to assess audit risk and to design auditprocedures to ensure that it is reduced to an acceptably low level. If it cannot be reduced to anacceptable level, the auditor should express a qualified opinion or a disclaimer of opinion as maybe appropriate.

Question-3

Factors that warrant a re-test of ControlORIn the course of audit of Z Ltd, its auditor wants to rely on audit evidence obtained in previousaudit in respect of effectiveness of internal controls instead of retesting the same during thecurrent audit. As an advisor to the auditor kindly caution him about the factors that may warranta re-test of controls (May 2013)

Answer

As per SA 330, Responses to assessed Risk, In determining whether it is appropriate to use auditevidence about the operating effectiveness of controls obtained in previous audits, and, if so, thelength of the time period that may elapse before retesting a control, the auditor shall consider thefollowing:(1)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(2)The risks arising from the characteristics of the control, including whether it is manual or

automated;(3)The effectiveness of general IT-controls;(4)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 havebeen personnel changes that significantly affect the application of the control.

(5)Whether the lack of a change in a particular control poses a risk due to changing circumstances;and

(6)The risks of material misstatement and the extent of reliance on the control.

402.1

SA 402 - AUDIT CONSIDERATIONS RELATING TO AN ENTITY USING A SERVICE ORGANISATION

Question -1

G Ltd. is a mobile phone operating company. Barring the marketing function it hadoutsourced the entire operations like maintenance of mobile infrastructure, customerbilling, payroll, accounting functions, etc. Assist the auditor of G Ltd. as to how he can obtainan understanding of how G Ltd. uses the services of the outsourced agency in its operations.

Answer

(a) As per SA 402 on “Audit Considerations Relating to an Entity Using a ServiceOrganisation”, when obtaining an understanding of the user entity in accordance with SA315 “Identifying and Assessing the Risks of Material Misstatement through Understandingthe Entity and its Environment”, the user auditor shall obtain an understanding of how a userentity uses the services of a service organisation in the user entity’s operations, including:

(i) The nature of the services provided by the service organisation and the significance of thoseservices to the user entity, including the effect thereof on the user entity’s internal control;

(ii) The nature and materiality of the transactions processed or accounts or financial reportingprocesses affected by the service organization;

(iii) The degree of interaction between the activities of the service organisation and those of theuser entity; and

(iv) The nature of the relationship between the user entity and the service organisation,including the relevant contractual terms for the activities undertaken by the serviceorganisation.

Question -2

A Company gets its accounting data processed by a third party to achieve cost reduction. As aStatutory Auditor of such a company, what are the additional precautions/checks that youwould consider for conduct of the audit?

Answer

Precaution to be taken by auditor in case accounting data processed by third party:Processing of accounting data may be given to a third party on account of variousconsiderations such as economy, own computer working to full capacity, an interim measuresrestricting accessibility to sensitive information, etc. A client may use a service organisationsuch as one that executes transactions and maintains related accountability or recordstransactions and processes related data (e.g., a computer systems service organisation). If aclient uses a service organisation, certain policies, procedures and records maintained by theservice organisation might be relevant to the audit of the financial statements of the client.

402.2

Consequently, the auditor would consider the nature and extent of activities undertaken byservice organisations so as to determine whether those activities are relevant to the audit and,if so, to assess their effect on audit risk.As per SA 402 “Audit Considerations relating to an Entity using a Service Organization”, whenobtaining an understanding of the user entity in accordance with SA 315, the user auditorshall obtain an understanding of how a user entity uses the services of a service organisationin the user entity’s operations, including:

(a) The nature of the services provided by the service organisation and the significance ofthose services to the user entity, including the effect thereof on the user entity’s internalcontrol;

(b) The nature and materiality of the transactions processed or accounts or financialreporting processes affected by the service organisation;

(c) The degree of interaction between the activities of the service organisation and those of theuser entity; and

(d) The nature of the relationship between the user entity and the service organisation,including the relevant contractual terms for the activities undertaken by the serviceorganisation.

Information on the nature of the services provided by a service organisation may be availablefrom a wide variety of sources, such as user manuals; system overviews; technical manuals; thecontract or service level agreement between the user entity and the service organisation;reports by service organisations, internal auditors or regulatory authorities on controls at theservice organisation; reports by the service auditor, including management letters, if available.

Question-3

In the course of the audit of R Ltd., the audit manager of ABC & Co. observed that R Ltd. hasoutsourced certain activities to an outsourcing agency. As the engagement partner guide theaudit manager in the assessment of services provided by the outsourcing agency in relation tothe audit. (RTP, May 2010, 2011)

Answer:

Obtaining an Understanding of the Services Provided by a Service Organisation, IncludingInternal Control.

Obtaining an understanding of the user entity in accordance with SA 315, the user auditorshall obtain an understanding of how a user entity uses the services of a service organisationin the user entity's operations, including:

1) The nature of the services provided by the service organisation and the significance of thoseservices to the user entity, including the effect thereof on the user entity's internal control;

2) The nature and materiality of the transactions processed or accounts or financial reportingprocesses affected by the service organisation;

402.3

3) The degree of interaction between the activities of the service organisation and those of theuser entity; and

4) The nature of the relationship between the user entity and the service organisation,including the relevant contractual terms for the activities undertaken by the serviceorganisation.

5) Information on the nature of the services provided by a service organisation may beavailable from a wide variety of sources, such as:

a. User manuals.b. System overviews.c. The contract or service level agreement between the user entity and the service

organisation.d. Reports by service organisations, internal auditors or regulatory authorities on controls at

the s organisation.e. Reports by the service auditor, including management letters, if available. Examples of

service organisation services that are relevant to the audit include:f. Maintenance of the user entity's accounting records & Management of assets.g. Initiating, recording or processing transactions as agent of the user entity.h. Technical manuals.

Question-4

G Ltd. is a mobile phone operating company. Barring the marketing function it hadoutsourced the entire operations maintenance of mobile infrastructure, customer billing,payroll, accounting functions, etc. Assist the auditor of G Ltd. as to how he can obtain anunderstanding of how G Ltd. uses the services of the outsourced agency in its operations.

Nov 2013, RTP Nov 2014

Answer:when obtaining an understanding of the user entity, the user auditor shall obtain anunderstanding of how a user entity uses the services of a service organisation in the userentity's operations, including:(1) The nature of the services provided by the service organisation and the significance of those

services to the user entity, including the effect thereof on the user entity's internal control.(2) The nature and materiality of the transactions processed or accounts or financial reporting

processes affected by the service organization.(3) The degree of interaction between the activities of the service organisation and those of the

user entity.(4) The nature of the relationship between the user entity and the service organisation.(5) Relevant contractual terms for the activities undertaken by the service organisation.(6) the user auditor shall evaluate the design and implementation of relevant controls at the

user(7) entity that relate to the services provided by the service organisation, including those that

are applied to the

402.4

(8) transactions processed by the service organization (h) the user auditor shall be Obtaining aType 1 or Type 2 report

(9) SA 450 Evaluation of Misstatements Identified objective of the auditor is to evaluate:(a) The effect of identified misstatements on the audit; and(b) The effect of uncorrected misstatements, if any, on the financial statements.

Question -5

When a Sub–Service Organization performs services for a Service Organization, there are twoalternative methods of presenting the description of controls. The Service Organizationdetermines which method will be used. As a User Auditor what information would you obtainabout controls at a Sub–Service Organization?(Nov-15)

Answer

If a service organisation uses a subservice organisation, the service auditor's report may eitherinclude or exclude the subservice organisation's relevant control objectives and related controlsin the service organisation's description of its system and in the scope of the service auditor'sengagement. These two methods of reporting are known as the inclusive method and thecarve-out method, respectively.

♦ If the Type 1 or Type 2 report excludes the controls at a subservice organisation, and theservices provided by the subservice organisation are relevant to the audit of the user entity'sfinancial statements, the user auditor is required to apply the requirements of this SA inrespect of the subservice organisation.

♦ The nature and extent of work to be performed by the user auditor regarding the servicesprovided by a subservice organisation depend on the nature and significance of those servicesto the user entity and the relevance of those services to the audit.

Question 6

In the course of audit of Raja and Rank Ltd., the audit manager of Sharma & Co. observed thatRaja and Rank Ltd. has outsourced certain activities to an outsourcing agency.(a) As the engagement partner, guide the audit manager in the assessment of services providedby the outsourcing agency in relation to the audit.(b) Discuss the procedure to be applied in case the user auditor is unable to obtain a sufficient

understanding from the user entity?

Answer

(a) As per SA 402 “Audit Considerations relating to an Entity Using a Service Organisation”, forobtaining understanding of the user entity in accordance with SA 315, the user auditor shallobtain an understanding of how a user entity uses the services of a service organization in theuser entity’s operation including:

402.5

(i) The nature of services provided by the service organisation and the significance of suchservices to the user entity, including its effect on the internal control of user entity.(ii) The nature and materiality of the transactions processed or accounts or financial reportingprocesses affected by the service organisation.(iii) The degree of interaction between the activities of the service organization and those ofuser entity and(iv) The nature of the relationship between the user entity and the service organizationincluding the relevant contractual terms for the activities undertaken by the serviceorganisation.When obtaining an understanding of internal control relevant to the audit in accordance withSA 315 “Identifying and Assessing the Risks of Material Misstatement through Understandingthe Entity and its Environment”, the user auditor shall evaluate the design and implementationof relevant controls at the user entity that relate to the services provided by the serviceorganisation, including those that are applied to the transactions processed by the serviceorganisation.(b) The user auditor shall determine whether a sufficient understanding of the nature andsignificance of the services provided by the service organisation and their effect on the userentity’s internal control relevant to the audit has been obtained to provide a basis for theidentification and assessment of risks of material misstatement.If the user auditor is unable to obtain a sufficient understanding from the user entity, the userauditor shall obtain that understanding from one or more of the following procedures:(i) Obtaining a Type 1 or Type 2 report, if available;(ii) Contacting the service organisation, through the user entity, to obtain specific information;(iii) Visiting the service organisation and performing procedures that will provide the necessaryinformation about the relevant controls at the service organisation; or(iv) Using another auditor to perform procedures that will provide the necessary information

about the relevant controls at the service organisation.

Question 6A company has outsourced its payroll accounting to another organization. Payroll constitutes45% of total expenditure. The auditor examines the printed reports received by the clientfrom the payroll company and test checks the calculation, which he finds to be in order.Based on this he concludes that a payroll expense is not materially misstated. Would this be aviolation of auditing standards?

AnswerYes, because SA-402 "Audit Considerations relating to an Entity using a Service Organization"

requires the auditor to perform the following audit proce-dures-♦ Obtaining an understanding of the services provided by a service organization♦ Understanding the control relating to services provided by the service organation.♦ Further procedures when a sufficient understanding cannot be obtained from the user entity♦ Responding to the assessed risks of material misstatement♦ Tests of controls♦ Fraud, non-compliance with laws and regulations and uncorrected misstatements in relation

to activities as the service organization

402.6

Merely checking the calculation of printed payroll report is not sufficient as per SA-402, theabove procedures has to follow for getting sufficient and appropriate audit evidence asregards service organization.

Question 6a company outsourced the activity of accounting data maintenance to the ServiceOrganisation to achieve cost reduction. As a Statutory Auditor of such company, what are theprecautions/checks that you would consider for conducting the audit?

450.1

SA 450 - EVALUATION OF MIS-STATEMENTS IDENTIFIED DURING THE AUDIT

Question-1

In audit plan for T Ltd, as the audit partner you want to highlight the sources ofmisstatements, arising from other than fraud, to your audit team and caution them.Identify the sources of misstatements.

Answer

According to SA 450 “Evaluation of Misstatements identified during the Audit”, the following arethe sources of misstatements arising from other than fraud -

(i) An inaccuracy in gathering or processing data from which the financial statements areprepared;

(ii) An omission of an amount or disclosure;(iii)An incorrect accounting estimate arising from overlooking, or clear misinterpretation of facts;

and(iv)Judgments of management concerning accounting estimates that the auditor considers

unreasonable or the selection and application of accounting policies that the auditorconsiders inappropriate.

Question-2

Discuss the impact of Uncorrected Misstatements identified during the audit and the Auditor’sresponse to the same.

Answer

Uncorrected Misstatements identified during the Audit: In accordance with SA 450“Evaluationof Misstatements identified during the Audit”, the auditor shall determinewhether uncorrectedmisstatements are material, individually or in aggregate.In making this determination, the auditor shall consider:

1. The size and nature of the misstatements, both in relation to particular classes oftransactions, account balances or disclosures and the financial statements as a whole, and theparticular circumstances of their occurrence; and

2. The effect of uncorrected misstatements related to prior periods on the relevant classes oftransactions, account balances or disclosures, and the financial statements as a whole.

The auditor shall communicate this with those charged with governanceuncorrectedmisstatements and the effect that they, individually or in aggregate, may have ontheopinion in the auditor’s report, unless prohibited by law or regulation.

Question-3

01. When reviewing an audit file you observe that the auditor test checked a sample of 5% ofsales and found errors of understatement aggregating to Rs. 24 lakhs. He got these corrected.Likewise, he had performed test checks for other areas too. Afterwards he gave a clean report on

450.2

the FS. On inquiry you find that he had not quantified any materiality for either engagement as awhole or any of the balances tested. Would this be violation of auditing standards?

Answer: Yes, it is violation of auditing standards SA-315 "Identifying and Assessing the Risk ofMaterial Misstatement through Understanding the Entity its Environment" requires an auditor toconsider materiality at both the overall financial information level and in relation to individualaccount balances and classes of transactions. SA- 450 "Evaluation of Misstatement Identifiedduring the Audit" further requires him to consider whether the effect of aggregate uncorrectedmisstatement on the financial statements is material. If he concludes that the aggregate ofuncorrected likely misstatement is material, he should express a qualified/adverse opinion as thecase may be.

Question-4

You are the audit manager of DPP & Co. and you are briefing your team on the approach toadopt in undertaking the review and finalisation stage of the audit. In particular, your auditsenior is unsure about the steps to take in relation to uncorrected misstatements.

Answer:

SA-450 Evaluation of Misstatements Identified During the Audit considers what a misstatementis and deals with the auditor's responsibility in relation to misstatements. It identifies amisstatement as being: A difference between the amount, classification, presentation, ordisclosure 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 financialreporting framework. Misstatements can arise from error or fraud. It also then definesuncorrected misstatements as: Misstatements that the auditor has accumulated during theaudit and that have not been corrected.There are three categories of misstatements:1. Factual misstatements are misstatements about which there is no doubt.2. Judgmental misstatements are differences arising from the judgments of management

concerning accounting estimates that the auditor considers unreasonable, or the selectionor application of accounting policies that the auditor considers inappropriate.

3. Projected misstatements are the auditor's best estimate of misstatements in populations,involving the projection of misstatements identified in audit samples to the entirepopulations from which the samples were drawn. The auditor has a responsibility toaccumulate misstatements which arise over the course of the audit unless they are verysmall amounts.

The auditor should determine whether uncorrected misstatements are material in aggregateor individually. All misstatements should be communicated to those charged withgovernance on a timely basis and request that they make necessary amendments. If thisrequest is refused then the auditor should consider the potential impact on their auditreport. A written representation should be requested from management to confirm thatunadjusted misstatements are immaterial.

500.1

SA 500 - AUDIT EVIDENCE

Question-1

Obtaining audit evidence in performing compliance and substantive procedures. Comment.

Answer

Obtaining Audit Evidence: As per SA 500 “Audit Evidence”, in performing compliance andsubstantive procedures, the auditor may obtain audit evidence by following methods-

Inspection • Examining records, documents or tangible assets.• Inspection involves examining records or documents, whether

internal or external, in paper form, electronic form, or othermedia.

• An example of inspection used as a test of controls is inspection ofrecords for evidence of authorisation.

• Inspection of tangible assets may provide reliable audit evidencewith respect to their existence, but not necessarily about theentity’s rights and obligations or the valuation of the assets.

Observation • Observation consists of witnessing a process or procedure beingperformed by others.

• For example, the auditor may observe the counting of inventoriesbeing performed by client’s personnel.

Inquiry andConfirmation

• “Inquiry” consists of seeking appropriate information fromknowledgeable persons inside or outside the entity.“Confirmation” consists of the response to an inquiry. Forexample, the auditor requests confirmation of receivables bydirect communication with debtors.

Recalculation • Recalculation consists of checking the mathematical accuracy ofdocuments or records. Recalculation may be performed manuallyor electronically.

AnalyticalProcedures

• Analytical Procedures refers to studying significant ratios andtrends and investigating unusual fluctuations.

Question-2

ENP Ltd. engaged an actuary to ascertain its employee cost, gratuity and leave encashmentliabilities. As an auditor of ENT LTD you would like to use the report of the actuary as an auditevidence. How would you evaluate the work of the actuary ?Answer-Evaluating the Work of Management’s Expert: As per SA 500 “Audit Evidence”, when informationto be used as audit evidence has been prepared using the work of a management’s expert, theauditor shall, to the extent necessary, having regard to the significance of that expert’s work forthe auditor’s purposes,-

500.2

(i) Evaluate the competence, capabilities and objectivity of that expert;(ii) Obtain an understanding of the work of that expert; and(iii) Evaluate the appropriateness of that expert’s work as audit evidence for the relevant

assertion.The auditor may obtain information regarding the competence, capabilities and objectivity ofa management’s expert from a variety of sources, such as personal experience with previouswork of that expert; discussions with that expert; discussions with others who are familiarwith that expert’s work; knowledge of that expert’s qualifications; published papers or bookswritten by that expert.Aspects of the management’s expert’s field relevant to the auditor’s understanding may includewhat assumptions and methods are used by the management’s expert, and whether they aregenerally accepted within that expert’s field and appropriate for financial reporting purposes.The auditor may also consider the following while evaluating the appropriateness of themanagement’s expert’s work as audit evidence for the relevant assertion:

(i) The relevance and reasonableness of that expert’s findings or conclusions, theirconsistency with other audit evidence, and whether they have been appropriatelyreflected in the financial statements;

(ii) If that expert’s work involves use of significant assumptions and methods, the relevanceand reasonableness of those assumptions and methods; and

(iii) If that expert’s work involves significant use of source data, the relevance, completeness,and accuracy of that source data.

