SECTION 1: REVISIONARY NOTES OF CERTAIN TOPICS …vpjclasses.com/study/CA Final Audit Updates May 2017.pdf · The principal enactments which govern the functioning of various types

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SECTION 1: REVISIONARY NOTES OF CERTAIN TOPICS SECTION 2: CORRIGENDUM SECTION 3- New Questions which were Covered in Feb & March 2017 Batch on EQCS


SECTION 1: REVISIONARY NOTES OF CERTAIN TOPICS

Type of Banking Institutions in India

Principal Enactments Governing Bank Audit

The principal enactments which govern the functioning of various types of banks are: ¨ Banking Regulation Act, 1949 ¨ State Bank of India Act, 1955 ¨ Companies Act, 1956 ¨ State Bank of India (Subsidiary Banks) Act, 1959 ¨ Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 ¨ Regional Rural Banks Act, 1976 ¨ Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 ¨ Information Technology Act, 2000 ¨ Prevention of Money Laundering Act, 2002 ¨ Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 ¨ Credit Information Companies Regulation Act, 2005 ¨ Payment and Settlement Systems Act, 2007

Characteristics of Bank’s system of Book Keeping

Entries in personal ledger made directly from the vouchers

Entries posted on the personal ledger through vouchers are summarised on daily basis.

The total of Summary Sheets are posted in control account of the General Ledger

Daily Trial Balance extracted from the General Ledger

The entries in the Summary Sheets and Personal Ledgers are verified by Independent persons, who are not connected with the transactions

Conduct of Bank Audit

1. Initial consideration by the Statutory auditor

2. Identifying and Assessing the Risks of Material Misstatements

3. Understanding the Bank and Its Environment including Internal Control

4. Understand the Bank’s Accounting Process

5. Understanding the Risk Management Process

Reserve Bank of India

Commercial Banks

Public Sector Banks

Nineteen Nationalized

Bank

SBI & Its Subsidiaries

Private Sector Banks

Regional Rural Banks

Co-operative Banks

Developments Banks


6. Engagement Team Discussions

7. Establish the Overall Audit Strategy

8. Develop the Audit Plan

9. Audit Planning Memorandum

10. Determine Audit Materiality

11. Consider Going Concern

12. Assess the Risk of Fraud including Money Laundering

13. Assess Specific Risks

14. Risk Associated with Outsourcing of Activities

15. Response to the Assessed Risks

16. Stress Testing

LFAR

It is a questionnaire filled by Auditor regarding the individual aspects appearing in FS and working of bank.

Furnished by the auditor in addition to the audit report as per the statutory requirement.

Any irregularity/ deficiency reported in LFAR, need to be reported firstly in the Main Auditors report

SLR

Background Central statutory auditors are required to verify the compliance of SLR on 12 odd dates in different months not having Fridays. To verify compliance with SLR requirements, the statutory auditor has to examine two aspects:

(a) Correctness of the figure of DTL at the close of business on the reporting Friday relevant to the dates selected by the auditor, and (b) Maintenance of prescribed percentage of liquid assets on the selected date.

Audit Procedure

1. Examine the composition of items of DTL as per circulars/instructions of RBI. 2. Verification of trial balance and cash balance for 12 selected dates by Branch auditors. 3. Inclusion of demand and time liabilities in Consolidated Statement based on the returns received from the unaudited branches. 4. Examine whether Net credit balance in Branch Adjustment Account has been included in liabilities. 5. In computation of liquid assets, deposits maintained with RBI, cash balance with itself or RBI, excess balance maintained with RBI, net balance in current account are all treated as cash. 6. Price of gold taken does not exceed market price. 7.Verify the valuation of Securities

Internal Control System

Cash Kept in joint custody

Test-checked counted in full

Cashier have no access to the customer’s ledger accounts

Payments made only after the vouchers passed for payment by the proper officer TELLER SYSTEM

Limit placed on the powers of tellers

Total payment made by a teller reconciled with the cash columns of the Voucher Summary Sheet every day

be frequent rotation of tellers

CLASSIFICATION AS PER PRUDENTIAL NORMS


Category of investment should be decided at the time of acquisition and recorded on investment proposal.

Non Performing Assets (NPAs)

Term Loans Interest /Installment remain overdue >90 days

Bills Purchased/Discounted

Bills remained overdue and unpaid >90days

Securitisation liquidity facility remains outstanding for more than 90 days

Agricultural Advances Interest/Installment remain overdue

Short duration crops >2 crop seasons

long duration crops >1 crop season

Credit Card Accounts Min. amount due not paid within 90 days from next statement due.

Other Accounts Amount overdue >90 days.

CC/OD Account remained out of order >90 days. Out of Order Status

Financial Factor Non-Financial Reasons

O/s Balance > DP/Sanction Limit No credit continuously in previous

90 days from Due Date or credit is not enough to cover the interest debited during the same period

Advance agst Stock: non availability of stock statement on regular basis i.e. 3 months old account irregular continuous 90 days NPA

Regular or adhoc sanction: non availability of FS or other data not renewed/reviewed within 180 days from due date NPA

Classification Norms relating to NPAs

Temporary Deficiencies

a) need not be classified as NPA merely due to the existence of some deficiencies which are temporary in nature

b) However where regular/adhoc credit limits have not been reviewed/renewed within 180 days from the due date/date of ad hoc sanction---- Treated as NPA.

Regularisation Near About Balance Sheet

Where the account indicates inherent weakness - deemed as a NPA.

Borrower-wise not Facility-wise

if anyone of the Credit Facilities granted to a borrower becomes NPA, all the facilities regarded

as NPA

Erosion in Value of Securities/ Frauds Committed by Borrowers

a) Classify as doubtful and provide provision accordingly, where realisable value is less than 50% of the value assessed by bank or accepted by RBI as the case may be.

b) Classify as Loss asset and write off fully, where realisable value is less than 10 % of the outstanding borrowed.

CG - Guaranteed Advances

Treated as NPA only when the government repudiates its guarantee.

However on interest of such advances will be recognised as income only if realised.

Held to Maturity (HTM)

•Securities acquired by bank with the intention

to hold till maturity.

Held for Trading (HFT)

•Securities acquired by bank with the intention of trading, i.e. to be sold

within 90 days.

Available for Sale (AFS)

•Securities which do not qualify for being classified

as HTM or HFT.


SG - Guaranteed Advances

Treated as NPA if interest / principal / other dues remain overdue for more than 90 days.

Advances Under Consortium

a) Each individual bank – Should classify advances based on the record of recovery of the respective individual member banks

b) The banks participating in the consortium need to arrange to get their share of recovery transferred from the lead bank or to get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset classification

Advances Against Term Deposits, NSCs, KVPs/ IVPs, etc.

Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP and life policies need

not be treated as NPAs, provided adequate margin is available in the accounts.

Agricultural Advances Affected by Natural Calamities

Banks may decide on their own relief measures, viz., conversion of the short term production loan into a term loan or reschedulement of the repayment period and the sanctioning of fresh short term loan, subject to the guidelines by RBI’s latest Master Circular on Prudential Norms on IRAC and provisioning pertaining to Advances. In such cases, the NPA classification would be governed by such rescheduled terms.

Staff Loans Housing loan/similar advances granted to staff members where interest is payable after

recovery of principal, interest need not be considered as overdue from first quarter onwards.

It should be classified as NPA only when there is a default on the respective due dates

Advances to PACS/FSS ceded to Commercial Banks

In case of advances granted under the on-lending system, however, ONLY THE PARTICULAR CREDIT FACILITY granted to PACSs or FSSs, which is in default for a period of two crop seasons in case of short duration crops and one crop season in case of long duration crops, will be classified as NPA and not all the credit facilities

Sale/ Purchase of NPAs:

the auditor should examine the policy laid down by the Board of Directors.The auditor should also examine that: (i) only such NPA has been sold which has remained NPA in the books of the bank for at least 2 years. (ii) the assets have been sold/ purchased “without recourse’ only. (iii) subsequent to the sale of the NPA, the bank does not assume any legal, operational or any other type of risk relating to the sold NPAs. (iv) the NPA has been sold at cash basis only. (v) the bank has not purchased an NPA which it had originally sold.

Sale of NPA’s Purchase of NPA’s

(i) It is removed from the books of the account. (ii)Short fall in the net book value --charged to P&L A/c. (iii) sale Value > NBV, no profit is recognised and the excess provision has not been reversed but retained to meet the shortfall/ loss on account of sale of other NPA.

(i) the NPA purchased is subjected to the provisioning requirements appropriate to the classification status (ii) any recovery in respect of such NPA is first adjusted against its acquisition cost and if recovered amount > acquisition cost recognised as profit. (iii) for the purpose of capital adequacy, banks has assigned 100% risk weights to the NPAs purchased from other banks.


Restructuring Of Cases - Once the bank receives an application/proposal in respect of an account for restructuring, it implies account is intrinsically weak. auditors need to take a view whether provision needs to be made in respect of such accounts pending approval for restructuring .

Upgradation of Account:

Strictly in terms of RBI guidelines.

Upgrading of accounts classified as “Sub –Standard” or “Doubtful” category wherein restructuring / rephasement of principal or interest has taken place should be upgraded to the “Standard Asset” category only after a period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due under the rescheduled terms, subject to satisfactory performance during the period.

Total amount becoming due during this period of one year should be recovered and there should be no overdues to make it eligible for upgradation

Audit Procedure for Accounts falling under CDR (Corporate Debt Restructuring)

(a) Review the PRESENT CLASSIFICATION OF THE ACCOUNT under IRAC norms adopted by the bank and corresponding provision made in the books of accounts, if any. If the account is already treated as NPA in the books of the bank, the same cannot be upgraded only because of the CDR package. (b) Review the Debtor- Creditor Agreement (DCA) and Inter Creditor Agreement (ICA) with respect to availability of such agreements (c) Ascertain the terms of rehabilitation along with the sacrifices, if any, to verify whether such sacrifices have been accounted in the books of accounts of the lender. (d) Ascertain whether any additional financing / conversion of loan into equity have been envisaged in the rehabilitation / restructuring program. (e)Where account has been referred to BIFR, as such cases are not eligible for restructuring under CDR system. Large value BIFR cases may be eligible for restructuring under CDR if specifically recommended by CDR core group. (f)Ensure wherein recovery suits have been filed, the initiative to resolve under CDR system is taken by at least by 75% of the creditors by value and 60% in number

Treatment of accounts restructured under CDR program: Classification and Provisioning:

The criteria for classification of accounts will be on the basis of record of recovery as per the existing prudential norms. The asset classification will be as per the lender bank‟s record of recovery and will be bank specific.

ensure that the lender has applied the usual asset classification norms pending outcome of the account with the CDR Cell.

