CA Inter Audit JKSC

THE RANKERS FACTORY
CAFCINTER CAFINAL CA
PRINCIPAL
MR. J. K. SHAH
INTER CA
Audit
Head Office
Shraddha, 4th Floor, Old Nagardas Road,
Near Chinai College, Andheri (E), Mumbai - 400 069.
022 - 2683 66 66
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INTER C.A. - AUDIT
INDEX
Ch. No. Chapter QUESTIONS Pg.No.

1 Nature, Objective and Scope of Audit 1–8
2 Audit Strategy, Audit Planning and Audit 9 – 15
Programme
3 Audit Documentation and Audit Evidence 16 – 31
4 Risk Assessment and Internal Control 32 – 41
5 Fraud and Responsibilities of Auditor in 42 – 48
this regard
6 Audit in an Automated Environment 49 – 52
7 Audit Sampling 53 – 57
8 Analytical Procedures 58 – 62
9 Audit of Items of Financial Statements 63 – 79
10 Company Audit 80 – 117
11 Audit Report 118 – 124
12 Audit of Banks 125 – 135
13 Audit of Different types of entities 136 – 150
Annexure 1 Standards on Auditing 151 – 302
Annexure 1a Questions on Standards on Auditing 303 – 323
Annexure 2 Theoretical Questions from Module 324 – 343
Annexure 3 Correct or incorrect Questions 344 - 352
J.K.SHAH CLASSES INTER C.A. – AUDIT
CHAPTER 1 NATURE SCOPE AND OBJECTIVE OF AUDITING

(INTRODUCTION TO AUDIT AND BASIC CONCEPTS)
Sr.No Topics as per Module JKSC Textbook Reference

1 Meaning and Definition of Audit Q1
2 Objectives of Auditing Q2 and SA 200
3 Scope of Audit and Aspects to be covered Q3
Concept of Assertion Chapter 3
4 Types of Audit Q4
5 Advantages of Audit Q9
6 Inherent Limitations of Audit Q5
Extra Basic Principles Governing an Audit Q6
7 Relationship of Auditing with other disciplines Q7
8 Standard Setting Process Standards on Auditing
9 Qualities of an Auditor Q8
10 Elements of a System of Quality Control SA 220
11 Preconditions for an Audit SA 210
12 Agreement on Audit Engagement Terms SA 210
13 Recurring Audits SA 210
14 Limitation on Scope Prior to Audit Engagement SA 210
Acceptance
15 Acceptance of a Change in Engagement SA 210
Extra Concept of Independence Q 10
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Q.1. Define and Explain Auditing.
“An audit is independent examination of financial information of any entity,
whether profit oriented or not, and irrespective of its size or legal form, when
such an examination is conducted with a view to expressing an opinion thereon.”
The person conducting this task should take care to ensure that financial
statements would not mislead anybody. This he can do honestly by satisfying
himself that:
(i) the accounts have been drawn up with reference to entries in the books of
account;
(ii) the entries in the books of account are adequately supported by sufficient and
appropriate evidence;
(iii) none of the entries in the books of account has been omitted in the process of
compilation and nothing which is not in the books of account has found place in
the statements;
(iv) the information conveyed by the statements is clear and unambiguous;
(v) the financial statement amounts are properly classified, described and disclosed in
conformity with accounting standards; and
(vi) the statement of accounts present a true and fair picture of the operational results
and of the assets and liabilities.
Q.2. Objectives of Auditing
Objective means the purpose for which audit is conducted. The objectives of auditor are
based on the following principles:
1. Preparation and presentation of financial statements is the responsibility of
management.
2. Prevention and detection of fraud and errors is the responsibility of management.
3. Auditor’s duty is to express an opinion on financial statements
4. Auditor cannot be held responsible for the fraud done by management if auditor
was not negligent in performing his duties. However, if it is proved that auditor was
negligent then he can be held responsible for fraud.
5. Auditor is a watchdog and not a bloodhound i.e. auditor performs audit procedures
with a questioning mind and not a suspicious mind. He will accept the records and
documents as genuine unless he finds evidence which creates a doubt over
reliability and correctness of such records and documents
Based on the above auditor’s objectives can be classified as follows:
PRIMARY OBJECTIVE: The primary objective of auditor is to form and express an
opinion via audit report whether financial statements show a true and fair view of state
of affairs and profit & loss account
SECONDARY OBJECTIVE/DERIVED OBJECTIVE/INCIDENTAL OBJECTIVE: The
secondary objective of auditor is prevention and detection of fraud and errors during the
course of audit.
SUPPORTING CASE LAW:
If there remains a deep laid fraud in the accounts, which in the normal course of
examination of accounts may not come to light, it will not be construed as failure of
audit, provided the auditor was not negligent in the carrying out his normal work. This
principle was established as early as in 1896 in the leading case in Re-Kingston Cotton
Mills Co.
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Q.3. Scope of Audit and Aspects to be covered.
Scope means Coverage i.e. areas and extent to be covered by an auditor while
conducting audit of financial statements. Scope of audit is governed by following factors:
1) Applicable law and regulation
2) The ICAI Pronouncements
3) The Terms of Engagement
The terms of engagement cannot, however, restrict the scope of an audit in relation to
matters which are prescribed by legislation or by the pronouncements of the Institute.
The auditor is not expected to perform duties which fall outside the scope of
audit.
The principal aspect to be covered in an audit concerning final statements of
account are the following:
(i) An examination of the system of accounting and internal control to ascertain
whether it is appropriate for the business and helps in properly recording all
transactions.
(ii) Reviewing the system and procedures to find out whether they are adequate
(iii) Checking of the arithmetical accuracy of the books of account by the verification of
postings, balances, etc.
(iv) Verification of the authenticity and validity of transaction entered into by making an
examination of the entries in the books of accounts with the relevant supporting
documents.
(v) Comparison of the balance sheet and profit and loss account or other statements
with the underlying record in order to see that they are in accordance therewith.
(vi) Verification of the title, existence and value of the assets appearing in the balance
sheet.
(vii) Verification of the liabilities stated in the balance sheet.
(viii) Checking the result shown by the profit and loss and to see whether the results
shown are true and fair.
(ix) Confirming that the statutory requirements have been complied with.
(x) Reporting to the appropriate person/body whether the statements of account
examined do reveal a true and fair view of the state of affairs and of the profit and
loss of the organisation
Q4. Explain Types of Audit of financial statements.
(i) Statutory Audit- Audit required under law: The organisations which require audit
under law are the following:
(a) companies governed by the Companies Act, 2013;
(b) banking companies governed by the Banking Regulation Act, 1949;
(c) electricity supply companies governed by the Electricity Supply Act, 1948;
(d) co-operative societies registered under the Co-operative Societies Act, 1912;
(e) public and charitable trusts registered under various Religious and
Endowment Acts;
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(g) corporations set up under an Act of Parliament or State Legislature such as
the Life Insurance Corporation of India.
(h) Specified entities under various sections of the Income-tax Act, 1961.
(ii) Voluntary Audit- In the voluntary category are the audits of the accounts of
proprietary entities, partnership firms, Hindu undivided families, etc. In respect of
such accounts, there is no basic legal requirement of audit.
Q.5. Explain Inherent Limitations of Auditing.
The process of auditing is such that it suffers from certain limitations, i.e. the
limitation which auditor cannot overcome irrespective of the nature and extent of
audit procedures. The limitations arise from
1. Nature of financial reporting: Many financial statement items involve
subjective decisions or assessments or a degree of uncertainty, and there may
be a range of acceptable interpretations or judgments that may be made.
Auditor cannot obtain conclusive evidence for such items and hence there is a
possibility that management may intentionally or unintentionally under recognise or
over recognise certain financial items.
2. Nature of audit procedures: There is the possibility that management or
others may not provide, intentionally or unintentionally, the complete information
that is relevant to the preparation and presentation of the financial statements
or that has been requested by the auditor. Auditor has limited legal powers and
hence it is possible that he may not be able to detect certain errors
3. Cost-Benefit analysis: There is a balance to be struck between the reliability of
information and its cost. Auditor needs to evaluate the cost to be incurred and
the value of the information obtained i.e. whether it is worth to incur the cost or not.
Due to the cost constraints, he may be unable to perform in-depth examination.
4. Timelines of financial reporting:
There is an expectation by users of financial statements that the auditor will form
an opinion on the financial statements within a reasonable period of time
and hence it is impracticable to address all information. Auditor performs audit
procedures on sampling basis to form and express an opinion and it is possible
that he may not be able to detect certain material errors due to sampling technique
Due to the above inherent limitations, the auditor is not expected to, and cannot,
reduce audit risk to zero and cannot therefore obtain absolute assurance that the
financial statements are free from material misstatement due to fraud or error.
Q.6. Explain Basic Principles Governing an Audit of Financial Statements.