Question-3

M/s LNK’s group gratuity scheme’s valuation by actuary shows wide variation compared to theprevious year’s figures. As a Statutory Auditor, how would you deal in this situation?

Answer

Using the Work of Management’s Expert: As per SA 500 “Audit Evidence”, when information tobe used as audit evidence has been prepared using the work of a management’s expert, theauditor shall, to the extent necessary, having regard to the significance of that expert’s work forthe auditor’s purposes,-(a) Evaluate the competence, capabilities and objectivity of that expert;(b) Obtain an understanding of the work of that expert; and(c) Evaluate the appropriateness of that expert’s work as audit evidence for the relevantassertion.The auditor may obtain information regarding the competence, capabilities and objectivity of amanagement’s expert from a variety of sources, such as personal experience with previous workof that expert; discussions with that expert; discussions with others who are familiar with thatexpert’s work; knowledge of that expert’s qualifications; published papers or books written bythat expert.Aspects of the management’s expert’s field relevant to the auditor’s understanding may includewhat assumptions and methods are used by the management’s expert, and whether they aregenerally accepted within that expert’s field and appropriate for financial reporting purposes.

500.3

The auditor may also consider the following while evaluating the appropriateness of themanagement’s expert’s work as audit evidence for the relevant assertion:(i) The relevance and reasonableness of that expert’s findings or conclusions, their consistencywith other audit evidence, and whether they have been appropriately reflected in the financialstatements;(ii) If that expert’s work involves use of significant assumptions and methods, the relevance andreasonableness of those assumptions and methods; and(iii) If that expert’s work involves significant use of source data, the relevance, completeness, andaccuracy of that source data.The auditor has to evaluate the work of an expert, say, actuary, before adopting the same.This becomes more crucial since M/s LNK’s group gratuity scheme’s valuation by actuary showswide variation compared to previous year figures. There is no doubt that relevance andreasonableness of assumptions and methods used are the responsibility of the expert, but theauditor has to determine whether they are appropriate based on the auditor’s knowledge of theclient’s business and result of his audit procedures.In the present case, the auditor must verify the reasonableness of assumptions made andmethods adopted by the actuary in the evaluation particularly with reference to factors such asrate of return on investments, retirement age, number and salary of employees, etc.Accordingly, the auditor has to satisfy himself whether valuation done by the actuary can beadopted, otherwise he may report on his findings for wide variation.

Question 4

The auditor of SS Ltd. accepted the gratuity liability valuation based on the certificate issued by aqualified actuary. However, the auditor noticed that the retirement age adopted is 65 years asagainst the existing retirement age of 60 years. The company is considering a proposal toincrease the retirement age. Comment.

Answer

Evaluating the Work of Management’s Expert: As per SA 500 “Audit Evidence”, wheninformation to be used as audit evidence has been prepared using the work of a management’sexpert, the auditor shall, to the extent necessary, having regard to the significance of thatexpert’s work for the auditor’s purposes, -(a) Evaluate the competence, capabilities and objectivity of that expert;(b) Obtain an understanding of the work of that expert; and(c) Evaluate the appropriateness of that expert’s work as audit evidence for the relevantassertion.The auditor may obtain information regarding the competence, capabilities and objectivity of amanagement’s expert from a variety of sources, such as personal experience with previous workof that expert; discussions with that expert; discussions with others who are familiar with thatexpert’s work; knowledge of that expert’s qualifications; published papers or books written bythat expert.Aspects of the management’s expert’s field relevant to the auditor’s understanding may includewhat assumptions and methods are used by the management’s expert, and whether they aregenerally accepted within that expert’s field and appropriate for financial reporting purposes.The auditor may also consider the following while evaluating the appropriateness of themanagement’s expert’s work as audit evidence for the relevant assertion:

500.4

(i) The relevance and reasonableness of that expert’s findings or conclusions, their consistencywith other audit evidence, and whether they have been appropriately reflected in the financialstatements;(ii) If that expert’s work involves use of significant assumptions and methods, the relevance andreasonableness of those assumptions and methods; and(iii) If that expert’s work involves significant use of source data, the relevance, completeness, andaccuracy of that source data.

Question 5

Y Ltd. engaged an actuary to ascertain its employee cost, gratuity and leave encashmentliabilities. As the auditor of Y Ltd., you would like to use the report of the actuary as an auditevidence. How do you evaluate the work of the actuary?

Answer

Evaluating the Work of Management’s Expert:As per SA 500 “Audit Evidence”, when information to be used as audit evidence has beenprepared using the work of a management’s expert, the auditor shall, to the extent necessary,having regard to the significance of that expert’s work for the auditor’s purposes,-(a) Evaluate the competence, capabilities and objectivity of that expert;(b) Obtain an understanding of the work of that expert; and(c) Evaluate the appropriateness of that expert’s work as audit evidence for the relevantassertion.The auditor may obtain information regarding the competence, capabilities and objectivity of amanagement’s expert from a variety of sources, such as personal experience with previous workof that expert; discussions with that expert; discussions with others who are familiar with thatexpert’s work; knowledge of that expert’s qualifications; published papers or books written bythat expert.Aspects of the management’s expert’s field relevant to the auditor’s understanding may includewhat assumptions and methods are used by the management’s expert, and whether they aregenerally accepted within that expert’s field and appropriate for financial reporting purposes.The auditor may also consider the following while evaluating the appropriateness of themanagement’s expert’s work as audit evidence for the relevant assertion:(i) The relevance and reasonableness of that expert’s findings or conclusions, their consistencywith other audit evidence, and whether they have been appropriately reflected in the financialstatements;(ii) If that expert’s work involves use of significant assumptions and methods, the relevance andreasonableness of those assumptions and methods; and(iii)If that expert’s work involves significant use of source data, the relevance, completeness, andaccuracy of that source data.

501.1

SA 501 - AUDIT EVIDENCE - SPECIFIC CONSIDERATIONS FOR SELECTED ITEMS

Question-1

Comment on the following:You are the auditor of Easy Communications Ltd. for the year 2013–14. The inventory as atthe end of the year i.e. 31.3.14 was Rs. 2.25 crores.Due to unavoidable circumstances, youcould not be present at the time of annual physical verification. Under the abovecircumstances how would you ensure that the physical verification conducted by themanagement was in order?

Answer

As per SA 501 “Audit Evidence – Additional Considerations for Specific Items”, the auditorshould perform audit procedures, designed to obtain sufficient appropriate audit evidenceduring his attendance at physical inventory counting.SA 501 is additionalguidance to thatcontained in SA 500, “Audit Evidence”, with respect to certain specific financial statementamounts and other disclosures.

General • Attendance at physical count• To Check Existence and condition• To compared with record

Inventory CountingConducted At Date OtherThan B/S Date

He shall perform additional procedure w.r.t. changes ininventory between count date & B/S date.

Auditor Unable To AttendInventory Count Due ToUnforeseen Circumstances

• He shall make some count on alternate date and performprocedures on intervening transactions.

d. Attendance At InventoryCount Is Impracticable

• He shall perform alternate procedures. If it is not possible,then modify the audit report.

Inventory Under Control Of AThird Party

• Confirmationfrom third party.• Obtaining service auditor’s report w.r.t. adequacy of

procedures of third party.• Attending / arranging another auditor to attend third party’s

counting procedure.• Inspecting documentation (Example - warehouse receipts).• Request confirmation from parties when inventory has been

pledged as collateral.

Question-2

The Auditor of PQR Pvt. Ltd having Turnover of ` 12 Crores, was not able to get theconfirmation about the existence and value of certain Stock. However, a certificate from theManagement has been obtained regarding the existence and value of the Stock at the yearend. The Auditor relied on the same and without any further procedure, signed the AuditReport. Is he right in his approach?

501.2

Answer

Validity of Written Representation:a) The physical verification of stock is the primaryresponsibility of the management.b) The auditor, however, is required to examine the verification programme adopted by the

management.c) He must satisfy himself about theexistence and valuation of stock.d) In the case of PQR Pvt. Ltd., the auditor has not beenable to verify the existence and value of

certain stock despite the verification procedurefollowed in routine audit.e) He accepted the certificate given to him by the managementwithout making any further

enquiry

He should evaluate whether such representations are reasonable and consistent with otherevidences and should consider whether individuals making such representations can beexpected to be well informed on the matter. “Written Representations” cannot be asubstitute for other audit evidence that the auditor could reasonably expect to be available.

If the auditor is unable to obtain sufficient appropriate audit evidence that he believes wouldbe available regarding a matter, which has or may have a material effect on the financialinformation, this will constitute a limitation on the scope of his examination even if he hasobtained a representation from management on the matter.

Therefore, the approach adopted by the auditor is not tenable.

Question-3

“If inventory is material to the financial statements, the auditor shall obtain sufficientappropriate audit evidence regarding the existence of inventory by attending the physicalinventory counting unless impracticable”. Discuss.

Answer

The auditor shall obtain sufficient appropriate audit evidence regarding the existence andcondition of inventory by attending the physical inventory counting, unless impracticable, to –(i) Evaluate management’s instructions and procedures for recording and controlling the results

of the entity’s physical inventory counting.(ii) Observe the performance of management’s count procedures.(iii) Inspect the inventory.(iv) Perform test counts.Inspecting inventory when attending physical inventory counting assists the auditor inascertaining the existence of the inventory (though not necessarily its ownership), and inidentifying, for example, obsolete, damaged or ageing inventory.

Question-4

LMN Ltd. supplies navy uniforms across the country. The company has 4 warehouses atdifferent locations throughout the India and 5 warehouses at the borders. The major stocksare generally supplied from the borders. LMN Ltd. appointed M/s OPQ & Co. to conduct itsaudit for the financial year 2014-15. Mr. O, partner of M/s OPQ & Co., attended all the physicalinventory counting conducted throughout the India but could not attend the same at bordersdue to some unavoidable reason.You are required to advise M/s OPQ & Co.,

501.3

(i)How sufficient appropriate audit evidence regarding the existence and condition ofinventory may be obtained?

(ii)How an `auditor is supposed to deal when attendance at physical inventory counting isimpracticable?

Answer

(i) Special Consideration with Regard to Inventory: As per SA 501 “Audit Evidence- SpecificConsiderations for Selected Items”, when inventory is material to the financial statements,the auditor shall obtain sufficient appropriate audit evidence regarding the existence andcondition of inventory by:

(a)Attendance at physical inventory counting, unless impracticable, to:(1)Evaluate management’s instructions and procedures for recording andcontrolling the results

of the entity’s physical inventory counting;(2) Observe the performance of management’s count procedures;(3) Inspect the inventory; an(4) Perform test counts; and(b) Performing audit procedures over the entity’s final inventory records todetermine whether

they accurately reflect actual inventory count results.(ii) Attendance at Physical Inventory Counting Not Practicable: In some cases,attendance at

physical inventory counting may be impracticable. This may be dueto factors such as thenature and location of the inventory, for example, whereinventory is held in a location thatmay pose threats to the safety of the auditor.The matter of general inconvenience to theauditor, however, is not sufficient tosupport a decision by the auditor that attendance isimpracticable. Further, asexplained in SA 200 “Overall Objectives of the Independent Auditorand theConduct of an Audit in Accordance with Standards on Auditing”, the matterofdifficulty, time, or cost involved is not in itself a valid basis for the auditor to omitan auditprocedure for which there is no alternative or to be satisfied with auditevidence that is lessthan persuasive.

Further, where attendance is impracticable, alternative audit procedures, forexample, inspectionof documentation of the subsequent sale of specific inventoryitems acquired or purchased priorto the physical inventory counting, may providesufficient appropriate audit evidence about theexistence and condition ofinventory.In some cases, though, it may not be possible to obtain sufficient appropriate auditevidenceregarding the existence and condition of inventory by performingalternative audit procedures.In such cases, SA 705 on Modifications to the opinion in the Independent Auditor’s Report,requires the auditor to modify theopinion in the auditor’s report as a result of the scopelimitation.

505.1

SA 505 - EXTERNAL CONFIRMATIONS

Question-1

The auditor of H Ltd. wanted to obtain confirmation from its trade payables.But themanagement made a request to the auditor not to seek confirmation from certain tradepayables citing disputes. Can the auditor of H Ltd. accede to this request?

Answer

SA 505, “External Confirmations”, establishes standards on the auditor’s use of externalconfirmation as a means of obtaining audit evidence. It requires that the auditor should employ external confirmation procedures in consultation

with the management. The auditor may come across certain situations in which the management may request him

not to seek external confirmation from certain parties because of dispute with the tradepayables, etc.

The management, for example, might make such a request on the grounds that due to adispute with the particular trade payable, the request for confirmation might aggravatethe sensitive negotiations between the entity and the trade payables.

(1) In such cases, when an auditor agrees to management’s request not to seek externalconfirmation regarding certain trade payables, the auditor should consider validity ofgrounds for such a request and assess management’s integrity and obtain evidence tosupport the same.

(2) The auditor should also ask the management to submit its request in a written form,detailing therein the reasons for such a request.

(3) If the auditor of H Ltd. agrees to management’s request not to seek external confirmationregarding a particular matter, the auditor should document the reasons for acceding tothe management’s request and should apply alternative procedures to obtain sufficientappropriate evidence regarding that matter.

While considering the validity of request, in case the auditor of H Ltd. reaches at aconclusion that the same was not valid, he may appropriately modify the report.

Question-2

During the course of audit of Star Limited the auditor received some of the confirmation ofthe balances of trade payables outstanding in the balance sheetthrough externalconfirmation by negative confirmation request. In the list of trade payables, there arenumber of trade payables of small balances except one, old outstanding of ` 15 Lacs, ofwhom, no confirmation on the credit balance received. Comment with respect to Standard ofAuditing.

505.2

Answer

External Confirmation: As per SA 505, “External Confirmation”, NegativeConfirmation is a request that the confirming partyrespond directly to the auditor only if the confirming partydisagrees with the information provided in the request.

Negative confirmations provide less persuasive auditevidence than positive confirmations.

Risk The failure to receive a response to a negativeconfirmation request does not explicitly indicate receipt bythe intended confirming party of the confirmation requestor verification of the accuracy of the informationcontained in the request.

Accordingly, a failure of a confirming party to respond to anegative confirmation request provides significantly lesspersuasive audit evidence than does a response to apositive confirmation request.

Confirming parties also may be more likely to respondindicating their disagreement with a confirmation requestwhen the information in the request is not in their favor,and less likely to respond otherwise.

Present Problem In the instant case, the auditor sent the negativeconfirmation requesting the trade payables havingoutstanding balances in the balance sheet while doingaudit of Star Limited.

One of the old outstanding of rupees 15 lacs has not sentthe confirmation on the credit balance.

In case of non response, the auditor may examinesubsequent cash disbursements or correspondence fromthird parties, and other records, such as goods receivednotes.

Further non response for negative confirmation requestdoes not means that there is some misstatement asnegative confirmation request itself is to respond tothe auditor only if the confirming party disagrees withthe information provided in the request.

Conclusion If the auditor identifies factors that give rise to doubts aboutthe reliability of the response to the confirmation request, heshall obtain further audit evidence to resolve those doubts.

505.3

Question-3

The accountant of C Ltd. has requested you, not to send balance confirmations to a particulargroup of trade receivables since the said balances are under dispute and the matter ispending in the Court. As a Statutory Auditor, how would you deal?

Answer

SA 505 “External Confirmations”, establishes standards on the auditor’s use of externalconfirmation as a means of obtaining audit evidence. If the management refuses to allow theauditor to a send a confirmation request, the auditor shall:a. Inquire as to Management’s reasons for the refusal, and seek audit evidence as to their

validity and reasonableness,b. Evaluate the implications of management’s refusal on the auditor’s assessment of the

relevant risks of material misstatement, including the risk of fraud, and on the nature, timingand extent of other audit procedures, and

c. Perform alternative audit procedures designed to obtain relevant and reliable auditevidence.

If the auditor concludes that management’s refusal to allow the auditor to send aconfirmation request is unreasonable or the auditor is unable to obtain relevant and reliableaudit evidence from alternative audit procedures, the auditor shall communicate with thosein charge of governance and also determine its implication for the audit and his opinion.

Question-4

Write short notes on Situations where external confirmations can be used.

Answer

Situations where external confirmations can be used:

(i) Bank balance from bankers(ii) Account receivable balances(iii) Inventories held by third parties(iv) Property title deeds held by third parties(v) Investments purchased but delivery not taken(vi) Loan from lenders(vii) Account payable balances(viii) Long outstanding share application money.

Question-5

Mr. Z who is appointed as auditor of Elite Co, Ltd. wants to use confirmation request as auditevidence during the course of audit. What are the factors to be considered by Mr. Z when

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designing a confirmation request ? Also slate the effects of using positive externalconfirmation request by Mr. Z,(May-16)

Answer(a) As per SA 505, “External Confirmation”, factors to be considered when designingconfirmation requests include:

(i) The assertions being addressed.(ii) Specific identified risks of material misstatement, including fraud risks.(iii) The layout and presentation of the confirmation request.(iv) Prior experience on the audit or similar engagements.(v) The method of communication (for example, in paper form, or by electronic or other

medium).(vi) Management’s authorisation or encouragement to the confirming parties to respond

to the auditor. Confirming parties may only be willing to respond to a confirmationrequest containing management’s authorisation.

(vii) The ability of the intended confirming party to confirm or provide the requestedinformation (for example, individual invoice amount versus total balance).

510.1

SA 510 - INITIAL AUDIT ENGAGEMENTS-OPENING BALANCES

Question-1

What are ‘Initial Audit Engagements’?

Answer

Initial Audit Engagement: As per SA 510 “Initial Audit Engagements - Opening Balances”, initialaudit 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.In an initial audit engagement the auditor will have to satisfy about the sufficiency andappropriateness of ‘Opening Balances’ to ensure that they are free from misstatements, whichmay materially affect the current financial statements. Lay down the audit procedure, you willfollow in cases:(i) When the financial statements are audited for the preceding period by another auditor; and(ii) When financial statements are audited for the first time.

