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Question BankStandard On Auditing

C.A. FINALEDITION - 1

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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 anAudit in Accordance with Standards on Auditing

200.1-.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

AccountingEstimates, and Related Disclosures

540.1

SA 550 Related Parties 550.1SA 560 Subsequent Events 560.1SA 570 Going Concern 570.1SA 580 Written Representations 580.1

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600-699 Using Work of OthersSA 600 Using the Work of Another Auditor 600.1SA 610 Using The Work of Internal Auditors 610.1SA 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 intheIndependent Auditor’s Report

706.1

SA 710 Comparative Information - Corresponding Figures andComparativeFinancial 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

SpecialPurpose Frameworks

800.1

SA 805 Special Considerations - Audits of Single Financial StatementsandSpecific Elements, Accounts or Items of a Financial Statement

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 3402.14000-4699 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 HistoricalFinancialInformation, & other Assurance & Related ServicesEngagements

SQC.1

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200.1

SA – 200 (Revised)

“Overall Objectives of the Independent Auditor and Conduct of Audit in accordance with SAs

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

Answer-

The basic principles which govern the auditor’s professional responsibilities and which should becomplied 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 a knowledge of theclient’s business.

(vii) Audit evidence: The auditor should obtain sufficient appropriate auditevidence through the performance of compliance and

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200.2

substantive procedures to enable him to draw reasonableconclusions there from 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.

Question-2

Comment on the following:M/s XYZ & Co., auditors of Goodwill Education Foundation, a recognised nonprofit organisation feelsthat the standards on auditing need not be applied as Goodwill Education Foundation is a non-profitmaking 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, inthe independent examination of financial statements/information of any entity; whether profit-oriented or not and irrespective of its size, or legal form (unless specified otherwise) when such anexamination 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 to ensurethat SAs are followed in the audit of financial information covered by their audit reports.

(d) In the given case, even though the client is a non-profit oriented entity the SAs shall apply andthe auditor shall be guilty of professional misconduct for failing to discharge his duty in case of non-compliance with SAs.

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210.1

SA 210 (REVISED)AGREEING THE TERMS OF AUDIT ENGAGEMENTS

Question 1

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

Answaer-As per SA 210 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, the followingfactors may make it appropriate to revise the terms of the audit engagement or to remind the entity ofexisting terms:

(i) Any indication that the entity misunderstands the objective and scope of the audit.(ii) Any revised or special terms of the audit engagement.(iii) A recent change of senior management.(iv) A significant change in ownership.(v) A significant change in nature or size of the entity’s business.(vi) A change in legal or regulatory requirements.(vii) A change in the financial reporting framework adopted in the preparation of the financial

statements.(viii) A change in other reporting requirements.

Question 2M/s. PQR & Company, Chartered Accountants have been appointed StatutoryAuditors of a listed Company for the year ended 31st March, 2008. Draft anappropriate engagement letter to be sent to the Board of Directors for the same.

Refer Class Notes

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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 out the audit of W Ltd., amanufacturer of waste paper bins. You are unhappy with W Ltd.'s inventory valuation policy and have raised theissue several times with the audit manager. He has dealt with the client for a number of years and does not see whatyou are making a fuss about. 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 had dealt with W Ltd. for somany years, the other partners have decided to leave the audit of W Ltd. in his capable hands. Comment on thesituation 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 engagementon behalf 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 therequirements of SA 220 directing, supervising and reviewing the audit are not inplace.

(3) Conflicting Views: In this scenario the audit manager and senior haveconflicting views about the valuation of inventory. This does not appear to havebeen handled well, with the manager refusing to discuss the issue with thesenior.

(4) Resolving of Disputes: SA 220, requires that the audit engagement partner takesresponsibility for setting disputes in accordance with the firm's policy in respectof resolution of difference of opinion required by SQC 1" Quality Control forFirms that Perform Audits and Reviews of Historical Financial Information, andOther Assurance and Related Services Engagements".

(5) Reasons for Failure to Resolve the Disputes: In this case, the lack ofengagement partner may have contributed to this failure to resolve the disputes.In any event, at best, the failure to resolve the difference of opinion is a breach ofthe firm's policy under SQC 1. At worst, it indicates that the firm does not havea suitable policy concerning such disputes required by SQC.l "Quality Controlfor Firms that Perform Audits and Reviews of Historical Financial Information,and Other Assurance and Related Services Engagements".

Question-2"The work performed by each assistant needs to be reviewed by personnel of at leastequal competence."(May 2011)

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220.2

Answer:Reviewing the work performed by Assistant: As per SA 220 "Quality Control foran Audit of Financial Statements" the firm's review responsibility policies andprocedures are determined on the basis that work of less experienced teammembers is reviewed by more experienced team members.

EP is responsible for the engagement and its performance, and for the report thatis issued on behalf of the firm, and who, where required, has the appropriateauthority from a professional, 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 ofconsideration whether, for example:

(1) The work has been performed in accordance with professional standards andregulatory and legal 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-3Importance of KYC Requirements for a Chartered Accountant's Practice. (Nov 2014)

Answer

As per SA-220 (Revised) The practicing chartered accountant should obtaininformation regarding the client, whether or not to undertake the assignment withthe client. This may be due 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 toprovide it with reasonable assurance that it will undertake or continuerelationships and engagements only where it:

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220.3

a) Has considered the integrity of the client and does not have information thatwould lead it to conclude that the client lacks integrity;

b) Is competent to perform the engagement and has the capabilities, time andresources to do so; 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 decidingwhether to continue an existing engagement, and when considering acceptanceof a new engagement with an existing client.

With regard to the integrity of a client matters that the firm considers include, forexample:

(1) The identity and business reputation of the client's principal owners, keymanagement, 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 asaggressive interpretation of accounting standards and the internal controlenvironment.

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

(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.

CA SURENDRA AGRAWAL


230.1

SA 230 - AUDIT DOCUMENTATION

Question-1

As an auditor how would you deal with the following: The statutory auditor of theholding company demands for the working paper of the auditors of the subsidiarycompany, of which you are the auditor?Answer:

As per SA 230, “Audit Documentation” working papers are the property of the auditor.The auditor may, at his discretion, make portion of or extracts of his working papersavailable to his client.

SA 600 “Using the Work of Another Auditors” also states that an auditor should respectthe confidentiality of information acquired during the course of his audit work andshould not disclose such information unless there is a legal or professional duty todisclose.

As per ICAI Guidelines, statutory auditor of an enterprise do not have right of access tothe audit working papers of the branch auditor. An auditor can rely on the work ofanother auditor, without having any right of access to the audit working papers of otherauditor.Conclusion: Statutory auditor of Holding company cannot have access to auditworking papers of the subsidiary company’s auditor. He can however, asks the auditorto answer certain questions about the manner in which the audit is conducted andcertain other clarifications regarding audit

Question-2

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

Answer

Record of: Audit procedures performed Relevant audit evidence obtained, & Conclusions reached

Purposeincludes 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.

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230.2

(5) Quality control review and inspections(6) Conduct of external inspections.

Question-3Discuss various contents of permanent audit file and current file. (Nov 2005, May2007)Answer-(1) Permanent Audit file: It includes -

(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 minutesrelevant to the audit.

(3) A record of the study and evaluation of the internal controls related to theaccounting 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.

(2) 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 weaknessesin relevant internal controls.

(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.

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240.1

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

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. Asa 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 isrequired to perform his responsibilities as laid down in SA 240, “The Auditor’sresponsibilities relating to Fraud in an Audit of Financial Statements”. First of all, as perSA 240, the auditor needs to perform procedures whether the financial statements arematerially misstated. Because an instance of fraud cannot be considered as an isolatedoccurrence and it becomes important for the auditor to perform audit procedures andrevise the audit risk assessment. Secondly, the auditor needs to consider the impact offraud on financial statements and its disclosure in the audit report. Thirdly, the auditorshould communicate the matter to the Chairman and Board of Directors. Finally, inview of the fact that the fraud has been committed at the highest level of management,it affects the reliability of audit evidence previously obtained since there is a genuinedoubt about representations of management.

Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company,in the course of the performance of his duties as auditor, has reason to believe that anoffence involving fraud is being or has been committed against the company by officersor employees of the company, he shall immediately report the matter to the CentralGovernment within 60 days of his knowledge and after following the prescribedprocedure.

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240.2

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 March2014, an auditor found out an error in the valuation of inventory, which affects thefinancial statement materially – Comment as per standards on auditing.

Answer

Errors in Valuation of Inventories and Auditor’s Responsibilities: SA 240, “TheAuditor’s Responsibilities Relating Fraud in an Audit of Financial Statements”, requiresthat if circumstances indicate the possible existence of fraud or error, the auditor shouldconsider the potential effect of the suspected fraud or error on the financialinformation.

If the auditor believes the suspected fraud or error could have a material effect on thefinancial information, he should perform such modified or additional procedures ashe determines to be appropriate.

SA 240 also requires that when the auditor identifies a misstatement, the auditor shallevaluate whether such a misstatement is indicative of fraud.

If there is such an indication, the auditor shall evaluate the implications of themisstatement in relation to other aspects of the audit, particularly the reliability ofmanagement representations, recognizing that an instance of fraud is unlikely to be anisolated occurrence.

The auditor should consider requesting the management to adjust the financialinformation or consider extending his audit procedures. If the management refusesto adjust the financial information and the results of extended audit procedures do notenable the auditor to conclude that the aggregate of uncorrected misstatements is notmaterial, the auditor should express a qualified or adverse opinion, as appropriate. Inthe instant case, the auditor has detected the material errors affecting the financialstatements; the auditor should communicate his findings to the management on atimely basis, consider the implications on true and fair view and also ensure thatappropriate disclosures have been made.

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240.3

Question-3

M/s Honest Limited has entered into a transaction on 5th March, 2014, near year-end,whereby it has agreed to pay ` 5 lakhs per month to Mr. Y as annual retainer-ship feefor "engineering consultation". No amount was actually paid, but ` 60 lakhs isprovided in books of account as on March 31, 2014.

Your inquiry elicits a response that need-based consultation was obtained roundthe year, but there is no documentary or other evidence of receipt of the service. Asthe auditor of M/s Honest Limited, what would be your approach?

Answer

As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit ofFinancial Statements”, fraud can be committed by management overridingcontrols using such techniques as Recording fictitious journal entries, particularly closeto the end of an accounting period, to manipulate operating results or achieve otherobjectives.

Keeping in view the above, it is clear that Company has passed fictitious journal entriesnear year end to manipulate the operating results. Also Auditor’s enquiry eliciteda response that need-based consultation was obtained round the year, but there is nodocumentary or other evidence of receipt of the service, is not acceptable.

Accordingly, the auditor would adopt the following approach-

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, in the course of the performance of his duties as auditor, has reason to believethat an offence involving fraud is being or has been committed against the company byofficers or employees of the company, he shall immediately report the matter to the

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

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240.4

Central Government within 60 days of his knowledge and after following theprescribed procedure.

Question-4

In the course of audit of K Ltd., its auditor Mr. 'N' observed that there was a specialaudit conducted at the instance of the management on a possible suspicion of a fraudand requested for a copy of the report to enable him to report on the fraud aspects.Despite many reminders it was not provided. In absence of the special audit report,Mr. 'N' insisted that he be provided with at least a written representationin respect of fraud on/by the company. For this request also, the management remainedsilent. Please guide Mr. 'N'.

Answer

Auditors Responsibilities Relating to Fraud: As per SA 240, “The Auditor’sResponsibilities relating to Fraud in an Audit of Financial Statements”, the primaryresponsibility for the prevention and detection of fraud rests with both those chargedwith governance of the entity and management. In addition an auditor conducting anaudit in accordance with SAs is responsible for obtaining reasonable assurance that thefinancial statements taken as a whole are free from material misstatement, whethercaused by fraud or error.

The risk of not detecting a material misstatement resulting from fraud is higher than therisk of not detecting one resulting from error. This is because fraud may involvesophisticated and carefully organized schemes designed to conceal it, such as forgery,deliberate failure to record transactions, or intentional misrepresentations being madeto the auditor.

As per SA 580, “Written Representations”, if management modifies or does not providethe requested written representations, it may alert the auditor to the possibility that oneor more significant issues may exist. Further, If management does not provide one ormore of the requested written representations, the auditor shall discuss the matter withmanagement; re-evaluate the integrity of management and evaluate the effect that thismay have on the reliability of representations (oral or written) and audit evidence in

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240.5

general; and take appropriate actions, including determining the possible effect on theopinion in the auditor’s report.

In the instant case, in the course of audit of K Ltd., its auditor Mr. N observed that therewas a special audit conducted at the instance of the management on a possiblesuspicion of fraud. Therefore, the auditor requested for special audit report, whichwas not provided by the management despite of many reminders. Mr. N also insistedfor written representation in respect of fraud on/by the company. For this request alsomanagement remained silent.

Hence, the fact is required to be reported and the auditor should also disclaim anopinion on the financial statements.

Question-5

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

Answer

As per SA 240, “”, Fraudulent financial reporting involves intentional misstatementsor omissions of amounts or disclosures in financial statements to deceive financialstatement users. It may be accomplished by manipulation, falsification, or alteration ofaccounting records or supporting documents from which the financial statements areprepared or Misrepresentation in, or intentional omission from, the financial statementsof events, etc.

It often involves management override of controls, misappropriation of assetsetc that otherwise may appear to be operating effectively. Fraud can be committedby management overriding controls using such techniques as:

(1) Recording fictitious journal entries, particularly close to the end of anaccounting period, to manipulate operating results or achieve other objectives.

(2) Inappropriately adjusting assumptions and changing judgments used toestimate account balances.

(3) Omitting, advancing or delaying recognition in the financial statements ofevents and transactions that have occurred during the reporting period.

(4) Concealing, or not disclosing, facts that could affect the amounts recordedin the financial statements.

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240.6

(5) Engaging in complex transactions that are structured to misrepresent thefinancial 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 personalbank accounts).