Basic Principles Governing an Audit: The basic principles which govern the auditor’s
professional responsibilities and which should be complied with wherever an audit is
carried are described below-
1. Planning: The auditor should plan his work to enable him to conduct an effective
audit in an efficient and timely manner. Plans should be based on
knowledge of the client’s business.
2. Confidentiality: The auditor should respect the confidentiality of information
acquired in the course of his work and should not disclose any such
information to a third party without specific authority or unless there is a legal or
professional duty to disclose.
3. Work performed by others: When the auditor delegates work to assistants or
uses work performed by other auditors and experts, he continues to be
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responsible for forming and expressing his opinion on the financial information.
However, he will be entitled to rely on work performed by others, provided he
exercises adequate skill and care and is not aware of any reason to believe
that he should not have so relied.
4. Accounting system and Internal Control: The auditor should gain an
understanding of the accounting system and related controls and should study and
evaluate the operation of those internal controls upon which he wishes to rely in
determining the nature, timing and extent of other audit procedures.
5. Audit evidence: The auditor should obtain sufficient appropriate audit evidence
through the performance of audit procedures to enable him to draw
reasonable conclusions there from on which to base his opinion on the
financial information.
6. Audit Conclusions and Reporting: The auditor should review and assess the
conclusions drawn from the audit evidence obtained and from his knowledge of
business of the entity as the basis for the expression of his opinion on the financial
information.
7. Documentation: The auditor should document matters which are important in
providing evidence that the audit was carried out in accordance with the basic
principles.
8. Integrity, objectivity and independence: The auditor should be straight forward,
honest and sincere in his approach to his professional work. He should maintain
an impartial attitude and both be and appear to be free of any interest
which might be regarded, whatever is actual effect, as being incompatible with
integrity and objectivity.
9. Skills and Competence: The audit should be performed and the report prepared
with due professional care by persons who have adequate training,
experience and competence in auditing. The auditor requires specialised skills
and competence along with a continuing awareness of developments on
accounting and auditing matters, and relevant regulations and statutory
requirements.
Q.7. Explain Relationship of auditing with other disciplines
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Auditing and Accounting: It has been pointed out earlier that both accounting and
auditing are closely related with each other as auditing reviews the financial statements
which are nothing but a result of the overall accounting process.
Auditing and Law: The relationship between auditing and law is very close one.
Auditing involves examination of various transactions from the view point of whether or
not these have been properly entered into.
Auditing and Economics: As, it is well known, accounting is concerned with the
accumulation and presentation of data relating to economic activity. From the auditing
view point, the auditors are more concerned with Micro economics rather than with the
Macro economics.
Auditing and Behavioural Science: The discipline of behavioural science is closely
linked with the subject of auditing. While it may be said that an auditor, particularly the
financial auditor, deals basically with the figures contained in the financial statements
but he shall be required to interact with a lot of people in the organisation. The
knowledge of human behaviour is indeed very essential for an auditor so as to
effectively discharge his duties
Auditing and Statistics & Mathematics: With the passage of time, test check
procedures in auditing have become part of generally accepted auditing procedures.
With the emergence of test check procedure, discipline of statistics has come quite
close to auditing as the auditor is also expected to have the knowledge of statistical
sampling so as to arrive at meaningful conclusions. The knowledge of mathematics is
also required on the part of auditor particularly at the time of verification of inventories.
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Auditing and Data Processing: Today, organisations are witnessing revolution in the
field of data processing of accounts. Many organisations are carrying out their financial
accounting activities with the help of computers. With such a phenomenal growth in the
field of computer sciences, the auditor should have good knowledge of the components,
general capability of the system and the related terms.
Auditing and Financial Management: Auditing is also closely related with other
functional fields of business such as finance, production, marketing, personnel and
other general areas of business management. With the overgrowing field of auditing,
the financial services sector occupies a dominant place in our system
Auditing and Production: Regarding production function, it may be stated that a good
auditor is one who understands the client and his business. While carrying out the audit
activity, the auditor is required to evaluate transactions from the accounting aspect in
relation to the process through which it has passed through as accounting for by-
products; joint-products may also require to be done.
Q.8. Explain Qualities of Auditor

Auditor should possess qualities such as tact, caution, firmness, good temper, integrity,
discretion, industry, judgement, patience, clear headedness and reliability.
He must have a thorough knowledge of the general principles of law which govern
matters with which he is likely to be in intimate contact. The Companies Act, 2013 and
the Partnership Act, 1932 need special mention but mercantile law, specially the law
relating to contracts, is no less important. Needless to say, where undertakings are
governed by a special statute, its knowledge will be imperative; in addition, a sound
knowledge of the law and practice of taxation is unavoidable.
He must pursue an intensive programme of theoretical education in subjects like
financial and management accounting, general management, business and corporate
laws, computers and information systems, taxation, economics, etc. Both practical
training and theoretical education are equally necessary for the development of
professional competence of an auditor for undertaking any kind of audit assignment.
The auditor should be equipped not only with a sufficient knowledge of the way in which
business generally is conducted but also with an understanding of the special features
peculiar to a particular business whose accounts are under audit.
Q.9. Explain Advantages of Audit

The fact that audit is compulsory by law, in certain cases by itself should show that
there must be some positive utility in it. The chief utility of audit lies in reliable financial
statements on the basis of which the state of affairs may be easy to understand. Apart
from this obvious utility, there are other advantages of audit.
Some or all of these are of considerable value even to those enterprises and
organisations where audit is not compulsory, these advantages are given below:
(a) It safeguards the financial interest of persons who are not associated with the
management of the entity, whether they are partners or shareholders.
(b) It acts as a moral check on the employees from committing defalcations or
embezzlement.
(c) Audited statements of account are helpful in settling liability for taxes, negotiating
loans and for determining the purchase consideration for a business.
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(d) These are also useful for settling trade disputes for higher wages or bonus as well
as claims in respect of damage suffered by property, by fire or some other
calamity.
(e) An audit can also help in the detection of wastages and losses to show the
different ways by which these might be checked, especially those that occur due to
the absence or inadequacy of internal checks or internal control measures.
(g) Audit ascertains whether the necessary books of account and allied records have
been properly kept and helps the client in making good deficiencies or
inadequacies in this respect.
(h) As an appraisal function, audit reviews the existence and operations of various
controls in the organisations and reports weaknesses, inadequacies, etc., in them.
(i) Audited accounts are of great help in the settlement of accounts at the time of
admission or death of partner.
(j) Government may require audited and certified statement before it gives assistance
or issues a license for a particular trade
Q.10. Independence is a pre-requisite of auditing financial statements. Comment.

1) Independence cannot be defined as it is a state of mind
2) Independence means that auditor’s judgment should not be influenced by any 3rd
party
3) The ICAI has issued a guidance note on Independence of auditors
4) According to the guidance note independence implies that judgment of a person is
not subordinate to wishes or directions of another person who might have
engaged him or to his own self interest
5) It is not only important to be independent but it is also important to appear as
independent i.e. independence of mind and independence of appearance should
co-exist. Independence of auditor must not only exist in fact, but should also
appear to exist to all reasonable persons.
6) There are various threats to independence such as financial interest threat,
familiarity threat and self-review threat where auditor’s judgment may come under
influence
7) In order to secure independence of auditor there are safeguards in the form of
statutory provisions mentioned in Companies Act, 2013 and Chartered
Accountants Act, 1949
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CHAPTER 2 AUDIT STRATEGY PLANNING AND PROGRAMMING)
Sr.No Topics as per Module JKSC Textbook

Reference
1 Audit Planning Q1, Q2
2 Audit Strategy Q3, Q4
3 Relationship between audit strategy and audit Q5
plan
4 Development of Audit Plan Q1
5 Audit Planning- A Continuous Process Q1, Q6
6 Overall audit strategy and the audit plan- the Q1
auditor’s responsibility
7 Changes to the planning decisions during the Q7
course of audit
8 Direction Supervision and Review Q8
9 Documentation of Audit Plan Q9
10 Audit Programme Q10
11 Quality Control for Audit Work- Delegation and SA 220
Supervision of Audit Work
12 Audit Planning and Materiality Q11, Q12
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Q.1. Short note- Audit plan to conduct an effective audit
“The auditor should plan his work to enable him to conduct an effective audit in an
efficient and timely manner. Plans should be based on knowledge of the client’s
business”.
Plans should be made to cover, among other things:
(a) acquiring knowledge of the client’s accounting systems, policies and internal
control procedures;
(b) establishing the expected degree of reliance to be placed on internal control;
(c) determining and programming the nature, timing, and extent of the audit
procedures to be performed; and
(d) coordinating the work to be performed.
SA-300, “Planning an Audit of Financial Statements” further expounds this principle.
According to it, planning is not a discrete phase of an audit, but rather a continual and
iterative process that often begins shortly after (or in connection with) the completion of
the previous audit and continues until the completion of the current audit engagement.
Q.2. Benefits of Planning

Adequate planning benefits the audit of financial statements in several ways, including
the following:
(a) Helping the auditor to devote appropriate attention to important areas of the audit.
(b) Helping the auditor identify and resolve potential problems on a timely basis.
(c) Helping the auditor properly organize and manage the audit engagement so that it
is performed in an effective and efficient manner.
(d) Assisting in the selection of engagement team members with appropriate levels of
capabilities and competence to respond to anticipated risks, and the proper
assignment of work to them.
(e) Facilitating the direction and supervision of engagement team members and the
review of their work.
Q.3. Short note- Audit Strategy