(i) Financial Statements Audited by another Auditor– Audit Procedure:

Copies of the audited financial statements- If the prior period’s financial statements were audited by a predecessor auditor, the auditor

may be able to obtain sufficient appropriate audit evidence regarding the opening balances byperusing the copies of the audited financial statements including the other relevantdocuments relating to the prior period financial statements such as supporting schedules tothe audited financial statements.

Ordinarily, the current auditor can place reliance on the closing balances contained in thefinancial statements for the preceding period, except when during the performance of auditprocedures for the current period the possibility of misstatements in opening balances isindicated.

(ii)Audit of Financial Statements for the First Time – Audit Procedure:

When the audit of financial statements is being conducted for the first time, the auditor hasto perform auditing procedures to obtain sufficient appropriate audit evidence.

Since opening balances represent effect of transaction and events of the preceding period andaccounting policies applied in the preceding period, the auditor need to obtain evidencehaving regard to nature of opening balances, materiality of the opening balances andaccounting policies.

Since it will not be possible for auditor to perform certain procedures, e.g., observing physicalverification of inventories, etc. the auditor may obtain confirmation, etc. and perform suitableprocedures in respect of fixed assets, investments, etc. The auditor can also obtainmanagement representation with regards to the opening balances.

Question-2

Comment on the following:

510.2

You have been appointed as the audit of Good Health Ltd.for2013-14 which was audited byCA Trust worthy in 2012-13.As the Auditor of the company state the steps you would taketo ensure that the Closing Balances of 2012-13 have been brought to account in 2013-14 asOpening Balances and the Opening Balances do not contain misstatements.

Answer

As per SA510“Initial Audit Engagements—OpeningBalances”,in conducting an initial auditengagement,the objective of the auditor with respect to opening balancesis to obtainsufficient appropriate audit evidence about whether:

(i)Opening balances contain misstatements that materially affect the current period’sfinancial statements;and

(ii) Appropriate accounting policies reflected in the opening balances have been consistentlyapplied in the current period’s financial statements, or changes there to are properlyaccounted for and adequately presented and disclosed in accordance with the applicablefinancial reporting framework.

Being new assignment audit evidence regarding opening balances can be obtained byperusing the copies of the audited financial statements.

For current assets and liabilities some audit evidence can ordinarily be obtained as part ofaudit procedures during the current period. For example,the collection/payment of openingbalances of receivables and payables will provide audit evidence as to their existence, rightsand obligations,completeness and valuation at the beginning of the period.

In respect of other assets and liabilities such as fixed assets,investments long term debt,theauditor will examine the records relating to opening balances. The audit or may also be able toget confirmation from third parties(e.g., balances of long term loan obtained from banks).

Question-3

CA. Jack, a recently qualified practicing Chartered Accountant got his first audit assignment ofFutura (P) Ltd. for the financial year 2014-15. He obtained all the relevant appropriate auditevidence for the items related to Statement of Profit and Loss. However, while auditing theBalance Sheet items, CA. Jack left out obtaining appropriate audit evidence, say, confirmations,from the outstanding Accounts Receivable amounting ` 150 lakhs, continued as it is from the lastyear, on the affirmation of the management that there is no receipts and further credits duringthe year. CA. Jack, therefore, excluded from the audit programme, the audit of accountsreceivable on the understanding that it pertains to the preceding year which was already auditedby predecessor auditor. Comment.

Answer-

(a) Verification of Accounts Receivable: As per SA 510 “Initial Audit Engagements –Opening Balances”, while conducting an initial audit engagement, the objective of the auditorwith respect to opening balances is to obtain sufficient appropriate audit evidence aboutwhether-(i) Opening balances contain misstatements that materially affect the current period’s financialstatements; and(ii) Appropriate accounting policies reflected in the opening balances have been consistentlyapplied in the current period’s financial statements, or changes thereto are properly accounted

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for and adequately presented and disclosed in accordance with the applicable financial reportingframework.When the financial statements for the preceding period were audited by another auditor, thecurrent auditor may be able to obtain sufficient appropriate auditevidence regarding openingbalances by perusing the copies of the audited financial statements.Ordinarily, the current auditor can place reliance on the closing balances contained in thefinancial statements for the preceding period, except when during the performance of auditprocedures for the current period the possibility of misstatements in opening balances isindicated.For current assets and liabilities, some audit evidence about opening balances may be obtainedas part of the current period’s audit procedures, say, the collection of opening accountsreceivable during the current period will provide some audit evidence of their existence, rightsand obligations, completeness and valuation at the beginning of the period.

Thus, CA. Jack should have requested the management to provide written representation fortheir views and expressions; and he should also not exclude the audit procedure of closingbalances of Accounts Receivable from his audit programme. Consequently, CA. Jack shall alsobe held guilty for professional misconduct for not exercising due diligence, or grosslynegligence in the conduct of his professional duties as per the Code of Ethics.

Question-4CA. Ashutosh has been appointed as an auditor of Awesome Health Ltd. for the financial year2014-15 which was audited by CA. Amrawati in 2013-14. As the Auditor of Awesome HealthLtd., state the steps that CA. Ashutosh would take to ensure that the Closing Balances of thefinancial year 2013-14 have been brought to account in 2014-15 as Opening Balances and theOpening Balances do not contain any misstatements

Answer

Obtaining sufficient appropriate audit evidence while conducting Initial AuditEngagement :According to SA 510 on “Initial Audit Engagements- Opening Balances”,the objective of theAuditor while conducting an initial audit engagement with respect to opening balances is toobtain sufficient appropriate audit evidence so that the-(i) opening balances of the preceding period have been correctly brought forward to the

current period;(ii) opening balances do not contain any misstatement that materially affect thecurrent period’s

financial statements; and(iii) appropriate accounting policies reflected in the opening balances have beenconsistently

applied in the current period’s financial statements, or changesthereto are properlyaccounted for and adequately presented and disclosed inaccordance with the applicablefinancial reporting framework.

Being a new assignment, audit evidence regarding opening balances can be obtained by perusingthe copies of the audited financial statements.For current assets and liabilities, some audit evidence about opening balances may be obtainedas part of the current period’s audit procedures. For example, the collection/ payment ofopening accounts receivable/ accounts payable during the current period will provide someaudit evidence of their existence, rights and obligations, completeness and valuation at thebeginning of the period.

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In respect of other assets and liabilities such as property plant and equipment,investments,long term debts, the auditor will examine the records relating to opening balances. The auditormay also be able to get the confirmation from third parties (e.g., balances of long term loanobtained from banks can be confirmed from the Bank Loan statement).

Question-5

"In cases where audit sample selection has been done on a random basis, no statistical processfor selection of samples needs to be followed". Comment.Answer : Selection of Samples on random basis:

♦ As per SA 530 "Audit Sampling" sampling means application of audit procedures to lessthan 100% of items within a population of audit relevance such that all sampling unitshave a chance of selection in order to provide the auditor with a reasonable basis onwhich to draw conclusions about the entire population.♦ Statistical sampling is an approach to sampling that has the following characteristics:(i) Random selection of the sample items; and(ii) The use of probability theory to evaluate sample results, including measurement ofsampling risk.♦ Essential features of statistical sampling are random selection and use of probabilitytheory. Examples of Statistical sampling are Random selection, Systematic Selection andMonetary Unit Sampling.♦ Audit sample collection on a random basis ensures that all items within a populationhave an equal chance of selection by the use of random number tables or randomnumber generators. This method is considered appropriate provided the population to besampled consists of reasonably similar units and false within a reasonable range.

Conclusion : For application of statistical sampling techniques, one of the prerequisite isselection on random basis, hence in case of selection of an audit sample on random basis, noother statistical process for selection of samples need to be followed.

520.1

SA 520 - ANALYTICAL PROCEDURES

Question-1

The reliability of data is influenced by its source and nature and is dependent on thecircumstances under which it is obtained. Accordingly, what are the relevant criteria whichdetermine whether the data is reliable for the purposes of designing substantive analyticalprocedures?

Answer

Relevant Criteria for Determining Reliability of Data: SA 520 on ‘Analytical Procedures’ providesthat the reliability of data is influenced by its source and nature and is dependent on thecircumstances under which it is obtained.Accordingly, the following are relevant criteria when determining whether data is reliable forpurposes of designing substantive analytical procedures-1) Source of the information available. For example, information may be more reliable when it

is obtained from independent sources outside the entity;2) 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 specialisedproducts;

3) Nature and relevance of the information available. For example, whether budgets have beenestablished as results to be expected rather than as goals to be achieved; and

4) Controls over the preparation of the information that are designed to ensure itscompleteness, accuracy and validity. For example, controls over the preparation, review andmaintenance of budgets.

530.1

SA 530 - AUDIT SAMPLING

Question-1

Write short notes on the following:Sampling Risk

Answer

Sampling Risk: As per SA 530 “Audit Sampling”, the risk that the auditor’s conclusion based on asample may be different from the conclusion if the entire population were subjected to the sameaudit 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, orin the case of a test of details, that a material misstatement does not exist when in fact itdoes. The auditor is primarily concerned with this type of erroneous conclusion becauseit affects audit effectiveness and is more likely to lead to an inappropriate audit opinion.

(ii) In the case of a test of controls, that controls are less effective than they actually are, orin the case of a test of details, that a material misstatement exists when in fact it doesnot. This type of erroneous conclusion affects audit efficiency as it would usually lead toadditional work to establish that initial conclusions were incorrect.

Question-2

While planning the audit of S Ltd. you want to apply sampling techniques. What are the riskfactors you should keep in mind?

Answer

Risk Factors while applying sampling techniques: As per SA 530 “Audit Sampling”, sampling risk isthe risk that the auditor’s conclusion based on a sample may be different from the conclusion ifthe entire population were subjected to the same audit procedure. Sampling risk can lead to twotypes 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 affectsaudit 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 thecase of tests of details, that a material misstatements exists when in fact it does not. Thistype of erroneous conclusion affects audit efficiency as it would usually lead to additionalwork to establish that initial conclusions were incorrect.

540.1

SA 540-AUDITING ACCOUNTING ESTIMATES, INCLUDING FAIR VALUEACCOUNTING ESTIMATES, & RELATED DISCLOSURES

Question-1

While auditing Z Ltd., you observe certain material financial statement assertions have beenbased on estimates made by the management. As the auditor how do you minimize the risk ofmaterial misstatements?

Answer

As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, andRelated Disclosures”, the auditor shall obtain an understanding of the following in order toprovide a basis for the identification and assessment of the risks of material misstatements foraccounting estimates:(1)The requirements of the applicable financial reporting framework relevant to the accounting

estimates, including related disclosures.(2)How Management identifies those transactions, events and conditions that may give rise to

the need for accounting estimates to be recognised or disclosed, in the financialstatements. In obtaining this understanding, the auditor shall make inquiries ofmanagement about changes in circumstances that may give rise to new, or the need to reviseexisting, accounting estimates.

(3)The estimation making process adopted by the management including-a) The method, including where applicable the model, used in making the accounting

estimates.b) Relevant controls.c) Whether management has used an expert?d) The assumption underlying the accounting estimates.e) Whether there has been or ought to have been a change from the prior period in the methods

for making the accounting estimates, and if so, why; andf) Whether and, if so, how the management has assessed the effect of estimation uncertainty.

Question-2

With reference to the Standards on Auditing state the examples of accounting estimates thatmay have a high estimation uncertainty.

Answer

Examples of Accounting Estimates that may have a High Estimation Uncertainty: As per SA 540,“Auditing Accounting Estimates, Including Fair Value Accounting Estimates and RelatedDisclosures”, the auditor shall determine whether, in the auditor’s judgment, any of thoseaccounting estimates that have been identified as having high estimation uncertainty give rise tosignificant risks.Examples of accounting estimates that may have high estimation uncertainty include thefollowing:

540.2

• Accounting estimates that are highly dependent upon judgment, for example, judgmentsabout the outcome of pending litigation or the amount and timing of future cash flowsdependent on uncertain events many years in the future.• Accounting estimates that are not calculated using recognised measurement techniques.• Accounting estimates where the results of the auditor’s review of similar accounting estimatesmade in the prior period financial statements indicate a substantial difference between theoriginal accounting estimate and the actual outcome.• Fair value accounting estimates for which a highly specialised entity-developed model is usedor for which there are no observable inputs.

550.1

SA 550 - RELATED PARTIES

Question-1

Elaborate how the Statutory Auditor can verify the existence of related parties for the purposeof reporting under Accounting Standard 18.

Answer

Verification of Existence of Related Parties: As per SA 550 “Related Parties”, during the audit, theauditor shall remain alert, when inspecting records or documents, for arrangements or otherinformation that may indicate the existence of related party relationships or transactionsthat management has not previously identified or disclosed to the auditor. Example-(i)Entity Income Tax Returns.(ii)Information supplied by the entity to regulatory authorities.(iii)Shareholder registers to identify the entity’s principal shareholders.(iv)Statements of conflicts of interest from management and those charged with governance.(v)Records of the entity’s investments and those of its pension plans.(vi)Contracts and agreements with key management or those charged with governance.(vii)Significant contracts and agreements not in the entity’s ordinary course of business.(viii)Specific invoices and correspondence from the entity’s professional advisors.(ix)Life insurance policies acquired by the entity.(x)Significant contracts re-negotiated by the entity during the period. (xi) Internal auditors’

reports.(xii)Documents associated with the entity’s filings with a securities regulator (e.g.,

prospectuses). Arrangements that may indicate the existence of previously unidentified or undisclosed

related party relationships or transactions. In particular, the auditor shall inspect the following for indications of the existence of related

party relationships or transactions that management has not previously identified ordisclosed to the auditor:

(i)Bank, legal and third party confirmations obtained as part of the auditor’s procedures.(ii)Minutes of meetings of shareholders and of those charged with governance; and(iii)Such other records or documents as the auditor considers necessary in the

circumstances of the entity.

Question-2

In the course of audit of Q Ltd, its statutory auditor wants to be sure of the adequacy ofrelated party disclosures? Kindly guide the auditor in identifying the possible source of relatedparty information.

Answer

Identification ofpossible sourcesfor RelatedParties’

As per SA 550 on, “Related Parties”, the auditor should reviewinformation provided by the management of the entity identifying thenames of all known related parties.

However, it is the management, which is primarily responsible for

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information: identification of related parties. The duties of an auditor with regard to reporting of related party

transaction as required by Accounting Standard 18 “Related PartyDisclosures” is given in SA 550.

Auditor Work SA 550 requires that to identify names of all known related parties, The auditor may inspect records or documents that may provide

information about related party relationships and transactions. for example entity income tax returns, information supplied by the

entity to regulatory authorities, shareholder registers to identify theentity’s principal shareholders, statements of conflicts of interest frommanagement and those charged with governance, records of theentity’s investments and those of its pension plans, contracts andagreements with key management or those charged with governance,significant contracts and agreements not in the entity’s ordinary course ofbusiness, specific invoices and correspondence from the entity’sprofessional advisors, life insurance policies acquired by the entity,significant contracts re-negotiated by the entity during the period,internal auditors’ reports, documents associated with the entity’s filingswith a securities regulator (e.g., prospectuses).

Further Work Obtaining further information on significant transactionsoutside theentity’s normal course of business enables the auditor to evaluatewhether fraud risk factors.

Ifany, are present and, where the applicable financial reportingframework establishes related party requirements, to identify the risks ofmaterial misstatement.

In addition, the auditor needs to be alert for transactions which appearunusual in the circumstances and which may indicate the existence ofpreviously unidentified related parties.

Examples of transactions outside the entity’s normal course of businessmay include complex equity transactions, such as corporaterestructurings or acquisitions, transactions with offshore entities injurisdictions with weak corporate laws, the leasing of premises or therendering of management services by the entity to another party if noconsideration is exchanged, sales transactions with unusually largediscounts or returns, transactions with circular arrangements, forexample, sales with a commitment to repurchase, transactions undercontracts whose terms are changed before expiry etc.

WR Finally, the auditor should also obtain a written representation from themanagement concerning the completeness of information providedregarding the identification of related parties.

Question-3

JY & Co. is appointed as auditor of Breeze Ltd. JY & Co. seeks your guidance for reviewing therecords and documentation of the company regarding ‘related party transactions in thenormal course of business’. Describe the steps to be followed.

550.3

Answer

Review of Records and Documentation Regarding Related Party Transaction: According to SA550 “Related Parties”, during the audit, the auditor shall remain alert, when inspecting recordsor documents, for arrangements or other information that may indicate the existence of relatedparty relationships or transactions that management has not previously identified or disclosed tothe auditor.In particular, the auditor shall inspect the following for indications of the existence of relatedparty relationships or transactions that management has not previously identified or disclosed tothe auditor:(a) Bank, legal and third party confirmations obtained as part of the auditor’s procedures;(b) Minutes of meetings of shareholders and of those charged with governance; and(c) Such other records or documents as the auditor considers necessary in the circumstances of

the entity.

560.1

SA 560 - SUBSEQUENT EVENTS

Question-1

Briefly describe the auditor's responsibility regarding subsequent events.

Answer

Subsequent Events and Auditor's Responsibility: When the auditor draws up his audit plan,checking of subsequent events is an important audit procedure irrespective of the level of testchecks employed for checking of the transactions during the year. In fact more detailed check isnormally required for subsequent events to confirm certain assertions contained in the financialstatements, e.g., the payment made by debtors after the close of accounting period wouldconfirm that outstanding debtors on the date of the balance sheet date have been realised. SA560 on "Subsequent Events" establishes standards on the auditor's responsibility regardingsubsequent events. SA 560 on "Subsequent Events" states that the term "subsequent events"refers to events occurring between the date of the financial statements and the date ofthe auditor’s report, and facts that become known to the auditor after the date of the auditor’sreport.. AS 4 on " Contingencies and Events Occurring after the Balance Sheet Date" deals withall those significant events, both favourable and unfavourable, that occur between the balancesheet date and the date on which the financial statements are approved by the Board ofDirectors in the case of a company and by the corresponding approving authority in thecase of any other entity. As per AS 4, two types of events can be identified:(a) those whichprovide further evidence of conditions that existed at the balance sheet date; and (b) thosewhich are indicative of conditions that arose subsequent to the balance sheet date. SA 560lays down that the auditor should consider the effect of subsequent events on thefinancial statements and on the auditor's report. When the time between the close of the year-end and the adoption of accounts is about to take place, examination of subsequent eventsgains more importance.