The asset classification status should be restored to the position, which existed at the time of reference to the cell if the restructuring under the CDR system takes place.

The auditor should also ensure that in case a standard asset has been restructured second or more time, it has been downgraded to “sub-standard” asset.

Ensure that proper disclosure in the Notes to Accounts in respect of CDR of SME undertaken by the bank during the year

Capital Adequacy Ratio (CAR)

Meaning Capital adequacy is the adequacy of sufficiency of capital resources of a bank in relation to the risk associated with its operations. This Ratio indicates the sufficiency or adequacy in % terms

Minimum CAR

All Indian scheduled commercial Banks (excluding RRB) & foreign banks operating in India to maintain CAR at a minimum of 9%.

Computation [Capital Funds ÷ Risk weighted assets and off balance sheet items] x 100

Constituents of Capital Funds

For purpose of computing the capital adequacy ratio, capital funds are classified into two categories: Tier I Capital, Tier II Capital


Tier I Capital It consists mainly of share capital and disclosed reserves and it is a bank’s highest quality capital because it is fully available to cover losses.

Tier II Capital It consists of certain reserves and certain types of subordinated debt. The loss absorption capacity of Tier II capital is lower than that of Tier I capital.

Cash In Hand Balances with RBI Balances with Other Banks Visit branch on the last working day on the last

working day PV

If Not Work back to B/S Figures Evaluate Internal Controls

Ensure insurance policy taken

Count / Inspect the Foreign Currency Notes and their Conversion

currency chest not mixed with cash balances

Obtain a certificate (W/R from Bank)

Verify the ledger balances V bank confirmation certificates

Review reconciliation statements

written explanation as to the reasons for old outstanding transactions

Review the reco statements.

Examine year-end large transactions

examine the original deposit receipt.

Money at Call and Short Notice

Meaning Audit Procedures

Money lent for one day is money at ‘call’ while money lent for a period of more than 1 day and up to 14 days is money at ‘short notice’.

lender bank does not get any security for money lent

Participants: all scheduled commercial banks (excluding RRBs), all co-operative banks other than land development banks and all primary dealers, both as borrowers and lenders.

a) Examine proper authorisation b) Examine compliance with r guidelines laid down by HO c) Verify the call loans with the certificates of the borrowers and the call

loan receipts held by the bank. d) Examine balances as shown in the relevant register tally with the control

accounts as per the GL. e) Examine subsequent repayments received to verify year-end balances. f) Ensure call loans made by a bank are not netted-off against call loans

received. g) (i)interest properly accrued and accounted (ii) brokerage as per RBI

guidelines.

Inter Office Adjustments

Ensure that the Inter Branch Accounts are sub-divided in to: segments/areas like – (a) Demand Drafts, (b) Inter Branch Remittances, (c) Head Office Account, etc.

Evaluate of reconciliation at the Head office Verify the closing balances Obtain year wise break up in respect of un-reconciled entries. Examine any reversal entry indicating the possibility of irregular payments or frauds Enquire the reason for cash in transit beyond a reasonable period Examine whether all payments of drafts are matched with the credit in books Examine transactions other than those relating to Inter- Branch transactions have been included in inter-branch

accounts. Test check the computation of interest on Inter Branch Transactions.


Statutory Reserves

Every banking company incorporated in India has to transfer 20% of its profits to its reserve fund each year before declaring dividends.

Non-Banking Assets Acquired in Satisfaction of Claims

SA 610

EA has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the use of the

work of the internal audit function or internal auditors to provide direct assistance

Using the work of the internal audit function Using internal auditors to provide DIRECT ASSISTANCE Under DSR of EA

A. Evaluating the Internal Audit Function (a) organizational status (b)Level of competence © IA’s systematic & disciplined approach

Determining Whether IAs Can Be Used to Provide Direct Assistance for Purposes of the Audit

Whether prohibited by law or regulation

IF Not evaluate Prohibited evaluate the existence and significance of threats to

objectivity and level of competence of the internal

auditors

B. Determining the Nature and Extent of Work of the Internal Audit Function that Can Be Used

Nature, scope of the work that has been performed and and its relevance to the external auditor’s overall audit strategy and audit plan.

EA shall make all significant judgments and Prevent undue use of work of IAF and perform more of the work directly.

Evaluate using the work of IAF to the extent planned would still result in the EA being sufficiently involved in the audit

EA shall communicating with TCWG in terms of SA 260 how the EA planns to use the work of IAF

Determining the Nature and Extent of Work that Can Be Assigned to Internal Auditors Providing Direct Assistance 1. Extent of using Direct Assistance- (a) The amount of judgment involved and Evaluation of the audit evidence gathered; (b)The assessed ROMM and (c) evaluation of the existence and significance of threats to the objectivity and level of competence of the internal auditors 2. Direct assistance cannot be used- In case the answer to the above is negative. 3. Communicate with TCWG nature and extent of the planned use of IA’s to provide direct assistance, so as to reach a mutual understanding. 4. EVALUATE his own involvement as EA has the sole Responsibility for Opinion express

C. Using the Work of IAF 1. Read the reports of the internal audit function 2. EVALUATING

a) The work of the IAF had been properly planned, performed, supervised, reviewed and documented;

b) SAAE had been obtained to draw reasonable conclusions; and

c) Conclusions reached are appropriate and the reports are consistent with the results of the work performed.

3.Nature and extent of the EA’s audit procedures shall be responsive to evaluation of (FACTORS):

a. The amount of judgment involved; b. The assessed ROMM

Using Internal Auditors to Provide Direct Assistance 1. EA shall (a)Obtain written agreement from Entity that IA’s will be allowed to follow the EA’s instructions, and that the Entity will not intervene (b)Obtain written agreement from the IA that they will keep confidential specific matters as instructed by the EA 2.EA shall – (a) DSR the work performed by IA’s as per SA–220, (b) check back to the underlying audit evidence for some of the work performed by the IA’s. 3. The DSR by the EA, of the work performed by the IA’s shall be sufficient in order for the EA to be

Meaning PeriodAS-10 Not

ApplyValuation Dispute


c. The extent to which the IAF organizational status and relevant policies and procedures support the objectivity of the internal auditors; and d. The level of competence of the function; and shall include reperformance of some of the work.

satisfied that the IA’s have obtained sufficient appropriate audit evidence to support the conclusions based on that work.

SAE 3420 “ASSURANCE ENGAGEMENTS TO REPORT ON THE COMPILATION OF PRO FORMA FINANCIAL

INFORMATION INCLUDED IN A PROSPECTUS

REQUIREMENT

Section I- EA Section II- Planning and Performing an Engagement

Section II- Forming an Opinion

Practitioner has the capabilities and competence to perform

Applicable criteria are suitable

Evaluate the wording of the opinion prescribed by the relevant law or regulation

SOURCES from which the UFI have been extracted have been audited or reviewed and a modified audit opinion or review conclusion has been expressed, or the report contains an EOMP---

Applicable criteria are suitable UFI extracted from an appropriate source; Pro forma adjustments be:

(i) Directly attributable to the event or transaction; (ii) Factually supportable; and (iii) Consistent with the entity’s applicable FRF and its accounting policies

Appropriate presentation be made and disclosures

Materiality- evaluate whether the PFI has been compiled, on the basis of the applicable criteria

Obtaining an Understanding of How the Responsible Party Has Compiled the Pro Forma Financial Information and Other Engagement Circumstances

law or regulation precludes publication of a prospectus that contains a modified opinion- Discuss the Matters with RP. IF RP Doesn’t agree- Withdraw

law or regulation may not preclude publication of a prospectus that contains a modified opinion- practitioner determines that a modified opinion is appropriate


Whether Law Permits use of Practioner’s Report

If the entity’s historical FI has never been audited or reviewed- Whether sufficient understanding of the entity and its accounting and financial reporting practices can be obtained

Agreement of the responsible party- Disclosing the Applied Criteria, Compiling the Info.,access, additional Info.

Obtaining Evidence about the Appropriateness of the Source from Which the Unadjusted Financial Information Has Been Extracted

Obtaining Evidence about the Appropriateness of the Pro Forma Adjustments

Modified Audit Opinion or Review Conclusion, or EOMP, with Respect to the Source from Which the Unadjusted Financial Information Has Been Extracted-- See Steps Below

Source from Which the Unadjusted Financial Information Has Been Extracted or Pro Forma Adjustments Not Appropriate-- See Steps Below

Evaluating the Presentation of the Pro Forma Financial Information

Preparing the Assurance Report- TAI MAA DPS

Modified Audit Opinion or Review Conclusion, or EOMP, with Respect to the Source from Which the Unadjusted Financial Information Has Been Extracted

practitioner shall evaluate (a) The potential consequence on PFI based on applicable criteria (b)further appropriate action to taken; © effect on the practitioner’s ability to report as per Terms of Engagement

Source from Which the Unadjusted Financial Information Has Been Extracted or Pro Forma Adjustments Not Appropriate

Discuss the matter

If the practitioner is unable to agree- evaluate what further action to take.

SRE 2400(REVISED) ENGAGEMENTS TO REVIEW HISTORICAL FINANCIAL STATEMENTS

REQUIREMENT

Section I- Preliminary General Aspects

Section II- Acceptance and Continuance of Client

Relationships and Review Engagements

Section II- Forming an Opinion

Complying with Relevant Requirements

Ethical Requirements

Professional Scepticism and Professional Judgment

Engagement Level Quality Control

Factors Affecting Acceptance and Continuance of Client Relationships and Review Engagements- ethical requirements, information needed to perform unavailable, doubt management’s integrity, limitation on the scope

Preconditions for Accepting a Review Engagement- PIA

Agreeing the Terms of Engagement

Communication with Management and TCWG

Materiality in a Review of Financial Statements

The Practitioner’s Understanding- SA 315 5 Factors

Design and perform inquiry and analytical procedures-ACE,RTP, unusual transactions, Fraud, events occurring between FS date and Practitioner’s date, Going Concern

Additional Procedures When the Practitioner Becomes Aware that the FS May Be Materially Misstated

Forming the Practitioner’s Conclusion on the Financial Statements- ATIME

REPORTING- AS Discussed in Class


SECTION -2 Corrigendum

Co-operative Society

Q A Co-operative Society having receipts above Rs.40 lakhs gets its accounts audited by a person eligible to

do audit under Co-operative Societies Act, 1912, who is not a Chartered Accountant. State with reasons

whether such audit report can be furnished as tax audit report under Section 44 AB of the Income Tax Act,

1961? (3 Marks) [N09][N]

Ans This Questions has been deleted from the chapter of Co-operative Societies because the same question was Given in Tax Audit Chapter and the answer given thereat needs to be followed.