The auditor shall establish an overall audit strategy that sets the scope, timing and
direction of the audit, and that guides the development of the audit plan.
The process of establishing the overall audit strategy assists the auditor to
Determine such matters as:
1. The resources to deploy for specific audit areas, such as the use of appropriately
experienced team members for high risk areas or the involvement of experts on
complex matters;
2. The amount of resources to allocate to specific audit areas, such as the number of
team members assigned to observe the inventory count at material locations, the
extent of review of other auditors’ work in the case of group audits, or the audit
budget in hours to allocate to high risk areas;
3. When these resources are to be deployed, such as whether at an interim audit
stage or at key cut-off dates; and
4. How such resources are managed, directed and supervised, such as when team
briefing and debriefing meetings are expected to be held, how engagement
partner and manager reviews are expected to take place (for example, on-site or
off -site), and whether to complete engagement quality control reviews.
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Q.4. Mention the factors to be considered while developing overall audit strategy
In establishing the overall audit strategy, the auditor shall
(a) Identify the characteristics of the engagement that define its scope; example: The
expected audit coverage, including the number and locations of components to be
included.
(b) Ascertain the reporting objectives of the engagement to plan the timing of the audit
and the nature of the communications required; example: The entity’s timetable for
reporting, such as at interim and final stages.
(c) Consider the factors that, in the auditor’s professional judgment, are significant in
directing the engagement team’s efforts;
(d) Consider the results of preliminary engagement activities and, where applicable,
whether knowledge gained on other engagements performed by the engagement
partner for the entity is relevant; and
(e) Ascertain the nature, timing and extent of resources necessary to perform the
engagement.
Q.5. Short note- Relationship between overall audit plan and strategy
Once the overall audit strategy has been established, an audit plan can be developed to
address the various matters identified in the overall audit strategy, taking into account
the need to achieve the audit objectives through the efficient use of the auditor’s
resources. The establishment of the overall audit strategy and the detailed audit plan
are not necessarily discrete or sequential processes, but are closely inter-related since
changes in one may result in consequential changes to the other.
The auditor shall develop an audit plan that shall include a description of
(a) The nature, timing and extent of planned risk assessment procedures, as
determined under SA 315 “Identifying and Assessing the Risks of Material
Misstatement through Understanding the Entity and Its Environment”.
(b) The nature, timing and extent of planned further audit procedures at the assertion
level, as determined under SA 330 “The Auditor’s Responses to Assessed Risks”.
(c) Other planned audit procedures that are required to be carried out so that the
engagement complies with SAs.
Q.6. Mention the importance of knowledge of client’s business in assessing the risk
and developing an overall plan
Without adequate knowledge of client’s business, a proper audit is not possible. As per
SA-315, “Identifying and Assessing the Risk of Material Misstatement through
Understanding the Entity and Its Environment”, the auditor shall obtain an
understanding of the following:
(a) Relevant industry, regulatory and other external factors including the applicable
financial reporting framework.
(b) The nature of the entity, including:
(i) its operations;
(ii) its ownership and governance structures;
(iii) the types of investments that the entity is making and plans to make,
including investments in special-purpose entities; and
(iv) the way that the entity is structured and how it is financed;
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to enable the auditor to understand the classes of transactions, account balances, and
disclosures to be expected in the financial statements.
(c) The entity’s selection and application of accounting policies, including the reasons
for changes thereto. The auditor shall evaluate whether the entity’s accounting
policies are appropriate for its business and consistent with the applicable financial
reporting framework and accounting policies used in the relevant industry.
(d) The entity’s objectives and strategies, and those related business risks that may
result in risks of material misstatement.
In addition to the importance of knowledge of the client’s business in establishing the
overall audit plan, such knowledge helps the auditor to identify areas of special audit
consideration.
Q.7. During the course of audit, if auditor comes across circumstances which may
require a revision in the plan and strategy, then can he revise such plan and
strategy?
The auditor shall update and change the overall audit strategy and the audit plan as
necessary during the course of the audit. As a result of unexpected events, changes in
conditions, or the audit evidence obtained from the results of audit procedures, the
auditor may need to modify the overall audit strategy and audit plan and thereby the
resulting planned nature, timing and extent of further audit procedures, based on the
revised consideration of assessed risks.
This may be the case when information comes to the auditor’s attention that differs
significantly from the information available when the auditor planned the audit
procedures. For example, audit evidence obtained through the performance of
substantive procedures may contradict the audit evidence obtained through tests of
controls.
Q.8. Factors to be considered while planning direction, supervision and review of the
work performed by engagement team
The nature, timing and extent of the direction and supervision of engagement team
members and review of their work vary depending on many factors, including:
1. The size and complexity of the entity.
2. The area of the audit.
3. The assessed risks of material misstatement
4. The capabilities and competence of the individual team members performing the
audit work.
Q.9. Short note- Documentation of Audit plan

The auditor shall document:
(a) the overall audit strategy;
(b) the audit plan; and
(c) any significant changes made during the audit engagement to the overall audit
strategy or the audit plan, and the reasons for such changes.
- The documentation of the overall audit strategy is a record of the key
decisions considered necessary to properly plan the audit and to
communicate significant matters to the engagement team.
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- The auditor may summarize the overall audit strategy in the form of a
memorandum that contains key decisions regarding the overall scope, timing
and conduct of the audit.
- It also serves as a record of the proper planning of the audit procedures that
can be reviewed and approved prior to their performance.
- The auditor may use standard audit programs and/or audit completion
checklists, tailored as needed to reflect the particular engagement
circumstances.
Q.10.What do you understand by audit programme? Mention the advantages and

disadvantages
Definition : An audit programme consists of a series of verification procedures to be
applied to the financial statements and accounts of a given company for the purpose of
obtaining sufficient evidence to enable the auditor to express an informed opinion on
such statements.
In other words, an audit programme is a detailed plan of applying the audit procedures
in the given circumstances with instructions for the appropriate techniques to be
adopted for accomplishing the audit objectives.
For the purpose of programme construction, the following points should be kept
in mind:
(1) Stay within the scope and limitation of the assignment.
(2) Determine the evidence reasonably available and identify the best evidence for
deriving the necessary satisfaction.
(3) Apply only those steps and procedures which are useful in accomplishing the
verification purpose in the specific situation.
(4) Consider all possibilities of error.
(5) Co-ordinate the procedures to be applied to related items.
The advantages of an audit programme are:
(a) It provides the assistant carrying out the audit with total and clear set of
instructions of the work generally to be done.
(b) It is essential, particularly for major audits, to provide a total perspective of the
work to be performed.
(c) Selection of assistants for the jobs on the basis of capability becomes easier when
the work is rationally planned, defined and segregated.
(d) The assistants, by putting their signature on programme, accept the responsibility
for the work carried out by them individually and, if necessary, the work done may
be traced back to the assistant.
The disadvantages are:
(a) The work may become mechanical and particular parts of the programme may be
carried out without any understanding of the object of such parts in the whole audit
scheme.
(b) The programme often tends to become rigid and inflexible following set grooves;
the business may change in its operation of conduct, but the old programme may
still be carried on. Changes in staff or internal control may render precaution
necessary at points different from those originally decided upon.
(c) Inefficient assistants may take shelter behind the programme i.e. defend
deficiencies in their work on the ground that no instruction in the matter is
contained therein.
(d) A hard and fast audit programme may kill the initiative of efficient and enterprising
assistants.
All these disadvantages may be eliminated by imaginative supervision of the work
carried on by the assistants
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Q11.Explain the concept of Materiality and performance materiality in context with
planning an audit of financial statements
Materiality is an important consideration for an auditor to evaluate whether the financial
statements reflect a true or fair view or not.
When planning the audit, the auditor considers what would make the financial
information materially misstated. The auditor’s preliminary assessment of materiality
related to specific account balances and classes of transactions helps the auditor
decide such questions as what items to examine and whether to use sampling and
analytical procedures. This enables the auditor to select audit procedures that, in
combination, can be expected to support the audit opinion at an acceptably low degree
of audit risk.
Performance materiality:
When establishing the overall audit strategy, the auditor shall determine materiality for
the financial statements as a whole. If, in the specific circumstances of the entity, there
is one or more particular classes of transactions, account balances or disclosures for
which misstatements of lesser amounts than the materiality for the financial
statements as a whole could reasonably be expected to influence the economic
decisions of users taken on the basis of the financial statements, the auditor shall also
determine the materiality level or levels to be applied to those particular classes of
transactions, account balances or disclosures.
Performance materiality means the amount or amounts set by the auditor at less than
materiality for the financial statements as a whole.
Materiality for the financial statements as a whole may need to be revised as a result of
a change in circumstances that occurred during the audit (for example, a decision to
dispose of a major part of the entity’s business), new information, or a change in the
auditor’s understanding of the entity and its operations as a result of performing further
audit procedures.
If the auditor concludes that a lower materiality for the financial statements as a whole
than that initially determined is appropriate, the auditor shall determine whether it is
necessary to revise performance materiality, and whether the nature, timing and extent
of the further audit procedures remain appropriate.
Q.12.Mention the factors to be considered for identification of an appropriate

benchmark for determining materiality.
Determining materiality involves the exercise of professional judgment. A percentage is
often applied to a chosen benchmark as a starting point in determining materiality for
the financial statements as a whole. Factors that may affect the identification of an
appropriate benchmark include the following:
1’. The elements of the financial statements. Example: Assets, liabilities, equity,
revenue, expenses
2’. Whether there are items on which the attention of the users of the particular
entity’s financial statements tends to be focused.
3’. The nature of the entity, where the entity is at in its life cycle, and the industry and
economic environment in which the entity operates;
4’. The entity’s ownership structure and the way it is financed.
5’. The relative volatility of the benchmark.
: 14 :
Example: The auditor may consider five percentage of profit before tax to be
appropriate for a profit oriented entity in a manufacturing industry, while the auditor may
consider one percentage of total revenue or total expenses to be appropriate for a not-
for-profit entity. Higher or lower percentages, however, may be deemed appropriate in
different circumstances.
: 15 :
CHAPTER 3 AUDIT DOCUMENTATION AND EVIDENCE
Sr.No List of topics as per module JKSC textbook

reference
1 Audit Documentation Q1-Q6
2 SA 500 Audit Evidence Q7-Q12
3 SA 580 Written Representation Q17,Q18
4 SA 501 Audit Evidence- Specific consideration Q19-Q22
for selected items
5 SA 505 External Confirmation Q13-Q16
6 SA 510 Initial Audit Engagement Q23
7 SA 550 Related Party Q24.Q25
8 Concept of true and fair view Q29
9 SA 560 Subsequent Events Q26
10 SA 570 Going Concern Q27, Q28
: 16 :
Q.1. What do you understand by audit documentation? List down the purposes for
maintaining audit documentation
SA 230 on “Audit Documentation”, audit documentation refers to the record of audit
procedures performed, relevant audit evidence obtained, and conclusions the auditor
reached. (terms such as “working papers” or “work papers” are also sometimes used.
Audit documentation provides:

(a) evidence of the auditor’s basis for a conclusion about the achievement of the
overall objectives of the auditor; and
(b) evidence that the audit was planned and performed in accordance with SAs and
applicable legal and regulatory requirements.
Purpose of Audit Documentation