Question-2

As a statutory auditor of a company, comment on the following:

(a) A fire broke out on 15th May, 2013, in which material worth ` 50 lakhs which was lying ininventory since 1st March, 2013 was totally destroyed. The financial statements of thecompany have not been adopted till the date of fire. The management of the companyargues that since the loss occurred in the year, 2013-14, no provision for the loss needs tobe made in the financial statements for 2012-13.

560.2

Answer

(a) Event occurring after the balance sheet date: This case requires attention to SA 560“Subsequent Events” and AS 4 “Contingencies and Events occurring after the BalanceSheet Date”.

AsperAS4“Contingencies and Events occurring after the Balance Sheet Date”,adjustments toassets and liabilities are required for events occurring after the balance sheet date that provideadditional information materially affecting the determination of the amounts relating toconditions existing at the balance sheet date or that indicate that the fundamental accountingassumption of going concern (i.e., the continuance of existence or substratum of theenterprise) is not appropriate.

AS 4 also requires disclosure of the non-adjusting event, in the report of the approvingauthority.Further, as per SA 560 “Subsequent Events”, the auditor should assure that all events occurringsubsequent to the date of the financial statements and for which the applicable financialreporting framework requires adjustment or disclosure have been adjusted or disclosed.The event took place after the close of the accounting year and does not relate toconditions existing at the balance sheet date. Thus, it will have no effect on itemsappearing at the balance sheet date because as per AS 4 “Contingencies and Events Occurringafter Balance Sheet Date” have to be adjusted that provide evidence of conditions existing as atthe balance sheet date. However, the auditor has to ensure that this loss will not materiallyaffect the substratum of the enterprises as per its size, nature and complexity of operations.Thus, subject to satisfaction in respect of non-violation of going concern concept, the companyhas correctly accounted by not providing provision. However, the auditor is required to ensurethe proper disclosure of abovementioned event.

Question-3

A Co. Ltd. has not included in the Balance Sheet as on 31-03-2014 a sum of ` 1.50 crores beingamount in the arrears of salaries and wages payable to the staff for the last 2 years as a resultof successful negotiations which were going on during the last 18 months andconcluded on 30-04-2014. The auditor wants to sign the said Balance Sheet and give the auditreport on 31-05-2014. The auditor came to know the result of the negotiations on 15-05-2014. Comment.

Answer

Subsequent Events: This case requires attention to SA 560 “Subsequent Events”,AS 4“Contingencies and Events occurring after the Balance Sheet Date” and AS 29 "Provisions,Contingent liabilities and Contingent Assets".As per AS 4 “Contingencies and Events occurring after the Balance Sheet Date”, adjustments toassets and liabilities are required for events occurring after the balance sheet date that provide

560.3

additional information materially affecting the determination of the amounts relating toconditions existing at the balance sheet date. Similarly as per AS 29 "Provisions, Contingentliabilities and Contingent Assets", future events that may affect the amount required to settlean obligation should be reflected in the amount of a provision where there is sufficientobjective evidence that the will occur.In the instant case, the amount of `1.50 crores is a material amount and it is the result of anevent, which has occurred after the Balance Sheet date. The facts have become known to theauditor before the date of issue of the Audit Report and Financial Statements.

The auditor has to perform the procedure to obtain sufficient, appropriate evidence coveringthe period from the date of the financial statements i.e. 31-3-2014 to the date of AuditorsReport ie.31-05-2014. It will be observed that as a result of long pending negotiations a sum of` 1.50 cores representing arrears of salaries of the year 2012-13 and 2013-14 have notbeenincluded in the financial statements. It is quite clear that the obligation requires provisionfor outstanding expenses as per AS 4 and AS 29.

As per SA 560 “Subsequent Events”, the auditor should assure that all events occurringsubsequent to the date of the financial statements and for which the applicable financialreporting framework requires adjustment or disclosure have been adjusted or disclosed.So the auditor should request the management to adjust the sum of ` 1.50 crores by makingprovision for expenses. If the management does not accept the request the auditor shouldqualify the audit report.SA 560 further requires that the auditor shall perform audit procedures designed to obtainsufficient appropriate audit evidence that all events occurring between the date of the financialstatements and the date of the auditor’s report that require adjustment of, or disclosure in, thefinancial statements have been identified. The auditor is not, however, expected to performadditional audit procedures on mattersto which previously applied audit procedures haveprovided satisfactory conclusions.

The auditor shall perform the procedures required above so that they cover the period fromthe date of the financial statements to the date of the auditor’s report, or as near aspracticable thereto. The auditor shall take into account the auditor’s risk assessment indetermining the nature and extent of such audit procedures, 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

whetherany subsequent events have occurred which mightaffect 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 statementsand inquiring about matters discussed at any such meetings for which minutes are not yetavailable.

(d) Reading the entity’s latest subsequent interim financial statements, if any.

When, as a result of the procedures performed above, the auditor identifies events that require

560.4

adjustment of, or disclosure in, the financial statements, the auditor shall determinewhether each such event is appropriately reflected in those financial statements.

Question -4

Briefly explain Audit procedures on subsequent events.

Answer

Audit Procedures on Subsequent Events: As per SA 560 “Subsequent Events”, events occurringbetween the dates of balance sheet and audit report and the facts that become known to theauditor after the date of the auditor’s report.The auditor shall perform audit procedures designed to obtain sufficient appropriate auditevidence that all events occurring between the date of the financial statements and the date ofthe auditor’s report that require adjustment of, or disclosure in, the financial statements havebeen identified. The auditor is not, however, expected to perform additional audit procedureson matters to which previously applied audit procedures have provided satisfactoryconclusions.The auditor shall perform the procedures required above so that they cover the period fromthe date of the financial statements to the date of the auditor’s report, or as near aspracticable thereto. The auditor shall take into account the auditor’s risk assessment indetermining the nature and extent of such audit procedures, 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 financialstatements.

(c) Reading minutes, if any, of the meetings, of the entity’s owners, management and thosecharged with governance, that have been held after the date of the financial statementsand inquiring about matters discussed at any such meetings for which minutes are not yetavailable.

(d) Reading the entity’s latest subsequent interim financial statements, if any.

When, as a result of the procedures performed as required the auditor identifies events thatrequire adjustment of, or disclosure in, the financial statements, the auditor shall determinewhether each such event is appropriately reflected in those financial statements.

570.1

SA 570 - GOING CONCERN

Question-1

While examining the going concern assumption of an entity, what important indicationsshould be evaluated and examined?Or write short notes on the following:Financial indications to be considered for evaluating the assumption of going concern

Answer

Evaluating Going Concern Assumption: SA 570 “Going Concern”, requires that while planning aperforming audit procedure and in evaluating the results thereof, the auditor should considerthe appropriateness of the going concern assumption underlying the preparation of the financialstatements. In assessing such a risk, the auditor should examine the following indications-Financial Indications Net liability or net current liability position. Fixed-term borrowings approaching maturity without realistic prospects of renewal or

repayment; or excessive reliance on short-term borrowings to finance long-term assets. Indications of withdrawal of financial support by trade payables. Negative operating cash flows indicated by historical or prospective financial statements. Adverse key financial ratios. Substantial operating losses or significant deterioration in the value of assets used to generate

cash flows.Operating IndicationsManagement intentions to liquidate the entity or to cease operations. Loss of key management without replacement. Loss of a major market, key customer(s), franchise, license, or principal supplier(s). Labour difficulties. Shortages of important supplies. Emergence of a highly successful competitor.

Question-2

ABC Company files a law suit against Unlucky Company for ` 5 crores. The Attorney ofUnlucky Company feels that the suit is without merit, so Unlucky Company merely disclosesthe existence of the law suit in the notes accompanying its financial statements. As an auditorof Unlucky Company, how will you deal with the situation?

Answer

(a) As per AS 29 "Provisions, Contingent liabilities and Contingent Assets", a contingentliability is a possible obligation that arises from past events and the existence of which will beconfirmed only by the occurrence or non-occurrence of one or more uncertain future events notwholly within the control of the enterprise.Further, future events that may affect the amount required to settle an obligation should bereflected in the amount of a provision where there is sufficient objective evidence that theevent will occur.

570.2

As per SA 570 “Going Concern”, there are certain examples of events or conditions that,individually or collectively, may cast significant doubt about the going concernassumption. Pending legal or regulatory proceedings against the entity that may, if successful,result in claims that the entity is unlikely to be able to satisfy is one of the example of suchevent.

When the auditor concludes that the use of the going concern assumption is appropriate inthe circumstances but a material uncertainty exists, the auditor shall determine whether thefinancial statements adequately describe the principal events or conditions that maycast significant doubt on the entity’s ability to continue as a going concern andmanagement’s plans to deal with these events or conditions; and disclose clearly that thereis a material uncertainty related to events or conditions that may cast significant doubton the entity’s ability to continue as a going concern and, therefore, that it may be unableto realize its assets and discharge its liabilities in the normal course of business.

In the instant case, ABC Company has filed a law suit against Unlucky Company for ` 5 crores.Though, the attorney of Unlucky Company feels that the suit is without merit so the companymerely discloses the existence of law suit in the notes accompanying its financial statements.But the auditor may evaluate the source data on which basis the opinion is formed. If theauditor finds the uncertainty, he may request the management to adjust the sum of ` 5 croreby making provision for expenses as per AS 29. If the management does not accept therequest the auditor should qualify the audit report.

Question-3

R & Co. is the statutory auditor of S Ltd. For the financial year ended on 31st March 2014, SLtd had disclosed in the notes (Note No. X) "The state pollution control board had ordered theclosure of the company's only manufacturing plant on the ground that it is environmentallydamaging, which the company had challenged in a law suit. Pending the outcome of the lawsuit the financial statements are prepared on a going concern basis". Further the financialstatements prepared by the management of S Ltd include financial statements of certainbranches which are audited by other auditors. What are the reporting responsibilities of R &Co.?

Answer(a) Reporting Responsibilities of Statutory Auditor: This question involves two broad aspect

with respect to reporting requirements i.e. (i) one which deals with Going Concern aspectwhere the company has gone for legal suit and (ii) other is work done by other auditors.As per facts of the case, the State Pollution Control Board has issued the closure order for SLtd., on account of environmental damaging by its only manufacturing plant. However,S Ltd had challenged the same by way of a law suit. Due to pendency of the outcome of thelegal suit, the company has prepared its financial statements on going concern basis.As per SA 570 “Going Concern”, under the going concern assumption, an entity is viewed ascontinuing in business for the foreseeable future. General purpose financial statements areprepared on a going concern basis, unless management either intends to liquidate the entityor to cease operations, or has no realistic alternative but to do so. Management’sassessment of the entity’s ability to continue as a going concern involves making ajudgment, at a particular point in time, about inherently uncertain future outcomes ofevents or conditions.

570.3

The auditor’s responsibility is to obtain sufficient appropriate audit evidence about theappropriateness of management’s use of the going concern assumption in thepreparation and presentation of the financial statements and to conclude whether there is amaterial uncertainty about the entity’s ability to continue as a going concern. For this the auditormay take the help of expert.As per SA 620, “Using the Work of an Auditor’s Expert”, if expertise in a field isnecessary to obtain sufficient appropriate audit evidence, he may determine to use the work ofan auditor’s expert. On the basis of expert’s opinion he may decide to rely or not on assessmentof management.As per SA 570 “Going Concern”, pending legal proceedings is a condition that, individually,may cast significant doubt about the going concern assumption. Existence of above conditionsignifies that a material uncertainty exists.Further, when the auditor concludes that the use of the going concern assumption is appropriatein the circumstances but a material uncertainty exists, the auditor shall determine whether thefinancial statements:(i) Adequately describe the principal events or conditions that may cast significant doubt

on the entity’s ability to continue as a going concern and management’s plans to deal withthese events or conditions; and

(ii) Disclose clearly that there is a material uncertainty related to events or conditions that maycast significant doubt on the entity’s ability to continue as a going concern and, therefore,that it may be unable to realise its assets and discharge its liabilities in the normal course ofbusiness.If adequate disclosure is made in the financial statements, the auditor shall express anunmodified opinion and include an Emphasis of Matter paragraph as per SA 706“Emphasis of matter paragraphs and other matter paragraphs in the IndependentAuditor’s Report”, in the auditor’s report to:

(a) Highlight the existence of a material uncertainty relating to the event or condition that maycast significant doubt on the entity’s ability to continue as a going concern; and

(b) Draw attention to the note in the financial statements that discloses the matters

In the present situation, management of S Ltd. had disclosed the above fact in the financialstatement. Further, use of the going concern assumption is appropriate but a materialuncertainty exists so assuming the assessment and disclosure of S Ltd. in order, R & Co. shouldinclude an Emphasis of Matter paragraph in the auditor’s report.Further, as per SA 600 “Using the work of Another Auditor”, when the principal auditor has tobase his opinion on the financial information of the entity as a whole relying uponthe statements and reports of the other auditors, his report should state clearly the

division of responsibility for the financial information of the entity by indicating the extent towhich the financial information of components audited by the other auditors have been includedin the financial information of the entity, e.g., the number of divisions/ branches/ subsidiaries orother components audited by other auditors.Note: Alternative answer is possible assuming that company is not going concern; hence auditorshould issue adverse report.

Question -4

A Company's net worth is eroded and trade payables are unpaid due to liquidityconstraints. The management represents to the statutory auditor that the promoter's wife is

570.4

expected to give an unsecured loan to meet the liquidity constraints and thatnegotiations are underway to secure large export orders.Answer

Going Concern Assumption: In this case, it is subjective, but prima-facie a mere expectation offuture cash flows from the promoter’s wife without any firm commitment and the possibility ofan export order being negotiated, may not that be sufficient appropriate audit evidence ofmitigating factors for resolving the going concerns question under SA 570 “Going Concern”.

Question-5

Yummy Ltd., dealing in manufacturing and trading of milk butter, has a benchmark in itsproduct for so many years. Tasty Ltd., a rival company to Yummy Ltd., has introduced its newproduct, peanut butter. Due to being health conscious, the consumers have shifted from milkbutter to peanut butter within few months. This has result into massive loss during the year toYummy Ltd. due to non-selling of perishable milk products. The company has also startedhaving negative net worth. It's production head, finance head and marketing head have alsoleft the company.The company has no sound action plan to mitigate these situations. Kindly guide the auditor ofYummy Ltd., how he should deal with the situation.

Answer

Inability to Continue as a Going Concern: As per SA 570 on “Going Concern”, it is theresponsibility of the Auditor to obtain sufficient appropriate audit evidence about theappropriateness of management’s use of the going concern assumption in the preparation andpresentation of the financial statements and to conclude whether there is a material uncertaintyabout the entity’s ability to continue as a going concern. The auditor shall evaluatemanagement’s assessment of the entity’s ability to continue as a going concern. In evaluatingmanagement’s assessment, the auditor shall consider whether management’s assessmentincludes all relevant information of which the auditor is aware as a result of the audit.

In the instant case, Yummy Ltd. has suffered massive loss due to introduction of a substitute ofits product by its rival company, Tasty Ltd., and having negative net worth also. Besides this, itsproduction head, finance head and marketing head have also left the company. The company, inaddition, has no action plan to mitigate these situations. Thus there are clear indications thatthere is danger to entity’s ability to continue in future. Considering the fact that there is nosound plan of action from the management to mitigate these factors and to put the companyback on the recovery, the going concern assumption does not hold appropriate.Therefore, the auditor should ask the management for its adequate disclosure in the financialstatement and include the same in his report. However, if the management fails to makeadequate disclosure, the auditor should express a qualified or adverse opinion.

Question-6

Mr. Ram, an auditor, identified some events that cast significant doubt on the entity’s abilityto continue as a going concern. What are the additional procedures he should perform as perthe related Standard on Auditing?

570.5

Answer

Additional Audit Procedures When Events or Conditions Are Identified: As per SA 570 “GoingConcern”, when events or conditions have been identified that may cast significant doubt on theentity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriateaudit evidence to determine whether or not a material uncertainty exists through performingadditional audit procedures, including consideration of mitigating factors. These procedures shallinclude:(i) When management has not yet performed an assessment of the entity’s ability to continue asa going concern, requesting management to make its assessment.(ii) Evaluating management’s plans for future actions in relation to its going concern assessment,whether the outcome of these plans is likely to improve the situation and whethermanagement’s plans are feasible in the circumstances.(iii) When the entity has prepared a cash flow forecast, and analysis of the forecast is asignificant factor in considering the future outcome of events or conditions in the evaluation ofmanagement’s plans for future action:

(1) Evaluating the reliability of the underlying data generated to prepare the forecast; and(2) Determining whether there is adequate support for the assumptions underlying the

forecast.(iv) Considering whether any additional facts or information have become available since thedate on which management made its assessment.(v) Requesting written representations from management and, where appropriate, thosecharged with governance, regarding their plans for future action and the feasibility of theseplans.

580.1

SA 580 - WRITTEN REPRESENTATIONS

Question-1

An auditor of Sagar Ltd. was not able to get the confirmation about the existence and value ofcertain machineries. However, the management gave him a certificate to prove the existenceand value of the machinery as appearing in the books of account. The auditor accepted thesame without any further procedure and signed the audit report. Is he right in his approach?

Answer

Validity of Management Representation: The physical verification of fixed assets is the primaryresponsibility of the management. The auditor, however, is required to examine the verificationprogramme adopted by the management. He must satisfy himself about the existence, ownership and valuation of fixed assets. In the case of Sagar Ltd., the auditor has not been able to verify the existence and value of

some machinery despite the verification procedure followed in routine audit. He accepted the certificate given to him by the management without making any further

enquiry. As per SA 580, when representation relate to matters which are material to the financial

information, then the auditor should seek corroborative audit evidence for other sourcesinside or outside the entity.

He should evaluate whether such representations are reasonable and consistent with otherevidences and should consider whether individuals making such representations can beexpected to be well informed on the matter.

“Written Representations” cannot be a substitute for other audit evidence that the auditorcould reasonably expect to be available. If the auditor is unable to obtain sufficientappropriate audit evidence that he believes would be available regarding a matter which hasor may have a material effect on the financial information, this will constitute a limitation onthe scope of his examination even if he has obtained a representation from management onthe matter. Therefore, the approach adopted by the auditor is not right.