SA 250

Q State the reporting responsibility of an auditor in the context of non-compliance of Law and Regulation in

an audit of Financial Statement.

Ans Reporting responsibility of an auditor in the context of non -compliance of Law and Regulation: According to SA 250 “Consideration of Laws and Regulations in an Audit of Financial Statements”, the reporting responsibilities of an Auditor may be divided into the following categories - Reporting Non-Compliance to Those Charged with Governance: Unless all of those charged with governance are involved in management of the entity, and therefore are aware of matters involving identified or suspected non -compliance already communicated by the auditor, the auditor shall communicate with those charged with governance matters involving non-compliance with laws and regulations 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 be intentional and material, the auditor shall communicate the matter to those charged with governance as soon as practicable. If the auditor suspects that management or those charged with governance are involved in non-compliance, the auditor shall communicate the matter to the next higher level of authority at the entity, if it exists, such as an audit committee or supervisory board. Where no higher authority exists, or if the auditor believes that the communication may not be acted upon or is unsure as to the person to whom to report, the auditor shall consider the need to obtain legal advice. Reporting Non-Compliance in the Auditor’s Report on the Financial Statements: If the auditor concludes that the non -compliance has a material effect on the financial statements, and has not been adequately reflected in the financial statements, the auditor shall, in accordance with SA 705 express a qualified or adverse opinion on the financial statements. If the auditor is precluded by management or those charged with governance from obtaining sufficient appropriate audit evidence to evaluate whether non -compliance that may be material to the financial statements has, or is likely to have, occurred, the auditor shall express a qualified opinion or disclaim an opinion on the financial statements on the basis of a limitation on the scope of the audit in accordance with SA 705. If the auditor is unable to determine whether non -compliance has occurred because of limitations imposed by the circumstances rather than by management or those charged with governance, the auditor shall evaluate the effect on the auditor’s opinion in accordance with SA 705. Reporting Non-Compliance to Regulatory and Enforcement Authorities: If the auditor has identified or suspects non -compliance with laws and regulations, the auditor shall determine whether the auditor has a responsibility to report the identified or suspected non -compliance to parties outside the entity.

INSURANCE

Q RQ Insurance Ltd. has made a provision of 25% on unexpired risks reserve in its books. Comment. (5

Marks) (Final May 2008)

Ans This Answer is Redundant now. See New Question Below


Q AX Insurance Limited has made a provision of 75% of net premium in case of marine hull insurance and

50% in case of marine cargo and miscellaneous business of net premium for unexpired risks reserve in its

books. Comment.[PM]

Ans New Ans as Per PM 2017 Unexpired Risks Reserve: The Insurance Laws (Amendment) Act, 2015 notified dated 20th March, 2015 has amended the Insurance Act, 1938, General Insurance Business (Nationalisation) Act, 1972 and Insurance Regulatory and Development Authority Act, 1999. In view of changes made by Amendment Act, valuation of every item of liability of the insurer should be done in the manner as may be specified by the regulations made in this behalf. Therefore, assuming that there is no prescribed limit (till the time it is specified in regulations), both the provisions made by AX Insurance Limited is in order.

PSU AUDIT Q ABG & Co., a Chartered Accountant firm has been appointed by C & AG for performance audit of a Sugar

Industry. What factors should be considered by ABG & Co., while planning a performance audit of Sugar

Industry?

Ans Factors to be considered while planning the Performance Audit: While planning a performance audit of Sugar Industry, the auditors should take care of certain factors which are listed below: (i) to consider significance and the needs of potential users of the audit report. (ii) to obtain an understanding of the program to be audited. (iii) to consider legal and regulatory requirements. (iv) to consider management controls. (v) to identify criteria needed to evaluate matters subject to audit. (vi) to identify significant findings and recommendations from previous audits that could affect the current audit objectives. Auditors should determine if management has corrected the conditions causing those findings and implemented those recommendations. (vii) to identify potential sources of data that could be used as audit evidence and consider the validity and reliability of these data, including data collected by the audited entity, data generated by the auditors, or data provided by third parties. (viii) to consider whether the work of other auditors and experts may be used to satisfy some of the auditors' objectives. (ix) to provide sufficient staff and other resources to do the audit. (x) to prepare a written audit plan.

Note: 3 Revised Standards are applicable for May 2017 Attempt- SA 610, SRE 2400 & SRS 4410.

ONLY THE Questions and Answers mentioned below are relevant as of now.

SA 610

Q CA. Amboj, a practicing chartered accountant has been appointed as an internal auditor of Textile Ltd. He conducted the physical verification of the inventory at the year-end and handed over the report of such verification to CA. Kishor, the statutory auditor of the Company, for his view and reporting. Can CA. Kishor rely on such report? OR You are appointed statutory auditor of X Ltd. X Ltd. has an internal audit system and reports for the same are given to you. Mention the factors you will consider to ensure that the said system of internal audit of X Ltd. is commensurate with the size of the company and nature of its business.

Ans Using the Work of Internal Auditor: As per SA 610 “Using the Work of Internal Auditors”, while determining whether the work of the internal auditors can be used for the purpose of the audit, the external auditor shall evaluate (a) The extent to which the internal audit function’s organizational status and relevant policies and procedures support the objectivity of the internal auditors; (b) The level of competence of the internal audit function; and


(c) Whether the internal audit function applies a systematic and disciplined approach, including quality control. Further, the external auditor shall not use the work of the internal audit function if the external auditor determines that: (a) The function’s organizational status and relevant policies and procedures do not adequately support the objectivity of internal auditors; (b) The function lacks sufficient competence; or (c) The function does not apply a systematic and disciplined approach, including quality control. In the instant case, CA. Kishor should ascertain the internal auditor’s scope of verification, area of coverage and method of verification. He should review the report on physical verification taking into consideration these factors. If possible he should also test check few items and he can also observe the procedures performed by the internal auditors. If the statutory auditor is satisfied about the appropriateness of the verification, he can rely on the report but if he finds that the verification is not in order, he has to decide otherwise. The final responsibility to express opinion on the financial statement remains with the statutory auditor.

SRE 2400

Q You are engaged to review the system and the information generated from the financial statements. Discuss the elements of the practitioner’s report for the Historical Financial Statements review engagement.

Ans Elements of the Practitioner’s Report for Review Engagement: As per SRE 2400 “Engagements to Review Historical Financial Statements”, The practitioner’s report for the review engagement shall be in writing, and shall contain the following elements: (a) A title, which shall clearly indicate that it is the report of an independent practitioner for a review engagement; (b) The addressee(s), as required by the circumstances of the engagement; (c) An introductory paragraph that: (i) Identifies the financial statements reviewed, including identification of the title of each of the statements contained in the set of financial statements and the date and period covered by each financial statement; (ii) Refers to the summary of significant accounting policies and other explanatory information; and (iii) States that the financial statements have been reviewed; (d) A description of the responsibility of management for the preparation of the financial statements, including an explanation that management is responsible for: (i) Their preparation in accordance with the applicable financial reporting framework including, where relevant, their fair presentation; (ii) Such internal control as management determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error; (e) If the financial statements are special purpose financial statements: (i) A description of the purpose for which the financial statements are prepared and, if necessary, the intended users, or reference to a note in the special purpose financial statements that contains that information; and (ii) If management has a choice of financial reporting frameworks in the preparation of such financial statements, a reference within the explanation of management’s responsibility for the financial statements to management’s responsibility for determining that the applicable financial reporting framework is acceptable in the circumstances; (f) A description of the practitioner’s responsibility to express a conclusion on the financial statements including reference to this SRE and, where relevant, applicable law or regulation; (g) A description of a review of financial statements and its limitations, and the following statements: (i) A review engagement under this SRE is a limited assurance engagement; (ii) The practitioner performs procedures, primarily consisting of making inquiries of management and others within the entity, as appropriate, and applying analytical procedures, and evaluates the evidence obtained; and (iii) The procedures performed in a review are substantially less than those performed in an audit conducted in accordance with Standards on Auditing (SAs), and, accordingly, the practitioner does not express an audit opinion on the financial statements;


(h) A paragraph under the heading “Conclusion” that contains: (i) The practitioner’s conclusion on the financial statements as a whole in accordance with this SRS, as appropriate; and (ii) A reference to the applicable financial reporting framework used to prepare the financial statements. (i) When the practitioner’s conclusion on the financial statements is modified: (i) A paragraph under the appropriate heading that contains the practitioner’s modified conclusion in accordance with this SRS, as appropriate; and (ii) A paragraph, under an appropriate heading, that provides a description of the matter(s) giving rise to the modification; (j) A reference to the practitioner’s obligation under this SRE to comply with relevant ethical requirements; (k) The date of the practitioner’s report; (l) The practitioner’s signature; and (m) The place of signature.

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

Ans As Per SRE 2400(Revised) “Engagements to Review Historical Financial Statements”, in obtaining SAAE as the basis for a conclusion on the financial statements as a whole, the practitioner shall design and perform inquiry and analytical procedures:

(a) To address all material items in the financial statements, including disclosures; and (b) To focus on addressing areas in the financial statements where material misstatements are likely to arise.

The practitioner’s inquiries of management and others within the entity, as appropriate, shall include the following:

(a) How management makes the significant accounting estimates required under the applicable financial reporting framework; (b) The identification of related parties and related party transactions, including the purpose of those transactions; (c) Whether there are significant, unusual or complex transactions, events or matters that have affected or may affect the entity’s financial statements, including: (d) The existence of any actual, suspected or alleged: (i) Fraud or illegal acts affecting the entity; and (ii) Non-compliance with provisions of laws and regulations that are generally recognized to have a direct effect on the determination of material amounts and disclosures in the financial statements, such as tax and pension laws and regulations; (e) Whether management has identified and addressed events occurring between the date of the financial statements and the date of the practitioner’s report that require adjustment of, or disclosure in, the FS; (f) The basis for management’s assessment of the entity’s ability to continue as a going concern; (g) Whether there are events or conditions that appear to cast doubt on the entity’s ability to continue as a going concern; (h) Material commitments, contractual obligations or contingencies that have affected or may affect the entity’s financial statements, including disclosures; and (i) Material non-monetary transactions or transactions for no consideration in the financial reporting period under consideration. In designing analytical procedures, the practitioner shall consider whether the data from the entity’s accounting system and accounting records are adequate for the purpose of performing the analytical procedures.