(8) Stealing physical assets or intellectual property (for example, stealinginventory for personal use or for sale, stealing scrap for resale, colludingwith a competitor by disclosing technological data in return for payment).

(9) Causing an entity to pay for goods and services not received (for example,payments to fictitious vendors, kickbacks paid by vendors to the entity’spurchasing agents in return for inflating prices, payments to fictitiousemployees).

Question-6

Explain briefly duties and responsibilities of an auditor in case of materialmisstatement resulting 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 withboth those 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 isproperly planned 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. Collusionmay cause 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 financial

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240.7

information 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 of controlsand recognizing the fact that audit procedures that are effective for detecting error may not beeffective in detecting fraud.

Question -7 Comment on the following: While conducting statutory Audit of ABC Ltd., youcome across IOUs amounting to Rs. 2 crores as against a cash balance shown in books of Rs. 2.10crores. You also observe that despite similar high balances throughout the year, small amountsof Rs. 50,000 are withdrawn from the bank to meet day-to-day expenses. [May 09 - New (5marks)]

Answer: According to SA 240 "Auditors responsibilities relating to Fraud in an audit offinancial statements", 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.

In this case, the circumstances indicate the possibility of fraud and accordingly, the] auditormust investigate 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 cashmore frequently 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 thisfact appropriately in his Audit Report.

Question 8

You notice a misstatement resulting from fraud or suspected fraud during the auditand conclude that it is not possible to continue the performance of audit. As a StatutoryAuditor, 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,the auditor shall:

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

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

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240.8

3. If the auditor withdraws:

a. Discuss with the appropriate level of management and those charged withgovernance, the auditor’s withdrawal from the engagement and the reasons forthe withdrawal; and

b. Determine whether there is a professional or legal requirement to reportto the person or persons who made the audit appointment or, in some cases, toregulatory authorities, the auditor’s withdrawal from the engagement and thereasons 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 march2012, an auditor found out an error in the valuation of inventory, which affects thefinancial Statement materially - comment as per standards on auditing." (RTP Nov2013)

Answer-

(1) SA 240 requires that if circumstances indicate the possible existence of fraud orerror, the auditor should consider the potential effect of the suspected fraud orerror on the financial information.

(2) If the auditor believes the suspected fraud or error could have a material effecton the financial information, he should perform such modified or additionalprocedures as he determines to be appropriate.

(3) SA 240 also requires that whence auditor identifies a misstatement, the auditorshall evaluate whether such a misstatement is indicative offraud.

(4) If there is such an indication, the auditor shall evaluate the implications of themisstatement in relation to other aspects of the audit, particularly the reliabilityof management representations, recognising that an instance of fraud is unlikelyto be an isolated occurrence.

(5) Further, SA 320 Materiality in Planning and Performing an Audit, also requiresthat in such circumstances, the auditor should consider requesting themanagement to adjust the financial information or consider extending his auditprocedures.

(6) If the management refuses to adjust the financial information and the results ofextended audit procedures do not enable the auditor to conclude that theaggregate of uncorrected misstatements is not material, the auditor shouldexpress a qualified or adverse opinion, as appropriate.

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240.9

(7) In the instant case, the auditor has detected the material errors affecting thefinancial statements; the auditor should communicate his findings to themanagement on a timely basis, consider the implications on true and fair viewand also ensure that appropriate disclosures have been made.

Question-10

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

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250.1

SA 250 - CONSIDERATIONS OF LAW AND REGULATIONS IN AN AUDIT OFFINANCIAL STATEMENTS

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 portionof the labour employed was child labour. On questioning the management, the auditorwas told that it was outside his scope of the financial audit to look into the compliancewith other laws.

Question-2State the reporting responsibility of an auditor in the context of non-compliance ofLaw and Regulation in an audit of Financial Statement.

Answer

Reporting responsibility of an auditor in the context of non-compliance of Lawand Regulation: According to SA 250 “Consideration of Laws and Regulations inan Audit of Financial Statements”, the reporting responsibilities of an Auditor may bedivided into the following categories-

Reporting Non-Compliance to Those Charged with Governance: Unless all ofthose charged with governance are involved in management of the entity, andtherefore are aware of matters involving identified or suspected non-compliancealready communicated by the auditor, the auditor shall communicate with thosecharged with governance matters involving non-compliance with laws andregulations that come to the auditor’s attention during the 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 beintentional and material, the auditor shall communicate the matter to those chargedwith governance as soon as practicable.

If the auditor suspects that management or those charged with governance areinvolved in non-compliance, the auditor shall communicate the matter to the nexthigher level of authority at the entity, if it exists, such as an audit committee orsupervisory board. Where no higher authority exists, or if the auditor believes that thecommunication may not be acted upon or is unsure as to the person to whom toreport, the auditor shall consider the need to obtain legal advice.

Reporting Non-Compliance in the Auditor’s Report on the Financial Statements: If

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250.2

the auditor concludes that the non-compliance has a material effect on the financialstatements, and has not been adequately reflected in the financial statements, theauditor shall, in accordance with SA 705 express a qualified or adverse opinion onthe financial statements.

If the auditor is precluded by management or those charged with governance fromobtaining sufficient appropriate audit evidence to evaluate whether non-compliancethat may be material to the financial statements has, or is likely to have, occurred, theauditor shall express a qualified opinion or disclaim an opinion on the financialstatements on the basis of a limitation on the scope of the audit in accordance with SA705.

If the auditor is unable to determine whether non-compliance has occurredbecause of limitations imposed by the circumstances rather than by management orthose charged with governance, the auditor shall evaluate the effect on the auditor’sopinion in accordance with SA 705.

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

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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 theaudit of financial statements with those charged with the governance of an entity”. Brieflystate the matters 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 thefinancial statements that have been prepared by management with the oversightof those charged with governance; and

(ii) The audit of the financial statements does not relieve management or thosecharged with governance 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’saccounting practices, including accounting policies, accounting estimates andfinancial statement disclosures. When applicable, the auditor shall explain tothose charged with governance why the auditor considers a significantaccounting practice, that is acceptable under the applicable financial reportingframework, not to be most appropriate to the particular circumstances of theentity;

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 audit that, in the auditor’s professional

judgment, are significant to the oversight of the financial reporting process.

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260.2

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:

As per SA 260, the auditor may decide whether to communicate orally or in writing, the extentof detail or summarization in the communication, and whether to communicate in a structuredor unstructured 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.

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265.1

SA 265

COMMUNICATING DEFICIENCIES IN INTERNAL CONTROL TO THOSE CHARGED WITH GOVERNANCE(TCWG) & MANAGEMENT

Question -1Indicate the precise nature of auditor's liability in the following situations and supportyour views 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 thesame to the knowledge of the Managing Director of the company. In the subsequent yearhuge defalcation came to the notice of the management. The origin of the same wastraced to the earlier year. The management wants to sue the auditor for negligence andalso plans to file 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 theunder noted 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)Answers-

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 thedesign of the internal control system and non-compliance with identified controlprocedures increase 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 financialinformation. If the auditor believes the suspected fraud or error could have a materialeffect on the financial information, he should perform such modified or additionalprocedures as he determines to be appropriate. Thus, normally speaking, as long asthe auditor took due care in performing the audit work, he cannot be held liable.

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299.1

SA-299 (Responsibility of joint Auditors)

Question:1Write a short note on Responsibility of Joint Auditors.AnswerResponsibility of Joint Auditors: SA 299 on, “Responsibility of Joint Auditors” dealswith the professional responsibilities, which the auditors undertake in accepting suchappointments as joint auditors. Main features of the said SA are discussed below:

♦ Division of Work: Where joint auditors are appointed, they should, by mutualdiscussion, divide the audit of identifiable units or specified areas. Certain areas ofwork, owing to their importance or owing to the nature of work involved would notbe divided and would be covered by all the joint auditors. Such a division affectedby the joint auditors should be adequately documented and preferablycommunicated to the auditee.♦ Coordination: Where in the course of his work, a joint auditor comes acrossmatters which are relevant to the areas of other joint auditors and which require jointdiscussion, he should communicate the same to all the other joint auditors in writingbefore the finalisation of audit and preparation of audit report.In respect of the work divided amongst the joint auditors, each joint auditor isresponsible only for the work allocated to him, whether or not he has made a separatereport 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 iscarried out by all of them.(ii) in respect of decisions taken by all the joint auditors concerning the nature, timingor extent of the audit procedures to be performed by any of the joint auditors.(iii) in respect of matters which are brought to the notice of the joint auditors by anyone of them and on which there is an agreement among the joint auditors.(iv)for examining that the financial statements of the entity comply with the disclosurerequirements of the relevant statute.(v) for ensuring that the audit report complies with the requirements of therelevant statute.(vi)it is the separate and specific responsibility of each joint auditor to study andevaluate the prevailing system of internal control relating to the work allocated to him,the extent of enquiries to be made in the course of his audit.(vii) the responsibility of obtaining and evaluating information and explanation fromthe management is generally a joint responsibility of all the auditors.(viii) each joint auditor is entitled to assure that the other joint auditors have carriedout their part of work in accordance with the generally accepted audit procedures andtherefore it would not be necessary for joint auditor to review the work performed byother joint auditors.Normally, the joint auditors are able to arrive at an agreed report. However where thejoint auditors are in disagreement with regard to any matters to be covered by thereport, each one of them should express his own opinion through a separate report. A

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299.2

joint auditor is not bound by the views of majority of joint auditors regarding mattersto be covered in the report and should express his opinion in a separate report in caseof a disagreement.

Question -2ABC & Co. and DEF & Co., Chartered Accountant Firms were appointed as jointauditors of Good Health Care Limited for 2009-10. A special audit was conducted u/s233A of the Companies Act, 1956 during March 2011 and observed gross understatementof revenue. The revenue aspects were look after by DEF & Co., but there was nodocumentation for the division of work between the joint auditors.

Answer(1)As per SA 299 "Responsibilities of Joint Auditor" where joint auditors areappointed, they should, 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 isresponsible only 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 theirpart of work as per generally accepted audit procedure. It is not necessary for themto review the other joint auditor's work(7)In the present case, though the revenue aspects were looked after by DEF & Co.,but as there is no documentation for division of the work between them, ABC & Co,has not reviewed the work as they have put their reliance on the work performed byDEF & Co.(8)There is a violation of SA 299 as the division of work has not been documented,normally DEF & Co. Will be held liable for negligence, if DEF & Co refuses to acceptsole responsibility for fault then ABC & Co will have to prove by other ways andmeans of evidences that the particular area of audit was exclusively done by DEF &Co. only.

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300.1

SA 300

PLANNING AN AUDIT OF FINANCIAL STATEMENTS

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315.1

SA 315 - IDENTIFYING AND ASSESSING THE RISK OF MATERIALMISSTATEMENT

THROUGH 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 undertookthe risk assessment and found that the detection risk relating to certain class oftransactions cannot be reduced to acceptance level.

Answer

Assessment of Risk and Acceptable Level: SA 315 and SA 330 “Identifying andAssessing the Risk of Material Misstatement Through Understanding the Entityand its Environment” and “The Auditor’s Responses to Assessed Risks”establishes standards on the procedures to be followed to obtain anunderstanding of the accounting and internal control systems and on auditrisk and its components: inherent risk, control risk and detection risk.

SA 315 and SA 330 require that the auditor should use professional judgement toassess audit risk and to design audit procedures to ensure that it isreduced to an acceptably low level. “Detection risk” is the risk that anauditor’s substantive procedures will not detect a misstatement that exists in anaccount balance or class of transactions that could be material. The higher theassessment of inherent and control risks, the more audit evidence theauditor should obtain from the performance of substantive procedures.

When both inherent and control risks are assessed as high, the auditor needsto consider whether substantive procedures can provide sufficient appropriateaudit evidence to reduce detection risk, and therefore audit risk, to an acceptablylow level.

The auditor should use his professional judgement to assess audit risk and todesign audit procedures to ensure that it is reduced to an acceptably low level. Ifit cannot be reduced to an acceptable level, the auditor should express a qualifiedopinion or a disclaimer of opinion as may be appropriate.

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315.2

Question -2

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

Answer

Specific Risk to an Entity’s internal Control: As per SA 315 “Identifying and Assessingthe Risks of Material Misstatement through Understanding the Entity andits Environment”, IT system also poses specific risks to an entity’s Internal Control.They are–

(1) Reliance on systems or programs that are inaccurately processing data, processinginaccurate data or both.

(2) Unauthorised access to data that may result in destruction of data orimproper changes to data, including the recording of unauthorized ornon-existent transactions, or inaccurate recording of transactions. Particular riskmay arise when multiple users access a common database.

(3) The possibility of IT personnel gaining access beyond those necessary to performtheir assigned 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 auditpartner you are concerned about inherent and control risk for material financialstatement assertions. What could be the areas you look forward for deficiencies andrisk identification? (May 2010)

Answer

The auditor in accordance with SA 314 should make an assessment of inherent andcontrol risk for material financial statement assertions. In a CIS environment the risk ofa Material financial statement ascertain being erroneously stated could arise from thedeficiencies in the following case as

1. Program Development and maintenance.

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315.3

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 thatare processed through the computer.

Question -3

Amu & Co. was appointed as auditor of Great India Ltd. As the audit partner whatare the points to be considered while evaluating the "Knowledge of the Business" inthe conduct of an audit? (RTP)

Answer-

The Broad matters to be considered while obtaining knowledge of business for a newaudit assignment are set out in SA 315 Identifying and Assessing the Risks of MaterialMisstatement through Understanding the Entity and its environment.

1. Relevant industry, regulatory, economic and other external factors including theapplicable financial reporting framework

2. 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, includinginvestments in 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 expectedin the financial statements.

3. The entity's selection and application of accounting policies.

4. The entity's objectives and strategies, and those related business risks that mayresult in risks of material misstatement.

5. The measurement and review of the entity's financial performance.

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315.4

Question- 4

Comments on the following:

While carrying out the statutory audit of a large entity, what are the substantiveprocedures to be 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'sjudgment may have information that is likely to assist in identifying risks of materialmisstatement due to fraud or error.