Question-2

Explain what is meant by “Written Representations” and indicate to what extent an auditorcan place reliance on such representations.

Answer

Written Representation A written statement by management provided to the auditorto confirm certain matters or to support other audit evidence.Written representations in this context do not include financialstatements, the assertions therein, or supporting books andrecords.

Why Necessary Audit evidence is all the information used by the auditor inarriving at the conclusions on which the audit opinion is based.

Thus written representations are necessary information that theauditor requires in connection with the audit of the entity’s

580.2

financial statements. Accordingly, similar to responses toinquiries, written representations are audit evidence.

Although written representations provide necessary auditevidence, they do not provide sufficient appropriate auditevidence on their own about any of the matters with which theydeal.

Furthermore, the fact that management has provided reliablewritten representations does not affect the nature or extent ofother audit evidencethat the auditor obtains about thefulfillment of management’s responsibilities, or about specificassertions.

Steps The auditor shall request management to provide a writtenrepresentation that it has fulfilled its responsibility for thepreparation of the financial statements in accordance withthe applicable financial reporting framework, including whererelevant their fair presentation, as set out in the terms of theaudit engagement.

Other SAs require the auditor to request writtenrepresentations. If, in addition to such required representations,the auditor determines that it is necessary to obtain one or morewritten representations to support other audit evidence relevanttothe financial statements or one or more specific assertions inthe financialstatements, the auditor shall request such otherwrittenrepresentations.Thedate ofthe written representationsshall be asnear as practicable to, but not after, the date of theauditor’s report on the financial statements. The writtenrepresentations shall be for all financial statements andperiod(s)referred to in the auditor’s report.

Thewritten representations shall be in the form of arepresentation letter addressed to the auditor. If law orregulationrequires managementto make written publicstatements about its responsibilities, and the auditor determinesthat such statements provide some or all of the representations,the relevant matters covered by such statements need not beincluded in the representation letter.

Conclusion In particular, if written representations are inconsistent withother audit evidence, the auditor shallperform audit proceduresto attempt to resolve the matter.

If the matter remains unresolved, the auditor shall reconsiderthe assessment of the competence, integrity, ethical values ordiligence of management, or of its commitment to orenforcement of these, and shall determine the effect that thismay have on the reliability of representations (oral or written)and audit evidence in general.

If the auditor concludes that the written representations are notreliable, the auditor shall take appropriate actions, includingdetermining the possible effect on the opinion in the auditor’sreport.

580.3

Question-3

State briefly the basic elements of Management Representation Letter.

Answer

Basic Elements of a Management Representation Letter: As per SA 580“WrittenRepresentations”, some of the basic elements of a Management Representation letterare-

(1) It is a written statement by management provided to the auditor to confirm certainmatters or to support other audit evidence.

(2) It does not include financial statements, the assertions therein, or supporting books andrecords.

(3) The auditor shall request management to provide a written representation that it hasfulfilled its responsibility for the preparation of the financial statements in accordance withthe applicable financial reporting framework, including where relevant their fairpresentation, as set out in the terms of the audit engagement.

(4) The written representations shall be for all financial statements and period(s) referred to inthe auditor’s report.

Question -4

(a) In the course of audit of ABC Ltd. its management refuses to provide writtenrepresentations. As an auditor what is your duty?

Answer

(a) Duty of an Auditor if management refuses to provide written representations: As per SA 580“Written Representations”, if the management does not provide one or more of therequested written representations, the auditor shall:

(i) Discuss the matter with management,(ii) Re-evaluate the Integrity of the management and evaluate the effect that this may have on

the reliability of representations (oral or written) and audit evidence in general, and(iii)Take appropriate actions, including determining the possible effect on the opinion in the

auditor’s report.

The auditor should disclaim an opinion on the financial statements if management does notprovide written representations in accordance with SA 705 “Modifications to the Opinionin the Independent Auditor’s Report”.

600.1

SA 600 - USING THE WORK OF ANOTHER AUDITOR

Question-1

“There should be sufficient liaison between a principal auditor and other auditors”. Discuss theabove statement and state in this context the reporting considerations, when the auditor usesthe work performed by other auditor.

Answer

SA 600 on “Using the Work of Another Auditor” lays down the procedure to be applied insituations where a principal auditor reporting on the financial statement of the entity uses thework of another independent auditor:- SA 600 contemplates coordination between auditors and requires that there should be

sufficient liaison between the principal auditor and the other auditor. For this purpose, the principal auditor may find it necessary to issue written

communication(s) to the other auditor. The other auditor, knowing the context in which his work is to be used by the principal

auditor, should co-ordinate with the principal auditor. For example, by bringing to theprincipal auditor’s immediate attention any significant findings requiring to be dealt with atentity level, adhering to the time-table for audit of the component etc.

He should ensure compliance with the relevant statutory requirements. Similarly, theprincipal auditor should advise the other auditor of any matters that come to his attentionthat he thinks may have an important bearing on the other auditor’s work.

When considered necessary by him, the principal auditor may require the other auditor toanswer a detailed questionnaire regarding matters on which the principal auditor requiresinformation for discharging his duties. The other auditor should respond to suchquestionnaire on a timely basis.

When the principal auditor concludes, based on his procedures, that the work of the otherauditor cannot be used and the principal auditor has not been able to performsufficient additional procedures regarding the financial information of the componentaudited by the other auditor, the principal auditor should express a qualified opinion ordisclaimer of opinion because there is a limitation on the scope of audit.

In all circumstances, if the other auditor issues, or intends to issue, a modified auditor's report,the principal auditor should consider whether the subject of the modification is of such natureand significance, in relation to the financial information of the entity on which the principalauditor is reporting that it requires a modification of the principal auditor's report.

Question-2

Describe the relevance of SA 600 while auditing consolidation of Financial Statements.

Answer

The principal auditor, if he decides to use the work of another auditor in relation to the audit ofconsolidated financial statements, should comply with the requirements of SA 600.

600.2

While complying with the requirements of SA 600, ‘Using the Work of Another Auditor’, theprincipal auditor should keep the following under consideration:(i) When planning to use the work of another auditor, the principal auditor should consider the

professional competence of the other auditor in the context of specific assignment if theother auditor is not a member of the Institute of Chartered Accountants of India.

(ii) The principal auditor should perform procedures to obtain sufficient appropriate auditevidence, that the work of the other auditor is adequate for the principal auditor'spurposes, in the context of the specific assignment. When using the work of another auditor,the principal auditor should advise the other auditor of the:a) Information/assurance required by the other auditor; this emanates/precludes the

principal auditor’s determination of how the work of the other auditor would affect theaudit of consolidated financial statements, for example, the information required fromthe auditor of a subsidiary would be different from that required from the auditor of ajoint venture;

b) Use that is to be made of the other auditor's work and report and make sufficientarrangements for co-ordination of their efforts at the planning stage of the audit; and

c) Significant accounting, auditing and reporting requirements and obtain representation asto compliance with them.

Question-3

B Ltd is the Subsidiary company of A Ltd. ABC & Associates has been appointed as auditor of ALtd. for the Financial Year 2014-15 and XYZ & Associates has been appointed as auditor of BLtd for the year 2014-15. Explain the role of ABC & Associates and XYZ & Associates as auditorsof the parent company and subsidiary respectively.

Answer

Role of Auditor in case of Parent Company and Subsidiary Company: As per SA 600 “Using theWork of Another Auditor”, there should be sufficient liaison between the principal auditor(hereinafter referred as auditor of Parent Company and the other auditor (hereinafter referredas auditor of Subsidiary Company).Role of Principal Auditor (ABC & Associates- Auditor of Parent Company):(i) It is necessary to issue written communication(s) as a principal auditor to the other auditor.(ii) The principal auditor should advise the other auditor of any matters that come to hisattention that he thinks may have an important bearing on the other auditor’s work.(iii) When considered necessary by him, the principal auditor may require the other auditor toanswer a detailed questionnaire regarding matters on which the principal auditor requiresinformation for discharging his duties.Role of Other Auditor (XYZ & Associates- Auditor of Subsidiary Company):(i) The other auditor, knowing the context in which his work is to be used by the principalauditor, should co-ordinate with the principal auditor. For example, by bringing to the principalauditor’s immediate attention any significant findings requiring to be dealt with at entity level,adhering to the time-table for audit of the component, etc.(ii) He should ensure compliance with the relevant statutory requirements.(iii) The other auditor should respond to the questionnaire on a timely basis sent by Principal

Auditor.

610.1

SA 610 - USING THE WORK OF INTERNAL AUDITORS

Question-1

In the course of the statutory audit of Z Ltd, its statutory auditors, having determined that thework of internal auditor is likely to be adequate for the purpose of statutory audit, wanted touse the work of internal auditor in respect of physical verification of fixed assets. How anevaluation of this specific work done by the internal auditor can be done?(Nov-15)

Answer

Evaluation of Specific Work Done by Internal Auditor: The statutory auditor should as a part ofhis audit, carryout general evaluation of the internal audit function to determine the extent towhich he can place reliance upon the work of the internal auditor. As per SA 610 “Using the Work of Internal Auditors”, the nature, timing and extent of the

audit procedures performed on specific work of the internal auditors will depend on theexternal auditor’s assessment of the risk of material misstatement, the evaluation of theinternal audit function, and the evaluation of the specific work of the internal auditors.

Such audit procedures may include examination of items already examined by theinternal auditors, examination of other similar items; and observation of proceduresperformed by the internal auditors.

Further, to determine the adequacy of specific work performed by the internal auditors forthe external auditor’s purposes, the external auditor shall evaluate whether:

(1) The work was performed by internal auditors having adequate technical training andproficiency;

(2) The work was properly supervised, reviewed and documented;(3) Adequate audit evidence has been obtained to enable the internal auditors to draw

reasonable conclusions;(4) Conclusions reached are appropriate in the circumstances and any reports prepared by the

internal auditors are consistent with the results of the work performed; and(5) Any exceptions or unusual matters disclosed by the internal auditors are properly resolved.

Question-2

CA. Amboj, a practicing chartered accountant has been appointed as an internal auditorofTextile Ltd. He conducted the physical verification of the inventory at the year-endand handedover the report of such verification to CA. Kishor, the statutory auditor ofthe Company, for hisview and reporting. Can CA. Kishor rely on such report?

Answer

Using the Work of Internal Auditor: As per SA 610 “Using the Work of InternalAuditors”, whiledetermining whether the work of the internal auditors is likely to beadequate for the purposeof the audit, the external auditor shall evaluate-(1) The objectivity of the internal audit function;(2) Technical competence of the internal auditors;(3) Whether the work of the internal auditors is likely to be carried out with dueprofessional

care; and

610.2

(4) Whether there is likely to be effective communication between the internal auditorsand theexternal auditor.

The external auditor shall evaluate whether the internal auditors have adequate technicaltraining and proficiency; work was properly supervised, reviewed and documented; anyreports prepared are consistent with the results of the work performed etc.

In the instant case, CA. Kishor should ascertain the internal auditor’s scope of verification,area of coverage and method of verification. He should review the report on physicalverification taking into consideration these factors. If possible he should also test check fewitems and he can also observe the procedures performed by the internal auditors.

If the statutory auditor is satisfied about the appropriateness of the verification, he can relyon the report but if he finds that the verification is not in order, he has to decide otherwise.The final responsibility to express opinion on the financial statement remains with thestatutory auditor.

620.1

SA 620 - USING THE WORK OF AN EXPERT

Question-1

While doing audit, Ram, the Auditor requires reports from experts for the purpose of Auditevidence. What types of reports/opinions he can obtain and to what extent he can rely uponthe same?Answer

Using the Work of an Auditor’s Expert: As per SA 620, “Using the Work of an Auditor’s Expert”,during the audit, the auditor may seek to obtain, in conjunction with the client or independently,audit evidence in the form of reports, opinions, valuations and statements of an expert.While doing audit, Ram, the auditor can obtain the following types of reports, or options orstatements of an expert for the purpose of audit evidence:(i) The valuation of complex financial instruments, land and buildings, plant and machinery,

jewelry, works of art, antiques, intangible assets, assets acquired and liabilities assumed inbusiness combinations and assets that may have been impaired.

(ii) The actuarial calculation of liabilities associated with insurance contracts or employeebenefit plans.

(iii) The estimation of oil and gas reserves.(iv) The valuation of environmental liabilities, and site clean-up costs.(v) The interpretation of contracts, laws and regulations.(vi) The analysis of complex or unusual tax compliance issues.

When the auditor intends to use the work of an expert, he shall evaluate the adequacy of theauditor’s expert’s work, including the relevance and reasonableness of that expert’s findings orconclusions, and their consistency with other audit evidence; if that expert’s work involves use ofsignificant assumptions and methods, the relevance and reasonableness of those assumptionsand methods in the circumstances; and if that expert’s work involves the use of source data thatis significant to his work, the relevance, completeness, and accuracy of that source data.If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’spurposes, he shall agree with that expert on the nature and extent of further work to beperformed by that expert; or perform further audit procedures appropriate to thecircumstances.

Question-2Mr. Mohan, an auditor of KTEN Limited wants to use the work of an expert. With reference tothe Standard on Auditing, state the factors which suggest the need for detailed and writtenagreement between the auditor and the auditor’s expert.AnswerAs per SA 620, “Using the work of an Auditor’s Expert”, some of the matters may affect thelevel of detail and formality of the agreement between the auditor and the auditor’s expert,including whether it is appropriate that the agreement be in writing. For example, the followingfactors may suggest the need for more a detailed agreement than would otherwise be the case,or for the agreement to be set out in writing:• The auditor’s expert will have access to sensitive or confidential entity information.• The respective roles or responsibilities of the auditor and the auditor’s expert are differentfrom those normally expected.

620.2

• Multi-jurisdictional legal or regulatory requirements apply.• The matter to which the auditor’s expert’s work relates is highly complex.• The auditor has not previously used work performed by that expert.• The greater the extent of the auditor’s expert’s work, and its significance in the context of theaudit.

Question-3Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on,found faulty.

AnswerUsing the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”,the expertise of an expert may be required in the actuarial calculation of liabilities associatedwith insurance contracts or employee benefitplans etc., however, the auditor has sole responsibility for the audit opinion expressed, and thatresponsibility is not reduced by the auditor’s use of the work ofan auditor’s expert. The auditor shall evaluate the adequacy of the auditor’s expert’s work forthe auditor’s purposes, including the relevance and reasonableness of that expert’s findings orconclusions, and their consistency with other audit evidence as per SA 500.Further, in view of SA 620, if the expert’s work involves use of significant assumptions andmethods, then the relevance and reasonableness of thoseassumptions and methods must be ensured by the auditor and if the expert’s work involves theuse of source data that is significant to that expert’s work, the relevance, completeness, andaccuracy of that source data in the circumstances must be verified by the auditor.In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd., referredtheir own known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert asper SA 620. Mr. Y’s referred actuary has provided the gratuity valuation report, which later onfound faulty. Further, Mr. Z is not agreed with this report therefore he submitted a separateaudit report specifically for such gratuity valuation. In such situation, it was duty of Mr. X, Mr. Yand Mr. Z, before using the gratuity valuation report of Actuary, to ensure the relevance andreasonableness of assumptions and methods used. They were also required to examine therelevance, completeness and accuracy of source data used for such report before expressingtheir opinion.Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty reportwithout examining the adequacy of expert actuary’s work whereas Mr. Z will not be held liablefor the same due to separate opinion expressed by him.

700.1

SA 700 - FORMING AN OPINION AND REPORTING ON FS

Question-1

Enumerate the ‘Basic Elements of Audit Report’ as enshrined in SA 700.

Answer

Basic Elements of Auditor’s Report: As per SA 700, “Forming an Opinion and Reporting onFinancial Statements”, the auditor’s report includes the following basic elements:

1. Title: The auditor’s report shall have a title that clearly indicates that it is the reportof an independent auditor.2. Addressee: The auditor’s report shall be addressed as required by the circumstances of

the engagement.3. Auditor’s Opinion: 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 reportshall 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.4. 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 ethical requirements relating to the audit, and has fulfilled the auditor’s otherethical responsibilities in accordance with these requirements. The statement shall referto the Code of Ethics issued by ICAI;

(d) States whether the auditor believes that the audit evidence the auditor has obtained issufficient and appropriate to provide a basis for the auditor’s opinion.

5. Going Concern: Where applicable, the auditor shall report in accordance with SA 5706. Key Audit Matters: For audits of complete sets of general purpose financial statements of

listed entities, the auditor shall communicate key audit matters in the auditor’s report inaccordance with SA 701. When the auditor is otherwise required by law or regulation ordecides to communicate key audit matters in the auditor’s report, the auditor shall do soin accordance with SA 701.

7. Responsibilities for the Financial Statements: The auditor’s report shall include a sectionwith a heading “Responsibilities of Management for the Financial Statements.” Theauditor’s report shall use the term that is appropriate in the context of the legalframework applicable to the entity and need not refer specifically to “management”. Insome entities, the appropriate reference may be to those charged with governance.

8. Auditor’s Responsibilities for the Audit of the Financial Statements.9. Location of the description of the auditor’s responsibilities for the audit of the financial

statements.

700.2

10. Other Reporting Responsibilities.11. Signature of the Auditor.

Auditor’s Report for Audits Conducted in Accordance with Both Auditing Standards issued bythe Institute of Chartered Accountants of India and International Standards on Auditing.

Illustrative Format of Independent Auditor's Report on the Standalone Financial Statements ofa listed Company under the Companies Act, 2013Following circumstances are assumed:♦ Audit of a complete set of F.S. of a listed company (registered under the Companies Act.2013) using a fair presentation framework.♦ The F.S. are prepared by management in accordance with the AS prescribed u/s 133.• The auditor has concluded an unmodified opinion.♦ Auditor concluded that no material uncertainty related to events or conditions thatmay cast significant doubt on the entity's ability to continue as a going concern exist.♦ Key audit matters have been communicated in accordance with SA 701.