Q Contrast this assignment with the statutory audit of the company’s financial statements with regard to the scope of the assignment and to the report issued. [RTP MAY 2011]

Ans (a) Contrast of a review assignment with the statutory audit of the company’s financial statements with regard to the scope of the assignment and to the report issued are hereunder:

SCOPE

Review assignment Statutory audit

Scope of Review assignments are generally falls in agreement between parties

Scope of Statutory audit should be in accordance with the Companies Act or in accordance with other statute.


Scope of Review assignments are restricted to instructions

Scope of Statutory audit should be in accordance with Audit Regulations and Norms

Review assignment should be done in accordance with SREs

Statutory audit should be conducted in accordance with SAs,14 Statements and Guidance Notes etc

REPORT

Review assignment Statutory audit

Report of Review Assignment is addressed to the board

Statutory Audit Report is Addressed to the members

Format of Report of Review Assignment is wholly discretionary

Statutory Audit Report is on true and fair view and as per prescribed Format.

Report of Review Assignment is private report

Statutory Audit Reports are in public domain

SRS 4410

Q Write short notes on the Reporting on a compilation engagements [N06,PM]

Ans Reporting on a compilation engagements: As per SRS 4410 “Compilation Engagements”, the practitioner’s report issued for the compilation engagement shall be in writing, and shall include the following elements: (a) The report title; (b) The addressee(s), as required by the terms of the engagement; (c) A statement that the practitioner has compiled the financial information based on information provided by management; (d) A description of the responsibilities of management, or those charged with governance as appropriate, in relation to the compilation engagement, and in relation to the financial information; (e) Identification of the applicable financial reporting framework and, if a special purpose financial reporting framework is used, a description or reference to the description of that special purpose financial reporting framework in the financial information; (f) Identification of the financial information, including the title of each element of the financial information if it comprises more than one element, and the date of the financial information or the period to which it relates; (g) A description of the practitioner’s responsibilities in compiling the financial information, including that the engagement was performed in accordance with this SRS, and that the practitioner has complied with relevant ethical requirements; (h) A description of what a compilation engagement entails in accordance with this SRS; (i) Explanations that:

(i) Since a compilation engagement is not an assurance engagement, the practitioner is not required to verify the accuracy or completeness of the information provided by management for the compilation; and (ii) Accordingly, the practitioner does not express an audit opinion or a review conclusion on whether the financial information is prepared in accordance with the applicable financial reporting framework.

(j) If the financial information is prepared using a special purpose financial reporting framework, an explanatory paragraph that: (i) Describes the purpose for which the financial information is prepared and, if necessary, the intended users, or contains a reference to a note in the financial information that discloses this information; and (ii) Draws the attention of readers of the report to the fact that the financial information is prepared in accordance with a special purpose framework and that, as a result, the information may not be suitable for other purposes; (k) The date of the practitioner’s report; (l) The practitioner’s signature; and


(m) The Place of signature. The practitioner shall date the report on the date the practitioner has completed the compilation engagement in accordance with this SRS.

Q While compiling the accounts of Hope Ltd., you observed that a few accounting standards have not been followed and there have been omission of some information which was required to be followed in the current situation. How would you deal with this?[4 Marks-Nov 15,PM 2017]

Ans Non-Compliance with the Accounting Standards: As per SRS 4410(Revised) “Compilation Engagements”, in the case of a company, the financial statements compiled must comply with the relevant provisions of the Companies Act, including the Accounting Standards and, accordingly, give a true and fair view. However, without carrying out the procedures necessary for an audit, the accountant cannot form any opinion on whether the accounts give a true and fair view, even though he has compiled these financial statements. The compilation is based on the information supplied to the accountant by the client and does not include any verification thereof. However, if the accountant becomes aware of material non-compliance with any applicable Accounting Standard(s), the same should be brought to the attention of the management and, if the same is not rectified by the management, it should be included in the Notes to the Accounts and the compilation report of the accountant. Thus, for not following and omission of some information which was required to be followed in the current situation for Hope Ltd., we should bring this matter to the attention of the management for rectification and, if the same is not rectified by the management, we should include the same in the Notes to the Accounts and the compilation report of the accountant.

Q 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. On pointing the same, the partners of Y & Co. tell you that since you are not conducting an audit, the said figures duly certified by the firm should be accepted. Comment.[PM] & [May 09] New

Ans Engagement to Compile Financial Information and Misstatements: As per “SRS 4410(Revised) “Compilation Engagements”, If the practitioner becomes aware during

the course of the engagement that: (a) The compiled financial information does not adequately refer to or describe the applicable FRF; (b) Amendments to the compiled financial information are required for the financial information not to be materially misstated; or (c) The compiled financial information is otherwise misleading, the practitioner shall propose the appropriate amendments to management.

If management declines, or does not permit the practitioner to make the proposed amendments to the compiled financial information, the practitioner shall withdraw from the engagement and inform management and TCWG of the reasons for withdrawing.

If withdrawal from the engagement is not possible, the practitioner shall determine the professional and legal responsibilities applicable in the circumstances.

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 in taking the inventory of closing stock at the end of the year and the valuation thereof. The tax auditor should also examine the basis adopted for ascertaining the cost and this basis should be consistently followed. It is very necessary for an auditor to ensure that the method followed for valuation of stock results in disclosure of correct profit and gains.

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

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


SECTION 3-SOME OF THE NEW QUESTIONS COVERED AFTER RELEASE OF PM 2017

PRFESSIONAL ETHICS

Q M/s XYZ, a firm in practice, develops a website “xyz.com”. The colour chosen for the website was a very bright green and the web-site was to run on a “push” technology where the names of the partners of the firm and the major clients were to be displayed on the web-site without any disclosure obligation from any regulator(PM 2017)

Ans- Posting of Particulars on Website: The Council of the Institute had approved posting of particulars on website by Chartered Accountants in practice under Clause (6) of Part I of First Schedule to the Chartered Accountants Act, 1949 subject to the prescribed guidelines. The relevant guidelines in the context of the website hosted by M/s XYZ are:

No restriction on the colours used in the website;

The websites are run on a “pull” technology and not a “push” technology

Names of clients and fees charged not to be given. However, disclosure of names of clients and/or fees charged, on the website is permissible only where it is required by a regulator, whether or not constituted under a statute, in India or outside India, provided that such disclosure is only to the extent of requirement of the regulator. Where such disclosure of names of clients and/or fees charged is made on the website, the member/ firm shall ensure that it is mentioned on the website [in italics], below such disclosure itself, that “This disclosure is in terms of the requirement of [name of the regulator] having jurisdiction in [name of the country/area where such regulator has jurisdiction] vide [Rule/ Directive etc. under which the disclosure is required by the Regulator]. In view of the above, M/s XYZ would have no restriction on the colours used in the website but failed to satisfy the other two guidelines. Thus, the firm would be liable for professional misconduct since it would amount to soliciting work by advertisement.

Q- PQR and Associates, Chartered Accountants have their website and on the letterhead of the firm it is mentioned that "Visit our website: PQR com". In the website, the nature of assignments handled, name of prominent clients and fees charged are also displayed without any disclosure obligation from any regulator.(PM 2017)

Ans- The Council of the Institute of Chartered Accountants has issued guidelines for posting the particulars on Website by Chartered Accountants in practice and firms of Chartered Accountants in practice under Clause (6) of Part I of First Schedule to the Chartered Accountants Act, 1949. According to the guidelines the details in the website should be so designed that it does not amount to soliciting client or professional work. It is permitted to mention the website address on letterhead but soliciting people to visit website is not permitted. Nature of assignments handled (to be displayable only on specific “pull” request) may be allowed to be displayed on the Websites but Names of clients and fee charged cannot be given. However, disclosure of names of clients and/or fees charged, on the website is permissible only where it is required by a regulator, whether or not constituted under a statute, in India or outside India, provided that such disclosure is only to the extent of requirement of the regulator. Where such disclosure of names of clients and/or fees charged is made on the website, the member/ firm shall ensure that it is mentioned on the website [in italics], below such disclosure itself, that “This disclosure is in terms of the requirement of [name of the regulator] having jurisdiction in [name of the country/area where such regulator has jurisdiction] vide [Rule/ Directive etc. under which the disclosure is required by the Regulator]. In the given case, PQR and Associates letterhead invites to people to visit their website. Similarly the website mentions the nature of assignments, names of the prominent clients and fees charged. The nature of assignments is permitted for display only on specific 'Pull" request. And the name of clients, the fees charged is not permitted unless required by regulator. Therefore, PQR & Associates will be held guilty of Professional Misconduct under Clause (6) of Part I of First Schedule to the Chartered Accountants Act, 1949.


Q P, a Chartered Accountant in practice, accepts appointment as statutory auditor for LMN Pvt. Ltd. Q, brother of P has substantial interest in LMN Pvt. Ltd. (5 Marks, June 2009,PM)

Ans-

As Per PM 2016 PM 2017

Relative of Auditor Holding Position of Director with Substantial Interest: Clause (4) of Part I of Second Schedule to the Chartered Accountants Act, 1949 states that if an auditor expresses his opinion on the financial statements of any business or enterprise in which he, his firm or partner in his firm has a substantial interest, he is committing professional misconduct. Further as per Council General Guidelines, 2008, a member of the Institute shall not express his opinion on financial statements of any business or enterprise in which one or more persons, who are his “relatives” within the meaning of AS 18 have, either by themselves or in conjunction with such member, a substantial interest in the said business or enterprise.

The Council also emphasizes that the aforesaid requirement of Clause (4) is equally applicable while performing all types of attest functions by the members.

This is further a contravention of section 141(3)(f) of the Companies Act, 2013, which requires that a person shall not be eligible for appointment as an auditor of a company whose relative is a director or is in the employment of the company as a director or key managerial personnel.