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

Question-5

Explain briefly the Flow Chart technique for evaluation of the Internal Controlsystem

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 showthe controls in each section or sub-section, it provides most concise and comprehensiveway for reviewing the internal controls and the evaluator's findings, brings the e controlstructure in a most condensed and meaningful manner.

Question-6

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

Answer

SA 315 & SA 330 prescribes that the auditor should obtain an understanding of theaccounting and internal control systems sufficient to plan the audit and develop aneffective audit approach, in this context, surprise checks intend to ascertain whether thesystem of internal control is operating effectively and whether the accounting and otherrecords are prepared concurrently and kept up-to-date. Surprise checks are a useful

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315.5

method of determining whether or not errors exist and where they exist, of bringing thematter promptly to the attention of the management so that corrective action is takenimmediately. Consequently, surprise visits by the auditor can exercise a good moralcheck on the client's staff.

Therefore Surprise Checks help the auditors to ascertain whether the internal controlsystem is operating effectively in a Company or not

Question-7

M/s Sodhi & Associates have been appointed as the auditor of Raheja Ltd. Engagedin the business of manufacturing and export of handloom goods. The partner of thefirm explains to the audit team that the formulation of audit strategy shall form thebasis of audit planning to achieve the audit objectives in the most effective andefficient manner. As head of the audit team, narrate the steps involved in theformulation of audit strategy. RTP Nov 2013

Answer-

Audit strategy is concerned with designing optimised audit approaches that seeks toachieve the necessary audit assurance at the lowest cost within the constraints of theinformation available. The formulation of audit strategy as shall be evident from theprocess as explained in the following paragraphs in fact shall form the basis of auditplanning to achieve the audit objectives in the most efficient and effective manner.Audit strategy generally involves the following steps:

a) Knowledge of Business

b) Performing analytical procedures

c) Evaluating Inherent risk

d) Evaluating Internal Control

Question-8

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

Answer-

Internal Check System - Internal check system implies organization of the overallsystem of book-keeping and arrangement of Staff duties in such a way that no one

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315.6

person can carry through a transaction and record every aspect thereof. It is a part ofoverall control system and operates basically as a built-in-device as far as organizationand job-allocation aspects of the controls are concerned.

The general condition pertaining to the internal check system may be summarized asunder -

(1) No single person should have complete control over any important aspect of thebusiness operation. Every employee's action should come under the review ofanother person.

(2) Staff duties should be rotated from time to time so that members do not performthe 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 physicalcondition.

(6) Mechanical devices should be used, where ever practicable to prevent loss ormisappropriation of cash.

(7) Budgetary control should be exercised and wide deviations observed should bereconciled.

(8) For stock taking, at the close of the year, trading activities should, if possible besuspended, and it should be done by staff belonging to several sections of theorganization.

(9) The financial and administrative powers should be distributed very judiciouslyamong different officers and the manner in which those are actually exercisedshould be reviewed periodically.

(10) Procedures should be laid down for periodical verification and testing of differentsections of 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.

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315.7

(ii) To avoid and minimize the possibility of commission of errors and fraud by anystaff.

(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 subjectto proper scrutiny and check.

(vi) To prevent and avoid the misappropriation or embezzlement of cash andfalsification of accounts.

10. You are the auditor of Vishakha Steel Pressing Limited, which manufacturessmall pressing from sheet-steel. The process generates scrap steel which is placeddaily by the work force into a bin kept for that purpose in the yard. Every Friday alorry arrives from a small local scrap merchant. The bin is loaded on to the lorry andreplaced by an empty bin. The weight is obtained by the gatekeeper using thecompany weighbridge. He notes the weight in a book kept for that purpose in thegate office. Each month a cheque is received through the post from the scrapmerchant accompanied by a remittance advice stating the weight of scrap collected,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 arerequired 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 Nov 2014

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 beachieved 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 marketprice and validation.

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

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315.8

(iv) An independent official should attend the weighing and the enter in the book. Keyaudit procedures 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 andvariance being investigated.

(ii) Compare remittance advices/related quantity and reconcile with the quantity ingate keeper's book.

(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 withmanufacturing records of steel used in processing

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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 theconcept of materiality for the financial statements as a whole. Please guide him as tothe factors that may affect the identification of an appropriate benchmark for thispurpose.

Answer-

SA 320 “Materiality in Planning and Performing an Audit” prescribes the use ofBenchmarks in Determining Materiality for the Financial Statements as a Whole.Factors that may affect the identification of an appropriate benchmark includethe 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 particularentity’s financial statements tends to be focused (for example, for the purpose ofevaluating financial performance users may tend to focus on profit, revenue ornet assets);

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

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

(v) The relative volatility of the benchmark.

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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 evidenceobtained in previous audit in respect of effectiveness of internal controls instead ofretesting the same during the current audit. As an advisor to the auditor kindlycaution him about the factors that may warrant a re-test of controls

Answer

(a) As per SA 330 on “The Auditor’s Responses to Assessed Risks”, changes mayaffect the relevance of the audit evidence obtained in previous audits such that theremay no longer be a basis for continued reliance.

The auditor’s decision on whether to rely on audit evidence obtained in previous auditsfor control is a matter of professional judgment. In addition, the length of time betweenretesting such 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 substantiveprocedures to be performed to assess the risk of material misstatement?

Answer:

Substantive Procedures to be performed to assess the risk of material misstatement: Asper SA 330, “The Auditor’s Response to Assessed Risk”, substantive procedure is anaudit procedure designed to detect material misstatements at the assertion level. Theycomprise tests of details and substantive analytical procedures.

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330.2

2

Test of Details: The nature of the risk and assertion is relevant to the design of tests ofdetails. For example, tests of details related to the existence or occurrence assertion mayinvolve selecting from items contained in a financial statement amount andobtaining the relevant audit evidence. On the other hand, tests of details relatedto the completeness assertion may involve selecting from items that are expected to beincluded in the relevant financial statement amount and investigating whether they areincluded.

In designing tests of details, the extent of testing is ordinarily thought of in terms of thesample size.

Substantive Analytical Procedure: Substantive analytical procedures are generallymore applicable to large volumes of transactions that tend to be predictable overtime. The application of planned analytical procedures is based on the expectation thatrelationships among data exist and continue in the absence of known conditions to thecontrary. However, the suitability of a particular analytical procedure will depend uponthe auditor’s assessment of how effective it will be in detecting a misstatement that,individually or when aggregated with other misstatements, may cause the financialstatements to be materially misstated.

In some cases, even an unsophisticated predictive model may be effective as ananalytical procedure. For example, where an entity has a known number of employeesat fixed rates of pay throughout the period, it may be possible for the auditor to use thisdata to estimate the total payroll costs for the period with a high degree ofaccuracy, thereby providing audit evidence for a significant item in the financialstatements and reducing the need to perform tests of details on the payroll. The useof widely recognised trade ratios (such as profit margins for different types ofretail 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 andperform substantive 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 allrisks of material misstatement; and;

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330.3

3

There are inherent limitations to internal control, including managementoverride. Depending on the circumstances, the auditor may determine that:

Performing only substantive analytical procedures will be sufficient to reduce theaudit 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 -2

Procedure in case detection risk cannot be reduced to acceptance levelOR

"While commencing the statutory audit of B Company Limited, the auditor undertookthe risk assessment and found that the detection risk relating to certain class oftransactions cannot be reduced to acceptance level." (RTP)Answer-

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

(2) These standards require that the auditor should use professional judgement toassess audit risk and to design audit procedures to ensure that it is reduced to anacceptably low level.

(3) "Detection risk" is the risk that an auditor's substantive procedures will notdetect a misstatement that exists in an account balance or class of transactionsthat could be material.

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

(5) When both inherent and control risks are assessed as high, the auditor needs toconsider whether substantive procedures can provide sufficient appropriateaudit evidence to reduce detection risk, and therefore audit risk, to an acceptablylow level.

(6) 6. The auditor should use his professional judgement to assess audit risk and todesign audit procedures to ensure that it is reduced to an acceptably low level. If

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330.4

4

it cannot be reduced to an acceptable level, the auditor should express a qualifiedopinion or a disclaimer of opinion as may be 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 inprevious audit in respect of effectiveness of internal controls instead of retesting thesame during the current audit. As an advisor to the auditor kindly caution him aboutthe factors that may warrant a re-test of controls (May 2013)Answer-

As per SA 330, Responses to assessed Risk, In determining whether it is appropriate touse audit evidence about the operating effectiveness of controls obtained in previousaudits, and, if so, the length of the time period that may elapse before retesting acontrol, the auditor shall consider the following:

(1) The effectiveness of other elements of internal control, including the controlenvironment, the entity's monitoring of controls, and the entity's risk assessmentprocess

(2) The risks arising from the characteristics of the control, including whether it ismanual 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 previousaudits, and whether there have been personnel changes that significantly affectthe application of the control.

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

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

CA SURENDRA AGRAWAL


402.1

SA 402 - AUDIT CONSIDERATIONS RELATING TO AN ENTITY USING A SERVICEORGANISATION

Question -1

G Ltd. is a mobile phone operating company. Barring the marketing function it hadoutsourced the entire operations like maintenance of mobile infrastructure,customer billing, payroll, accounting functions, etc. Assist the auditor of G Ltd. as tohow he can obtain an understanding of how G Ltd. uses the services of the outsourcedagency 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 withSA 315 “Identifying and Assessing the Risks of Material Misstatement throughUnderstanding the Entity and its Environment”, the user auditor shall obtain anunderstanding of how a user entity uses the services of a service organisation in theuser entity’s operations, including:

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

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

(iii) The degree of interaction between the activities of the service organisation andthose of the user 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 costreduction. As a Statutory Auditor of such a company, what are the additionalprecautions/checks that you would consider for conduct of the audit?

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402.2

Answer

Precaution to be taken by auditor in case accounting data processed by thirdparty: Processing of accounting data may be given to a third party onaccount of various considerations such as economy, own computer working tofull capacity, an interim measures restricting accessibility to sensitiveinformation, etc.

A client may use a service organisation such as one that executes transactionsand maintains related accountability or records transactions and processesrelated data (e.g., a computer systems service organisation).

If a client uses a service organisation, certain policies, procedures and recordsmaintained by the service organisation might be relevant to the audit of thefinancial statements of the client. Consequently, the auditor would consider thenature and extent of activities undertaken by service organisations so as todetermine whether those activities are relevant to the audit and, if so, to assesstheir effect on audit risk.

As per SA 402 “Audit Considerations relating to an Entity using a ServiceOrganization”, when obtaining an understanding of the user entity in accordancewith SA 315, the user auditor shall obtain an understanding of how a user entity usesthe services of a service organisation in the user entity’s operations, including:

(a) The nature of the services provided by the service organisation and thesignificance of those services to the user entity, including the effect thereof on the userentity’s internal control;

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

(c) The degree of interaction between the activities of the service organisation andthose of the user entity; and

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

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402.3

Information on the nature of the services provided by a service organisation may beavailable from a wide variety of sources, such as user manuals; system overviews;technical manuals; the contract or service level agreement between the user entity andthe service organisation; reports by service organisations, internal auditors orregulatory authorities on controls at the service organisation; reports by the serviceauditor, including management letters, if available.

Question -3

In the course of the audit of R Ltd., the audit manager of ABC & Co. observed that RLtd. has outsourced certain activities to an outsourcing agency. As the engagementpartner guide the audit manager in the assessment of services provided by theoutsourcing agency in relation to the audit. (RTP, May 2010, 2011)

Answer:

Obtaining an Understanding of the Services Provided by a ServiceOrganisation, Including Internal Control.

Obtaining an understanding of the user entity in accordance with SA 315, theuser auditor shall obtain an understanding of how a user entity uses the servicesof a service organisation in the user entity's operations, including:

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

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

3) The degree of interaction between the activities of the service organisation andthose of the user entity; and

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

5) Information on the nature of the services provided by a service organisationmay be available 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.

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e. Reports by the service auditor, including management letters, if available.Examples of service organisation services that are relevant to the auditinclude:

f. Maintenance of the user entity's accounting records & Management ofassets.

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 obtainan understanding of how G Ltd. uses the services of the outsourced agency in its -ions.Nov 2013, RTP Nov 2014

when obtaining an understanding of the user entity, the user auditor shall obtain an -randing 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 thesignificance of those services to the user entity, including the effect thereof on theuser entity's internal control.

(2) The nature and materiality of the transactions processed or accounts or financialreporting processes affected by the service organization.

(3) The degree of interaction between the activities of the service organisation andthose of the user entity.

(4) The nature of the relationship between the user entity and the serviceorganisation.

(5) Relevant contractual terms for the activities undertaken by the serviceorganisation.

(6) the user auditor shall evaluate the design and implementation of relevantcontrols at the user

(7) entity that relate to the services provided by the service organisation, includingthose that are applied to the

(8) transactions processed by the service organization (h) the user auditor shall beObtaining a Type 1 or Type 2 report

(9) SA 450 Evaluation of Misstatements Identifiedobjective of the auditor is to evaluate:

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(a) The effect of identified misstatements on the audit; and

(b) The effect of uncorrected misstatements, if any, on the financial statements.

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450.1

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

Question-1In audit plan for T Ltd, as the audit partner you want to highlight the sourcesof misstatements, arising from other than fraud, to your audit team and cautionthem. Identify the sources of misstatements.

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

(i) An inaccuracy in gathering or processing data from which the financial statementsare prepared;(ii) An omission of an amount or disclosure;(iii) An incorrect accounting estimate arising from overlooking, or clearmisinterpretation of facts; and(iv) Judgments of management concerning accounting estimates that the auditorconsiders unreasonable or the selection and application of accounting policies that theauditor considers inappropriate.