INDEPENDENT AUDITOR'S REPORTTo the Members of ABC Company LimitedReport on the Audit of the Standalone Financial StatementsOpinionWe have audited the standalone financial statements of ABC Company Limited ("the Company"),which comprise the balance sheet as at 31 st March 20XX, and the statement of Profit and Loss,(statement of changes in equity) and statement of cash flows for the year then ended, and notesto the financial statements, including a summary of significant accounting policies and otherexplanatory information [in which are included the Returns for the year ended on that dateaudited by the branch auditors of the Company's branches located at (location of branches)].In our opinion and to the best of our information and according to the explanations given to us,the aforesaid standalone financial statements give the information required by the Act in themanner so required and give a true and fair view in conformity with the accounting principlesgenerally accepted in India, of the State of affairs of the Company as at March 31, 20XX, andprofit/loss, (changes in equity) and its cash flows for the year ended on that date.Basis for OpinionWe conducted our audit in accordance with the Standards on Auditing (SAs) specified undersection 143(10) of the Companies Act, 2013. Our responsibilities under those Standards arefurther described in the Auditor's Responsibilities for the Audit of the Financial Statementssection of our report. We are independent of the Company in accordance with the Code of Ethicsissued by the Institute of Chartered Accountants of India together with the ethical requirementsthat are relevant to our audit of the financial statements under the provisions of the CompaniesAct, 2013 and the Rules thereunder, and we have fulfilled our other ethical responsibilities inaccordance with these requirements and the Code of Ethics. We believe that the audit evidencewe have obtained is sufficient and appropriate to provide a basis for our opinion.Key Audit MattersKey audit matters are those matters that, in our professional judgment, were of mostsignificance in our audit of the financial statements of the current period. These matters wereaddressed in the context of our audit of the financial statements as a whole, and in forming ouropinion thereon, and we do not provide a separate opinion on these matters.[Description of each key audit matter in accordance with SA 701.]

700.3

Management's Responsibility for the Standalone Financial StatementsThe Company's Board of Directors is responsible for the matters stated in section 134(5) of theCompanies Act, 2013 ("the Act") with respect to the preparation of these standalone financialstatements that give a true and fair view of the financial position, financial performance,(changes in equity) and cash flows of the Company in accordance with the accounting principlesgenerally accepted in India, including the accounting Standards specified under section 133 ofthe Act. This responsibility also includes maintenance of adequate accounting records inaccordance with the provisions of the Act for safeguarding of the assets of the Company and forpreventing and detecting frauds and other irregularities; selection and application of appropriateimplementation and maintenance of accounting policies; making judgments and estimates thatare reasonable and prudent; and design, implementation and maintenance of adequate internalfinancial controls, that were operating effectively for ensuring the accuracy and completeness ofthe accounting records, relevant to the preparation and presentation of the financial statementthat give a true and fair view and are free from material misstatement, whether due to fraud orerror.In preparing the financial statements, management is responsible for assessing the Company'sability to continue as a going concern, disclosing, as applicable, matters related to going concernand using the going concern basis of accounting unless management either intends to liquidatethe Company or to cease operations, or has no realistic alternative but to do so.Those Board of Directors are also responsible for overseeing the Company's financial reportingprocess.Auditor's Responsibilities for the Audit of the Financial StatementsOur objectives are to obtain reasonable assurance about whether the financial statements as awhole are free from material misstatement, whether due to fraud or error, and to issue anauditor's report that includes our opinion. Reasonable assurance is a high level of assurance, butis not a guarantee that an audit conducted in accordance with SAs will always detect a materialmisstatement when it exists. Misstatements can arise from fraud or error and are consideredmaterial if, individually or in the aggregate, they could reasonably be expected to influence theeconomic decisions of users taken on the basis of these financial statements.Report on Other Legal and Regulatory RequirementsAs required by the Companies (Auditor's Report) Order, 2016 ("the Order"), issued by the CentralGovernment of India in terms of sub-section (11) of section 143 of the Companies Act 2013, wegive in the Annexure a statement on the matters specified in paragraphs 3 and 4 of the Order, tothe extent applicable. As required by Section 143(3) of the Act, we report that

a) We have sought and obtained all the information and explanations which to the best ofour knowledge and belief were necessary for the purposes of our audit.

b) In our opinion, proper books of account as required by law have been kept by theCompany so far as it appears from our examination of those books [and proper returnsadequate for the purposes of our audit have been received from the branches not visitedby us.]

c) [The reports on the accounts of the branch offices of the Company audited under section143(8) of the Act by branch auditors have been sent to us and have been properly dealtwith by us in preparing this report]

d) The Balance Sheet, the Statement of Profit and Loss, and the Cash Flow Statement dealtwith by this Report are in agreement with the books of account [and with the returnsreceived from the branches not visited by us].

e) In our opinion, the aforesaid standalone financial statements comply with the AccountingStandards specified under section 133 of the Act, read with Rule 7 of the Companies(Accounts) Rules, 2014.

700.4

f) On the basis of the written representations received from the directors as on 31 stMarch, 20XX taken on record by the Board of Directors, none of the directors isdisqualified as on 31st March, 20XX from being appointed as a director in terms ofsection 164(2) of the Act.

g) With respect to the adequacy of the internal financial controls over financial reporting ofthe Company and the operating effectiveness of such controls, refer to our separateReport in "Annexure A".

h) With respect to the other matters to be included in the Auditor's Report in accordancewith Rule 11 of the Companies (Audit and Auditors) Rules, 2014, in our opinion and to thebest

i) of our information and according to the explanations given to us:i. The Company has disclosed the impact of pending litigations on its financial position in its

financial statements - Refer Note XX to the financial statements; [or the Company doesnot have any pending litigations which would impact its financial position]

ii. ii The Company has made provision, as required under the applicable law or accountingstandards, for material foreseeable losses, if any, on long-term contracts includingderivative contracts - Refer Note XX to the financial statements; [or the Company did nothave any long-term contracts including derivative contracts for which there were anymaterial foreseeable losses.]

iii. There has been no delay in transferring amounts, required to be transferred, to theInvestor Education and Protection Fund by the Company {or, following are the instancesof delay in transferring amounts, required to be transferred, to the Investor Educationand Protection Fund by the Company or there were no amounts which were required tobe transferred to the Investor Education and Protection Fund by the Company}.

For XYZ & Co.Chartered Accountants (Firm's Registration No.)

Signature (Name of the Member Signing the Audit Report)(Designation)

(Membership No. XXXXX)

Place of Signature:Date:

705.1

SA 705 - MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’SREPORT

Question-1

You have been appointed as an auditor of X Ltd., for the year 2011-12. During the course ofaudit, you found that inventory valuation was done on LIFO basis and it is overvalued by Rs 20Crore. Further, you also observe the attrition rate of the employees at the entry level is 1%however industry rate is 5%. INDEPENDENT

INDEPENDENT AUDITORS REPORT

To,The Member of X Ltd.Report on the Audit of the Standalone Financial StatementsQualified Opinion

Qualified OpinionWe have audited the standalone financial statements of ABC Company Limited ("theCompany"), which comprise the balance sheet as at March 31,20XX, and the statement ofProfit and Loss, (statement of changes in equity) and the statement of cash flows for the yearthen ended and notes to the financial statements, including a summary of significantaccounting policies and other explanatory information (in which are included the Returns forthe year ended on that date audited by the branch auditors of the Company's brancheslocated at (location of branches)).In our opinion and to the best of our information and according to the explanations given tous, except for the effects of the matter described in the Basis for Qualified Opinion section ofour report, the aforesaid financial statements give a true and fair view in conformity with theaccounting principles generally accepted in India, of the state of affairs of the Company as atMarch 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended onthat date.

BASIS FOR QUALIFIED OPINIONThe company has valued inventory based on LIFO (last in first out) method and there is anovervaluation of the inventory by Rs 20 crore. As per Accounting Standard and Guidance Note onValuation of Inventory, inventory Valuation is based on FIFO method (first in first out).

We conducted our audit in accordance with Standards on Auditing (SAs) specified under section 143(10)of the Companies Act, 2013. Our responsibilities under those Standards are further described in theAuditor's Responsibilities for the Audit of the Financial Statements section of our report. We areindependent of the Company in accordance with the Code of Ethics issued by the Institute of CharteredAccountants of India together with the ethical requirements that are relevant to our audit of the financialstatements under the provisions of the Companies Act, 2013 and we have fulfilled our other ethicalresponsibilities in accordance with these requirements and the ICAI's Code of Ethics. We believe that theaudit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.Key Audit MattersKey audit matters are those matters that, in our professional judgment, were of most significance in ouraudit of the financial statements of the current period. These matters were addressed in the context ofour audit of the financial statements as a whole, and in forming our opinion thereon, and we do notprovide a separate opinion on these matters. In addition to the matter described in the Basis for Qualified

705.2

Opinion section we have determined the matters described below to be the key audit matters to becommunicated in our report.[Description of each key audit matter in accordance with SA 701.]Responsibilities of Management and Those Charged with Governance for the Financial Statements[Reporting in accordance with SA 700 (Revised).]Auditor's Responsibilities for the Audit of the Financial Statements[Reporting in accordance with SA 700 (Revised).]Other MatterWe did not audit the financial statements /information of(number) branches includedin the standalone financial statements of the Company whose financial statements/financialinformation reflect total assets of Rs._as at 31st March, 20XX and total revenues ofRs._for the year ended on that date, as considered in the standalone financial statements.The financial statements/information of these branches have been audited by the branch auditors whosereports have been furnished to us, and our opinion in so far as it relates to the amounts and disclosuresincluded in respect of these branches, is based solely on the report of such branch auditors.Our opinion is not modified in respect of this matter.Report on Other Legal and Regulatory Requirements[Reporting in accordance with SA 700 (Revised).]

For XYZChartered Account (Firm's Registration No

Signature(Name of the Member Signing the Audit Rep

(Designation)(Membership No. XXXXX)

Place of SignatureDate:

Question-2

XYZ Ltd has significant operations in a foreign country. Due to civil and politicalunrest in that country physical verification of inventory and fixed assets could not becarried out and you are not in a position to obtain a evidence through other auditprocedures also. The value of fixed assets and inventory forms part of 80% of the assetvalue of the company. As the auditor of XYZ Ltd what factors do you consider in yourreporting responsibility. Also draft draft a suitable report that will be incorporated inthe main audit report (Reporting under CARO 2003To,

The Member of XYZ Ltd.Report on the Audit of the Standalone Financial StatementsDisclaimer of OpinionWe were engaged to audit the accompanying standalone financial statements of XYZ Company Limited,Limited ("the Company"), which comprise the balance sheet as at March 31,20XX, and thestatement of Profit and Loss, (statement of changes in equity) and the statement of cash flows for theyear then ended and notes to the financial statements, including a summary of significant accountingpolicies and other explanatory information (in which are included the Returns for the year ended on thatdate audited by the branch auditors of the Company's branches located at (location of branches)).We do not express an opinion on the accompanying consolidated financial statements of the Group.Because of the significance of the matter described in the Basis for Disclaimer of Opinion section of our

705.3

report, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for anaudit opinion on these consolidated financial statements.Basis for Disclaimer of OpinionThe Company's investment in its Foreign operations is carried at Rs. XXX in the Company's Balance Sheet,which represents over 80% of. the Company's assets as at March 31, 20XX in the form of fixed assets andInventory Hence are unable to comment on substantial part of companies assets abroad.Hence we areunable to express any opinion' the companies' financial statements.

Management's Responsibility for the Financial StatementsAuditor's Responsibility

Legal and other reporting requirementsSignature :Membership No. :Firm No.Place :Date:

Question-3

Format of Auditor's Report with ADVERSE Opinion on Consolidated F.S. of a Parent Companyprepared under G.AAPs as required for compliance with SEBI regulatory requirement (i.e. FairPresentation Framework)"The F.S. are materially misstated due to non-consolidation of asubsidiary. The material misstatement is deemed to be pervasive to the F.S. The effects of themisstatement on the F.S. have not been determined because it was not practicable to do so"

INDEPENDENT AUDITOR'S REPORTThe Member of …………. Ltd.Report on the Audit of the Consolidated Financial StatementsAdverse OpinionWe have audited the accompanying consolidated financial statements of ABC Company Limited(hereinafter referred to as the "Holding Company") and its subsidiaries (the Holding Company and itssubsidiaries together referred to as "the Group"), its associates and joint controlled entities, whichcomprise the consolidated balance sheet as at March 31, 2XXX, the consolidated statement of profit andLoss, (consolidated statement of changes in equity) and the consolidated statement of cash flows for theyear then ended, and notes to the consolidated financial statements, including a summary of significantaccounting policies (hereinafter referred to as the "consolidated financial statements").In our opinion and to the best of our information and according to the explanations given to us. becauseof the significance of the matter discussed in the Basis for Adverse Opinion section of our report, theaccompanying consolidated financial statements do not give a true and fair value state of affairs of theGroup, its associates and jointly controlled entities, as at March 31,20XX, of its consolidated profit/loss,(consolidated position of changes in equity) and the consolidated cash flows for the year then ended.Basis for Adverse OpinionAs explained in Note X, the Company has not consolidated the financial statements of subsidiaryXYZ Company it acquired during 20XX because it has not yet been able to ascertain the fairvalues of certain of the subsidiary's material assets and liabilities at the acquisition date. Thisacquisition is therefore accounted for as an investment. Under the accounting principlesgenerally accepted in India, the subsidiary should have been consolidated because it is controlledby the Company. Had XYZ been consolidated, many elements in the accompanying financial

705.4

statements would have been materially affected. The effects on the financial statements of thefailure to consolidate have not been determined.

We conducted our audit in accordance with Standards on Auditing (SAs) specified under section 143(10)of the Companies Act, 2013. Our responsibilities under those Standards are further described in theAuditor's Responsibilities for the Audit of the Financial Statements section of our report. We areindependent of the Company in accordance with the Code of Ethics issued by the Institute of CharteredAccountants of India together with the ethical requirements that are relevant to our audit of the financialstatements under the provisions of the Companies Act, 2013 and we have fulfilled our other ethicalresponsibilities in accordance with these requirements and the ICAI's Code of Ethics. We believe that theaudit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.

Management's Responsibility for the Consolidated Financial StatementsAuditor's Responsibility

For XYZ & Co. Chartered Accountants Firm's Registration NumberSignature(Name of the Member Signing the Audit Report)(Designation) Membership NumberPlace of Signature Date

706.1

SA 706 - EMPHASIS OF MATTER PARAGRAPHS & OTHER MATTER PARAGRAPHS INTHEINDEPENDENT AUDITOR’S REPORT

Case Studies

You are the auditor of XYZ Ltd. There is uncertainty relating to a pending exceptional litigationMatter – say there is a law suit filed against the company for tax or some other matter. Youcannot conclude that it should be provided for.Solution

– Emphasis of Matter paragraphAfter Basis opinion paragraph following shall be added:“We draw attention to Note X to the financial statements which describes the uncertaintyrelated to the outcome of the lawsuit filed against the Company by XYZ Company. Our opinionis not qualified in respect of this matter

Case StudiesIn case of auditor of Consolidated Financial Statement, there are certain subsidiaries whichwere not audited by him but which form part of the consolidated financial statements underreport. Also the amounts involved are not insignificant.Solution

– Other Matter paragraphOther Matter“We did not audit the financial statements of certain subsidiaries, whose financial statementsreflect total assets (net) of Rs. XXXX as at March 31, 20XX, total revenues of Rs. XXXX and netcash outflows amounting to Rs. XXXX for the year then ended. These financial statementshave been audited by other auditors whose reports have been furnished to us by theManagement, and our opinion is based solely on the reports of the other auditors. Ouropinion is not qualified in respect of this matter.”

Illustration of Emphasis of Matter ParaINDEPENDENT AUDITOR’S REPORTTo the Members of ABC Company LimitedReport on the Audit of the Standalone Financial StatementsOpinionWe have audited the standalone financial statements of ABC Company Limited (“theCompany”), which comprise the balance sheet as at March 31, 20X1, and the statement ofProfit & Loss, (statement of changes in equity) and the statement of cash flows for the yearthen ended, and notes to the financial statements, including a summary of significantaccounting policies and other explanatory information (in which are included the Returns forthe year ended on that date audited by the branch auditors of the Company’s brancheslocated at (location of branches)).In our opinion, and to the best of our information and according to the explanations given tous the aforesaid financial statements, give a true and fair view, in conformity with theaccounting principles generally accepted in India, of the state of affairs of the Company as atMarch 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended onthat date.Basis for OpinionWe conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities

706.2

under those standards are further described in the Auditor’s Responsibilities for the Audit ofthe Financial Statements section of our report. We are independent of the Company inaccordance with the ethical requirements that are relevant to our audit of the financialstatements as per the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013 ,and we have fulfilled our other ethical responsibilities in accordance with these requirements.We believe that the audit evidence we have obtained is sufficient and appropriate to providea basis for our opinion.Emphasis of MatterWe draw attention to Note X of the financial statements, which describes the effects of a firein the Company’s production facilities. Our opinion is not modified in respect of this matter.Key Audit MattersKey audit matters are those matters that, in our professional judgment, were of mostsignificance in our audit of the financial statements of the current period. These matters wereaddressed in the context of our audit of the financial statements as a whole, and in formingour opinion thereon, and we do not provide a separate opinion on these matters.[Description of each key audit matter in accordance with SA 701.]Other MatterThe financial statements of ABC Company for the year ended March 31, 20X0, were auditedby another auditor who expressed an unmodified opinion on those statements on March 31,20X1.Responsibilities of Management and Those Charged with Governance for the FinancialStatements [Reporting in accordance with SA 700 (Revised) – see Illustration 1 in SA 700(Revised) given in Auditing Pronouncement.]Auditor’s Responsibilities for the Audit of the Financial Statements[Reporting in accordance with SA 700 (Revised) – see Illustration 1 in SA 700 (Revised).]Report on Other Legal and Regulatory Requirements[Reporting in accordance with SA 700 (Revised) – see Illustration 1 in SA 700 (Revised).]For XYZ & CoChartered Accountants(Firm’s Registration No.)

710.1

SA 710 - COMPARATIVE INFORMATION - CORRESPONDING FIGURES &COMPARATIVE FINANCIAL STATEMENTS

Question-1

Write short notes on the following:(a) Auditor's responsibilities regarding comparatives OR(b) Auditor’s responsibilities regarding comparatives: SA 710, “Comparative Information ORWrite short notes on Corresponding figures.