The following are the purpose of Audit documentation:
1. Assisting the engagement team to plan and perform the audit.
2. Assisting members of the engagement team to direct and supervise the audit
work, and to discharge their review responsibilities.
3. Enabling the engagement team to be accountable for its work.
4. Retaining a record of matters of continuing significance to future audits.
5. Enabling the conduct of quality control reviews and inspections.
6. Enabling the conduct of external inspections in accordance with applicable legal,
regulatory or other requirements.
Q.2. Mention the factors affecting form content and extent of audit documentation.
Also give some examples of audit documentation
The form, content and extent of audit documentation depend on factors such as:
2. The nature of the audit procedures to be performed.
3. The identified risks of material misstatement.
4. The significance of the audit evidence obtained.
5. The nature and extent of exceptions identified.
6. The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit evidence
obtained.
7. The audit methodology and tools used.
Audit Documentation include:
Audit programmes.
Analyses.
Issues memoranda.
Summaries of significant matters.
Letters of confirmation and representation.
Checklists.
Correspondence (including e-mail) concerning significant matters.
: 17 :
The auditor may include copies of the entity’s records (for example, significant and
specific contracts and agreements) as part of audit documentation. Audit documentation
is not a substitute for the entity’s accounting records.
Q.3. Mention the concept of audit file.
Audit file may be defined as one or more folders or other storage media, in physical or
electronic form, containing the records that comprise the audit documentation for a
specific engagement.
The auditor shall assemble the audit documentation in an audit file and complete the
administrative process of assembling the final audit fi le on a timely basis after the date
of the auditor’s report.
SQC 1 “Quality Control” requires firms to establish policies and procedures for the
timely completion of the assembly of audit files. An appropriate time limit within which to
complete the assembly of the final audit file is ordinarily not more than 60 days after the
date of the auditor’s report.
Q.4. Give examples of significant matters which may require audit documentation.
Mention the circumstances in which it is appropriate to prepare audit
documentation relating to the use of professional judgment.
Judging the significance of a matter requires an objective analysis of the facts and
circumstances.
Examples of significant matters include:
Matters that give rise to significant risks.
Results of audit procedures indicating (a) that the financial statements could be
materially misstated, or (b) a need to revise the auditor’s previous assessment of
the risks of material misstatement and the auditor’s responses to those risks.
Circumstances that cause the auditor significant difficulty in applying necessary
audit procedures.
Findings that could result in a modification to the audit opinion or the inclusion of
an Emphasis of Matter Paragraph in the auditor’s report.
An important factor in determining the form, content and extent of audit documentation
of significant matters is the extent of professional judgment exercised in performing the
work and evaluating the results.
Some examples of circumstances in which it is appropriate to prepare audit

documentation relating to the use of professional judgment include, where the
matters and judgments are significant:
The rationale for the auditor’s conclusion when a requirement provides that the
auditor ‘shall consider’ certain information or factors, and that consideration is
significant in the context of the particular engagement.
The basis for the auditor’s conclusion on the reasonableness of areas of
subjective judgments (for example, the reasonableness of significant accounting
estimates).
The basis for the auditor’s conclusions about the authenticity of a document when
further investigation (such as making appropriate use of an expert or of
: 18 :
confirmation procedures) is undertaken in response to conditions identified during
the audit that caused the auditor to believe that the document may not be
authentic.
Q.5. Short note- completion memorandum

The auditor may consider it helpful to prepare and retain as part of the audit
documentation a summary (sometimes known as a completion memorandum) that
describes-
the significant matters identified during the audit and
how they were addressed.
Such a summary may facilitate effective and efficient review and inspection of the audit
documentation, particularly for large and complex audits. Further, the preparation of
such a summary may assist auditor’s consideration of the significant matters
Q.6. Short note- Ownership and retention of working papers

Standard on Quality Control (SQC) 1 provides that, unless otherwise specified by law or
regulation, audit documentation is the property of the auditor. He may at his discretion,
make portions of, or extracts from, audit documentation available to clients, provided
such disclosure does not undermine the validity of the work performed, or, in the case of
assurance engagements, the independence of the auditor or of his personnel.
After the assembly of the final audit file has been completed, the auditor shall not delete
or discard audit documentation of any nature before the end of its retention period.
SQC 1 requires firms to establish policies and procedures for the retention of
engagement documentation. The retention period for audit engagements ordinarily is no
shorter than seven years from the date of the auditor’s report, or, if later, the date of the
group auditor’s report.
SA 500- AUDIT EVIDENCE

Q.7. Explain Audit Evidence. What do you understand by Sufficiency and
appropriateness of Audit Evidence?
Audit evidence may be defined as the information used by the auditor in arriving at the
conclusions on which the auditor’s opinion is based. Audit evidence includes both
information contained in the accounting records underlying the financial statements and
other information.
Explaining this further, audit evidence includes:-
(1) Information contained in the accounting records: Accounting records include
the records of initial accounting entries and supporting records, such as checks
and records of electronic fund transfers; invoices; contracts; the general and
subsidiary ledgers, journal entries.
(2) Other information that authenticates the accounting records and also
supports the auditor’s rationale behind the true and fair presentation of the
financial statements: Other information which the auditor may use as audit
evidence includes, for example minutes of the meetings, written confirmations
from trade receivables and trade payables etc.
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Sufficiency of Audit Evidence: Sufficiency is the measure of the quantity of audit
evidence. The quantity of audit evidence needed is affected by the auditor’s
assessment of the risks of misstatement (the higher the assessed risks, the more audit
evidence is likely to be required). Auditor’s judgment as to sufficiency may be
affected by the factors such as:
(i) Materiality
(ii) Risk of material misstatement
(iii) Size and characteristics of the population.
Appropriateness of Audit Evidence: Appropriateness is the measure of the quality of

audit evidence; that is, its relevance and its reliability in providing support for the
conclusions on which the auditor’s opinion is based.
Q.8. What are the types of audit Evidence.
Internal evidence and external evidence: Evidence which originates within the
organisation being audited is internal evidence. E.g. Sales invoice, Copies of sales
challan and forwarding notes, goods received note, inspection report, copies of cash
memo, debit and credit notes, etc.
External evidence on the other hand is the evidence that originates outside the client’s
organization. Eg. Purchase invoice, supplier’s challan and forwarding note, debit notes
and credit notes coming from parties, quotations, confirmations, etc.
Q. 9. Short note- Reliability of Audit Evidence

The reliability of information to be used as audit evidence, and therefore of the audit
evidence itself, is influenced by its source and its nature, and the circumstances under
which it is obtained, including the controls over its preparation and maintenance where
relevant.
The reliability of audit evidence is increased when it is obtained from independent
sources outside the entity.
The reliability of audit evidence that is generated internally is increased when the
related controls, including those over its preparation and maintenance, imposed by
the entity are effective.
Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or
by inference (for example, inquiry about the application of a control).
Audit evidence in documentary form, whether paper, electronic, or other medium,
is more reliable than evidence obtained orally (for example, a contemporaneously
written record of a meeting is more reliable than a subsequent oral representation
of the matters discussed).
Audit evidence provided by original documents is more reliable than audit
evidence provided by photocopies or facsimiles, or documents that have been
: 20 :
filmed, digitised or otherwise transformed into electronic form, the reliability of
which may depend on the controls over their preparation and maintenance.
Q.10.Explain Audit Techniques.

Audit procedures to obtain audit evidence can include:
(i) Inspection
(ii) Observation
(iii) External Confi rmation
(iv) Recalculation
(v) Reperformance
(vi) Analytical Procedures
(vii) Inquiry
Inspection: Inspection involves examining records or documents, whether internal or
external, in paper form, electronic form, or other media, or a physical examination of an
asset.
Observation: Observation consists of looking at a process or procedure being
performed by others.
External Confirmation: An external confirmation represents audit evidence obtained
by the auditor as a direct written response to the auditor from a third party (the
confirming party), in paper form, or by electronic or other medium. External confirmation
procedures frequently are relevant when addressing assertions associated with certain
account balances and their elements. However, external confirmations need not be
restricted to account balances only.
Recalculation: Recalculation consists of checking the mathematical accuracy of
documents or records. Recalculation may be performed manually or electronically.
Re-performance: Re-performance involves the auditor’s independent execution of
procedures or controls that were originally performed as part of the entity’s internal
control.
Analytical Procedures: Analytical procedures consist of evaluations of financial
information made by a study of plausible relationships among both financial and
nonfinancial data.
Inquiry: Inquiry consists of seeking information of knowledgeable persons, both
financial and non-financial, within the entity or outside the entity. Inquiry is used
extensively throughout the audit in addition to other audit procedures. Inquiries may
range from formal written inquiries to informal oral inquiries. Evaluating responses to
inquiries is an integral part of the inquiry process.
Q.11.Explain the concept of Assertions with examples.

Assertions are representations made by management regarding financial items in
financial statements either directly or indirectly. It means what management
wants to convey regarding a particular financial item. Auditor needs to obtain
sufficient and appropriate audit Evidence to verify management’s assertions.
(a) Assertions about classes of transactions and events for the period under audit:
(i) Occurrence—transactions and events that have been recorded have
occurred and pertain to the entity.
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(ii) Completeness—all transactions and events that should have been recorded
have been recorded.
(iii) Accuracy—amounts and other data relating to recorded transactions and
events have been recorded appropriately.
(iv) Cut-off—transactions and events have been recorded in the correct
accounting period.
(v) Classification—transactions and events have been recorded in the proper
accounts.
(b) Assertions about account balances at the period end:
(i) Existence—assets, liabilities, and equity interests exist.
(ii) Rights and obligations—the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
(iii) Completeness—all assets, liabilities and equity interests that should have
been recorded have been recorded.
(iv) Valuation and allocation—assets, liabilities, and equity interests are included
in the financial statements at appropriate amounts and any resulting
valuation or allocation adjustments are appropriately recorded.
Q.12.Explain Audit Procedures in brief.