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500.1

SA 500 - AUDIT EVIDENCE

Question 44

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

Answer

Obtaining Audit Evidence: As per SA 500 “Audit Evidence”, in performing complianceand substantive procedures, the auditor may obtain audit evidence by followingmethods-

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

whether internal or external, in paper form, electronicform, or other media.

• An example of inspection used as a test of controls isinspection of records for evidence of authorisation.

• Inspection of tangible assets may provide reliable auditevidence with respect to their existence, but notnecessarily about the entity’s rights and obligations or thevaluation of the assets.

Observation • Observation consists of witnessing a process orprocedure being performed by others.

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

Inquiry andConfirmation

• “Inquiry” consists of seeking appropriate informationfrom knowledgeable persons inside or outside the entity.“Confirmation” consists of the response to an inquiry.For example, the auditor requests confirmation ofreceivables bydirect communication with debtors.

Recalculation • Recalculation consists of checking the mathematicalaccuracy of documents or records. Recalculation may beperformed manually or electronically.

AnalyticalProcedures

• Analytical Procedures refers to studying significantratios and trends and investigating unusual fluctuations.

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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 inventoryas at the end of the year i.e. 31.3.14 was Rs. 2.25 crores. Due to unavoideablecircumstances, you could not be present at the time of annual physical verification.Under the above circumstances how would you ensure that the physical verificationconducted by the management was in order?

Answer

As per SA 501 “Audit Evidence – Additional Considerations for Specific Items”, theauditor should perform audit procedures, designed to obtain sufficient appropriateaudit evidence during his attendance at physical inventory counting. SA 501 isadditional guidance to that contained in SA 500, “Audit Evidence”, with respect tocertain specific financial statement amounts 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 andperform procedures on intervening transactions.

d. Attendance At InventoryCount Is Impracticable

• He shall perform alternate procedures. If it is notpossible, then modify the audit report.

Inventory Under ControlOf A Third Party

• confirmation from 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.•

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505.1

SA 505 - EXTERNAL CONFIRMATIONS

Question 11

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’suse of external confirmation as a means of obtaining audit evidence.

It requires that the auditor should employ external confirmation procedures inconsultation with the management.

The auditor may come across certain situations in which the management mayrequest him not to seek external confirmation from certain parties because ofdispute with the trade payables, etc.

The management, for example, might make such a request on the grounds thatdue to a dispute with the particular trade payable, the request forconfirmation might aggravate the sensitive negotiations between the entity andthe trade payables.

(1) In such cases, when an auditor agrees to management’s request not to seekexternal confirmation regarding certain trade payables, the auditor shouldconsider validity of grounds for such a request and assess management’sintegrity and obtain evidence to support the same.

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

(3) If the auditor of H Ltd. agrees to management’s request not to seek externalconfirmation regarding a particular matter, the auditor should document thereasons for acceding to the management’s request and should apply alternativeprocedures to obtain sufficient appropriate evidence regarding that matter. While considering the validity of request, in case the auditor of H Ltd.

reaches at a conclusion that the same was not valid, he mayappropriately modify the report.

Question -2

During the course of audit of Star Limited the auditor received some of theconfirmation of the balances of trade payables outstanding in the balance sheetthrough external confirmation by negative confirmation request. In the list of tradepayables, there are number of trade payables of small balances except one, old

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505.2

outstanding of ` 15 Lacs, of whom, no confirmation on the credit balance received.Comment with respect to Standard of Auditing.

Answer-

External Confirmation: As per SA 505, “External Confirmation”,Negative Confirmation is a request that theconfirming party respond directly to the auditoronly if the confirming party disagrees with theinformation provided in the request.

Negative confirmations provide less persuasiveaudit evidence than positive confirmations.

Risk The failure to receive a response to a negativeconfirmation request does not explicitly indicatereceipt by the intended confirming party of theconfirmation request or verification of the accuracyof the information contained in the request.

Accordingly, a failure of a confirming party torespond to a negative confirmation request providessignificantly less persuasive audit evidence thandoes a response to a positive confirmation request.

Confirming parties also may be more likely torespond indicating their disagreement with aconfirmation request when the information in therequest is not in their favor, and less likely torespond otherwise.

Present Problem In the instant case, the auditor sent the negativeconfirmation requesting the trade payableshaving outstanding balances in the balance sheetwhile doing audit of Star Limited.

One of the old outstanding of rupees 15 lacs hasnot sent the confirmation on the credit balance.

In case of non response, the auditor mayexamine subsequent cash disbursements orcorrespondence from third parties, and otherrecords, such as goods received notes.

Further non response for negative confirmation

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505.3

request does not means that there is somemisstatement as negative confirmation requestitself is to respond to the auditor only if theconfirming party disagrees with the informationprovided in the request.

Conclusion if the auditor identifies factors that give rise to doubtsabout the reliability of the response to the confirmationrequest, he shall obtain further audit evidence to resolvethose doubts.

Question -3

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

Answer

SA 505 “External Confirmations”, establishes standards on the auditor’s use ofexternal confirmation as a means of obtaining audit evidence. If the managementrefuses to allow the auditor to a send a confirmation request, the auditor shall:

a. Inquire as to Management’s reasons for the refusal, and seek auditevidence as to their validity and reasonableness,

b. Evaluate the implications of management’s refusal on the auditor’sassessment of the relevant risks of material misstatement, including therisk of fraud, and on the nature, timing and extent of other auditprocedures, and

c. Perform alternative audit procedures designed to obtain relevant andreliable audit evidence.

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 andreliable audit evidence from alternative audit procedures, the auditor shallcommunicate with those in charge of governance and also determine its implicationfor the audit and his opinion.

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505.4

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.

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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 - OpeningBalances”, initial audit engagement is an engagement in which either:

(i) The financial statements for the prior period were not audited; or

(ii) The financial statements for the prior period were audited by a predecessor auditor.

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 regardingthe opening balances by perusing the copies of the audited financial statementsincluding the other relevant documents relating to the prior period financialstatements such as supporting schedules to the audited financial statements.

Ordinarily, the current auditor can place reliance on the closing balancescontained in the financial statements for the preceding period, except whenduring the performance of audit procedures for the current period the possibilityof misstatements in opening balances is indicated.

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

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510.2

When the audit of financial statements is being conducted for the firsttime, the auditor has to perform auditing procedures to obtain sufficientappropriate audit evidence.

Since opening balances represent effect of transaction and events of thepreceding period and accounting policies applied in the preceding period,the auditor need to obtain evidence having regard to nature of openingbalances, materiality of the opening balances and accounting policies.

Since it will not be possible for auditor to perform certain procedures, e.g.,observing physical verification of inventories, etc. the auditor may obtainconfirmation, etc. and perform suitable procedures in respect of fixedassets, investments, etc. The auditor can also obtain managementrepresentation with regards to the opening balances.

Question-2Comment on the following:

You have been appointed as the auditor of Good Health Ltd. for 2013-14 which wasaudited by CA Trustworthy in 2012-13. As the Auditor of the company state the stepsyou would take to ensure that the Closing Balances of 2012-13 have been brought toaccount in 2013-14 as Opening Balances and the Opening Balances do notcontain misstatements.

As per SA 510 “Initial Audit Engagements—Opening Balances”, in conductingan initial audit engagement, the objective of the auditor with respect to openingbalances is to obtain sufficient appropriate audit evidence about whether:

(i) Opening balances contain misstatements that materially affect thecurrent period’s financial statements; and

(ii) Appropriate accounting policies reflected in the opening balances havebeen consistently applied in the current period’s financial statements, orchanges thereto are properly accounted for and adequately presented anddisclosed in accordance with the applicable financial reporting framework.

Being new assignment audit evidence regarding opening balances can beobtained by perusing the copies of the audited financial statements.

For current assets and liabilities some audit evidence can ordinarily be obtainedas part of audit procedures during the current period. For example, thecollection/payment of opening balances of receivables and payables will provideaudit evidence as to their existence, rights and obligations, completeness andvaluation at the beginning of the period.

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

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520.1

SA 520 - ANALYTICAL PROCEDURES

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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 conclusionbased on a sample may be different from the conclusion if the entire population weresubjected to the same audit procedure.

Sampling risk can lead to two types of erroneous conclusions:

(i) In the case of a test of controls, that controls are more effective than they actuallyare, or in the case of a test of details, that a material misstatement does not existwhen in fact it does. The auditor is primarily concerned with this type oferroneous conclusion because it affects audit effectiveness and is more likely tolead to an inappropriate audit opinion.

(ii) In the case of a test of controls, that controls are less effective than they actuallyare, or in the case of a test of details, that a material misstatement exists when infact it does not. This type of erroneous conclusion affects audit efficiency as itwould usually lead to additional work to establish that initial conclusions wereincorrect.

Question -2

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

Answer

Risk Factors while applying sampling techniques: As per SA 530 “Audit Sampling”,sampling risk is the risk that the auditor’s conclusion based on a sample may bedifferent from the conclusion if the entire population were subjected to the same auditprocedure. 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 actuallyare, or in the case of tests of details, that a material misstatement does not existswhen in fact it does. The auditor is primarily concerned with this type of

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erroneous conclusion because it affects audit effectiveness and is more likely tolead to an inappropriate audit opinion.

(ii) In the case of test of controls, the controls are less effective than they actually are,or in the case of tests of details, that a material misstatements exists when in factit does not. This type of erroneous conclusion affects audit efficiency as itwould usually lead to additional work to establish that initial conclusions wereincorrect.

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540.1

SA 540-AUDITING ACCOUNTING ESTIMATES, INCLUDING FAIR VALUE

ACCOUNTING ESTIMATES, & RELATED DISCLOSURES

Question -1

While auditing Z Ltd., you observe certain material financial statement assertions havebeen based on estimates made by the management. As the auditor how do youminimize the risk of material misstatements?

Answer

As per SA 540 “Auditing Accounting Estimates, Including Fair Value AccountingEstimates, and Related Disclosures”, the auditor shall obtain an understanding of thefollowing in order to provide a basis for the identification and assessment of the risks ofmaterial misstatements for accounting estimates:

(1) The requirements of the applicable financial reporting framework relevant to theaccounting estimates, including related disclosures.

(2) How Management identifies those transactions, events and conditions that may giverise to the need for accounting estimates to be recognised or disclosed, in thefinancial statements. In obtaining this understanding, the auditor shall makeinquiries of management about changes in circumstances that may give rise to new, orthe need to revise existing, 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.

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550.1

SA 550 - RELATED PARTIES

Question -1

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

Answer

Verification of Existence of Related Parties: As per SA 550 “Related Parties”, during theaudit, the auditor shall remain alert, when inspecting records or documents, forarrangements or other information that may indicate the existence of related partyrelationships or transactions that management has not previously identified ordisclosed 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 withgovernance.(v) Records of the entity’s investments and those of its pension plans.

(vi) Contracts and agreements with key management or those charged withgovernance.(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) Internalauditors’ 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 notpreviously identified or disclosed to the auditor:

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

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550.2

Question 2In 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 ofrelated party information.

Answer

Identification ofpossible sourcesfor RelatedParties’information:

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

However, it is the management, which is primarily responsiblefor identification of related parties.

The duties of an auditor with regard to reporting of related partytransaction 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 relatedparties,

The auditor may inspect records or documents that mayprovide information about related party relationships andtransactions.

for example entity income tax returns, information suppliedby the entity to regulatory authorities, shareholder registersto identify the entity’s principal shareholders, statements ofconflicts of interest from management and those charged withgovernance, records of the entity’s investments and those ofits pension plans, contracts and agreements with keymanagement or those charged with governance, significantcontracts and agreements not in the entity’s ordinary course ofbusiness, specific invoices and correspondence from the entity’sprofessional advisors, life insurance policies acquired by theentity, significant contracts re-negotiated by the entity during theperiod, internal auditors’ reports, documents associated with theentity’s filings with a securities regulator (e.g., prospectuses).

Further Work Obtaining further information on significant transactionsoutside the entity’s normal course of business enables theauditor to evaluate whether fraud risk factors.

if any, are present and, where the applicable financial reportingframework establishes related party requirements, to identify therisks of material misstatement.

In addition, the auditor needs to be alert for transactions which

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550.3

appear unusual in the circumstances and which may indicate theexistence of previously unidentified related parties.

Examples of transactions outside the entity’s normal course ofbusiness may include complex equity transactions, such ascorporate restructurings or acquisitions, transactions withoffshore entities in jurisdictions with weak corporate laws, theleasing of premises or the rendering of management services bythe entity to another party if no consideration is exchanged, salestransactions with unusually large discounts or returns,transactions with circular arrangements, for example, sales with acommitment to repurchase, transactions under contracts whoseterms are changed before expiry etc.

WR Finally, the auditor should also obtain a written representation fromthe management concerning the completeness of informationprovided regarding the identification of related parties.

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560.1

SA 560 - SUBSEQUENT EVENTS

Question-1Briefly describe the auditor's responsibility regarding subsequent events.Answer-Subsequent Events and Auditor's Responsibility: When the auditor draws uphis audit plan, checking of subsequent events is an important audit procedureirrespective of the level of test checks employed for checking of thetransactions during the year. In fact more detailed check is normally requiredfor subsequent events to confirm certain assertions contained in the financialstatements, e.g., the payment made by debtors after the close of accountingperiod would confirm that outstanding debtors on the date of the balance sheetdate have been realised. SA 560 on "Subsequent Events" establishes standardson the auditor's responsibility regarding subsequent events. SA 560 on"Subsequent Events" states that the term "subsequent events" refers toevents occurring between the date of the financial statements and the dateof the auditor’s report, and facts that become known to the auditor after thedate of the auditor’s report.. AS 4 on " Contingencies and Events Occurringafter the Balance Sheet Date" deals with all those significant events, bothfavourable and unfavourable, that occur between the balance sheet date andthe date on which the financial statements are approved by the Board ofDirectors in the case of a company and by the corresponding approvingauthority in the case of any other entity. As per AS 4, two types of events canbe identified:(a) those which provide further evidence of conditions thatexisted at the balance sheet date; and (b) those which are indicative ofconditions that arose subsequent to the balance sheet date. SA 560 laysdown that the auditor should consider the effect of subsequent events onthe financial statements and on the auditor's report. When the time betweenthe close of the year-end and the adoption of accounts is about to take place,examination of subsequent events gains 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 lakhswhich was lying in inventory since 1st March, 2013 was totally destroyed. Thefinancial statements of the company have not been adopted till the date of fire.