In the given case, Mr. Shah, Chartered Accountant, has certified the financial statements of a company in which his wife is a director with substantial interest.

Hence, this amounts to professional misconduct which attracts Clause (4) of Part I of Second Schedule to the Chartered Accountants Act, 1949 and Mr. Shah shall have to vacate the office accordingly.

Accepting Appointment as an Auditor where

Relative Holding Substantial Interest: Clause

(9) of Part I of the First Schedule to the

Chartered Accountants Act, 1949, provides

that a member in practice shall be deemed to

be guilty of professional misconduct if he

accepts an appointment as auditor of a

company without first ascertaining from it

whether the requirements of Sections 224 and

225 of the Companies Act, 1956 (now Section

139 and 140 read with Section 141 of the

Companies Act, 2013), in respect of such

appointment have been duly complied with.

Further, as per Section 141(3)(d)(i) of the

Companies Act, 2013, a person shall not be

eligible for appointment as an auditor of a

company who, or his relatives or partner is

holding any security of or interest in the

company.

In the instant case, since Q, a relative has

a substantial interest in LMN Pvt. Ltd., P

cannot conduct the audit and needs to vacate

the office. Thus, P will be guilty of misconduct

in terms of above clause

CARO 2016 & Corporate Governance needs to be covered from PM 2017 Only. We have covered the same in

latest batch after the release of PM 2017

AUDITOR’S LIABILITY

Q Mr. Fresh, a newly qualified chartered accountant, wants to start practice and he requires your advice, among other things, on criminal liabilities of an auditor under the Companies Act, 2013. Kindly guide him.

Ans Criminal Liability of an Auditor under the Companies Act, 2013: The circumstances in which an auditor can be prosecuted under the Companies Act and the penalties to which he may be subjected are briefly stated below- (i) Criminal liability for Misstatement in Prospectus- As per Section 34 of the Companies Act, 2013, where a prospectus, issued, circulated or distributed includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, every person who authorises the issue of such prospectus shall be liable under section 447. This section shall not apply to a person if he proves that such statement or omission was immaterial or that he had reasonable grounds to believe, and did up to the time of issue of the prospectus believe, that the statement was true or the inclusion or omission was necessary.


(ii) Punishment for False Statement - According to Section 448 of the Companies Act, 2013, if in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act or the rules made thereunder, any person makes a statement- (1) which is false in any material particulars, knowing it to be false; or (2) which omits any material fact, knowing it to be material, he shall be liable under section 447. Punishment for Fraud - As per Section 447 of the Companies Act, 2013, without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud. It may be noted that where the fraud in question involves public interest, the term of imprisonment shall not be less than 3 years. Explanation — For the purposes of this section— (i) “fraud” in relation to affairs of a company or any body corporate, includes any act, omission, concealment of any fact or abuse of position committed by any person or any other person with the connivance in any manner, with intent to deceive, to gain undue advantage from, or to injure the interests of, the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss; (ii) “wrongful gain” means the gain by unlawful means of property to which the person gaining is not legally entitled; (iii) “wrongful loss” means the loss by unlawful means of property to which the person losing is legally entitled. Direction by Tribunal in case auditor acted in a fraudulent manner: As per Section 140(5), the Tribunal either suo motu or on an application made to it by the Central Government or by any person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company to change its auditors. However, if the application is made by the Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place. It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable for action under section 447. It is hereby clarified that the case of a firm, the liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its director or officers.

EQCS Q.1 Briefly discuss the compliance procedures and their use in evaluation of internal controls.

Ans Compliance Procedures and Evaluation of Internal Controls: The auditor should obtain sufficient appropriate audit evidence through the performance of compliance and substantive procedures to enable him to draw reasonable conclusions therefrom on which to base his opinion on the financial information. According to it, compliance procedures are tests designed to obtain reasonable assurance that those internal controls on which audit reliance is to be placed are in effect. Obtaining audit evidence from compliance procedures is intended to reasonably assure the auditor in respect of the following assertions:


Existence - that the internal control exists.

Effectiveness that the internal control is operating effectively.

Continuity - that the internal control has so operated throughout the period of intended reliance.

The auditor formulating his opinion on financial information needs reasonable assurance that transactions are properly authorised and recorded in the accounting records and that the transactions have not been omitted. Internal controls, even if fairly simple, may contribute to the reasonable assurance the auditor seeks. The auditors’ objective in studying and evaluating internal controls is to establish the reliance he can place thereon in determining the nature, timing and extent of his substantive auditing procedures. Compliance procedures are tests designed to obtain reasonable assurance that those internal controls on which audit reliance is to be placed are in place and are also effective. Compliance procedures enable the auditor to determine the existence, effectiveness and continuous operation of the internal control system. These procedures include tests requiring inspection of documents supporting transactions to gain evidence that controls have operated properly. For example, the auditor may see that the documents have been properly authorised. The auditor may also make enquiries about the observation of controls, for example, determining who actually performs each function not merely who is supposed to perform it. Compliance procedures are conducted by the auditor to gain evidence that those internal controls on which he intends to rely operates generally as identified by him and they function effectively throughout the period of intended reliance. The concept of effective operation recognises that some deviations from prescribed controls may have occurred. Based on the results of his compliance procedures, the auditor evaluates whether the internal controls are adequate for his purpose. If based on the results of the compliance procedures, the auditor concludes that it is not appropriate to rely on a particular internal control to the degree previously contemplated, he should ascertain whether there is another control which would satisfy his purpose and on which he might rely (after applying appropriate compliance procedures). Alternatively, he may modify the nature, timing or the extent of his substantive audit procedures.

Q-2 In the audit planning process of X Ltd., you would like to consider audit risk at the financial statement level. What are the factors can influence your decision?

Ans Audit risk at financial statement level: The following FACTORS will be considered for determination of audit risk at financial statement level

(i) Integrity of Management;

(ii) Management experience, knowledge and changes during the period;

(iii) Unusual pressures on the Management;

(iv) Nature of entity’s business;

(v) Factors affecting the Industry in which the entity operates.

Q-3 Describe how you would identify the inherent risk at the account balance and class of transaction level in the planning process of the audit of a large multi-locational company.

Ans Evaluating Inherent Risk: To assess inherent risk, the auditor would use professional judgment to evaluate numerous factors, having regard to his experience of the entity from previous audit engagements of the entity, any controls established by management to compensate for a high level of changes which might have taken place since his last assessment. Inherent audit risk at the level of Account Balance and Class of Transactions is: (i) Quality of the accounting system.


(ii) Financial statements are likely inherent risk, and his knowledge of any significant to be susceptible to misstatement, for example, accounts which required adjustment in the prior period or which involve a high degree of estimation. (iii) The complexity of underlying transactions and other events which might require using the work of an expert. (iv) The degree of judgement involved in determining account balances. (v) Susceptibility of assets to loss or misappropriation, for example, assets which are highly desirable and movable such as cash. (vi) The completion of unusual and complex transactions, particularly at or near period end. (vii) Transactions not subjected to ordinary processing.

Q-4 You have been appointed as the statutory auditor of a private limited company for the first time. Apart from adopting the conventional audit procedures such as posting, casting and vouching, what other auditing techniques would you employ for conducting the statutory audit?

Ans A statutory auditor conducting audit of a private company for the first time would do well in case he obtains knowledge of the business of the company to understand and assess the kind of audit procedures to be employed by him as per SA 315 and SA 330 “Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment” and “The Auditor’s Responses to Assessed Risks” respectively. Knowledge of the business is a frame of reference within which the auditor exercises professional judgement. Understanding the business and using this information appropriately assists the auditor in: (i) Assessing risks and identifying problems. (ii) Planning and performing the audit effectively and efficiently. (iii) Evaluating audit evidence. As far as adoption of conventional audit procedures is concerned, it would normally involve lot of time without commensurate benefits. In any case, if size of the business is large, the application of conventional procedure would involve extraordinary more time resulting into more cost and even then the auditor would not get the required satisfaction as to the figures contained in the financial statements. There may however, be some instances, say, where internal control systems are quite weak, it may perhaps be advisable to stick to conventional audit procedures such as vouching, etc. in detail. In any case, application of compliance procedure to evaluate the internal control systems in operations would enable the auditor to determine nature, extent and timing of substantive procedures. Depending upon various factors including size of the business, it is advisable to reduce the extent of checking by adopting test check approach. TEST-CHECK APPROACH is an accepted auditing procedure, which aims to test transactions on the basis of selection of samples from the entire population. AUDIT SAMPLING means the application of audit procedures to less than 100% of the items within an account balance or class of transactions to enable the auditor to obtain and evaluate audit evidence about some characteristic of the items selected in order to form or assist in forming a conclusion concerning the population. It is important to recognise that certain testing procedures do not come within the definition of sampling. Tests performed on 100% of the items within a population do not involve sampling. Likewise, applying audit procedures to all items within a population which have a particular characteristic (for example, all items over a certain amount) does not qualify as audit sampling with respect to the portion of the population examined, nor with regard to the population as a whole, since the items were not selected from the total population on a basis that was expected to be representative. Such items might imply some characteristic of the remaining portion of the population. The auditor would also consider the specific audit objectives to be achieved and the audit procedures which are likely to best achieve those objectives. In addition, when audit sampling is appropriate, consideration of the nature of the audit evidence sought and possible error conditions or other characteristics relating to that audit evidence will assist the auditor in defining what constitutes an error and what population to use for sampling. For example, when performing tests of control over an entity's purchasing procedures, the auditor will be concerned with matters such as whether an invoice was clerically checked and properly approved. On the other hand, when performing substantive procedures on invoices processed during the period, the auditor


will be concerned with matters such as the proper reflection of the monetary amounts of such invoices in the financial statements. After performing vouching, it is necessary for an auditor to perform verification of balances contained in the financial statements. VERIFICATION AND VALUATION of assets and liabilities contained in the balance sheet would involve obtaining evidence through methods like physical observations, confirmation, computation, inspection of documents and analytical reviews. Direct confirmation procedure provides an independent audit evidence to analyse the financial information contained in the accounting records. For example, confirmation may be done for trade receivables, trade payables, investments lying with third parties, bank balances, etc. Apart from conducting audit procedures like vouching and verification, it is quite useful to employ ANALYTICAL REVIEW PROCEDURES; In fact, analytical review procedures would provide substantive audit evidence to support various assertions in the financial statements. Over a period of time, the analytical review as a method of obtaining evidence has emerged as a significant auditing procedures. As per SA 520, analytical procedures means the analysis of significant ratios and trends including the resulting investigation of fluctuations and relationships that are inconsistent with other relevant information or which deviate from predicted amounts. Analytical procedures in planning the audit use both financial and non- financial information, for example, the relationship between sales and square footage of selling space or volume of goods sold. The auditor's reliance on substantive procedures to reduce detection risk relating to specific financial statement assertions may be derived from tests of details, from analytical procedures, or from a combination of both. The decision about which procedures to use to achieve a particular audit objective is based on the auditor's judgement about the expected effectiveness and efficiency of the available procedures in reducing detection risk for specific financial statement assertions. It further states that when analytical procedures identify significant fluctuations or relationships that are inconsistent with other relevant information or that deviate from predicted amounts, the auditor should investigate and obtain adequate explanations and appropriate corroborative evidence. Therefore, a statutory auditor who has been appointed for the first time must resort to evaluation of internal control system through performance of compliance procedures based on the knowledge of the client's business followed by vouching on a selected basis having regard to sampling. Physical observation and direct confirmation are also useful audit techniques in the verification of items contained in the financial statements. Ratio analysis or analytical procedures would also provide audit evidence as to various assertions contained in the financial statements.