Audit evidence to draw reasonable conclusions on which to base the auditor’s opinion is
obtained by performing:
(a) Risk assessment procedures: Risk assessment procedures refer to the audit
procedures performed to obtain an understanding of the entity and its
environment, including the entity’s internal control, to identify and assess the
risks of material misstatement, whether due to fraud or error.
&
(b) Further audit procedures, which comprise:
(i) Tests of controls, when required by the SAs or when the auditor has chosen
to do so In designing and performing tests of controls, the auditor shall:
(a) Perform other audit procedures in combination with inquiry to obtain
audit evidence about the operating effectiveness of the controls,
including:
a. How the controls were applied at relevant times during the period
under audit.
b. The consistency with which they were applied.
c. By whom or by what means they were applied
(ii) Substantive procedures, including tests of details and substantive analytical
procedures. The audit procedures inspection, observation, confirmation,
recalculation, re-performance and analytical procedures, often in some
combination, in addition to inquiry described below may be used as risk
assessment procedures, tests of controls or substantive procedures,
depending on the context in which they are applied by the auditor.
SA 505 External Confirmation
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Q.13.Explain External Confirmation as per SA 505. What do you understand by
positive confirmation request and negative confirmation request.
External confirmation may be defined as an audit evidence obtained as a direct written
response to the auditor from a third party (the confirming party), in paper form, or by
electronic or other medium.
Positive confirmation request – A request that the confirming party respond directly
to the auditor indicating whether the confirming party agrees or disagrees with the
information in the request, or providing the requested information.
Negative confirmation request – A request that the confirming party respond directly
to the auditor only if the confi rming party disagrees with the information provided in
the request.
Negative confirmation---------- It should be used less and only in following situation-----i)
The risk of material misstatement is low. ii) Too many similar items are required to be
confirmed which are very small. iii) There is a low chance that such requests will be
ignored. Iv) Exception rate expected is low.
Sometimes only positive confirmation is required to be done and the response may not
be available, in such cases auditor must consider the impact of such a situation on his
opinion.
Q.14.Short note- External Confirmation Procedure

When using external confirmation procedures, the auditor shall maintain control
over external confirmation requests, including:
- Determining the information to be confirmed or requested;
- Selecting the appropriate confirming party;
- Designing the confirmation requests after considering following factors:
- Risk of Material Misstatement involved in matters
- Method of communication
- Prior experience in the audit engagement
- Sending the requests, including follow-up requests when applicable, to the
confirming party.
Q.15.Factors to be considered while designing a confirmation request

The design of a confirmation request may directly affect the confirmation response
rate, and the reliability and the nature of the audit evidence obtained from responses.
Factors to consider when designing confirmation requests include:
Specific identified risks of material misstatement, including fraud risks.
The layout and presentation of the confirmation request.
Prior experience on the audit or similar engagements.
The assertions being addressed.
The method of communication [for example, in paper form, or by electronic mode
(like e-mail) or other medium].
: 23 :
Management’s authorisation or encouragement to the confirming parties to
respond to the auditor. Confirming parties may only be willing to respond to a
confirmation request containing management’s authorisation.
The ability of the intended confirming party to confirm or provide the requested
information (for example, individual invoice amount versus total balance).
Q.16.Mention the steps to be taken if management refuses to allow auditor to send a

confirmation request.
If management refuses to allow the auditor to send a confirmation request, the auditor
shall:
(a) Inquire as to management’s reasons for the refusal, and seek audit evidence as to
their validity and reasonableness;
(b) Evaluate the implications of management’s refusal on the auditor’s assessment of
the relevant risks of material misstatement, including the risk of fraud, and on the
nature, timing and extent of other audit procedures; and
(c) Perform alternative audit procedures designed to obtain relevant and reliable audit
evidence.
If the auditor concludes that management’s refusal to allow the auditor to send a
confirmation request is unreasonable, or the auditor is unable to obtain relevant and
reliable audit evidence from alternative audit procedures, the auditor shall communicate
with those charged with governance in accordance with SA 260.
The auditor also shall determine the implications for the audit and the auditor’s opinion
in accordance with SA 705.
SA 580 Written Representations
Q.17.What do you understand by Written Representations? Comment upon its

reliability.
Written representations may be defined as a written statement by management
provided to the auditor to confirm certain matters or to support other audit evidence.
Written representations in this context do not include financial statements, the
assertions therein, or supporting books and records.
Although written representations provide necessary audit evidence, they do not provide
sufficient appropriate audit evidence on their own about any of the matters with which
they deal. Furthermore, the fact that management has provided reliable written
representations does not affect the nature or extent of other audit evidence that the
auditor obtains about the fulfillment of management’s responsibilities.
The auditor shall request management to provide a written representation that it has
fulfilled its responsibility for the preparation of the financial statements.
Q.18.Mention the audit procedures if auditor develops doubt over reliability of written
representation or management refuses to provide written representation.
Doubt as to the Reliability of Written Representations
1. If the auditor has concerns about the competence, integrity, ethical values or
diligence of management, or about its commitment to or enforcement of these, the
auditor shall determine the effect that such concerns may have on the reliability of
representations (oral or written) and audit evidence in general
: 24 :
2. In particular, if written representations are inconsistent with other audit evidence,
the auditor shall perform audit procedures to attempt to resolve the matter. If the
matter remains unresolved, the auditor shall reconsider the assessment of the
competence, integrity, ethical values or diligence of management
3. If the auditor concludes that the written representations are not reliable, the auditor
shall take appropriate actions, including determining the possible effect on the
opinion in the auditor’s report in accordance with SA 705
Requested Written Representations Not Provided
If management does not provide one or more of the requested written representations,
the auditor shall:
(a) Discuss the matter with management;
(b) Re-evaluate the integrity of management and evaluate the effect that this may
have on the reliability of representations (oral or written) and audit evidence in
general; and
(c) Take appropriate actions, including determining the possible effect on the opinion
in the auditor’s report in accordance with SA 705,
The auditor shall disclaim an opinion on the financial statements in accordance
with SA 705 if:
(a) The auditor concludes that there is sufficient doubt about the integrity of
management such that the written representations are not reliable; or
(b) Management does not provide the written representations.
SA 501- Audit Evidence- Specific Consideration for Selected Items.

Q.19.Mention the Procedures for verifying existence and condition of the inventory.
When inventory is material to the financial statements, the auditor shall obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by:
(a) Attendance at physical inventory counting, unless impracticable, to:

(i) Evaluate management’s instructions and procedures for recording and
controlling the results of the entity’s physical inventory counting;
(ii) Observe the performance of management’s count procedures;
(iii) Inspect the inventory; and
(iv) Perform test counts.
(b) Performing audit procedures over the entity’s final inventory records to determine
whether they accurately reflect actual inventory count results.
Attendance at Physical Inventory Counting Involves:

(a) Inspecting the inventory to ascertain its existence and evaluate its condition, and
performing test counts;
(b) Observing compliance with management’s instructions and the performance of
procedures for recording and controlling the results of the physical inventory count;
and
(c) Obtaining audit evidence as to the reliability of management’s count procedures.
Q.20.Mention the Factors to be considered while planning attendance at Physical

Inventory Counting.
: 25 :
Matters relevant in planning attendance at physical inventory counting include, for
example:
(a) Nature of inventory.
(b) Stages of completion of work in progress.
(c) The risks of material misstatement related to inventory.
(d) The nature of the internal control related to inventory.
(e) Whether adequate procedures are expected to be established and proper
instructions issued for physical inventory counting.
(f) The timing of physical inventory counting.
(g) Whether the entity maintains a perpetual inventory system.
(h) The locations at which inventory is held, including the materiality of the inventory
and the risks of material misstatement at different locations, in deciding at which
locations attendance is appropriate
(i) Whether the assistance of an auditor’s expert is needed.
Q.21.Mention the procedures if inventory counting was not possible on the

planned/cut-off date.
Physical Inventory Counting Conducted Other than at the Date
of the Financial Statements
If physical inventory counting is conducted at a date other than the date of the financial
statements, the auditor shall, in addition to the procedures required above, perform
audit procedures to obtain audit evidence about whether changes in inventory between
the count date and the date of the financial statements are properly recorded.
If the Auditor is unable to Attend Physical Inventory Counting due to Unforeseen
Circumstances
If the auditor is unable to attend physical inventory counting due to unforeseen
circumstances, the auditor shall make or observe some physical counts on an
alternative date, and perform audit procedures on intervening transactions.
Attendance at Physical Inventory Counting Is Impracticable
If attendance at physical inventory counting is impracticable, the auditor shall perform
alternative audit procedures to obtain sufficient appropriate audit evidence regarding the
existence and condition of inventory. If it is not possible to do so, the auditor shall
modify the opinion in the auditor’s report in accordance with SA 705.
In some cases, attendance at physical inventory counting may be impracticable. This
may be due to factors such as the nature and location of the inventory, for example,
where inventory is held in a location that may pose threats to the safety of the auditor.
Q.22.Mention the audit procedures to be performed for verifying completeness of

litigation and claims
The auditor shall design and perform audit procedures in order to identify litigation and
claims involving the entity which may give rise to a risk of material misstatement,
including:
(a) Inquiry of management and, where applicable, others within the entity, including
in-house legal counsel;
(b) Reviewing minutes of meetings of those charged with governance and
correspondence between the entity and its external legal counsel; and
(c) Reviewing legal expense accounts.
The auditor shall, in addition to the procedures required by other SAs, seek direct
communication with the entity’s external legal counsel. The auditor shall do so through a
: 26 :
letter of inquiry requesting the entity’s external legal counsel to communicate directly
with the auditor.
If law, regulation or the respective legal professional body prohibits the entity’s external
legal counsel from communicating directly with the auditor, the auditor shall perform
alternative audit procedures.
In certain circumstances, the auditor also may judge it necessary to meet with the
entity’s external legal counsel to discuss the likely outcome of the litigation or claims.
SA 510 Initial Audit Engagement
Q.23.What do you understand by Initial audit Engagement? Mention the audit

procedures to be adopted for verifying opening balances in case of an initial audit
engagement.
An engagement in which either:
(i) The financial statements for the prior period were not audited; or
(ii) The financial statements for the prior period were audited by a predecessor
auditor.
The auditor shall obtain sufficient appropriate audit evidence about whether the
opening balances contain misstatements that materially affect the current period’s
financial statements by:
(a) Determining whether the prior period’s closing balances have been correctly
brought forward to the current period or, when appropriate, any adjustments
have been disclosed as prior period items in the current year’s Statement of
Profit and Loss;
(b) Determining whether the opening balances reflect the application of
appropriate accounting policies; and
(c) Performing one or more of the following:
(i) Where the prior year financial statements were audited, perusing the copies of the
audited financial statements including the other relevant documents relating to the
prior period financial statements;
(ii) Evaluating whether audit procedures performed in the current period provide
evidence relevant to the opening balances; or
(iii) Performing specific audit procedures to obtain evidence regarding the opening
balances.
SA 550 Related Party
Q.24.Explain Related Party as per SA 550

A party that is either:
(i) A related party as defined in the applicable financial reporting framework ; or
(ii) Where the applicable financial reporting framework establishes minimal or no
related party requirements:
(a) A person or other entity that has control or significant influence, directly or
indirectly through one or more intermediaries, over the reporting entity;
(b) Another entity over which the reporting entity has control or significant
influence, directly or indirectly through one or more intermediaries; or
: 27 :
(c) Another entity that is under common control with the reporting entity through
having:
Common controlling ownership;
Owners who are close family members; or
Common key management.
Q.25.Explain Auditor’s Responsibilities regarding Related Party transactions