Answer

– Corresponding Figures and Comparative Financial Statements”, establishes standards on theauditor’s responsibilities regarding comparatives.The auditor shall determine whether the financial statements include the comparativeinformation required by the applicable financial reporting framework and whether suchinformation is appropriately classified. For this purpose, the auditor shall evaluate whether:(1) The comparative information agrees with the amounts and other disclosures presented

in the prior period; and(2) 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, whetherthose changes have been properly accounted for and adequately presented and disclosed.

(3) If the auditor becomes aware of a possible material misstatement in the comparativeinformation while performing the current period audit, the auditor shall perform suchadditional audit procedures as are necessary in the circumstances to obtain sufficientappropriate audit evidence to determine whether a material misstatement exists. If theauditor had audited the prior period’s financial statements, the auditor shall also follow therelevant requirements of SA 560 (Revised).

(4) As required by SA 580 (Revised), the auditor shall request written representations for allperiods referred to in the auditor’s opinion. The auditor shall also obtain a specificwrittenrepresentation regarding any prior period item that is separately disclosed in thecurrent year’s statement of profit and loss.

Question-2

The audit report of P Ltd. for the year 2012-13 contained a qualification regarding non-provision of doubtful debts. As the statutory auditor of the company for the year 2013-14, howwould you report, if:(i) The company does not make provision for doubtful debts in 2013-14?(ii) The company makes adequate provision for doubtful debts in 2013-14?

Answer

Auditor’s responsibilities in cases where audit report for an earlier year is qualified is given in SA710 “ComparativeInformation–Corresponding Figures and Comparative Financial Statements”. As per SA 710, When 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 gaverise to the modified opinion is resolved and properly accounted for or disclosed in the

710.2

financial statements in accordance with the applicable financial reporting framework, theauditor’s opinion on the current period need not refer to the previous modification.

SA 710 further states that if the auditor’s report on the prior period, as previously issued,included a qualified 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. Inthe Basis for Modification paragraph in the auditor’s report, the auditor shall either:

(i) Refer to both the current period’s figures and the corresponding figures in the description ofthe matter giving rise to the modification when the effects or possible effects of the matteron the current period’s figures are material; or

(ii)In other cases, explain that the audit opinion has been modified because of the effects orpossible effects of the unresolved matter on the comparability of the current period’s figuresand the corresponding figures.

In the instant Case, if P Ltd. does not make provision for doubtful debts the auditor will haveto modify his report for both current and previous year’s figures as mentioned above. Ifhowever, the provision is made, the auditor need not refer to the earlier year’s modification.

720.1

SA 720 - THE AUDITOR’S RESPONSIBILITY IN RELATION TO OTHER INFORMATIONINDOCUMENTS CONTAINING AUDITED FS

800.1

SA 800 - SPECIAL CONSIDERATIONS - AUDITS OF FS PREPARED IN ACCORDANCEWITH SPECIALPURPOSE FRAMEWORKS

Question-1

XLtd. is a manufacturing co. located in Chennai. AB Inc, USA has invested 100mm and in thecompany's operm Ltd and AB Inc. had entered into Memorandum of understanding (MOU)vide agreement dated 13th Aug 2012 clause 7 of the agreement, the financial statements ofXltd., were required to be prepared as per the US regulatic US GAAP and to be audited byindependent CA. The investor wants to know liquidity, progress and growth of! Ltd., You havebeen appointed to conduct the audit of Special Purpose Financial Statements prepared as jagreement Draft a report as per SA 800.

Answer

BASIS OF ACCOUNTING AND RESTRICTION ON DISTRIBUTION FOR USEThe Management of X Ltd. has prepared the special purpose financial statements. The specialpurpose financial statements are Prepared as per the requirement of AB Inc, USA to understandthe liquidity, progress and growth of the X Ltd., The special Financial statements can bedistributed only to AB Inc, who has requested the same through clause 7 of the Agreementbetween X Ltd., and AB Inc and These special purpose financial statement are not meant forpublic purpose.

Question-2

The Financial Statements of TC & Co. have been prepared by Management of an Entity inaccordance with the Financial Reporting provisions of a contract (that is, a Special PurposeFramework) to comply with provision of the contract. Based on the contract, Managementdoes not have a choice of Financial Reporting Frameworks. As an Auditor what considerationswould be undertaken while planning and performing audit?(May-15)

Answer

• SA 200 (Revised) requires the auditor to comply with all SAs relevant to the audit. In planningand performing an audit of special purpose FS, the auditor shall determine whetherapplication of the SAs requires special consideration in the circumstances of the engagement.

• SA 315 requires the auditor to obtain an understanding of the entity’s selection andapplication of accounting policies.

• In the case of FS prepared in accordance with the provisions of a contract, the auditor shallobtain an understanding of any significant interpretationsof the contract that managementmade in the preparation of those FS.

• An interpretation is significant when adoption of another reasonable interpretation wouldhave produced a material difference in the information presented in the FS.

Question-3

The financial statements of Ace Ltd. have been prepared by the management in accordancewith special purpose frame work to meet the financial reporting provisions of a regulator. As

800.2

an auditor what considerations would be undertaken while planning and peforming an auditin case of such special purpose frame work ?

Answer

• SA 200 (Revised) requires the auditor to comply with all SAs relevant to the audit. In planningand performing an audit of special purpose FS, the auditor shall determine whetherapplication of the SAs requires special consideration in the circumstances of the engagement.

• SA 315 requires the auditor to obtain an understanding of the entity’s selection andapplication of accounting policies.

• In the case of FS prepared in accordance with the provisions of a contract, the auditor shallobtain an understanding of any significant interpretationsof the contract that managementmade in the preparation of those FS.

• An interpretation is significant when adoption of another reasonable interpretation wouldhave produced a material difference in the information presented in the FS.

800.1

SA 805 - SPECIAL CONSIDERATIONS - AUDITS OF SINGLE FS AND SPECIFICELEMENTS, ACCOUNTS OR ITEMS OF A FINANCIAL STATEMENT

Example of report on SA 805You have been appointed to conduct the audit of accounts receivable schedule prepared as on31.01.2012. The schedule been prepared by the collection department based on theirjudgment. The company X Ltd. has applied to SBI for Working capital loan of Rs 50 Crores. SBIwants validation of accounts receivable account and to ascertain whether The statement isreliable so that the working capital loan can be approved. Draft the report as per SA 805._

INDEPENDENT AUDITOR'S REPORTToThe State Bank of India,have examined the Accounts receivable schedule prepared as on 31st January 2012.MANAGEMENT REPONSIBILITY TO SCHEDULEThe management is responsible to prepare the schedule of accounts receivable as per the booksof accounts. This Responsibility includes the design, implementation and maintenance of internalcontrol relevant to the preparation and presentation of the financial statement that is free frommaterial misstatement, whether due to fraud or error.AUDITOR'S RESPONSIBILITYOur responsibility is to examine the accounts receivable schedule and to check whether it isprepared as per books of counts. As per SA 805, the auditor checks the single ledger account ofthe entity, X Ltd.; the audit is conducted as per requirements of SA 805. An audit involvesperforming procedures to obtain audit evidence about the amounts and closures in the financialstatement. The procedures selected depend on the auditor's judgment, including the assessmentof the risks of material misstatement of the financial statement, whether due to fraud or error.In making 1 risk assessments, the auditor considers internal control relevant to the entity'spreparation and fair presentation the financial statement in order to design audit proceduresthat are appropriate in the circumstances. An audit also includes evaluating the appropriatenessof accounting policies used and the reasonableness of accounting estimates, if any. made bymanagement, as well as evaluating the overall presentation of the financial statement. Webelieve that audit evidence we have obtained is sufficient and appropriate to provide a basis forour audit opinion.OPINION PARAGRAPHBased upon our examination and explanation given to us, the accounts receivables schedule hasbeen prepared as per Books of accounts and there are no misstatements.BASIS FOR PREPARATION AND RESTRICTION ON DISTRIBTUION OF USEThe Collection department of X ltd has prepared the Accounts Receivable schedule. The accountsReceivable schedule prepared for availing working capital loan of Rs 50 crores from SBI. TheAccounts Receivable schedule is prepared f BI to validate the account and to ascertain whetherthe statement is reliable for granting the working capital loan. The Accounts Receivable schedulecan be given only to SBI and no distribution to any other party is permitted. The schedule isprepared exclusively for SBI. As a result, the schedule may not be suitable for another purposeSignature:Membership No:Firm Registration No:Date:Place

810.1

SA 810 - ENGAGEMENTS TO REPORT ON SUMMARY FS

Example on report on SA 810

X Ltd., has made application to the oil Ministry for allocation of license for extracting oil in Bay ofBengal. The oil Ministry requires X Ltd to submit the proposal along with the Summary FinancialStatements (SFS) for the year 2011-12. You have been appointed to conduct the audit of SFS. Theaudit of SFS for the year 2011-12 was conducted by AB & Co. Chartered Accountants who hadissued the report on 12.8.2012.

INDEPENDENT AUDITORS REPORT ON SUMMARY FINANCIAL STATEMENTS

To,The Oil MinistryThe summary financial statements comprising ofa. Summary Balance sheet as at 31.03.2012.b. Summary Profit & Loss a/c for the year ended 31.03.2012c. Summary Cash Flow statement for the year ended 31.03.2012 of X Ltd.,

The financial statements were audited by AB & co., and the audit report on the same was issuedon 12th August 2012. The summary financial statements do not comply with section 211 ofcompanies Act. Further the summary financial statements do not disclose any events whichoccur after Balance Sheet

MANAGMENT RESPONSIBILITY TO SUMMARY FINANCILA STATEMENTThe management is responsible for preparation of summary financial statements.

AUDITORS RESPONSIBILITYOur responsibility is to check whether summary financial statements are fair summary of thefinancial statements. The audit is conducted as per SA 810 'Engagements to Report on SummaryFinancial Statements' as issued by ICAI.

OPINIONBased upon our examination and explanation given to us, the summary financial statementswhich are derived from the financial statements are a fair summary of the financial statements.

Basis OF PREPARATION AND RESTRICTION ON DISTRIBUTION FOR USEThe management of X Ltd. has prepared the summary financial statements. The summaryFinancial Statements are prepared to obtain license for extracting oil in Bay of Bengal. Thesummary Financial Statements are prepared illusively for the use of the Oil Ministry. Nodistribution in part or full of the summary financial statements, to any icier party is permitted,

SignatureMembership No:

810.2

Firm Registration No:Date:Place:

Question-1The management of CSUA Ltd. has prepared its summary financial 5 statements for the year 2015-16 tobe provided to its investors. Consequently the company warns to appoint you for conducting audit ofsummary financial statements. What are the procedures that you will perform and consider necessaryas the basis for forming an opinion on the summary financial statements?

Answer-As per SA 810, “Engagement to Report on Summary Financial Statements”, the auditor shallperform the following procedures, and any other procedures that the auditor may considernecessary, as the basis for the auditor’s opinion on the summary financial statements:

(i) Evaluate whether the summary financial statements adequately disclose their summarizednature and identify the audited financial statements.

(ii) When summary financial statements are not accompanied by the audited financialstatements, evaluate whether they describe clearly:

a. From whom or where the audited financial statements are available; orb. The law or regulation that specifies that the audited financial statements need not be made

available to the intended users of the summary financial statements and establishes thecriteria for the preparation of the summary financial statements.

(iii) Evaluate whether the summary financial statements adequately disclose the appliedcriteria.

(iv) Compare the summary financial statements with the related information in the auditedfinancial statements to determine whether the summary financial statements agree with orcan be re-calculated from the related information in the audited financial statements.

(v) Evaluate whether the summary financial statements are prepared in accordance with theapplied criteria.

(vi) Evaluate, in view of the purpose of the summary financial statements, whether thesummary financial statements contain the information necessary, and are at an appropriatelevel of aggregation, so as not to be misleading in the circumstances.

(vii) Evaluate whether the audited financial statements are available to the intended users ofthe summary financial statements without undue difficulty, unless law or regulation providesthat they need not be made available and establishes the criteria for the preparation of thesummary financial statements.

2400.1

SRE 2400 - ENGAGEMENTS TO REVIEW FINANCIAL STATEMENTS

Samples of report on SRE 2410/SRE 2400REPORT ON REVIEW OF INTERIM FINANCIAL INFORMATION

To,NSEBombay

We have reviewed the financial statements comprising ofa. Balance sheet as at 31.12.2012b. Profit & Loss a/c for the quarter ended 31.12.2012.c. Cash flow statement for the quarter ended 31.12.2012 of X ltd.,d. And summary of significant accounting policies & other explanatory notesManagement's ResponsibilityManagement is responsible for the preparation and fair presentation of this interim financialinformation in accordance with applicable financial reporting framework.Auditor's Responsibilitya) Our responsibility is to express a conclusion on this interim financial information based on our

review.b) We conducted our review in accordance with Standard on Review Engagements (SRE) 2410,

"Review of Interim Financial Information Performed by the Independent Auditor of theEntity".

c) A review of interim financial information consists of making inquiries, primarily of personsresponsible for financial and accounting matters, and applying analytical and other reviewprocedures.

d) A review is substantially less in scope than an audit conducted in accordance with Standardson Auditing and consequently does not enable us to obtain assurance that we would becomeaware of all significant matters that might be identified in an audit.

e) Based on our review, nothing has come to our attention that causes us to believe that theaccompanying interim financial information does not give a true and fair view the state ofaffairs of the entity as at Dec 31, 2012, and of its results of operations and its cash flows forthe three month period then ended in accordance with applicable financial reportingframework. Accordingly, we do not express an audit opinion subject to the followingobservations: Revenue was understated by Rs 50 Cr. Revenue recognition was not based on accrual basis.

This is not an audit; hence no opinion will be given on the financial statements.Signature :Membership No. :Firm Registration No. :Date :Place :

2400.2

Question 1You are engaged to review the system and the information generated from the financialstatements. Discuss the detailed procedures (general points only) that may be performed byyou as company auditor for review of financial statements.

AnswerProcedures for Review of Financial Statements: As per SRE 2400 “Engagements to ReviewFinancial Statements”, procedures for the review of financial statements will ordinarily include-(i) Discuss terms and scope of the engagement with the client and the engagement team.(ii) Prepare an engagement letter setting forth the terms and scope of the engagement.(iii)Obtain an understanding of the entity’s business activities and the system for recording

financial information and preparing financial statements.(iv) Inquire whether all financial information is recorded:

(a) Completely;(b) Promptly; and(c) After the necessary authorisation.

(v) Obtain the trial balance and determine whether it agrees with the general ledger and thefinancial statements.

(vi) Consider the results of previous audits and review engagements, including accountingadjustments required.

(vii) Inquire whether there have been any significant changes in the entity from the previous year(e.g., changes in ownership or changes in capital structure).

(viii) Inquire about the accounting policies and consider whether:(a) They comply with the applicable accounting standards;(b) They have been applied appropriately; and(c) They have been applied consistently and, if not, consider whether disclosure has been

made of any changes in the accounting policies.(ix) Read the minutes of meetings of shareholders, the board of directors and other appropriate

committees in order to identify matters that could be important to the review.(x) Inquire if actions taken at shareholder, board of directors or comparable meetings that affect

the financial statements have been appropriately reflected therein.(xi) Inquire about the existence of transactions with related parties, how such transactions have

been accounted for and whether related parties have been properly disclosed.(xii) Inquire about contingencies and commitments.(xiii) Inquire about plans to dispose of major assets or business segments.(xiv) Obtain the financial statements and discuss them with management.(xv) Consider the adequacy of disclosure in the financial statements and their suitability as to

classification and presentation.(xvi) Compare the results shown in the current period financial statements with those shown in

financial statements for comparable prior periods and, if available, with budgets andforecasts.

2400.3

(xvii) Obtain explanations from management for any unusual fluctuations or inconsistencies inthe financial statements.

(xviii)Consider the effect of any unadjusted errors – individually and in aggregate. Bring theerrors to the attention of management and determine how the unadjusted errors willinfluence the report on the review.

(xix) Consider obtaining a representation letter from management.

Question 2

You are engaged to review the system and the information generated from the financialstatements.Discuss the elements of the practitioner’s report for the Historical Financial Statements reviewengagement.

Answer

Elements of the Practitioner’s Report for Review Engagement: As per SRE 2400 “Engagementsto Review Historical Financial Statements”, The practitioner’s report for the review engagementshall be in writing, and shall contain the following elements:(a) A title, which shall clearly indicate that it is the report of an independent practitioner for areview engagement;(b) The addressee(s), as required by the circumstances of the engagement;(c) An introductory paragraph that:

(i) Identifies the financial statements reviewed, including identification of the title ofeach of the statements contained in the set of financial statements and the date andperiod covered by each financial statement;

(ii) Refers to the summary of significant accounting policies and other explanatoryinformation; and

(iii) States that the financial statements have been reviewed;(d) A description of the responsibility of management for the preparation of the financialstatements, including an explanation that management is responsible for:

(i) Their preparation in accordance with the applicable financial reporting frameworkincluding, where relevant, their fair presentation;

(ii) Such internal control as management determines is necessary to enable thepreparation of financial statements that are free from material misstatement,whether due to fraud or error;

(e) If the financial statements are special purpose financial statements:(i) A description of the purpose for which the financial statements are prepared and, if

necessary, the intended users, or reference to a note in the special purpose financialstatements that contains that information; and

(ii) If management has a choice of financial reporting frameworks in the preparation ofsuch financial statements, a reference within the explanation of management’sresponsibility for the financial statements to management’s responsibility fordetermining that the applicable financial reporting framework is acceptable in thecircumstances;

(f) A description of the practitioner’s responsibility to express a conclusion on the financialstatements including reference to this SRE and, where relevant, applicable law or regulation;

2400.4

(g) A description of a review of financial statements and its limitations, and the followingstatements:

(i) A review engagement under this SRE is a limited assurance engagement;(ii) The practitioner performs procedures, primarily consisting of making inquiries of

management and others within the entity, as appropriate, and applying analyticalprocedures, and evaluates the evidence obtained; and

(iii) The procedures performed in a review are substantially less than those performed inan audit conducted in accordance with Standards on Auditing (SAs), and, accordingly,the practitioner does not express an audit opinion on the financial statements;

(h) A paragraph under the heading “Conclusion” that contains:(i) The practitioner’s conclusion on the financial statements as a whole in accordance

with this SRS, as appropriate; and(ii) A reference to the applicable financial reporting framework used to prepare the

financial statements.(i) When the practitioner’s conclusion on the financial statements is modified:

(i) A paragraph under the appropriate heading that contains the practitioner’s modifiedconclusion in accordance with this SRS, as appropriate; and

(ii) A paragraph, under an appropriate heading, that provides a description of thematter(s) giving rise to the modification;

(j) A reference to the practitioner’s obligation under this SRE to comply with relevant ethicalrequirements;(k) The date of the practitioner’s report;(l) The practitioner’s signature; and(m) The place of signature.