Q-5 Write short notes on the following: (a) Walk through Tests (b) Cut-off Procedures.

Ans Walk through Tests: A walk through is a procedure in which an auditor traces a transaction from its initiation through the company’s information systems to the point when it is reflected in the financial reports. The auditor should perform one walk through, at a minimum, for each major class of transactions. A walk-through provides evidence to confirm that the auditor understands: (1) the process flow of transactions, (2) the design of identified controls for internal control components, including those related to preventing and detecting fraud, and (3) whether all points in the process have been identified at which misstatements related to relevant financial statement assertion could occur. Walk through also provide evidence to evaluate the effectiveness of the controls’ design and confirm that the controls have been placed in operation. When performing a walk-through, the auditor should: (i) Be sure that the walk-through encompasses the complete process (initiation, authorization,

recording, processing and reporting) for each significant process identified, including controls

intended to address fraud risk.

(ii) Ask the entity’s personnel, at each of key stage in the process, about their understanding of what the

company’s prescribed procedures require.

(iii) Determine whether processing procedures are performed as expected on a timely basis, and look for

any exceptions to prescribed procedures and controls.


(iv) Evaluate the quality of evidence provided and perform procedures that produce a level of evidence

consistent with the auditor’s objectives. The auditor should follow the whole process, using the same

documents and technology that company staff use, asking questions of different personnel at each

significant stage and asking follow- up questions to identify any abuse of controls or fraud indicators.

Once a walk-through is performed, the auditor may carry forward the documentation, noting updates, unless significant changes make preparation of new documentation more efficient. If such significant changes occur in the process flow of transactions or supporting computer applications, the auditor should evaluate the nature of changes and the effect on related accounts. The auditor should determine whether it is necessary to walk through transactions that were processed both before and after the change. (b) Cut-off Procedures: Cut-off procedures mean procedures employed to ensure the separation of transactions at the end of one year from those in the commencement of the next year. Usually, the problem of overlapping is found in inventory accounting since quite often goods are sold but passed on to the buyer only after the year is over or goods are bought but received only after the close of the year. This situation may create considerable problem for the proper stock taking of inventory. Therefore, the principal areas of application of cut-off procedures involve sales, purchases and stock. The auditor should satisfy himself by examination and test check that these procedures adequately ensure that:

(i) Goods purchased for which property has passed to the client have in fact been included in inventories

and that the liability if any, has been provided for.

(ii) Goods sold have been excluded from the inventories and credit has been taken for sales.

The auditor may examine a sample of documents evidencing the movement of stocks into and out of stores, including documents pertaining to period shortly before and shortly after the cut-off date, and check whether the stocks represented by those documents were included or excluded, as appropriate, during the stock-taking.

Q-6 Designing an Audit Strategy is the backbone of the “Audit Planning” process. Discuss.

Ans Audit strategy is concerned with designing optimised audit approaches that seeks to achieve the necessary audit assurance at the lowest cost within the constraints of the information available. The formulation of audit strategy as shall be evident from the process as explained in the following paragraphs in fact shall form the basis of audit planning to achieve the audit objectives in the most efficient and effective manner. Audit strategy generally involves the following steps: (i) Obtaining Knowledge of Business: SA 315 and SA 330 “Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment” and “The Auditor’s Responses to Assessed Risks” respectively states that in performing an audit of financial statements, the auditor should have or obtain knowledge of the business sufficient to enable the auditor to identify and understand the events, transactions and practices that, in the auditor’s judgement, may have a significant effect on the financial statements or on the examination or audit report. Knowledge of the business is a frame of reference within which the auditor exercises professional judgement. Understanding the business and using this information appropriately assists the auditor in assessing risks and identifying problems, planning and performing the audit effectively and efficiently. It also ensures that the audit staff assigned to an audit engagement obtains sufficient knowledge of the business to enable them to carry out the audit work delegated to them. This would also ensure that the audit staff understands the need to be alert for additional information and the need to share that information with the auditor and the other audit staff. (ii) Performing Analytical Procedures: The purpose of analytical procedures at the planning stage is attention-directing; corroboration is not normally necessary at this stage. The use of the analytical procedures during the planning stage requires the extensive use of accounting and business knowledge and experience to assess the potential for material misstatement in the financial statements as a whole, because the key aspect of the task is to identify the relevant risk indicators and to interpret them properly. Furthermore, analytical techniques applied during the planning stage are not generally as precise as the analytical techniques at the substantive stage. (iii) Evaluating Inherent Risk: To assess inherent risk, the auditor would use professional judgement to evaluate numerous factors such as quality of accounting system, unusual pressure on management, etc.


having regard to his experience of the entity from previous audit engagements of the entity, any controls established by management to compensate for a high level of inherent risk, and his knowledge of any significant changes which, might have taken place since his last assessment. (iv) Evaluating Internal Control: The auditor’s assessment of the control environment is crucial to the decision on whether to make an extended assessment of controls. This is because a good control environment is conducive to the maintenance of a reliable system of accounting and control procedures. For strategy purposes, the auditor should obtain a sufficient understanding of the control environment. The auditor needs an understanding of the accounting systems, regardless of whether the audit strategy will involve an extended assessment of internal accounting controls. This is done by:

(a) considering the results of gathering or updating information about the client; and

(b) making preliminary judgements about materiality, inherent risk and control effectiveness. These will

include identification of the system(s) the auditor proposes to subject to an extended assessment of

controls.

Thus, the audit strategy is evolved after considering the engagement objectives, the results of the business review, preliminary judgements as to materiality and identified inherent risks. Audit strategy also considers main points relating to planning and controlling the audit or comments on adequacy of the existing arrangements. Thus, the overall audit plan involving determination of timing, manpower, coordination and the directions in which the audit work has to proceed is dependent upon the audit strategy formulated by the audit firm.

Q-7 You have been appointed as the auditor of a Multiplex Cinema House. Draw an audit programme in respect of its Revenue and Expenditure.

Ans Audit Programme of Multiplex (i) Peruse the Memorandum of Association and Articles of Association of the entity. (ii)Ensure the object clause permits the entity to engage in this type of business. (iii)In the case of income from sale of tickets:

(1)Verify the control system as to how it is ensured that the collections on sale of tickets of various shows are properly accounted. (2) Verify the system of relating to online booking of various shows and the system of realization of money. (3) Check that there is overall system of reconciliation of collections with the number of seats available for different shows on a day.

(iv) Verify the internal control system and its effectiveness relating to the income from cafe shops, pubs etc., located within the multiplex. (v) Verify the system of control exercised relating to the income receivable from advertisements exhibited within the premises and inside the hall such as hoarding, banners, slides, short films etc. (vi) Verify the system of collection from the parking areas in respect of the vehicles parked by the customers. (vii) In the case of payment to the distributors verify the system of payment which may be either through out right payment or percentage of collection or a combination of both. Ensure at the time of settlement any payment of advance made to the distributor is also adjusted against the amount due. (viii) Verify the system of payment of salaries and other benefits to the employees and ensure that statutory requirements are complied with. (ix) Verify the payments effected in respect of the maintenance of the building and ensure the same is in order.

Q-8 Write short notes on the following: Sampling Risk

Ans Sampling Risk: As per SA 530 “Audit Sampling”, the risk that the auditor’s conclusion based on a sample may be different from the conclusion if the entire population were subjected to the same audit procedure. Sampling risk can lead to two types of erroneous conclusions: (i) In the case of a test of controls, that controls are more effective than they actually are, or in the case of a test of details, that a material misstatement does not exist when in fact it does. The auditor is primarily


concerned with this type of erroneous conclusion because it affects audit effectiveness and is more likely to lead to an inappropriate audit opinion. (ii) In the case of a test of controls, that controls are less effective than they actually are, or in the case of a test of details, that a material misstatement exists when in fact it does not. This type of erroneous conclusion affects audit efficiency as it would usually lead to additional work to establish that initial conclusions were incorrect. Sample size is affected by the level of sampling risk the auditor is willing to accept from the results of the sample. The lower the risk the auditor is willing to accept, the greater the sample size will need to be.

Q-9 ABC Company files a law suit against Unlucky Company for ` 5 crores. The Attorney of Unlucky Company feels that the suit is without merit, so Unlucky Company merely discloses the existence of the law suit in the notes accompanying its financial statements. As an auditor of Unlucky Company, how will you deal with the situation?

Ans Existence of Contingent Liability: As per AS 29 "Provisions, Contingent liabilities and Contingent Assets", a contingent liability is a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non- occurrence of one or more uncertain future events not wholly within the control of the enterprise. Further, future events that may affect the amount required to settle an obligation should be reflected in the amount of a provision where there is sufficient objective evidence that the event will occur. As per SA 570 “Going Concern”, there are certain examples of events or conditions that, individually or collectively, may cast significant doubt about the going concern assumption. Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy is one of the example of such event. When the auditor concludes that the use of the going concern assumption is appropriate in the circumstances but a material uncertainty exists, the auditor shall determine whether the financial statements adequately describe the principal events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern and management’s plans to deal with these events or conditions; and disclose clearly that there is a material uncertainty related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern and, therefore, that it may be unable to realize its assets and discharge its liabilities in the normal course of business. In the instant case, ABC Company has filed a law suit against Unlucky Company for ` 5 crores. Though, the attorney of Unlucky Company feels that the suit is without merit so the company merely discloses the existence of law suit in the notes accompanying its financial statements. But the auditor may evaluate the source data on which basis the opinion is formed. If the auditor finds the uncertainty, he may request the management to adjust the sum of ` 5 crore by making provision for expenses as per AS 29. If the management does not accept the request the auditor should qualify the audit report.