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560.2

The management of the company argues that since the loss occurred in theyear, 2013-14, no provision for the loss needs to be made in the financialstatements for 2012-13.

Answer

(a) Event occurring after the balance sheet date: This case requires attentionto SA 560 “Subsequent Events” and AS 4 “Contingencies and Events occurringafter the Balance Sheet Date”.As per AS 4 “Contingencies and Events occurring after the Balance SheetDate”,adjustments to assets and liabilities are required for events occurringafter the balance sheet date that provide additional information materiallyaffecting the determination of the amounts relating to conditions existing at thebalance sheet date or that indicate that the fundamental accountingassumption of going concern (i.e., the continuance of existence or substratumof the enterprise) is not appropriate.

AS 4 also requires disclosure of the non-adjusting event, in the report of theapproving authority.Further, as per SA 560 “Subsequent Events”, the auditor should assure that allevents occurring subsequent to the date of the financial statements and forwhich the applicable financial reporting framework requires adjustment ordisclosure have been adjusted or disclosed.The event took place after the close of the accounting year and does notrelate to conditions existing at the balance sheet date. Thus, it will haveno effect on items appearing at the balance sheet date because as per AS 4“Contingencies and Events Occurring after Balance Sheet Date” have to beadjusted that provide evidence of conditions existing as at the balance sheetdate. However, the auditor has to ensure that this loss will not materially affectthe substratum of the enterprises as per its size, nature and complexity ofoperations.Thus, subject to satisfaction in respect of non-violation of going concernconcept, the company has correctly accounted by not providing provision.However, the auditor is required to ensure the proper disclosure ofabovementioned event.

Question-3

A Co. Ltd. has not included in the Balance Sheet as on 31-03-2014 a sum of `1.50 crores being amount in the arrears of salaries and wages payable to thestaff for the last 2 years as a result of successful negotiations which were

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560.3

going on during the last 18 months and concluded on 30-04-2014. Theauditor wants to sign the said Balance Sheet and give the audit report 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 “SubsequentEvents”, AS 4 “Contingencies and Events occurring after the Balance SheetDate” and AS 29 "Provisions, Contingent liabilities and Contingent Assets".As per AS 4 “Contingencies and Events occurring after the Balance SheetDate”, adjustments to assets and liabilities are required for events occurringafter the balance sheet date that provide additional information materiallyaffecting the determination of the amounts relating to conditions existing at thebalance sheet date. Similarly as per AS 29 "Provisions, Contingent liabilitiesand Contingent Assets", future events that may affect the amount required tosettle an obligation should be reflected in the amount of a provisionwhere there is sufficient objective evidence that the will occur.In the instant case, the amount of `1.50 crores is a material amount and it is theresult of an event, which has occurred after the Balance Sheet date. The factshave become known to the auditor before the date of issue of the Audit Reportand Financial Statements.

The auditor has to perform the procedure to obtain sufficient, appropriateevidence covering the period from the date of the financial statements i.e. 31-3-2014 to the date of Auditors Report ie.31-05-2014. It will be observed that as aresult of long pending negotiations a sum of` 1.50 cores representing arrears of salaries of the year 2012-13 and 2013-14have not beenincluded in the financial statements. It is quite clear that the obligation requiresprovision for outstanding expenses as per AS 4 and AS 29.

As per SA 560 “Subsequent Events”, the auditor should assure that all eventsoccurring subsequent to the date of the financial statements and forwhich the applicable financial reporting framework requires adjustment ordisclosure have been adjusted or disclosed.So the auditor should request the management to adjust the sum of ` 1.50crores by making provision for expenses. If the management does not acceptthe request the auditor should qualify the audit report.SA 560 further requires that the auditor shall perform audit proceduresdesigned to obtain sufficient appropriate audit evidence that all eventsoccurring between the date of the financial statements and the date of theauditor’s report that require adjustment of, or disclosure in, the financial

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560.4

statements have been identified. The auditor is not, however, expected toperform additional audit procedures on matters to which previously appliedaudit procedures have provided satisfactory conclusions.

The auditor shall perform the procedures required above so that they cover theperiod from the date of the financial statements to the date of theauditor’s report, or as near as practicable thereto. The auditor shall take intoaccount the auditor’s risk assessment in determining the nature and extent ofsuch audit procedures, which shall include the following:

(a) Obtaining an understanding of any procedures management hasestablished to ensure that subsequent events are identified.

(b) Inquiring of management and, where appropriate, those charged withgovernance as to whether any subsequent events have occurred whichmight affect the financial statements.

(c) Reading minutes, if any, of the meetings, of the entity’s owners,management and those charged with governance, that have been heldafter the date of the financial statements and inquiring about mattersdiscussed at any such meetings for which minutes are not yet available.

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

When, as a result of the procedures performed above, the auditor identifiesevents that require adjustment of, or disclosure in, the financial statements, theauditor shall determine whether each such event is appropriately reflected inthose financial statements.

Question -4

Briefly explain Audit procedures on subsequent events.AnswerAudit Procedures on Subsequent Events: As per SA 560 “Subsequent Events”,events occurring between the dates of balance sheet and audit report and thefacts that become known to the auditor after the date of the auditor’s report.The auditor shall perform audit procedures designed to obtain sufficientappropriate audit evidence that all events occurring between the date of thefinancial statements and the date of the auditor’s report that requireadjustment of, or disclosure in, the financial statements have been identified.The auditor is not, however, expected to perform additional audit procedureson matters to which previously applied audit procedures haveprovided satisfactory conclusions.The auditor shall perform the procedures required above so that they cover theperiod from the date of the financial statements to the date of the

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560.5

auditor’s report, or as near as practicable thereto. The auditor shall take intoaccount the auditor’s risk assessment in determining the nature and extent ofsuch audit procedures, which shall include the following:(a) Obtaining an understanding of any procedures management hasestablished to ensure that subsequent events are identified.(b) Inquiring of management and, where appropriate, those charged withgovernance as to whether any subsequent events have occurred whichmight affect the financial statements.(c) Reading minutes, if any, of the meetings, of the entity’s owners,management and those charged with governance, that have been held after thedate of the financial statements and inquiring about matters discussed at anysuch meetings for which minutes are not yet available.(d) Reading the entity’s latest subsequent interim financial statements, if any.When, as a result of the procedures performed as required the auditoridentifies events that require adjustment of, or disclosure in, the financialstatements, the auditor shall determine whether each such event isappropriately reflected in those financial statements.

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570.1

SA 570 - GOING CONCERN

Question-1

While examining the going concern assumption of an entity, what important indications should beevaluated 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 whileplanning a performing audit procedure and in evaluating the results thereof, theauditor should consider the appropriateness of the going concern assumptionunderlying the preparation of the financial statements. In assessing such a risk, theauditor 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 financelong-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 Indications

Management 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.

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570.2

Question -2

ABC Company files a law suit against Unlucky Company for ` 5 crores. TheAttorney of Unlucky Company feels that the suit is without merit, so UnluckyCompany merely discloses the existence of the law suit in the notes accompanying itsfinancial statements. As an auditor of Unlucky Company, how will you deal with thesituation?

Answer

(a) As per AS 29 "Provisions, Contingent liabilities and Contingent Assets", acontingent liability is a possible obligation that arises from past events and the existenceof which will be confirmed only by the occurrence or non-occurrence of one or moreuncertain future events not wholly within the control of the enterprise.

Further, future events that may affect the amount required to settle an obligationshould be reflected in the amount of a provision where there is sufficient objectiveevidence that the event will occur.

As per SA 570 “Going Concern”, there are certain examples of events or conditionsthat, individually or collectively, may cast significant doubt about the goingconcern assumption. Pending legal or regulatory proceedings against the entity thatmay, if successful, result in claims that the entity is unlikely to be able to satisfy isone of the example of such event.

When the auditor concludes that the use of the going concern assumption isappropriate in the circumstances but a material uncertainty exists, the auditorshall determine whether the financial statements adequately describe theprincipal events or conditions that may cast significant doubt on theentity’s ability to continue as a going concern and management’s plans to dealwith these events or conditions; and disclose clearly that there is a materialuncertainty related to events or conditions that may cast significant doubton the entity’s ability to continue as a going concern and, therefore, that it maybe unable to realize its assets and discharge its liabilities in the normal course ofbusiness.

In the instant case, ABC Company has filed a law suit against Unlucky Companyfor ` 5 crores. Though, the attorney of Unlucky Company feels that the suit iswithout merit so the company merely discloses the existence of law suit in thenotes accompanying its financial statements. But the auditor may evaluate the

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570.3

source data on which basis the opinion is formed. If the auditor finds theuncertainty, he may request the management to adjust the sum of ` 5 crore bymaking provision for expenses as per AS 29. If the management does not acceptthe request 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 March2014, S Ltd had disclosed in the notes (Note No. X) "The state pollution control boardhad ordered the closure of the company's only manufacturing plant on the groundthat it is environmentally damaging, which the company had challenged in a lawsuit. Pending the outcome of the law suit the financial statements are prepared on agoing concern basis". Further the financial statements prepared by the managementof S Ltd include financial statements of certain branches which are audited by otherauditors. What are the reporting responsibilities of R & Co.?Answer

(a) Reporting Responsibilities of Statutory Auditor: This question involves twobroad aspect with respect to reporting requirements i.e. (i) one which deals with GoingConcern aspect where the company has gone for legal suit and (ii) other is work doneby other auditors.

As per facts of the case, the State Pollution Control Board has issued the closure orderfor S Ltd., on account of environmental damaging by its only manufacturingplant. However, S Ltd had challenged the same by way of a law suit. Due to pendencyof the outcome of the legal suit, the company has prepared its financial statements ongoing concern basis.

As per SA 570 “Going Concern”, under the going concern assumption, an entity isviewed as continuing in business for the foreseeable future. General purposefinancial statements are prepared on a going concern basis, unless management eitherintends to liquidate the entity or to cease operations, or has no realistic alternative but todo so. Management’s assessment of the entity’s ability to continue as a going concerninvolves making a judgment, at a particular point in time, about inherentlyuncertain future outcomes of events or conditions.

The auditor’s responsibility is to obtain sufficient appropriate audit evidence about theappropriateness of management’s use of the going concern assumption inthe preparation and presentation of the financial statements and to conclude whetherthere is a material uncertainty about the entity’s ability to continue as a going concern.For this the auditor may take the help of expert.

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570.4

As per SA 620, “Using the Work of an Auditor’s Expert”, if expertise in a fieldis necessary to obtain sufficient appropriate audit evidence, he may determine to usethe work of an auditor’s expert. On the basis of expert’s opinion he may decide to relyor not on assessment of management.

As per SA 570 “Going Concern”, pending legal proceedings is a condition that,individually, may cast significant doubt about the going concern assumption. Existenceof above condition signifies that a material uncertainty exists.

Further, when the auditor concludes that the use of the going concern assumption isappropriate in the circumstances but a material uncertainty exists, the auditor shalldetermine whether the financial statements:

(i) Adequately describe the principal events or conditions that may castsignificant doubt on the entity’s ability to continue as a going concern andmanagement’s plans to deal with these events or conditions; and

(ii) Disclose clearly that there is a material uncertainty related to events or conditionsthat may cast significant doubt on the entity’s ability to continue as a going concernand, therefore, that it may be unable to realise its assets and discharge its liabilities inthe normal course of business.

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 conditionthat may cast 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 inthe financial statement. Further, use of the going concern assumption is appropriate buta material uncertainty exists so assuming the assessment and disclosure of S Ltd. inorder, R & Co. should include an Emphasis of Matter paragraph in the auditor’s report.

Further, as per SA 600 “Using the work of Another Auditor”, when the principalauditor has to base his opinion on the financial information of the entity as a wholerelying upon

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570.5

the statements and reports of the other auditors, his report should state clearlythe division of responsibility for the financial information of the entity by indicating theextent to which the financial information of components audited by the other auditorshave been included in the financial information of the entity, e.g., the number ofdivisions/ branches/ subsidiaries or other components audited by other auditors.

Note: Alternative answer is possible assuming that company is not going concern,hence auditor should issue adverse report.

Question -4

A Company's net worth is eroded and trade payables are unpaid due toliquidity constraints. The management represents to the statutory auditor that thepromoter's wife is expected to give an unsecured loan to meet the liquidityconstraints and that negotiations are underway to secure large export orders.

Answer:

Going Concern Assumption: In this case, it is subjective, but prima-facie a mereexpectation of future cash flows from the promoter’s wife without any firmcommitment and the possibility of an export order being negotiated, may not thatbe sufficient appropriate audit evidence of mitigating factors for resolving the goingconcerns question under SA 570 “Going Concern”.

CA SURENDRA AGRAWAL


580.1

SA 580 - WRITTEN REPRESENTATIONS

Question-1

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

Answer

Validity of Management Representation: The physical verification of fixed assets is theprimary responsibility of the management. The auditor, however, is required toexamine the verification programme adopted by the management.

He must satisfy himself about the existence, ownership and valuation of fixedassets.

In the case of Sagar Ltd., the auditor has not been able to verify the existence andvalue of some machinery despite the verification procedure followed in routineaudit.

He accepted the certificate given to him by the management without making anyfurther enquiry.

As per SA 580, when representation relate to matters which are material to thefinancial information, then the auditor should seek corroborative audit evidencefor other sources inside or outside the entity.

He should evaluate whether such representations are reasonable and consistentwith other evidences and should consider whether individuals making suchrepresentations can be expected to be well informed on the matter.