Risk Assessment Procedures and Related Activities
1. The auditor shall inquire of management regarding:
(a) The identity of the entity’s related parties, including changes from the prior
period;
(b) The nature of the relationships between the entity and these related parties;
and
(c) Whether the entity entered into any transactions with these related parties
during the period and, if so, the type and purpose of the transactions.
2. The auditor shall inquire of management and others within the entity, to obtain an
understanding of the controls, if any, that management has established to:
(a) Identify, account for, and disclose related party relationships and transactions
in accordance with the applicable financial reporting framework;
(b) Authorise and approve significant transactions and arrangements with related
parties;
(c) Authorise and approve significant transactions and arrangements outside the
normal course of business.
Responses to the assessed risks of material misstatement
1. Identification of Previously Unidentified or Undisclosed Related Parties or
Significant Related Party Transactions:
During the audit, the auditor may inspect records or documents that may provide
information about related party relationships and transactions, for example:
Entity income tax returns.
Information supplied by the entity to regulatory authorities.
Shareholder registers to identify the entity’s principal shareholders.
Statements of conflicts of interest from management and those charged with
governance.
Records of the entity’s investments
Contracts and agreements with key management or those charged with
governance.
2. For identified significant related party transactions outside the entity’s
normal course of business, the auditor shall:
(a) Inspect the underlying contracts or agreements, if any, and evaluate whether:
(i) The business rationale (or lack thereof) of the transactions suggests
that they may have been entered into to engage in fraudulent financial
reporting or to conceal misappropriation of assets;
(ii) The terms of the transactions are consistent with management’s
explanations
: 28 :
(iii)The transactions have been appropriately accounted for and disclosed
in accordance with the applicable financial reporting framework; and
(b) Obtain audit evidence that the transactions have been appropriately
authorised and approved
3. When management has made an assertion in the financial statements to the effect
that a related party transaction was conducted on terms equivalent to those
prevailing in an arm’s length transaction, the auditor shall obtain sufficient
appropriate audit evidence about the assertion.
4. The auditor shall evaluate whether the identified related party relationships and
transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework
5. The auditor shall obtain written representations from management and, where
appropriate, those charged with governance that:
(a) They have disclosed to the auditor the identity of the entity’s related parties
and all the related party relationships and transactions of which they are
aware; and
(b) They have appropriately accounted for and disclosed such relationships and
transactions in accordance with the requirements of the framework.
SA 560 Subsequent Events
Q.26.What do you understand by Subsequent Events? Mention the audit procedures

as per SA 560
Subsequent events are such events which occur after date of financial statements and
before date of auditor’s report and facts that come to the knowledge of auditor after
issue of auditor’s report
Audit Procedures:
(a) Obtaining an understanding of any procedures management has established to
ensure that subsequent events are identified.
(b) Inquiring of management and, where appropriate, those charged with governance
as to whether any subsequent events have occurred which might affect the
financial statements.
(c) Reading minutes, if any, of the meetings, of the entity’s owners, management and
those charged with governance, that have been held after the date of the financial
statements and inquiring about matters discussed at any such meetings for which
minutes are not yet available.
(d) Reading the entity’s latest subsequent interim financial statements, if any.
Note- For Facts which become known to the auditor after the date of the auditor’s
report
(a) Discuss the matter with management and, where appropriate, those charged with
governance.
(b) Determine whether the financial statements need amendment and, if so,
: 29 :
(c) Inquire how management intends to address the matter in the financial
statements.
Report Revision: If auditor becomes aware of opinion changing facts after the date of
audit report and before the date of issue of financial statements, he may consider
possibility of report revision. In case of such revision, he should ask management to
return the original reports and then auditor shall issue amended reports.
SA 570- Going Concern
Q.27.Explain Indicators of Material Uncertainty Regarding Going Concern Assumption

Events or Conditions That May Cast Significant Doubt on the Entity’s
Ability to Continue as a Going Concern
The following are examples of events or conditions that, individually or collectively, may
cast significant doubt on the entity’s ability to continue as a going concern.
Financial
Net liability or net current liability position.
Fixed-term borrowings approaching maturity without realistic prospects of renewal
or repayment; or excessive reliance on short-term borrowings to finance long-term
assets.
Indications of withdrawal of financial support by creditors.
Negative operating cash flows indicated by historical or prospective financial
statements.
Adverse key financial ratios.
Operating
Management intentions to liquidate the entity or to cease operations.
Loss of key management without replacement.
Loss of a major market, key customer(s), franchise, license, or principal upplier(s).
Labor difficulties.
Shortages of important supplies.
Emergence of a highly successful competitor.
Other
Non-compliance with capital or other statutory or regulatory requirements, such as
solvency or liquidity requirements for financial institutions.
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.
Changes in law or regulation or government policy expected to adversely affect
the entity.
Uninsured or underinsured catastrophes when they occur.
Q.28.Mention the Audit Procedures to be performed if material uncertainty over going

concern assumption, is identified.
These procedures shall include:
(a) Where management has not yet performed an assessment of the entity’s ability to
continue as a going concern, requesting management to make its assessment.
(b) Evaluating management’s plans for future actions in relation to its going concern
assessment, whether the outcome of these plans is likely to improve the situation
and whether management’s plans are feasible in the circumstances.
: 30 :
(c) Where the entity has prepared a cash flow forecast, and analysis of the forecast is
a significant factor in considering the future outcome of events or conditions in the
evaluation of management’s plans for future actions:
(i) Evaluating the reliability of the underlying data generated to prepare the
forecast; and
(ii) Determining whether there is adequate support for the assumptions
underlying the forecast.
(d) Considering whether any additional facts or information have become available
since the date on which management made its assessment.
(e) Requesting written representations from management regarding their future action
plans and the feasibility of these plans.
Q.29.Explain the Concept of True and Fair View.

1) The phrase “true and fair view” is used in many statutes but it is not defined in any
act
2) True and fair view concept is closely related to the concept of materiality.
3) In order to form and express an opinion on true and fair view, auditor needs to
examine that all assets, liabilities, income and expenses are recorded at such
amounts and in such accounts which are in accordance with accounting policies
and principles and no material transaction has been omitted.
4) General considerations for verifying true and fair view
a. No asset or liability should be undervalued or over valued
b. No material asset should be omitted
c. No material liability should be omitted
d. Charge on asset, if any should be separately disclosed
e. Format of financial statements should be as per applicable financial reporting
framework
f. Selection and application of accounting policies should be as per accounting
standards
g. Any extraordinary or non-recurring item should be separately disclosed
: 31 :
CHAPTER 4 RISK ASSESSMENT AND INTERNAL CONTROL
Sr. List of topics as per module JKSC textbook reference

No
1 Audit Risk Q1
2 Identifying and assessing the Risks of Material Q2
Misstatement
3 Internal Control Q3-Q8
4 Evaluation of Control by the auditor
5 Testing of Internal control
6 Internal Control and IT environment Q9
7 Materiality and Audit Risk Q1
8 Documenting the Risk Q10
9 Internal Audit Q11, Q12
10 Standards of Internal Audit Q13
11 & Basics of Internal Financial Controls and
12 reporting Requirements Q14
: 32 :
Q.1. What do you understand by Audit Risk. Explain the components of Audit Risk.
Audit risk means the risk that the auditor gives an inappropriate audit opinion when the
financial statement are materially misstated. Thus, it is the risk that the auditor may fail
to express an appropriate opinion in an audit assignment.
Audit risk is a function of the risks of material misstatement and detection risk.
Risk of material misstatement may be defined as the risk that the financial
statements are materially misstated prior to audit. This consists of two components,
described as follows at the assertion level:
(a) Inherent risk—The susceptibility of an assertion about a class of transaction,
account balance or disclosure to a misstatement that could be material, either
individually or when aggregated with other misstatements, before consideration of
any related controls.
(b) Control risk—The risk that a misstatement that could occur in an assertion about
a class of transaction, account balance or disclosure and that could be material,
either individually or when aggregated with other misstatements, will not be
prevented, or detected and corrected, on a timely basis by the entity’s internal
control.
Detection risk: The risk that the procedures performed by the auditor to reduce audit
risk to an acceptably low level will not detect a misstatement that exists and that could
be material, either individually or when aggregated with other misstatements.
What is not included in Audit Risk ?
(i) Audit risk does not include the risk that the auditor might express an opinion that
the financial statements are materially misstated when they are not. This risk is
ordinarily insignificant.
(ii) Further, audit risk is a technical term related to the process of auditing; it does not
refer to the auditor’s business risks such as loss from litigation, adverse publicity,
or other events arising in connection with the audit of financial statements.
Q.2. Explain in detail the process of identifying and assessing the risk of material
misstatement.
As per SA 315 - “Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment”, the objective of the auditor is to identify
and assess the risks of material misstatement, whether due to fraud or error through
understanding the entity and its environment, including the entity’s internal control,
thereby providing a basis for designing and implementing responses to the assessed
risks of material misstatement.
The auditor shall perform risk assessment procedures to provide a basis for the
identification and assessment of risks of material misstatement at the financial
: 33 :
statement and assertion levels. Risk assessment procedures by themselves, however,
do not provide sufficient appropriate audit evidence on which to base the audit opinion.
The risks to be assessed include both those due to error and those due to fraud, and
both are covered by this SA.
Q.3. Mention the meaning of internal control system. List down the objectives of
internal control.
As per SA-315, “Identifying and Assessing the Risk of Material Misstatement Through
Understanding the Entity and its Environment”, the internal control may be defined
as “the process designed, implemented and maintained by those charged with
governance, management and other personnel to provide reasonable assurance about
the achievement of an entity’s objectives with regard to reliability of financial reporting,
effectiveness and efficiency of operations, safeguarding of assets, and compliance with
applicable laws and regulations.”
Objectives of Internal Control
(i) transactions are executed in accordance with managements general or specific
authorization;
(ii) all transactions are promptly recorded in the correct amount in the appropriate
accounts and in the accounting period in which executed so as to permit
preparation of financial information within a framework of recognized accounting
policies and practices and relevant statutory requirements, if any, and to maintain
accountability for assets;
(iii) assets are safeguarded from unauthorised access, use or disposition; and
(iv) the recorded assets are compared with the existing assets at reasonable intervals
and appropriate action is taken with regard to any differences.
: 34 :
Q.4. Mention the inherent limitations of internal control system.