Q-10 You are appointed as an auditor of Global Ltd. Explain the risk factors relating to misstatements arising from misappropriation of assets.

Ans Risk Factors Relating to Misstatements Arising from Misappropriation of Assets: As per SA 240, “The Auditor’s Responsibilities Relating to Fraud in audit of Financial Statements”, misappropriation of assets involves the theft of an entity’s assets and is often perpetrated by employees in relatively small and immaterial amounts. However, it can also involve management who are usually more able to disguise or conceal misappropriations in ways that are difficult to detect. Risk factors that relate to misstatements arising from misappropriation of assets are classified according to the three conditions generally present when fraud exists: incentives/pressures, opportunities, and attitudes/rationalization. The following are examples of risk factors related to misstatements arising from misappropriation of assets:

Incentives/Pressures: Opportunities: Attitudes/Rationalizations


Personal financial obligations may create pressure on management or employees with access to cash or other assets susceptible to theft to misappropriate those assets.

Adverse relationships between the entity and employees with access to cash or other assets susceptible to theft may motivate those employees to misappropriate those assets. For example, adverse relationships may be created by the following:

1. Known or anticipated future

employee layoffs.

2. Recent or anticipated changes to

employee compensation or benefit

plans.

3. Promotions, compensation or

other rewards inconsistent with

expectations.

Certain characteristics or

circumstances may increase

the susceptibility of assets to

misappropriation. For

example, opportunities to

misappropriate assets

increase when there are the

following:

Inventory items that are small in size, of high value, or in high demand.

Fixed assets which are small in size, marketable, or lacking observable identification of ownership.

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

Inadequate segregation of duties or independent checks.

Disregard for the need for monitoring or reducing risks related to misappropriations of assets.

Disregard for internal control over misappropriation of assets by overriding existing controls or by failing to take appropriate remedial action on known deficiencies in internal control.

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

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

Q-11 R & M Co. wants to be alert on the possibility of non-compliance with Laws and Regulations during the course of audit of SRS Ltd. R & M Co. seeks your guidance for identifying the indications of non compliance with Laws and Regulations. . [5 Marks-May 16]

Ans As per SA 250 “Consideration of Laws and Regulations in an Audit of Financial Statement”, the auditor shall perform the audit procedures to help identify instances of non-compliance with other laws and regulations that may have a material effect on the financial statements by inquiring of management and, where appropriate, those charged with governance, as to whether the entity is in compliance with such laws and regulations; and Inspecting correspondence, if any, with the relevant licensing or regulatory authorities. However, when the auditor becomes aware of the existence of, or information about, the following matters, it may also be an indication of non-compliance with laws and regulations:

Investigations by regulatory organisations and government departments or payment of fines or penalties.

Payments for unspecified services or loans to consultants, related parties, employees or government employees.

Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the entity or in its industry or to the services actually received.

Purchasing at prices significantly above or below market price.

Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers to numbered bank accounts.

Unusual payments towards legal and retainership fees.

Unusual transactions with companies registered in tax havens.

Payments for goods or services made other than to the country from which the goods or services originated.

Payments without proper exchange control documentation.


Existence of an information system which fails, whether by design or by accident, to provide an adequate audit trail or sufficient evidence.

Unauthorised transactions or improperly recorded transactions.

Adverse media comment.

Q-12 During the course of his audit, the auditor noticed material weaknesses in the internal control system and he wishes to communicate the same to the management. You are required to elucidate the important points the auditor should keep in the mind while drafting the letter of weaknesses in internal control system.[5 Marks-Nov 15]

Ans Important Points to be kept in Mind While Drafting Letter of Weakness: As per SA 265, “Communicating Deficiencies in Internal Control to Those who Charged with Governance and Management”, the auditor shall include in the written communication of significant deficiencies in internal control (i) A description of the deficiencies and an explanation of their potential effects; and (ii) Sufficient information to enable those charged with governance and management to understand the context of the communication. In other words, the auditor should communicate material weaknesses to the management or the audit committee, if any, on a timely basis. This communication should be, preferably, in writing through a letter of weakness or management letter. Important points with regard to such a letter are as follows: (1) The letter lists down the area of weaknesses in the system and offers suggestions for improvement. (2) It should clearly indicate that it discusses only weaknesses which have come to the attention of the auditor as a result of his audit and that his examination has not been designed to determine the adequacy of internal control for management. (3) This letter serves as a valuable reference document for management for the purpose of revising the system and insisting on its strict implementation. (4) The letter may also serve to minimize legal liability in the event of a major defalcation or other loss resulting from a weakness in internal control.

Q-13 Describe the relevance of SA 600 while auditing consolidation of Financial Statements. [4Marks-N15]

Ans Relevance of SA 600 While Auditing Consolidation of Financial Statements:

SA 600 ‘Using the Work of Another Auditor’ establishes standards when an auditor, reporting on the financial statements of an entity (the group—in the case of consolidated financial statements), uses the work of another auditor on the financial information of one or more components included in the financial statements of the entity. The principal auditor, if he decides to use the work of another auditor in relation to the audit of consolidated financial statements, should comply with the requirements of SA 600.

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

professional competence of the other auditor in the context of specific assignment if the other auditor

is not a member of the Institute of Chartered Accountants of India.

(ii) The principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that

the work of the other auditor is adequate for the principal auditor's purposes, in the context of the

specific assignment. When using the work of another auditor, the principal auditor should advise the

other auditor of the:

Information/assurance required by the other auditor; this emanates/precludes the principal

auditor’s determination of how the work of the other auditor would affect the audit of

consolidated financial statements, for example, the information required from the auditor of a

subsidiary would be different from that required from the auditor of a joint venture;


Use that is to be made of the other auditor's work and report and make sufficient arrangements

for co-ordination of their efforts at the planning stage of the audit; and

Significant accounting, auditing and reporting requirements and obtain representation as to compliance with them.

Q-14 During the course of audit of M/s CT Ltd. for the financial year 2014-15, it has noticed that ` 2.00 lakhs of employee contribution and ` 9.50 lakhs of employer contribution towards employee state insurance contribution have been accounted in the books of accounts in respective heads. Whereas, it was found that ` 4.00 lakhs only has been deposited with ESIC department during the year ended 31st March, 2015. The Finance Manager informed the auditor that due to financial crunch they have not deposited the amount due, but will deposit the amount overdue along with interest as and when financial position improves. Comment as a statutory auditor. (4 Marks-May 16)

Ans Non-Compliance of Laws and Regulations & Reporting Requirements: As per SA 250 “Consideration of Laws and Regulations in an Audit of Financial Statement”, it is the

responsibility of management, with the oversight of those charged with governance, to ensure that the entity’s operations are conducted in accordance with the provisions of laws and regulations, including compliance with the provisions of laws and regulations that determine the reported amounts and disclosures in an entity’s financial statements.

The auditor is responsible for obtaining reasonable assurance that the financial statements, taken as a whole, are free from material misstatement, whether caused by fraud or error. In conducting an audit of financial statements, the auditor takes into account the applicable legal and regulatory framework. If the auditor concludes that the non-compliance has a material effect on the financial statements, and has not been adequately reflected in the financial statements, the auditor shall express a qualified or adverse opinion on the financial statements.

Further, the auditor is required to report under clause (vii)(a) of Para 3 of CARO, 2016 whether the company is regular in depositing undisputed statutory dues including employees’ state insurance with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable, shall be indicated by the auditor.

In the instant case, even though accrual principles have been followed, disclosure of non-payment is necessary. The auditor should disclose the fact of non-payment of rupees 7.50 lakhs in his report.

Q-15 XY Ltd. is a manufacturing company, provided following details of wastages of raw materials in percentage, for various months. You have been asked to enquire into causes of abnormal wastage of raw materials. Draw out an audit plan. Wastage percentage are July 2016 1.5% Aug 2016 1.7% Sep 2016 1.4% Oct 2016 4.1%

Ans. Audit Plan to locate the Abnormal Wastage of Raw Material: To locate the reasons for the abnormal wastage, the auditor should FIRST OF ALL ASSESS THE GENERAL REQUIREMENTS as under: (i) Procure a list of raw materials, showing the names and detailed characteristics of each raw material. (ii)Obtain the standard consumption figures, and ascertain the basis according to which normal wastage figures have been worked out. Examine the break-up of a normal wastage into that in process, storage and handling stages. Also obtain control reports, if any, in respect of manufacturing costs with reference to predetermined standards. (iii)Examine the various records maintained for recording separately the various lots purchased and identification of each lot with actual material consumption and for ascertaining actual wastage figures therein (iv)Obtain reports of Preventive Maintenance Programme of machinery to ensure that the quality of goods manufacture is not of sub-standard nature or leads to high scrappage work. (v)Assess whether personnel employed are properly trained and working efficiently.


(vi)See whether quality control techniques have been consistent or have undergone any change. (vii)Examine inventory plans and procedures in report of transportation storage efficiency, deterioration, pilferage and whether the same are audited regularly. (viii)Examine whether the basis adopted for calculating wastage for September is the same as was adopted for the other three months. (ix) Obtain a statement showing break up of wastage figures in storage, handling and process for the four months under reference and compare the results of the analysis for each of the four months In addition, SOME SPECIFIC REASONS FOR ABNORMAL WASTAGE IN PROCESS may be considered by the auditor are as under: (i)Examine laboratory reports and inspection reports to find out if raw materials purchased were of a poor quality or were of sub-standard quality. This will be most useful if it is possible to identify the wastage out of each lot that has been purchased. (ii)Machine breakdown, power failure, etc. may also result into loss of materials in process. Check the machine utilisation statements. (iii)A high rate of rejections in the finished lots may also be responsible for abnormal wastage; therefore, examine the inspectors’ reports in respect of inspection carried out on the completion of each stage of work or process. (iv)It is possible that the wastage may have occurred because the particular lot out of which issues were made was lying in the store for a long time, leading to deterioration in quality or because of a change in the weather which may have led to the deterioration. Compare the wastage figures. (v)Abnormal wastage in storage and handling may arise due to the following reasons:

(1)Write offs on account of reconciliation of physical and book inventories: In case of periodical physical inventory taking, such write offs will be reflected only in the month such reconciliation takes place. (2)Accidental, theft or fire losses in storage: The auditor should examine the possibility of these for the purpose.