“Written Representations” cannot be a substitute for other audit evidence that theauditor could reasonably expect to be available. If the auditor is unable to obtainsufficient appropriate audit evidence that he believes would be available regarding amatter which has or may have a material effect on the financial information, this willconstitute a limitation on the scope of his examination even if he has obtained arepresentation from management on the matter. Therefore, the approach adopted bythe auditor is not right.

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580.2

Question -2

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

Answer:

Written Representation: A written statement by management provided tothe auditor to confirm certain matters or to supportother audit evidence. Written representations in thiscontext do not include financial statements, theassertions therein, or supporting books and records.

Why Necessary Audit evidence is all the information used by theauditor in arriving at the conclusions on which theaudit opinion is based.

Thus written representations are necessaryinformation that the auditor requires in connectionwith the audit of the entity’s financial statements.Accordingly, similar to responses to inquiries,written representations are audit evidence.

Although written representations provide necessaryaudit evidence, they do not provide sufficientappropriate audit evidence on their own about anyof the matters with which they deal.

Furthermore, the fact that management has providedreliable written representations does not affect thenature or extent of other audit evidence that theauditor obtains about the fulfillment ofmanagement’s responsibilities, or about specificassertions.

Steps The auditor shall request management to provide

a written representation that it has fulfilled itsresponsibility for the preparation of thefinancial statements in accordance with theapplicable financial reporting framework,including where relevant their fair presentation,as set out in the terms of the audit engagement.

Other SAs require the auditor to request writtenrepresentations. If, in addition to such requiredrepresentations, the auditor determines that it isnecessary to obtain one or more written

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580.3

representations to support other audit evidencerelevant to the financial statements or one ormore specific assertions in the financialstatements, the auditor shall request suchother written representations. The date of thewritten representations shall be as near aspracticable to, but not after, the date of theauditor’s report on the financial statements.The written representations shall be for allfinancial statements and period(s) referredto in the auditor’s report.

The written representations shall be in the formof a representation letter addressed to theauditor. If law or regulation requiresmanagement to make written publicstatements about its responsibilities, and theauditor determines that such statements providesome or all of the representations, the relevantmatters covered by such statements need not beincluded in the representation letter.

Conslusion In particular, if written representations areinconsistent with other audit evidence, theauditor shall perform audit procedures toattempt to resolve the matter.

If the matter remains unresolved, the auditorshall reconsider the assessment of thecompetence, integrity, ethical values or diligenceof management, or of its commitment to orenforcement of these, and shall determine theeffect that this may have on the reliability ofrepresentations (oral or written) and auditevidence in general.

If the auditor concludes that the writtenrepresentations are not reliable, the auditor shalltake appropriate actions, including determiningthe possible effect on the opinion in the auditor’sreport.

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580.4

Question-3

State briefly the basic elements of Management Representation Letter.

Answer

Basic Elements of a Management Representation Letter: As per SA 580“Written Representations”, some of the basic elements of a ManagementRepresentation letter are-

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

(2) It does not include financial statements, the assertions therein, or supportingbooks and records.

(3) The auditor shall request management to provide a written representation thatit has fulfilled its responsibility for the preparation of the financial statementsin accordance with the applicable financial reporting framework, includingwhere relevant their fair presentation, as set out in the terms of the auditengagement.

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

Question -4

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

Answer

(a) Duty of an Auditor if management refuses to provide written representations: Asper SA 580 “Written Representations”, if the management does not provide one or moreof the requested 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 mayhave on the reliability of representations (oral or written) and audit evidence ingeneral, and(iii) Take appropriate actions, including determining the possible effect on the opinionin the auditor’s report.

The auditor should disclaim an opinion on the financial statements if management doesnot provide written representations in accordance with SA 705 “Modifications tothe Opinion in the Independent Auditor’s Report”.

CA SURENDRA AGRAWAL


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 the above statement and state in this context the reporting considerations, whenthe auditor uses the work performed by other auditor.

Answer-SA 600 on “Using the Work of Another Auditor” lays down the procedure to beapplied in situations where a principal auditor reporting on the financial statement of the entityuses the work of another independent auditor.

SA 600 contemplates coordination between auditors and requires that thereshould be sufficient liaison between the principal auditor and the other auditor.

For this purpose, the principal auditor may find it necessary to issue writtencommunication(s) to the other auditor.

The other auditor, knowing the context in which his work is to be used by theprincipal auditor, should co-ordinate with the principal auditor. For example, bybringing to the principal auditor’s immediate attention any significant findingsrequiring to be dealt with at entity level, adhering to the time-table for audit ofthe component, etc.

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

When considered necessary by him, the principal auditor may require the otherauditor to answer a detailed questionnaire regarding matters on which theprincipal auditor requires information for discharging his duties. The otherauditor should respond to such questionnaire on a timely basis.

When the principal auditor concludes, based on his procedures, that the work ofthe other auditor cannot be used and the principal auditor has not beenable to perform sufficient additional procedures regarding the financialinformation of the component audited by the other auditor, the principalauditor should express a qualified opinion or disclaimer of opinion because thereis a limitation on the scope of audit.

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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, havingdetermined that the work of internal auditor is likely to be adequate for the purposeof statutory audit, wanted to use the work of internal auditor in respect of physicalverification of fixed assets. How an evaluation of this specific work done by theinternal auditor can be done?

Answer-

Evaluation of Specific Work Done by Internal Auditor: The statutory auditor should asa part of his audit, carryout general evaluation of the internal audit function todetermine the extent to which he can place reliance upon the work of the internalauditor.

As per SA 610 “Using the Work of Internal Auditors”, the nature, timing andextent of the audit procedures performed on specific work of the internalauditors will depend on the external auditor’s assessment of the risk of materialmisstatement, the evaluation of the internal audit function, and the evaluation ofthe specific work of the internal auditors.

Such audit procedures may include examination of items already examinedby the internal auditors, examination of other similar items; and observation ofprocedures performed by the internal auditors.

Further, to determine the adequacy of specific work performed by the internalauditors for the external auditor’s purposes, the external auditor shall evaluatewhether:

(1) The work was performed by internal auditors having adequate technicaltraining and proficiency;

(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 workperformed; and

(5) Any exceptions or unusual matters disclosed by the internal auditors areproperly resolved.

CA SURENDRA AGRAWAL


620.1

SA 620 - USING THE WORK OF AN EXPERT

Question-1

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-

Evaluating Adequacy Of Auditor’s Expert’s Work

• Findings and Conclusion: Relevance, reasonableness and consistency with otheraudit evidence.

• Significant Assumptions and Methods used. Relevance and reasonableness inthe circumstance.

• Source data used Relevance, completeness, and accuracy.

In the present case, the auditor must verify the reasonableness of assumptions madeand methods adopted by the actuary in the evaluation particularly with reference tofactors such as rate of return on investments, retirement age, number and salary ofemployees, etc. Accordingly, the auditor has to satisfy himself whether valuation doneby the actuary can be adopted, otherwise he may report on his findings for widevariation.

Question -2

The auditor of SS Ltd. accepted the gratuity liability valuation based on the certificateissued by a qualified actuary. However, the auditor noticed that the retirement ageadopted is 65 years as against the existing retirement age of 60 years. Thecompany is considering a proposal to increase the retirement age. Comment.

Answer

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 ofliabilities associated with insurance contracts or employee benefit plans, however,the auditor has sole responsibility for the audit opinion expressed, and thatresponsibility is not reduced by the auditor’s use of the work of an auditor’s expert.

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620.2

Hence, the auditor shall evaluate the adequacy of the auditor’s expert’s work for theauditor’s purposes, including the relevance and reasonableness of that expert’s findingsor conclusions, and their consistency with other audit evidence as per SA 500.

If the expert’s work involves use of significant assumptions and methods, then therelevance and reasonableness of those assumptions and methods and if the expert’swork involves the use of source data that is significant to that expert’s work, therelevance, completeness, and accuracy of that source data in the circumstances must beensured by the auditor.

In the instant case, a qualified actuary has issued a certificate for gratuity liabilityvaluation, for which retirement age adopted is 65 years against the existing retirementage of 60 years; however, the company is considering a proposal to increase theretirement age. In view of SA 500 alongwith SA 620, the assumption made by actuaryhas no relevance and reasonableness as presently retiring age is of 60 years. Hence theauditor is required to bring out the facts to the notice of management and advice themodification accordingly. In case of failure of compliance of the same the auditor mayqualify the report.

Question -3

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 anaudit evidence. How do you evaluate the work of the actuary?

Answer

Evaluating the work of an Auditor’s Expert: As per SA 620 “Using the Work of anAuditor’s Expert”, when management has used a management’s expert in preparing thefinancial statements, the auditor’s decision on whether to use an auditor’s expertmay also be influenced by such factors as:

(1) The nature, scope and objectives of the management’s expert’s work.(2) Whether the management’s expert is employed by the entity, or is a party

engaged by it to provide relevant services.(3) The extent to which management can exercise control or influence over the work

of the management’s expert.(4) The management’s expert’s competence and capabilities.(5) Whether the management’s expert is subject to technical performance standards

or other professional or industry requirements.

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620.3

(6) Any controls within the entity over the management’s expert’s work.

However, an evaluation of the work of an expert can be done considering thefollowing facts:

(i) When the auditor plans to use the expert’s work as audit evidence, he should satisfyhimself as to the expert’s skills and competence by considering the expert’s: professional qualifications, license or membership in an appropriate professional

body, and experience and reputation in the field in which the evidence is sought. (ii) The

objectives and scope of the experts’ work.(i) A general outline as to specific items in the expert’s report. (iv) Confidentiality

of the client’s information used by the expert. (v) The source data used.(ii) The assumptions and methods used and, if appropriate, their comparison with

the prior period.(iii) The results of the expert’s work in the light of auditor’s overall knowledge of the

business and of the results of his audit procedures.(iv) The auditor should also satisfy himself that the substance of the expert’s

findings is properly reflected in the financial statements.(v) Consider whether the expert has used the appropriate source data, by making

inqiries of the expert.(vi) Conducting audit procedures on the data by the client to the expert to obtain

reasonable assurance that the data are appropriate.

Question -4

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

Answer

Using the Work of an Auditor’s Expert: As per SA 620, “Using the Work of an Auditor’sExpert”, during the audit, the auditor may seek to obtain, in conjunction with the clientor independently, audit evidence in the form of reports, opinions, valuations andstatements of an expert.

While doing audit, Ram, the auditor can obtain the following types of reports, oroptions or statements of an expert for the purpose of audit evidence:

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620.4

(i) The valuation of complex financial instruments, land and buildings, plant andmachinery, jewelry, works of art, antiques, intangible assets, assets acquired andliabilities assumed in business combinations and assets that may have been impaired.(ii) The actuarial calculation of liabilities associated with insurance contracts oremployee benefit plans.(iii) The estimation of oil and gas reserves.(iv) The valuation of environmental liabilities, and site clean-up costs. (v) Theinterpretation 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 adequacyof the auditor’s expert’s work, including the relevance and reasonableness of thatexpert’s findings or conclusions, and their consistency with other audit evidence; if thatexpert’s work involves use of significant assumptions and methods, the relevance andreasonableness of those assumptions and methods in the circumstances; and if thatexpert’s work involves the use of source data that is significant to his work, therelevance, completeness, and accuracy of that source data.If the auditor determines that the work of the auditor’s expert is not adequate for theauditor’s purposes, he shall agree with that expert on the nature and extent of furtherwork to be performed by that expert; or perform further audit procedures appropriateto the circumstances.

Question -5


Z Ltd. had appointed an outside expert to assess accrued gratuity liability of thecompany. Based on the said report, the company provides ` 80 lakhs as gratuity in thefinancial statements.

Answer-

SA 620 “Using the work of an Auditor’s Expert” states that while using the work of anexpert, auditor should consider the materiality of the item, nature and complexity of theitem, the other audit evidence available and professional qualifications, experience andreputation in the field of the concerned expert.

The auditor should ensure that the expert has used appropriate source data, has madeconsistent assumptions, has applied correct methods and that results of expert’s workare in line with auditor’s overall knowledge of the business and match with results ofhis audit procedures. The auditor should also ensure that substance of expert’s findingsis properly reflected in the financial information.

CA SURENDRA AGRAWAL


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 Reportingon Financial Statements”, the auditor’s report includes the following basic elements:

(a) Title;

(b) An addressee, as required by the circumstances of the engagement;

(c) An introductory paragraph that identifies the financial statements audited;

(d) A description of the responsibility of management (or other appropriate term) forthe preparation of the financial statements;

(e) A description of the auditor’s responsibility to express an opinion on thefinancial statements and the scope of the audit, that includes:

• A reference to Standards on Auditing and the law or regulation; and

• A description of an audit in accordance with those Standards;

(f) An opinion paragraph containing an expression of opinion on the financialstatements and a reference to the applicable financial reporting framework used toprepare the financial statements (including identifying the jurisdiction of origin ofthe financial reporting framework);

(g) The auditor’s signature;

(h) The date of the auditor’s report; and

(i) The place of signature.

Auditor’s Report for Audits Conducted in Accordance with Both Auditing Standardsissued by the Institute of Chartered Accountants of India and International Standardson Auditing.

CA SURENDRA AGRAWAL


705.1

SA 705 - MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’S REPORT

Question-1

The 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 GuidanceNote on Valuation of Inventory, inventory Valuation is based on FIFO method (first in firstout).

Answer-

QUALIFIED OPINIONBased upon our examination of an explanation given to us, the financial statements comprising ofa.Balance sheet as at 31st March 2012.b.Profit & Loss a/c for the year ended 31st March 2012.c.Cash flow statement for the year ended 31st March 2012.

Shows true and fair view subject to basis for qualified opinion paragraph. The auditis conducted as per LAWS & RegulationLegal and other reporting requirements

1. Reference that annexure is attached as per requirement of CARO 20032. Reference to audit report u/s 227(3)a) All explanation and Information has been obtainedb) proper books of account as required by law have been kept by the Companyc) Financial statements are in agreement with the books of accountsd) Financial statements comply with requirements of ASe) Director of public company is not disqualified u/s 274(1)(g)f) All the Returns are received from Branches.Signature :

Membership No. :Firm No.Place :Date:

Q. 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 in themain audit report (Reporting under CARO 2003 need not be considered).