Limitations of Internal Control
(i) Internal control can provide only reasonable assurance:
Internal control, no matter how effective, can provide an entity with only
reasonable assurance about achieving the entity’s financial reporting objectives.
The likelihood of their achievement is affected by inherent limitations of internal
control.
(ii) Human judgment in decision-making:
Realities that human judgment in decision-making can be faulty and that
breakdowns in internal control can occur because of human error.
(iii) Lack of understanding the purpose:
Equally, the operation of a control may not be effective, such as where information
produced for the purposes of internal control (for example, an exception report) is
not effectively used because the individual responsible for reviewing the
information does not understand its purpose or fails to take appropriate action.
(iv) Collusion among People:
Additionally, controls can be circumvented by the collusion of two or more people
or inappropriate management override of internal control. For example,
management may enter into side agreements with customers that alter the terms
and conditions of the entity’s standard sales contracts, which may result in
improper revenue recognition. Also, edit checks in a software program that are
designed to identify and report transactions that exceed specified credit limits may
be overridden or disabled.
(v) Judgements by Management:
Further, in designing and implementing controls, management may make
judgments on the nature and extent of the controls it chooses to implement, and
the nature and extent of the risks it chooses to assume.
(vi) Limitations in case of Small Entities:
Smaller entities often have fewer employees due to which segregation of duties is
not practicable. However, in a small owner-managed entity, the owner-manager
may be able to exercise more effective oversight than in a larger entity. This
oversight may compensate for the generally more limited opportunities for
segregation of duties.
On the other hand, the owner-manager may be more able to override controls because
the system of internal control is less structured. This is taken into account by the auditor
when identifying the risks of material misstatement due to fraud.
: 35 :
Q.5. Mention the factors to be considered in determining the controls relevant to audit
The entity’s objectives, and
therefore controls, relate to fi nancial reporting, operations and compliance; however,
not all of these objectives and controls are relevant to the auditor’s risk assessment.
Factors relevant to the auditor’s judgment about whether a control, individually
or in combination with others, is relevant to the audit may include such matters
as the following:
Materiality.
The significance of the related risk.
The size of the entity.
The nature of the entity’s business, including its organisation and ownership
characteristics.
The diversity and complexity of the entity’s operations.
Applicable legal and regulatory requirements.
The circumstances and the applicable component of internal control.
The nature and complexity of the systems that are part of the entity’s internal
Control
Whether, and how, a specific control, individually or in combination with others,
prevents, or detects and corrects, material misstatement.
Controls over the completeness and accuracy of information
Controls over the completeness and accuracy of information produced by the entity may
be relevant to the audit if the auditor intends to make use of the information in designing
and performing further procedures.
Internal control over safeguarding of assets
Internal control over safeguarding of assets against unauthorised acquisition, use, or
disposition may include controls relating to both financial reporting and operations
objectives. The auditor’s consideration of such controls is generally limited to those
relevant to the reliability of financial reporting.
Controls relating to objectives that are not relevant to an audit
An entity generally has controls relating to objectives that are not relevant to an audit
and therefore need not be considered. For example, an entity may rely on a
sophisticated system of automated controls to provide efficient and effective operations
(such as an airline’s system of automated controls to maintain flight schedules), but
these controls ordinarily would not be relevant to the audit.
Q.6. Explain in brief the components of Internal control system

The division of internal control into the following five components provides a useful
framework for auditors to consider how different aspects of an entity’s internal control
may affect the audit:
(A) The control environment;
(B) The entity’s risk assessment process
(C) The information system, including the related business processes, relevant to
financial reporting, and communication
(D) Control activities
(E) Monitoring of controls.
: 36 :
(A) Control Environment– Component of Internal Control– The auditor shall obtain
an understanding of the control environment. As part of obtaining this
understanding, the auditor shall evaluate whether:
(i) Management has created and maintained a culture of honesty and ethical
behavior; and
(ii) The strengths in the control environment elements collectively provide an
appropriate foundation for the other components of internal control.
(B) The Entity’s Risk Assessment Process– Component of Control Environment
The auditor shall obtain an understanding of whether the entity has a process for:
(a) Identifying business risks relevant to fi nancial reporting objectives;
(b) Estimating the significance of the risks;
(c) Assessing the likelihood of their occurrence; and
(d) Deciding about actions to address those risks.
(C) The information system, including the related business processes, relevant
to financial reporting and communication– Component of Control
Environment
The auditor shall obtain an understanding of the information system, including the
related business processes, relevant to financial reporting, including the following
are as:
(a) The classes of transactions in the entity’s operations that are significant to
the financial statements;
(b) The procedures by which those transactions are initiated, recorded,
processed, corrected as necessary, transferred to the general ledger and
reported in the financial statements;
(c) The related accounting records, supporting information and specific accounts
in the financial statements that are used to initiate, record, process and report
transactions;
(d) How the information system captures events and conditions that are
significant to the financial statements;
(D) Control Activities– Component of Internal Control
The auditor shall obtain an understanding of control activities relevant to the audit,
which the auditor considers necessary to assess the risks of material
misstatement. An audit requires an understanding of only those control
activities related to significant class of transactions, account balance, and
disclosure in the financial statements and the assertions which the auditor finds
relevant in his risk assessment process.
Examples of control activities are authorization, approval, segregation of duties
etc.
(E) Monitoring of Controls – Component of Internal Control
The auditor shall obtain an understanding of the major activities that the entity
uses to monitor internal control over financial reporting.
Management accomplishes through on-going activities, separate
evaluations etc.: Management accomplishes monitoring of controls through on-
going activities, separate evaluations, or a combination of the two.
On-going monitoring activities are often built into the normal recurring activities of
an entity and include regular management and supervisory activities.
: 37 :
Q.7. Mention the methods for evaluating internal control system
To facilitate the accumulation of the information necessary for the proper review
and evaluation of internal controls, the auditor can use one of the following to
help him to know the system and evaluate the same:
(i) Narrative record;
(ii) Check List;
(iii) Questionnaire; and
(iv) Flow chart.
The Narrative Record
This is a complete and exhaustive description of the system as found in operation by
the auditor. Actual testing and observation are necessary before such a record can be
developed. It may be recommended in cases where no formal control system is in
operation and would be more suited to small business.
A Check List
This is a series of instructions which a member of the auditing staff must follow. When
he completes instruction, he initials the space against the instruction. Answers to the
check list instructions are given by adopting distinctive “ticks”.
Internal Control Questionnaire
In the questionnaire, generally questions are so framed that a ‘Yes’ answer denotes
satisfactory position and a ‘No’ answer suggests weakness. Provision is made for an
explanation or further details of ‘No’ answers. In respect of questions not relevant to the
business, ‘Not Applicable’ reply is given.
A Flow Chart
It is a graphic presentation of each part of the company’s system of internal control. A
flow chart is considered to be the most concise way of recording the auditor’s review of
the system. It minimises the amount of narrative explanation and thereby achieves a
consideration or presentation not possible in any other form.
It is also necessary for the auditor to study the significant features of the business
carried on by the concern; the nature of its activities and various channels of goods and
materials.
Q.8. Evaluation of internal control is beneficial to the auditor. Do you agree? If yes,
then mention the benefits of evaluation of internal control
The review of internal controls will enable the auditor to know:
(i) whether errors and frauds are likely to be located in the ordinary course of
operations of the business;
(ii) whether an adequate internal control system is in use and operating as planned
by the management;
(iii) whether the controls adequately safeguard the assets;
(iv) how far and how adequately the management is discharging its function in so far
as correct recording of transactions is concerned;
(v) how reliable the reports, records and the certificates to the management can be;
(vi) the extent and the depth of the examination that he needs to carry out in the
different areas of accounting;
(vii) what would be appropriate audit technique and the audit procedure in the given
circumstances;
(viii) what are the areas where control is weak and where it is excessive; and
(ix) whether some worthwhile suggestions can be given to improve the control system.
: 38 :
Q.9. Short note- Internal control in IT environment
Generally, IT benefits an entity’s internal control by enabling an entity to:
 Consistently apply predefined business rules and perform complex calculations in
processing large volumes of transactions or data;
 Enhance the timeliness, availability, and accuracy of information;
 Facilitate the additional analysis of information;
 Enhance the ability to monitor the performance of the entity’s activities and its
policies and procedures;
IT also poses specific risks to an entity’s internal control, including, for
example:
 Reliance on systems or programs that are inaccurately processing data,
processing inaccurate data, or both.
 Unauthorised access to data that may result in destruction of data or improper
changes to data
Q.10.Mention the matters to be documented after evaluating the risk of material
misstatement
The auditor shall document:
(a) The discussion among the engagement team and the significant decisions
reached;
(b) Key elements of the understanding obtained regarding each of the aspects of the
entity and its environment and of each of the internal control components, the
sources of information from which the understanding was obtained; and the risk
assessment procedures performed;
(c) The identified and assessed risks of material misstatement at the financial
statement level and at the assertion level ; and
(d) The risks identified, and related controls about which the auditor has obtained an
understanding.
Q.11. Explain the provisions of internal audit- SEC 138 of companies act, 2013.
As per section 138 of the Companies Act, 2013 the following class of companies
(prescribed in rule 13 of Companies (Accounts) Rules, 2014) shall be required to
appoint an internal auditor or a fi rm of internal auditors, namely-
(a) every listed company;
(b) every unlisted public company having-
(i) paid up share capital of fifty crore rupees or more during the preceding
financial year; or
(ii) turnover of two hundred crore rupees or more during the preceding financial
year; or
(iii) outstanding loans or borrowings from banks or public financial institutions
exceeding one hundred crore rupees or more at any point of time during the
preceding financial year; or
(iv) outstanding deposits of twenty five crore rupees or more at any point of time
during the preceding financial year; and
(c) every private company having-
(i) turnover of two hundred crore rupees or more during the preceding financial
year; or
: 39 :
(ii) outstanding loans or borrowings from banks or public financial institutions
exceeding one hundred crore rupees or more at any point of time during the
preceding financial year:
It is provided that an existing company covered under any of the above criteria shall
comply with the requirements within six months of commencement of such section.
Who can be appointed as Internal Auditor?
As per section 138, the internal auditor shall either be a chartered accountant or a cost
accountant (whether engaged in practice or not), or such other professional as may be
decided by the Board to conduct internal audit of the functions and activities of the
companies. The internal auditor may or may not be an employee of the company.
Q.12. Mention the objectives and scope of internal audit.
1. Activities Relating to Governance: The internal audit function may assess the
governance process in its accomplishment of objectives on ethics and values,
performance management and accountability.
2. Activities Relating to Risk Management: The internal audit function may assist
the entity by identifying and evaluating significant exposures to risk and
contributing to the improvement of risk management. The internal audit function
may perform procedures to assist the entity in the detection of fraud.
3. Activities Relating to Internal Control:
(i) Evaluation of internal control: The internal audit function may be assigned
specific responsibility for reviewing controls, evaluating their operation and
recommending improvements thereto.
(ii) Examination of financial and operating information: The internal audit
function may be assigned to review the means used to identify, recognize,
measure, classify and report financial and operating information, and to make
specific inquiry into individual items, including detailed testing of transactions,
balances and procedures
: 40 :
(iii) Review of operating activities: The internal audit function may be assigned
to review the economy, efficiency and effectiveness of operating activities,
including nonfinancial activities of an entity.
(iv) Review of compliance with laws and regulations: The internal audit
function may be assigned to review compliance with laws, regulations and
other external requirements
Q.13. Short note- Standards on Internal audit issued by the ICAI