Question 3

You are offered to engage as a practitioner to perform a review of historical financial statementsof Samta Limited, where you have not audited the financial statements. Briefly discuss thepreconditions you will be considering prior to accepting such review engagement.

Answer

As per SRE 2400, “Engagement to Review Historical Financial Statements”, prior to accepting areview engagement, the practitioner shall:(1) Determine whether the financial reporting framework applied in the preparation of thefinancial statements is acceptable including, in the case of special purpose financial statements,obtaining an understanding of the purpose for which the financial statements are prepared andof the intended users; and(2) Obtain the agreement of management that it acknowledges and understands itsresponsibilities:(i) For preparation of the financial statements in accordance with the applicable financialreporting framework, including, where relevant, their fair presentation;(ii) For such internal control as management determines is necessary to enable the preparationof financial statements that are free from material misstatement, whether due to fraud or error;and(iii) To provide the practitioner with:

2400.5

a. Access to all information of which management is aware that is relevant to the preparation ofthe financial statements, such as records, documentation and other matters;b. Additional information that the practitioner may request from management for the purposeof the review; andc. Unrestricted access to persons within the entity from whom the practitioner determines itnecessary to obtain evidence.If the practitioner is not satisfied as to any of the matters set out above as preconditions foraccepting a review engagement, the practitioner shall discuss the matter with management orthose charged with governance. If changes cannot be made to satisfy the practitioner as to thosematters, the practitioner shall not accept the proposed engagement unless required by law orregulation to do so. However, an engagement conducted under such circumstances does notcomply with this SRE. Accordingly, the practitioner shall not include any reference within thepractitioner’s report to the review having been conducted in accordance with this SRE.If it is discovered after the engagement has been accepted that the practitioner is not satisfied asto any of the above preconditions, the practitioner shall discuss the matter with management orthose charged with governance, and shall determine:(a) Whether the matter can be resolved;(b) Whether it is appropriate to continue with the engagement; and(c) Whether and, if so, how to communicate the matter in the practitioner’s report.

2410.1

SRE 2410 - REVIEW OF INTERIM FINANCIAL INFORMATION PERFORMED BYINDEPENDENT AUDITOR OF THE ENTITY

Question-1

While compiling the financial statements of a concern, you observed that the inputinformation supplied by the concern is incomplete, incorrect and few of the AccountingStandards have not been followed. Describe, in brief, the procedure you will follow in theabove.

Answer

Compilation of Financial Information: According to SRS 4410 “Engagements to Compile FinancialInformation”, an accountant would normally have to rely upon the management for informationto compile the financial statements in a compilation engagement. If in the course of compilationof financial statements, it is observed that the information supplied by the entity is incorrect,incomplete or otherwise unsatisfactory, the accountant should perform following procedures:(i) Make any enquiries of management to assess the reliability and completeness of the

information provided;(ii) Assess internal controls prevailing in the entity; and(iii) Verify any matters or explanations.The accountant may also request the management to provide additional information. This maybe asked in the form of management representation letter. If the management refuses toprovide additional information, the accountant should withdraw from the engagement,informing the entity of the reasons for such withdrawal.If one or more accounting standards are not complied with, the same should be brought to thenotice of the management and if the same is not rectified by the management, the accountantshould include the same in notes to the accounts and the compilation report to themanagement.

3400.1

SAE 3400 - THE EXAMINATION OF PROSPECTIVE FINANCIAL INFORMATION

Question-1

T & Co. wants to issue a prospectus, to provide potential investors with informationabout future expectations of the Company. You are hired by T & Co. to examine the projectedfinancial statements and give report thereon. What things you will consider before acceptingthe audit engagement and what audit evidence will be obtained for reporting on projectedfinancial statements?

Answer

Projected Financial Statements: As per SAE 3400, “The Examination of Prospective FinancialInformation”, the answer is divided into two parts i.e.(i) the things to be considered before accepting the engagement and(ii) audit evidence to be obtained for reporting on projected financial statements.

(i) Acceptance of Engagement: As per SAE 3400, “The Examination of Prospective FinancialInformation”, before accepting an engagement to examine prospective financial information,the auditor would consider, amongst other things:(1) the intended use of the information;(2) whether the information will be for general or limited distribution;(3) the nature of the assumptions, that is, whether they are best-estimates or hypothetical

assumptions;(4) the elements to be included in the information; and(5) the period covered by the information.

Further, the auditor should not accept, or should withdraw from, an engagementwhen the assumptions are clearly unrealistic or when the auditor believes that the prospectivefinancial information will be inappropriate for its intended use.In accordance with SA 210, “Terms of Audit Engagement”, it is necessary that the auditor and theclient should agree on the terms of the engagement.(ii) Audit evidence to be obtained for Reporting on Projected Financial Statements: The

auditor should document matters, which are important in providing evidence to supporthis report on examination of prospective financial information, and evidence that suchexamination was carried out.The audit evidence in form of working papers will include:(1) thesources of information,(2) basis of forecasts and(3) theassumptions made in arriving the forecasts,(4) hypothetical assumptions, evidence supporting the assumptions,(5)managementrepresentations regarding the intended use and distribution of the

information, completeness of material assumptions,(6) management’s acceptance of its responsibility for the information, (7) audit plan,(8) the nature, timing and extent of examination procedures performed, and,(9) in case the auditor expresses a modified opinion or withdraws from the engagement, the

reasons forming the basis of such decision.

3402.1

SAE 3402 - ASSURANCE REPORTS ON CONTROLS AT A SERVICE ORGANISATION

3402.1

SAE 3420 - Engagements to Report on the Compilation of Pro Forma Financial Information

Question 1

The management of S Ltd. requests you to accept an engagement to report on compilation ofpro forma financial information to be included in a prospectus. In light of SAE 3420, what are thefactors to be considered by you as a practitioner before agreeing to accept such engagement toreport on pro forma financial information. (RTP May17)

Answer

Engagements to Report on the Compilation of Pro Forma Financial Information: As per SAE3420,” Engagements to Report on the Compilation of Pro Forma Financial Information Includedin a Prospectus”, before agreeing to accept an engagement to report on whether pro formafinancial information included in a prospectus has been compiled, in all material respects, on thebasis of the applicable criteria, the practitioner shall-(i) Determine that the practitioner has the capabilities and competence to perform theengagement;(ii) On the basis of a preliminary knowledge of the engagement circumstances and discussionwith the responsible party, determine that the applicable criteria are suitable and that it isunlikely that the pro forma financial information will be misleading for the purpose for which it isintended;(iii) Evaluate the wording of the opinion prescribed by the relevant law or regulation, if any, todetermine that the practitioner will likely be able to express the opinion so prescribed based onperforming the procedures specified in this SAE;(iv) Where the sources from which the unadjusted financial information and any acquiree ordivestee financial information have been extracted have been audited or reviewed and amodified audit opinion or review conclusion has been expressed, or the report contains anEmphasis of Matter paragraph,consider whether or not the relevant law or regulation permits the use of, or reference in thepractitioner’s report to, the modified audit opinion or review conclusion or the report containingthe Emphasis of Matter paragraph with respect to such sources;(v) If the entity’s historical financial information has never been audited or reviewed, considerwhether the practitioner can obtain a sufficient understanding of the entity and its accountingand financial reporting practices to perform the engagement;(vi) If the event or transaction includes an acquisition and the acquiree’s historical financialinformation has never been audited or reviewed, consider whether the practitioner can obtain asufficient understanding of the acquiree and its accounting and financial reporting practices toperform the engagement; and(vii) Obtain the agreement of the responsible party that it acknowledges and understands itsresponsibility for:(1) Adequately disclosing and describing the applicable criteria to the intended users if these arenot publicly available;(2) Compiling the pro forma financial information on the basis of the applicable criteria; and(3) Providing the practitioner with:(a) Access to all information (including, when needed for purposes of the engagement,information of the acquiree(s) in a business combination), such as records, documentation andother material, relevant to evaluating whether the pro forma financial information has beencompiled, in all material respects, on the basis of the applicable criteria;

3402.2

(b) Additional information that the practitioner may request from the responsible party for thepurpose of the engagement;(c) Access to those within the entity and the entity’s advisors from whom the practitionerdetermines it necessary to obtain evidence relating to evaluating whether the pro formafinancial information has been compiled, in all material respects, on the basis of the applicablecriteria; and(d) When needed for purposes of the engagement, access to appropriate individuals within theacquiree(s) in a business combination.

4400.1

SRS 4400 -ENGAGEMENT TO PERFORM AGREED UPON PROCEDURE REGARDINGFINANCIALINFORMATION

Example of Report on SRS 4400

You have been appointed to perform Agreed upon Procedures in relation to X Ltd., for the year2011-12 in the area of inventory. Give your report (assume 2 procedures and 2 observations)REPORT ON FACTUAL FINDINGS

To,The management

We have performed agreed upon procedures in the area of inventory of X Ltd for the year ended31.03.2012. The management is responsible:a. For Preparation of financial statementsb. To provide all information and explanationc. To maintain books of accountsd. To maintain internal controle.To safeguard assets our responsibility is to apply agreed upon procedures and give

observations.Agreed upon procedures are those which are agreed between the client and the auditorwhereby after applying such procedures, the auditor gives the observation on the same. Theauditor performs agreed upon procedures in accordance with SRS 4400 as issued by ICAI.The agreed upon procedures areProcedure PI-Inventory valuation as per Accounting Standard 2 (Valuation of Inventories)Procedure P2-Vouching stores ledger, sales invoices and purchaseObservation O1-Based upon procedure PI, we have observed that the inventory is valued usingLIFO (Last in first out) method and it is overvalued by Rs50 crores. The inventory valuation is notas per Accounting Standard 2 as issued by ICAI.Observation 02-Based upon procedure P2, we have observed that closing stock valuation is notas per the rates of the closing stock categories,This is neither audit nor review; hence no opinion or assurance will be given,

Signature:Membership No:Firm Registration No:Date:Place:

4410.1

SRS 4410 - ENGAGEMENTS TO COMPILE FINANCIAL INFORMATION

Question-1

C & Co., hired Mr. A, Chartered Accountant, to compile its financial statements for the interimperiod ending on 31st December 2014. Kindly assist Mr. A in drafting scope of engagementletter with specific focus on C & Co's responsibility.

AnswerAs per SRS 4410 “Engagements to Compile Financial Information”, the engagement letter to beissued by Mr. A should state the following as management’s responsibility:1) The accuracy and completeness of the information supplied to us, including

maintenance of adequate accounting records and internal controls and selection andapplication of appropriate accounting policies.

2) Preparation and presentation of the financial statements of the entity, in accordance with theapplicable laws and regulations, if any.

3) Safeguarding the assets of the entity and also establishing appropriate controls designed toprevent and detect fraud and other irregularities.

4) Ensuring that the activities of the entity are carried in accordance with applicable laws andregulations and that it institutes appropriate controls to prevent and detect any non-compliance.

5) Ensuring complete disclosure of all material and relevant information to the accountant.

Question-2

Comment on the following:(a) You are appointed to compile financial statements of Y & Co. for tax purposes. During thecourse of work, you learn that the inventory is grossly understated. On pointing the same, thepartners of Y & Co. tell you that since you are not conducting an audit, the said figures dulycertified by the firm should be accepted.

Answer

1) Compilation of Financial Statements: According to SRS 4410 “Engagements to CompileFinancial Information”, if an accountant becomes aware of material misstatements, theaccountant should persuade the management to carry out necessary amendments in thefinancial statements or other compiled financial information.

2) If such amendments are not made and the financial statements are still consideredto be misleading the accountant should withdraw from the engagement.

3) As per guidance note on Tax Audit under section 44AB of the Income Tax Act, 1961, the stockauditor should study the procedure followed by the assesse in taking the inventory of closingstock at the end of the year and the valuation thereof.

4) The tax auditor should also examine the basis adopted for ascertaining the cost and this basisshould be consistently followed. It is very necessary for an auditor to ensure that themethod followed for valuation of stock results in disclosure of correct profit and gains.

In the instant case, appointment was made to compile financial statements for tax auditpurpose of Y & Co., a firm. It is our duty of to ensure that method followed for valuation ofstock results in disclosure of correct profit and gains.

4410.2

In this case the stock valuation was grossly understated. Consequently, disclosure of profit isalso not correct. Hence, contention of the Y & Co., that you are not the conducting an audit,the said figures duly certified by the firm should be accepted is not correct.

Question -3

Write a short note on Reporting on a compilation engagement.

Answer

Reporting on a compilation engagements: As per SA 4410 “Engagements to Compile FinancialInformation”, the report on compilation engagements should, ordinarily, be in the followinglayout:

a. Title: The title of the report should be “Accountant’s Report on Compilation of UnauditedFinancial Statements” (and not “Auditor’s Report”);

b. Addressee: The report should ordinarily be addressed to the appointing authority;c. Identification of the financial information also noting that it is based on the information

provided by the management;d. When relevant, a statement that the accountant is not ndependent of the entity;e. A statement that the management is responsible for:

♦ completeness and accuracy of the underlying data and complete disclosure of all materialand relevant information to the accountant;

♦ maintaining adequate accounting and other records and internal controls and selectingand applying appropriate accounting policies;

♦ preparation and presentation of financial statements or other financial information inaccordance with the applicable laws and regulations, if any;

♦ establishing controls to safeguard the assets of the entity and preventing anddetecting frauds or other irregularities;

♦ establishing controls for ensuring that the activities of the entity are carried out inaccordance with the applicable laws and regulations and preventing and detecting any non-compliance;

f. A statement that the engagement was performed in accordance with this Standard onRelated Services;

g. A statement that neither an audit nor a review has been carried out and that accordingly noassurance is expressed on the financial information;

h. A paragraph, when considered necessary, drawing attention to the disclosure of materialdepartures from the identified financial reporting framework;

i. Date of the report;j. Place of signature; andk. Accountant’s signature.

The financial statements or other financial information compiled by the accountant shouldcontain a reference such as “Unaudited,” “Compiled without Audit or Review” and also “Refer toCompilation Report” on each page of the financial information or on the front of thecomplete set of financial statements.

4410.3

Question-4

While compiling the financial statements of a concern, you observed that the inputinformation supplied by the concern is incomplete, incorrect and few of the AccountingStandards have not been followed. Describe, in brief, the procedure you will follow in theabove.

Answer

Compilation of Financial Information: According to SRS 4410 “Engagements to Compile FinancialInformation”, an accountant would normally have to rely upon the management for informationto compile the financial statements in a compilation engagement. If in the course of compilationof financial statements, it is observed that the information supplied by the entity is incorrect,incomplete or otherwise unsatisfactory, the accountant should perform following procedures:(1) Make any enquiries of management to assess the reliability and completeness of the

information provided;(2) Assess internal controls prevailing in the entity; and(3) Verify any matters or explanations.

The accountant may also request the management to provide additional information.This may be asked in the form of management representation letter. If themanagement refuses to provide additional information, the accountant shouldwithdraw from the engagement, informing the entity of the reasons for suchwithdrawal.

If one or more accounting standards are not complied with, the same should bebrought to the notice of the management and if the same is not rectified by themanagement, the accountant should include the same in notes to the accounts and thecompilation report to the management.

Question-5

Objectives of compilation engagement.

Answer

Objective of a Compilation Engagement: As per SRS 4410 “Engagements to Compile FinancialInformation”, the objective of a compilation engagement is for an accountant to use accountingexpertise, as opposed to auditing expertise, to collect, classify and summarise financialinformation. This ordinarily entails reducing detailed data to a manageable and understandableform without the requirement to test the assertions underlying that information. The proceduresemployed are not designed and do not enable the accountant to express any assurance on thefinancial information. However, users of the compiled financial information derive some benefitas a result of the accountant’s involvement because the service has been performed withprofessional competence and due care.A compilation engagement would ordinarily include the preparation of financial statements

(which may or may not be a complete set of financial statements) but may also include thecollection, classification and summarisation of other financial information, for example,preparation of quarterly financial results, restatement of financial statements in accordancewith a financial reporting framework other than in accordance with which the financialstatements to be restated are already prepared and presented.

4410.4

Question 6

Your engagement team member, Mr. Shyam, is engaged as practitioner for compilation ofhistorical financial information of Rama Ltd.You as a senior audit engagement team in-charge, brief him about what are the practitioner’sresponsibilities as he is engaged to assist management with the preparation and presentation ofhistorical financial information without obtaining any assurance on that information.

Answer

As per SRS 4410 “Compilation Engagements”, the engagement partner shall take responsibilityfor(i) The overall quality of each compilation engagement to which that partner is assigned; and(ii) The engagement being performed in accordance with the firm’s quality control policies andprocedures, by:(1) Following appropriate procedures regarding the acceptance and continuance of clientrelationships and engagements;(2) Being satisfied that the engagement team collectively has the appropriate competence andcapabilities to perform the compilation engagement;(3) Being alert for indications of non-compliance by members of the engagement team withrelevant ethical requirements, and determining the appropriate action if matters come to theengagement partner’s attention indicating that members of the engagement team have notcomplied with relevant ethical requirements;(4) Directing, supervising and performing the engagement in compliance with professionalstandards and applicable legal and regulatory requirements; and(5) Taking responsibility for appropriate engagement documentation being maintained.

SQC 1 - QUALITY CONTROL FOR FIRMS THAT PERFORM AUDIT AND REVIEWS OFHISTORICALFINANCIAL INF