Answer-INDEPENDENT AUDITORS REPORTTo the Members of XYZ "Company LimitedReport on the Financial StatementsWe were engaged to audit the accompanying financial statements of XYZ Company Limited ("theCompany"), will comprise the Balance Sheet as at March 31, 20XX, and the Statement of Profit andLoss and the Cash Flow Statement! the year then ended, and a summary of significant accountingpolicies and other explanatory information.Management's Responsibility for the Financial Statements

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705.2

Management is responsible for the preparation of these financial statements that give a true and fairview of financial position, financial performance and cash flows of the Company in accordance withthe accounting stare* referred to in sub-section (3C) of section 211 of the Companies Act, 1956 ("theAct"). This responsibility includes design, implementation and maintenance of internal controlrelevant to the preparation and fair presentation of financial statements that are free from materialmisstatement, whether due to fraud or error.

Auditor's ResponsibilityOur responsibility is to express an opinion on these financial statements based on our audit inaccordance with) Standards on Auditing issued by the Institute of Chartered Accountants of India.Because of the matter described in Basis for Disclaimer of Opinion paragraph, however, we werenot able to obtain sufficient appropriate audit evidenn provide a basis for an audit opinion.

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 Henr are unable to comment on substantial part of companies assets abroad.Hence we areunable to express any opinion' the companies' financial statements.Disclaimer of Opinion

Because of the significance of the matter described in the Basis for Disclaimer of Opinionparagraph we have not been able to obtain sufficient appropriate audit evidence to provide abasis for an audit opinion. Accordingly, we do not express an opinion on the financialstatements

Legal and other reporting requirementsa) All explanation and Information has been obtainedb) proper books of account as required by law have been kept by the Companyc) Financial statements are in agreement with the books of accountsd) Financial statements comply with requirements of ASe) Director of public company is not disqualified u/s 274(1)(g)f) All the Returns are received from Branches.Signature :

Membership No. :Firm No.Place :Date:

CA SURENDRA AGRAWAL


705.3

Q. 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 a subsidiary. Themateria] misstatement is deemed to be pervasive to the F.S. The effects of the misstatement on the F.S.have not been determined because it was not practicable to do so"

Answer-INDEPENDENT AUDITOR'S REPORT

To the Board of Directors of ABC Company LimitedManagement's Responsibility for the Consolidated Financial StatementsAuditor's ResponsibilityBasis for Adverse OpinionAs explained in Note X, the Company has not consolidated the financial statements ofsubsidiary XYZ Company it acquired during 20XX because it has not yet been able to ascertainthe fair values of certain of the subsidiary's material assets and liabilities at the acquisition date.This acquisition is therefore accounted for as an investment. Under the accounting principlesgenerally accepted in India, the subsidiary should have been consolidated because it iscontrolled by the Company. Had XYZ been consolidated, many elements in the accompanyingfinancial statements would have been materially affected. The effects on the financial statementsof the failure to consolidate have not been determined.Adverse OpinionIn our opinion, because of the significance of the matter discussed in the Basis for AdverseOpinion paragraph, the consolidated financial statements do not give a true and fair view inconformity with the accounting principles generally accepted in India:(b) in the case of the consolidated Balance Sheet, of the state of affairs of the Company as atMarch 31, OXX;(c) in the case of the consolidated Profit and Loss Account, of the profit/loss for the year endedon that date; and(d) in the case of the consolidated Cash Flow Statement, of the cash flows for the year ended onthat date.For XYZ & Co. Chartered Accountants Firm's Registration NumberSignature(Name of the Member Signing the Audit Report)(Designation) Membership NumberPlace of Signature Date

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706.1

SA 706 - EMPHASIS OF MATTER PARAGRAPHS & OTHER MATTER PARAGRAPHSIN THE INDEPENDENT AUDITOR’S REPORT

Case Studies

You are the auditor of XYZ Ltd. There is uncertainty relating to a pendingexceptional litigation Matter – say there is a law suit filed against the companyfor tax or some other matter. You cannot conclude that it should be provided for.

Solution

– Emphasis of Matter paragraph

after opinion paragraph following shall be added:

“We draw attention to Note X to the financial statements which describes theuncertainty related to the outcome of the lawsuit filed against the Company by XYZCompany. Our opinion is not qualified in respect of this matter

Case Studies

In case of auditor of Consolidated Financial Statement, there are certain subsidiarieswhich were not audited by him but which form part of the consolidated financialstatements under report. Also the amounts involved are not insignificant.

Solution

– Other Matter paragraph

Other Matter

“We did not audit the financial statements of certain subsidiaries, whose financialstatements reflect total assets (net) of Rs. XXXX as at March 31, 20XX, total revenues ofRs. XXXX and net cash outflows amounting to Rs. XXXX for the year then ended. Thesefinancial statements have been audited by other auditors whose reports have beenfurnished to us by the Management, and our opinion is based solely on the reports ofthe other auditors. Our opinion is not qualified in respect of this matter.”

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706.2

Format o f an Auditor's Report on Consolidated F.S. including an Other Matter Paragraphbased on Fair Presentation Framework"Other Matter Paragraph - Auditor's responsibility i n respect o f subsidiaries not audited by

him but which form part o f the consolidated financial statements under report"INDEPENDENT AUDITOR'S REPORT

To the Board of Directors of ABC Company LimitedManagement's Responsibility for the Consolidated FinancialStatementsAuditor's Responsibility Opinion Other MatterWe did not audit the financial statements of certain subsidiaries, whose financialstatements reflect total assets (net) of Rs. XXXX as at March 31,20XX, total revenues of Rs. XXXX and net cashoutflows amounting to Rs. XXXX for the year then ended. These financial statements haw been audited by otherauditors whose reports have been furnished to us by the Management, and our opinion is based solely on the reportsof the other auditors. Our opinion is not qualified in respect of this matter.

ForXYZ&Co. Chartered Accountants

Firm's Registration Number

Signature

(Name of the Member Signing the Audit Report

(Designation Membership NumberPlace of Signature Date

(Refer SA 700 Revised




CA SURENDRA AGRAWAL


710.1

SA 710 - COMPARATIVE INFORMATION - CORRESPONDING FIGURES &

COMPARATIVE FINANCIAL STATEMENTS

Questiom-1

Write short notes on the following:

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

Answer-

– Corresponding Figures and Comparative Financial Statements”, establishes standardson the auditor’s responsibilities regarding comparatives.The auditor shall determine whether the financial statements include thecomparative information required by the applicable financial reporting frameworkand whether such information is appropriately classified. For this purpose, theauditor shall evaluate whether:

(1) The comparative information agrees with the amounts and otherdisclosures presented in the prior period; and

(2) The accounting policies reflected in the comparative information are consistentwith those applied in the current period or, if there have been changes inaccounting policies, whether those changes have been properly accounted forand adequately presented and disclosed.

(3) If the auditor becomes aware of a possible material misstatement in thecomparative information while performing the current period audit, theauditor shall perform such additional audit procedures as are necessary in thecircumstances to obtain sufficient appropriate audit evidence to determinewhether a material misstatement exists. If the auditor had audited the priorperiod’s financial statements, the auditor shall also follow the relevantrequirements of SA 560 (Revised).

(4) As required by SA 580 (Revised), the auditor shall request writtenrepresentations for all periods referred to in the auditor’s opinion. The auditorshall also obtain a specific written representation regarding any prior period itemthat is separately disclosed in the current year’s statement of profit and loss.

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710.2

Question -2

The audit report of P Ltd. for the year 2012-13 contained a qualificationregarding non- provision of doubtful debts. As the statutory auditor of the companyfor the year 2013-14, how would you report, if:

(i) The company does not make provision for doubtful debts in 2013-14 (ii) Thecompany makes adequate provision for doubtful debts in 2013-14?

Answer

Auditor’s responsibilities in cases where audit report for an earlier year is qualified isgiven in SA 710 “Comparative Information – Corresponding Figures andComparative Financial Statements”.

As per SA 710, When the auditor’s report on the prior period, as previouslyissued, included a qualified opinion, a disclaimer of opinion, or an adverseopinion and the matter which gave rise to the modified opinion is resolved andproperly accounted for or disclosed in the financial statements in accordancewith the applicable financial reporting framework, the auditor’s opinion onthe current period need not refer to the previous modification.

SA 710 further states that if the auditor’s report on the prior period, as previouslyissued, included a qualified opinion and the matter which gave rise to themodification is unresolved, the auditor shall modify the auditor’s opinion on thecurrent period’s financial statements. In the Basis for Modification paragraph inthe auditor’s report, the auditor shall either:

(i) Refer to both the current period’s figures and the corresponding figures in thedescription of the matter giving rise to the modification when the effects orpossible effects of the matter on the current period’s figures are material; or

(ii) In other cases, explain that the audit opinion has been modified because of theeffects or possible effects of the unresolved matter on the comparability of thecurrent period’s figures and the corresponding figures.

In the instant Case, if P Ltd. does not make provision for doubtful debts the auditorwill have to modify his report for both current and previous year’s figures asmentioned above. If however, the provision is made, the auditor need not refer to theearlier year’s modification.

CA SURENDRA AGRAWAL


720.1

SA 720 - THE AUDITOR’S RESPONSIBILITY IN RELATION TO OTHERINFORMATION IN DOCUMENTS CONTAINING AUDITED FS

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800.1

SA 800 - SPECIAL CONSIDERATIONS - AUDITS OF FS PREPARED INACCORDANCE WITH SPECIAL PURPOSE FRAMEWORKS

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., Youhave been appointed to conduct the audit of Special Purpose Financial Statements preparedas j agreement Draft a report as per SA 800.

BASIS OF ACCOUNTING AND RESTRICTION ON DISTRIBUTION FOR USE

The 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 tounderstand the liquidity, progress and growth of the X Ltd., The special Financial statementscan be distributed only to AB Inc, who has requested the same through clause 7 of theAgreement between X Ltd., and AB Inc and These special purpose financial statement are notmeant for public purpose.

CA SURENDRA AGRAWAL


800.1

SA 805 - SPECIAL CONSIDERATIONS - AUDITS OF SINGLE FS AND SPECIFIC

ELEMENTS, 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 on 31.01.2012. The schedulebeen prepared by the collection department based on their judgment. The company X Ltd. has applied to SBI forWorking capital loan of Rs 50 Crores. SBI wants validation of accounts receivable account and to ascertain whetherThe statement is reliable 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. MANAGEMENTREPONSIBILITY TO SCHEDULEThe management is responsible to prepare the schedule of accounts receivable as per the books ofaccounts. This Responsibility includes the design, implementation and maintenance of internal controlrelevant to the preparation and presentation of the financial statement that is free from materialmisstatement, whether due to fraud or error.AUDITOR'S RESPONSIBILITYOur responsibility is to examine the accounts receivable schedule and to check whether it is prepared asper books of counts. As per SA 805, the auditor checks the single ledger account of the entity, X Ltd.; theaudit is conducted as per requirements of SA 805. An audit involves performing procedures to obtainaudit evidence about the amounts and closures in the financial statement. The procedures selecteddepend on the auditor's judgment, including the assessment of the risks of material misstatement of thefinancial statement, whether due to fraud or error. In making 1 risk assessments, the auditor considersinternal control relevant to the entity's preparation and fair presentation the financial statement in orderto design audit procedures that are appropriate in the circumstances. An audit also includes evaluatingthe appropriateness of accounting policies used and the reasonableness of accounting estimates, if any.made by management, 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 for our auditopinion.OPINION PARAGRAPHBased upon our examination and explanation given to us, the accounts receivables schedule has beenprepared 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. The AccountsReceivable schedule is prepared f BI to validate the account and to ascertain whether the statement isreliable for granting the working capital loan. The Accounts Receivable schedule can be given only to SBIand no distribution to any other party is permitted. The schedule is prepared exclusively for SBI. As aresult, the schedule may not be suitable for another purposeSignature:Membership No:Firm Registration No:Date:

Place

CA SURENDRA AGRAWAL


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 Bayof Bengal. The oil Ministry requires X Ltd to submit the proposal along with the SummaryFinancial Statements (SFS)for the year 2011-12. You have been appointed to conduct the audit ofSFS. The audit of SFS for the year 2011-12 was conducted by AB & Co. Chartered Accountantswho had issued 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 SheetMANAGMENT 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 onSummary Financial Statements' as issued by ICAI.

PINIONBased 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 USE

The 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,denature

Membership No:Firm Registration No:Date:Place:

CA SURENDRA AGRAWAL


2400.1

SRE 2400 - ENGAGEMENTS TO REVIEW FINANCIAL STATEMENTS

Samples of report on SRE 2410/SRE 2400REPORT ON REVIEW OF INTERIM FINANCIAL INFORMATIONTo,NSEBombayWe 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 interimfinancial information in accordance with applicable financial reporting framework.Auditor's Responsibilitya) Our responsibility is to express a conclusion on this interim financial informationbased 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 IndependentAuditor of the Entity".c) A review of interim financial information consists of making inquiries, primarily ofpersons responsible for financial and accounting matters, and applying analytical andother review procedures.d) A review is substantially less in scope than an audit conducted in accordance withStandards on Auditing and consequently does not enable us to obtain assurance that wewould become aware 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 thatthe accompanying interim financial information does not give a true and fair view thestate of affairs of the entity as at Dec 31, 2012, and of its results of operations and its cashflows for the three month period then ended in accordance with applicable financialreporting framework. Accordingly, we do not express an audit opinion subject to thefollowing observations:• 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 :

CA SURENDRA AGRAWAL


2410.1

SRE 2410 - REVIEW OF INTERIM FINANCIAL INFORMATION PERFORMED BY

INDEPENDENT AUDITOR OF THE ENTITY

Question 1

While compiling the financial statements of a concern, you observed that the input informationsupplied by the concern is incomplete, incorrect and few of the Accounting Standards have notbeen followed. Describe, in brief, the procedure you will follow in the above.