(vi)Examine whether any new production line was taken up during the month in respect of which standard input-output ratio is yet to be set-up.

Q-16 As an internal auditor of a Cement Manufacturing Company, draft an audit programme for verification of transportation charges for dispatches from the factory

Ans Procedure for Audit of Transportation Charges: (i) Check rates contracted with transporters for carriage of goods. (ii) Check whether the rates mentioned as per the contract are correctly taken in the transporter’s

Invoice. (iii) In case of discrepancy, check whether the same is authorized by the appropriate sanctioning

authority. (iv) Check that the transporter’s invoice includes a delivery challan which has customers stamp indicating

the receipt of goods. (v) In case there is no stamp on the delivery challan, check whether the goods are received back and there

is a corresponding inward note. (vi) Check whether all the goods to be dispatched have a transport booking order reference. (vii) Check whether each transporter’s invoice mentions the transport booking order reference. (viii) Check whether all the transport booking orders have corresponding transporters names. (ix) Check whether the transport booking orders are pre-numbered. (x) Check whether all the invoices are correctly booked in the books of accounts (xi) In case there is an additional charge by the transporter due to extra carriage, check for the relevant

supporting (like material Inward Note/Customer Rejection Note) and necessary authorization by the sanctioning authority.

(xii) Check whether service-tax on the transporters is correctly calculated and accounted. (xiii) Verify that there is a mechanism for linking all the Transport Bills to the sale invoices.


Q-17 As an internal auditor for a large manufacturing concern, you are asked to verify whether there are adequate records for identification and value of Plant and Machinery, tools and dies and whether any of these items have become obsolescent and not in use. Draft a suitable audit programme for the above

Ans The Internal Audit Programme in connection with Plant and Machinery and Tools and dies may be on the following lines: (i) Internal Control Aspects: The following may be incorporated in the audit programme to check the internal control aspects-

(a)Maintaining separate register for hired assets, leased asset and jointly owned assets. (b)Maintaining register of fixed asset and reconciling to physical inspection of fixed asset and to

nominal ledger. (c)All movements of assets are accurately recorded. (d)Authorisation be obtained for –

(1) a declaring a fixed asset scrapped. (2) selling a fixed asset.

(e) Check whether additions to fixed asset register are verified and checked by authorised person. (f)Proper recording of all additions and disposal. (g)Examining procedure for the purchase of new fixed assets, including written authority, work order, voucher and other relevant evidence. (h)Regular review of adequate security arrangements. (i)Periodic inspection of assets is done or not. (j)Regular review of insurance cover requirements over fixed assets.

(ii) Assets Register: To review the registers and records of plant, machinery, etc. showing clearly the date of purchase of assets, cost price, location, depreciation charged, etc. (iii) Cost Report and Journal Register: To review the cost relating to each plant and machinery and to verify items which have been capitalised. (iv) Code Register: To see that each item of plant and machinery has been given a distinct code number to facilitate identification and verify the maintenance of Code Register. (v) Physical Verification: To see physical verification has been conducted at frequent intervals. (vi)Movement Register: To verify (a) whether Movement Register for movable equipments and (b) log books in case of vehicles, etc. are being maintained properly. (vii)Assets Disposal Register: To review whether assets have been disposed off after proper technical and financial advice and sales/disposal/retirement, etc. of these assets are governed by authorisation, sales memos or other appropriate documents. (viii)Spare Parts Register: To examine the maintenance of a separate register of tools, spare parts for each plant and machinery. (ix)Review of Maintenance: To scrutinise the programme for an actual periodical servicing and overhauling of machines and to examine the extent of utilisation of maintenance department services. (x)Review of Obsolescence: To scrutinise whether expert’s opinion have been obtained from time to time to ensure purchase of technically most useful efficient and advanced machinery after a thorough study. (xi)Review of R&D: To review R&D activity and ascertain the extent of its relevance to the operations of the organisation, maintenance of machinery efficiency and prevention of early obsolescence

Q-18 “Surprise Checks” help the auditors to ascertain whether the internal control system is operating effectively in a Company or not. Discuss

Ans Surprise Checks: SA 315 & SA 330 “Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and its Environment” and “The Auditor’s Responses to Assessed Risks” prescribes that “the auditor should obtain an understanding of the accounting and internal control systems sufficient to plan the audit and develop an effective audit approach. The auditor should use professional judgement to assess audit risk and to design audit procedures to ensure that it is reduced to an acceptably low level.” The understanding of the accounting and internal control system can be obtained in several ways including inspection of documents making inquires of appropriate management, observation of activities, etc. It is in this context, surprise checks intend to ascertain whether the system of internal control is operating effectively and whether the accounting and other records are prepared concurrently and kept


up-to-date. Particularly, the observation of the entity’s activities and operations including observation of the organisation of computer operations, personnel performing control procedures and the nature of transaction processing on a surprise visit would reveal the exact manner in which the activities are being performed in the manner prescribed by the management. It has often been found that manipulations and frauds are facilitated under a system of book-keeping, which does not give proper emphasis to the need to keep the books up-to-date. Errors in book-keeping are often indicative of weaknesses in internal control which may be taken advantage of in order to perpetrate frauds or manipulations. Surprise checks are a useful method of determining whether or not such errors exist and where they exist, of bringing the matter promptly to the attention of the management so that corrective action is taken immediately. Consequently, surprise visits by the auditor can exercise a good moral check on the client’s staff. The Guidance Note issued by the Institute on the subject specifies that surprise checks are a part of the normal audit and the results of such checks are therefore important primarily to the auditor himself in deciding the scope of his audit and submitting his report thereon. The need for and frequency of surprise checks is obviously a matter to be decided having regard to the circumstances of each audit. It would depend upon the extent to which the auditor considers the internal control system as adequate, the nature of the clients’ transaction, the locations from which he operates and the relative importance of items like cash, investments, stores etc. However, wherever feasible a surprise check should be made at least once in the course of an audit. If this surprise check reveals any weaknesses in the system of internal control or any fraud or error or the fact that any book or register has not been properly maintained or kept up-to-date, the auditor should communicate the same to the management and ensure that action is taken on the matters communicated by him. It does not necessarily follow that all or any of the matters communicated to the management should form part of the auditor’s report on the accounts. Thus “surprise checks” help the auditors, during the course of their audit, to ascertain whether the internal control is operating effectively in a company or not.

Q-19 Write short notes on Statistical and Non-Statistical Sampling

Ans Statistical and Non-statistical Sampling: Audit sampling means the application of audit procedures to less than 100% of items within a population of audit relevance such that all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to draw conclusions about the entire population. As per SA 530, “Audit Sampling”, the auditor should select sample items in such a way that the sample can be expected to be representative of the population. This requires that all items in the population have an opportunity of being selected. There are two major methods in which the size of the sample and the selection of individual items of the sample are determined. These methods are statistical and non-statistical sampling. (i) Statistical sampling: This is a method of audit testing which is more scientific than testing based entirely on the auditor’s own judgment because it involves use of mathematical laws of probability in determining the appropriate sample size in varying circumstances. Statistical sampling has reasonably wide application where a population to be tested consists of a large number of similar items and more in the case of transactions involving compliance testing, trade receivables’ confirmation, payroll checking, vouching of invoices and petty cash vouchers. (ii) Non-statistical sampling: Under this method, the sample size and its composition are determined on the basis of the personal experience and knowledge of the auditor. This method has been in common application for many years because of its simplicity in operation. Traditionally, the auditor on the basis of his personal experience will determine the size of the sample and express it in terms that number of pages or personal accounts in the purchases or sales ledger to be checked. For example, March, June & September may be selected in year one and different months would be selected in the next year. An attempt would be made to avoid establishing a pattern of selection year after year to maintain an element of surprise as to what the auditor is going to check. It is a common practice to check large number of items towards the close of the year so that the adequacy of cut-off procedures can also be determined

Q-20 What are general matters to be considered by an auditor while taking up an engagement?

Ans (a) General matters to be considered while taking up a new engagement:


General

Economic factors

General level of economic activity (for example, recession, growth)

(i) The market and competition. (ii) Cyclical or seasonal activity. (iii) Government policies.

The industry-

important

conditions

affecting the

client’s business

(i) The market and competitions. (ii) Cyclical or seasonal activity. (iii) Changes in product technology. (iv) Business risk

The entity: (i) Management and ownership- important characteristics. (ii) Operating Management. (iii) The entity’s business – products markets, suppliers, expenses, operations.

(1) Nature of business(es) (for example manufacturing whole seller, financial services, import/ exports).

(2) Location of production facilities, warehouses, offices. (3) Employment (for example, by location, supply, wage levels, union

contracts, pension commitments, Government regulation). (4) Products or services and markets.

(iv) Financial performance– factors concerning the entity’s financial condition and profitability.

(v) Reporting environment- external influences which affect management in the preparation of the financial statements.

(vi) Legislation: (1) Regulatory environment and requirements. (2) Taxation both direct and indirect.

(b)Information about the client’s business: The auditor can obtain information about client’s business from the following sources:

(i) The client’s annual Reports to shareholders;

(ii) Minutes of meetings of shareholders, board of directors and important committees;

(iii) Internal financial management report for current and previous periods, including budgets, if

any;

(iv) The previous year’s audit working papers, and other relevant files;

(v) Firm personnel responsible for non audit services to the client who may be able to provide

information on matters that may affect the audit;

(vi) Discussions with the client;

(vii) The client’s policy and procedures manual;

(viii) Relevant publications of the Institute of Chartered Accountants of India and other professional

bodies, industry publication, trade Journals, magazines, newspapers or text books;

(ix) Consideration of the state of the economy and its effects on the client’s business;

(x) Visits to the client’s premises and plant facilities to the management.

Documents

SECTION 1: REVISIONARY NOTES OF CERTAIN TOPICS …vpjclasses.com/study/CA Final Audit Updates May 2017.pdf · The principal enactments which govern the functioning of various types