Answer

Compilation of Financial Information: According to SRS 4410 “Engagements toCompile Financial Information”, an accountant would normally have to rely upon themanagement for information to compile the financial statements in a compilationengagement. If in the course of compilation of financial statements, it is observed thatthe information supplied by the entity is incorrect, incomplete or otherwiseunsatisfactory, the accountant should perform following procedures:

(i) Make any enquiries of management to assess the reliability and completeness of theinformation 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 may be asked in the form of management representation letter. If the managementrefuses to provide additional information, the accountant should withdraw from theengagement, informing the entity of the reasons for such withdrawal.

If one or more accounting standards are not complied with, the same should be broughtto the notice of the management and if the same is not rectified by the management, theaccountant should include the same in notes to the accounts and the compilation reportto the management.

CA SURENDRA AGRAWAL


3400.1

SAE 3400 - THE EXAMINATION OF PROSPECTIVE FINANCIAL INFORMATION

Question 1

T & Co. wants to issue a prospectus, to provide potential investors withinformation about future expectations of the Company. You are hired by T & Co. toexamine the projected financial statements and give report thereon. What things youwill consider before accepting the audit engagement and what audit evidence will beobtained for reporting on projected financial statements?

Answer

Projected Financial Statements: As per SAE 3400, “The Examination of ProspectiveFinancial Information”, the answer is divided into two parts i.e.

(i) the things to be considered before accepting the engagement and

(ii) audit evidence to be obtained for reporting on projected financial statements.

(i) Acceptance of Engagement: As per SAE 3400, “The Examination of ProspectiveFinancial Information”, before accepting an engagement to examine prospectivefinancial 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 orhypothetical 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, anengagement when the assumptions are clearly unrealistic or when the auditor believesthat the prospective financial information will be inappropriate for its intended use.

In accordance with SA 210, “Terms of Audit Engagement”, it is necessary that theauditor and the client should agree on the terms of the engagement.

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3400.2

(ii) Audit evidence to be obtained for Reporting on Projected FinancialStatements: The auditor should document matters, which are important in providingevidence to support his report on examination of prospective financial information,and evidence that such examination was carried out.

The audit evidence in form of working papers will include:

(1) the sources of information,

(2) basis of forecasts and

(3) the assumptions made in arriving the forecasts,

(4) hypothetical assumptions, evidence supporting the assumptions,

(5) management representations regarding the intended use and distribution of theinformation, 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 theengagement, the reasons forming the basis of such decision.

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3402.1

SAE 3402 - ASSURANCE REPORTS ON CONTROLS AT A SERVICE ORGANISATION

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4400.1

SRS 4400 -ENGAGEMENT TO PERFORM AGREED UPON PROCEDUREREGARDING FINANCIAL INFORMATION

Example of Report on SRS 4400You have been appointed to perform Agreed upon Procedures in relation to X Ltd.,for the year 2011-12 in the area of inventory. Give your report (assume 2 proceduresand 2 observations)REPORT ON FACTUAL FINDINGSTo,The managementWe have performed agreed upon procedures in the area of inventory of X Ltd for theyear ended 31.03.2012. 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 giveobservations.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.The auditor performs agreed upon procedures in accordance with SRS 4400 as issuedby 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 using LIFO (Last in first out) method and it is overvalued by Rs50 crores. Theinventory valuation is not as per Accounting Standard 2 as issued by ICAI.Observation 02-Based upon procedure P2, we have observed that closing stockvaluation is not as 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:

CA SURENDRA AGRAWAL


4410.1

SRS 4410 - ENGAGEMENTS TO COMPILE FINANCIAL INFORMATION

Question 1

C & Co., hired Mr. A, Chartered Accountant, to compile its financial statements forthe interim period ending on 31st December 2014. Kindly assist Mr. A in draftingscope of engagement letter with specific focus on C & Co's responsibility.

Answer

As per SRS 4410 “Engagements to Compile Financial Information”, the engagementletter to be issued 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 andselection and application of appropriate accounting policies.

2) Preparation and presentation of the financial statements of the entity, inaccordance with the applicable laws and regulations, if any.

3) Safeguarding the assets of the entity and also establishing appropriate controlsdesigned to prevent and detect fraud and other irregularities.

4) Ensuring that the activities of the entity are carried in accordance withapplicable laws and regulations and that it institutes appropriate controls toprevent and detect any non-compliance.

5) Ensuring complete disclosure of all material and relevant information tothe accountant.

Question -2


(a) You are appointed to compile financial statements of Y & Co. for tax purposes.During the course of work, you learn that the inventory is grossly understated. Onpointing the same, the partners of Y & Co. tell you that since you are not conductingan audit, the said figures duly certified by the firm should be accepted.

Answer

1) Compilation of Financial Statements: According to SRS 4410 “Engagements toCompile Financial Information”, if an accountant becomes aware of materialmisstatements, the accountant should persuade the management to carry out

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4410.2

necessary amendments in the financial statements or other compiled financialinformation.

2) If such amendments are not made and the financial statements are stillconsidered to be misleading the accountant should withdraw from theengagement.

3) As per guidance note on Tax Audit under section 44AB of the Income Tax Act,1961, the stock auditor should study the procedure followed by the assessee intaking the inventory of closing stock at the end of the year and the valuationthereof.

4) The tax auditor should also examine the basis adopted for ascertaining the costand this basis should be consistently followed. It is very necessary for anauditor to ensure that the method followed for valuation of stock results indisclosure of correct profit and gains.

In the instant case, appointment was made to compile financial statements fortax audit purpose of Y & Co., a firm. It is our duty of to ensure that methodfollowed for valuation of stock results in disclosure of correct profit and gains.

In this case the stock valuation was grossly understated. Consequently, disclosure ofprofit is also not correct. Hence, contention of the Y & Co., that you are not theconducting an audit, the said figures duly certified by the firm should be accepted isnot correct.

Question -3

Write a short note on Reporting on a compilation engagements.Answer

Reporting on a compilation engagements: As per SA 4410 “Engagements toCompile Financial Information”, the report on compilation engagementsshould, ordinarily, be in the following layout:

a. Title: The title of the report should be “Accountant’s Report onCompilation of Unaudited Financial Statements” (and not “Auditor’sReport”);

b. Addressee: The report should ordinarily be addressed to theappointing authority;

c. Identification of the financial information also noting that it is based onthe information provided by the management;

d. When relevant, a statement that the accountant is not ndependent of the entity;

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4410.3

e. A statement that the management is responsible for:

♦ completeness and accuracy of the underlying data and completedisclosure of all material and relevant information to the accountant;

♦ maintaining adequate accounting and other records and internalcontrols and selecting and applying appropriate accounting policies;

♦ preparation and presentation of financial statements or other financialinformation in accordance with the applicable laws and regulations, ifany;

♦ establishing controls to safeguard the assets of the entity andpreventing and detecting frauds or other irregularities;

♦ establishing controls for ensuring that the activities of the entity arecarried out in accordance with the applicable laws and regulations andpreventing and detecting any non-compliance;

f. A statement that the engagement was performed in accordance with thisStandard on Related Services;

g. A statement that neither an audit nor a review has been carried out andthat accordingly no assurance is expressed on the financial information;

h. A paragraph, when considered necessary, drawing attention to thedisclosure of material departures from the identified financial reportingframework;

i. Date of the report;

j. Place of signature; and

k. Accountant’s signature.

The financial statements or other financial information compiled by theaccountant should contain a reference such as “Unaudited,” “Compiledwithout Audit or Review” and also “Refer to Compilation Report” on eachpage of the financial information or on the front of the complete set offinancial statements.

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 theAccounting Standards have not been followed. Describe, in brief, the procedure youwill follow in the above.

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4410.4

Answer

Compilation of Financial Information: According to SRS 4410 “Engagements to CompileFinancial Information”, an accountant would normally have to rely upon themanagement for information to compile the financial statements in a compilationengagement. If in the course of compilation of financial statements, it is observed thatthe information supplied by the entity is incorrect, incomplete or otherwiseunsatisfactory, the accountant should perform following procedures:

(1) Make any enquiries of management to assess the reliability and completeness ofthe 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 the management refuses to provide additional information, the accountantshould withdraw from the engagement, informing the entity of the reasons forsuch withdrawal.

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 accountsand the compilation report to the management.

CA SURENDRA AGRAWAL


SQC 1 - QUALITY CONTROL FOR FIRMS THAT PERFORM AUDIT AND REVIEWSOF HISTORICAL FINANCIAL INF

CA SURENDRA AGRAWAL


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Question 1"The auditors need not review accounting policies unless there is a change in the basis ofaccounting". Comment.

AnswerThe auditor while conducting an audit should critically examine the accounting policies adoptedby the client and test them for conformity with the accounting standards and recommendations of theInstitute. The Companies Act as well as many other statutes require that the financial statements ofan enterprise should give a true and fair view of its financial position and working results. Thisrequirement is implicit even in the absence of a specific statutory provision to this effect. However,what constitutes a 'true and fair' view has not been defined either in the Companies Act or in anyother statute. The pronouncements of the Institute seek to describe the accounting principlesand the methods of applying these principles in the preparation and presentation of financialstatements so that they give a true and fair view. The 'Preface to the Statements of AccountingStandards' issued by the Institute in 1979 states as under:"While discharging their attest function, it will be the duty of the members of the Institute to ensure thatthe Accounting Standards are implemented in the presentation of financial statements covered bytheir audit reports. In the event of any deviation from the Standards, it will be also their duty to makeadequate disclosures in their reports so that the users of such statements may be aware of suchdeviations."In cases where no pronouncement of the Institute exists, the auditor should examine theacceptability of the said accounting policy. The view presented in the financial statements of anenterprise of its state of affairs and of the profit or loss can be significantly affected by theaccounting policies followed in the preparation and presentation of the financial statements. Theaccounting policies followed vary from enterprise to enterprise. Disclosure of significant accountingpolicies followed is necessary if the view presented is to be properly appreciated. It is also quite clearthat there is no single list of accounting policies which are applicable to all circumstances. Thediffering circumstances in which enterprises operate in a situation of diverse and complexeconomic activity make alternative accounting principles and methods of applying those principlesacceptable. The choice of the appropriate accounting principles and the methods of applying thoseprinciples in the specific circumstances of each enterprise calls for considerable judgement by themanagement of the enterprise. The auditor is further required to determine whether the relevantinformation is properly disclosed in the financial statements by considering the judgements thatmanagement has made in preparing the financial statements; accordingly, the auditorassesses the selection and consistent application of accounting policies, the manner in whichthe information has been classified, and the adequacy of disclosure.Thus, the auditor should determine himself as to whether or not the said treatment is consistent withthe basic principles of accounting. Therefore, it would not be correct to state that the auditor need notreview the accounting policies unless there is a change in the basis of accounting.

Question -2Write short notes on Frauds through supplier ledger.

AnswerFrauds Committed through Suppliers Ledger: Fraud through supplies ledger could be madein any of the following ways, which the auditor has to take care of:(i) Inflating suppliers account with fictitious or duplicate invoices and subsequent

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misappropriations as if payments are made to the supplier(ii) Suppressing credit notes issued by the suppliers and withdrawing the corresponding

amount not claimed by them.(iii) Withdrawing amounts which remain unclaimed for more than the normal time limit for one

reason or other by showing the same have been paid to the parties.

(iv) Inflating values of items purchased and collecting the excess from suppliers i.e.accepting invoices at prices considerably higher than the market price and collecting the excessclaim from the suppliers directly.

Question 3S Ltd. issued Bonds to the tune of ` 100 lacs and provided security to the tune of ` 80 lacs for thesame. It insists that it will disclose the Bonds as "Secured" in the Balance Sheet of the Company.Comment.AnswerDisclosure in Balance Sheet: Prima facie, the Bonds issued to the tune of ` 100 lacs areprovided with security to the tune of ` 80 lacs i.e. neither fully secured nor unsecured.Guidance Note on the “Terms used in Financial Statements” issued by ICAI, states “Secured Loans”as loan secured wholly or partly against an asset. Hence the Bonds should be classifiedunder ‘Secured Loans’ for the purpose of disclosure in the Balance Sheet. However the nature ofsecurity should be clearly specified.Question 4Comment on the following:(a) 'A' Limited has paid minimum alternate tax under Section 115 JB of the Income Tax Act,

1961, for the year ended 31st March, 2014 The company wants to disclose the same as an'Asset' since the company is eligible to claim credit for the same.

Answer(a) Disclosure of MAT: As per Para 6 of the Guidance Note issued by ICAI on “Accounting for

credit available in respect of MAT under the IT Act, 1961”, although MAT credit is not adeferred tax asset under AS 22, yet it gives rise to expected future economic benefit in theform of adjustment of future income tax liability arising within the specific period.The Framework for the preparation and presentation of financial statements, issued by theICAI, defines the term ‘asset’ is a resource controlled by the enterprise as a result of past eventsfrom which future economic benefits are expected to flow to the enterprise.MAT paid in a year in respect of which the credit is allowed during the specified period under theIncome Tax Act is a resource controlled by the company as a result of past event, namelythe payment of MAT. The MAT credit has expected future economic benefits in the form ofits adjustment against the discharge of the normal tax liability if the same arises during thespecified period. Accordingly, such credit is an asset.According to the Framework, once an item meets the definition of the term ‘Asset’, it has tomeet the criteria for recognition of an asset, so that it may be recognised as such in thefinancial statements.Para 88 of the Framework provides the following criteria for recognition of an asset:An asset is recognised in the balance sheet when it is probable that the future economic benefits

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associated with it will flow to the enterprise and the asset has a cost or value that can bemeasured reliably.

Thus, if the auditor is satisfied that the probability of the company to claim the said credit ishigh, it could recognise the same as an asset. In balance sheet it could be shown underthe head “Loans and Advances” as MAT credit entitlement.

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