Considering the increasing importance of internal auditing, the Institute of Chartered
Accountants of India has constituted a Committee on Internal Audit (CIA) on February 5,
2004. The CIA was constituted with the object of formulating Standards and Guidance
Notes on Internal Audit now it is known as Internal Audit Standard Board.
The Board has, till date, issued eighteen Standards on Internal Audit (SIAs). The SIAs
aim to codify the best practices in the area of internal audit and also serve to provide a
benchmark of the performance of the internal audit services. While formulating SIAs, the
Board takes into consideration the applicable laws, customs, usages and business
environment and generally accepted auditing practices in India. SIAs are
recommendatory in nature.
Q14.Auditors’ Responsibility for Reporting on Internal Financial Controls over

Financial Reporting
Auditors are required to express an opinion on the effectiveness of an entity’s internal

controls over financial reporting, such opinion is in addition to and distinct from the
opinion expressed by the auditor on the financial statements.
Internal financial controls are the policies and procedures adopted by the company
for :
1. ensuring the orderly and efficient conduct of its business, including adherence to
company’s policies,
2. the safeguarding of its assets,
3. the prevention and detection of frauds and errors,
4. the accuracy and completeness of the accounting records, and
5. the timely preparation of reliable financial information.”
: 41 :
CHAPTER 5 AUDITOR’S RESPONSIBLITIES IN RELATION TO

FRAUD IN FINANCIAL STATEMENTS)
Sr.No List of Topics as per Module JKSC textbook

reference
1 Meaning of fraud Q1
2 Characteristics of fraud Q1, Q2 and Q3
3 Detection of fraud and error- Duty of auditor Q9
4 Fraud Risk factors and possibility of fraud Q4, Q5
5 Fraud Reporting Q6 and Q7
6 Auditor unable to continue the engagement Q8
Q.1. Explain Fraud in the context of auditing financial statements and characteristics
of fraud
The Standard on Auditing (SA) 240 “The Auditor’s Responsibilities Relating to Fraud in
an Audit of Financial Statements” defines the term ‘fraud’ as-
“an intentional act by one or more individuals among management, those charged with
governance, employees, or third parties, involving the use of deception to obtain an
unjust or illegal advantage”.
Although fraud is a broad legal concept, for the purposes of the SAs, the auditor is
concerned with fraud that causes a material misstatement in the financial
statements.
Two types of intentional misstatements are relevant to the auditor–
misstatements resulting from fraudulent financial reporting and
misstatements resulting from misappropriation of assets.
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, the
auditor does not make legal determinations of whether fraud has actually occurred.
Characteristics of fraud:
Misappropriation of assets:
It involves the theft of an entity’s assets and is often perpetrated by employees in
relatively small and immaterial amounts.
Misappropriation of assets can be accomplished in a variety of ways including:
Embezzling receipts
Stealing physical assets or intellectual property
Causing an entity to pay for goods and services not received
Using an entity’s assets for personal use
: 42 :
Q.2. Explain Management override of controls.
Fraudulent financial reporting often involves management override of controls
that otherwise may appear to be operating effectively. Fraud can be committed by
management overriding controls using such techniques as:
 Recording fictitious journal entries, particularly close to the end of an accounting
period, to manipulate operating results or achieve other objectives.
 Inappropriately adjusting assumptions and changing judgments used to estimate
account balances.
 Omitting, advancing or delaying recognition in the financial statements of events
and transactions that have occurred during the reporting period.
 Concealing, or not disclosing, facts that could affect the amounts recorded in the
 Engaging in complex transactions that are structured to misrepresent the financial
position or financial performance of the entity.
 Altering records and terms related to significant and unusual transactions.
Q.3. Explain misappropriation of goods and cash in detail.

Misappropriation of Goods
Fraud in the form of misappropriation of goods is more difficult to detect; for this
management has to rely on various measures. Apart from the various requirements of
record keeping about the physical quantities and their periodic checks, there must be
rules and procedures for allowing persons inside the area where goods are kept. In
addition there should be external security arrangements to see that no goods are taken
out without proper authority.
Defalcation of Cash
(a) By inflating cash payments:
Examples of inflation of payments:
(1) Making payments against fictitious vouchers.
(2) Making payments against vouchers, the amounts whereof have been
inflated.
(3) Manipulating totals of wage rolls either by including therein names of dummy
workers or by inflating them in any other manner.
(4) Casting a larger totals for petty cash expenditure and adjusting the excess in
the totals of the detailed columns so that cross totals show agreement.
(b) By suppressing cash receipts:
Few techniques of how receipts are suppressed are:
(1) Teeming and Lading: Amount received from a customer being
misappropriated; also to prevent its detection the money received from
another customer subsequently being credited to the account of the customer
who has paid earlier. Similarly, moneys received from the customer who has
paid thereafter being credited to the account of the second customer and
such a practice is continued so that no one account is outstanding for
payment for any length of time, which may lead the management to either
send out a statement of account to him or communicate with him.
(2) Adjusting unauthorised or fictitious rebates, allowances, discounts, etc. to
customer’ accounts and misappropriating amount paid by them.
(3) Writing off as debts in respect of such balances against which cash has
already been received but has been misappropriated.
: 43 :
Q.4. Explain Faud Risk Factors
Fraud Risk Factors may be defined as events or conditions that indicate an

incentive or pressure to commit fraud or provide an opportunity to commit fraud.
For each of these types of fraud, the risk factors are further classified based on the
three conditions generally present when material misstatements due to fraud occur:
(a) incentives/pressures,
(b) opportunities, and
(c) attitudes/rationalizations.
Incentives/Pressures:
1. Financial stability or profitability is threatened by economic, industry, or entity
operating conditions, such as (or as indicated by):
1. High degree of competition or market saturation, accompanied by declining
margins.
2. High vulnerability to rapid changes, such as changes in technology, product
obsolescence, or interest rates.
2. Personal financial obligations may create pressure on management or employees
with access to cash or other assets susceptible to theft to misappropriate those
assets. For example, adverse relationships may be created by the following:
1. Known or anticipated future employee layoff s.
2. Recent or anticipated changes to employee compensation or benefit plans.
3. Promotions, compensation, or other rewards inconsistent with expectations.
Opportunities:
1. The nature of the industry or the entity’s operations provides opportunities to
engage in fraudulent financial reporting that can arise from the following:
1. Significant related-party transactions not in the ordinary course of business or with
related entities not audited or audited by another firm.
2. A strong financial presence or ability to dominate a certain industry sector that
allows the entity to dictate terms or conditions to suppliers or customers that may
result in inappropriate or non-arm’s-length transactions.
2. Certain characteristics or circumstances may increase the susceptibility of assets
to misappropriation. For example, opportunities to misappropriate assets increase
when there are the following:
1. Large amounts of cash on hand or processed.
2. Inventory items that are small in size, of high value, or in high demand.
Attitudes/Rationalizations:
1. Communication, implementation, support, or enforcement of the entity’s values or
ethical standards by management, or the communication of inappropriate values
or ethical standards, that are not effective.
1. Known history of violations of securities laws or other laws and regulations.
2. Excessive interest by management in maintaining or increasing the entity’s
inventory price or earnings trend.
2. Disregard for the need for monitoring or reducing risks related to
misappropriations of assets.
1. 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.
2. Behaviour indicating displeasure or dissatisfaction with the entity or its treatment of
the employee.
: 44 :
Q.5. Mention the circumstances indicating possibility of fraud
(A) Discrepancies in the accounting records, including:

 Transactions that are not recorded in a complete or timely manner or are
improperly recorded as to amount, accounting period, classification, or entity
policy.
 Unsupported or unauthorized balances or transactions.
(B) Conflicting or missing evidence, including:
 Missing documents.
 Documents that appear to have been altered.
(C) Problematic or unusual relationships between the auditor and management,
including:
 Denial of access to records, facilities, certain employees, customers,
vendors, or others from whom audit evidence might be sought.
 Undue time pressures imposed by management to resolve complex or
contentious issues.
 Unusual delays by the entity in providing requested information
(D) Other
 Unwillingness by management to permit the auditor to meet privately with
those charged with governance.
 Accounting policies that appear to be at variance with industry norms.
Q.6. Explain fraud reporting to Central Government u/s 143 (12) of Companies Act,
2013
Reporting to the Central Government: As per sub-section (12) of section 143 of the
Companies Act, 2013, if an auditor of a company in the course of the performance of his
duties as auditor, has reason to believe that an offence of fraud involving such amount
or amounts as may be prescribed (which involves or is expected to involve individually
an amount of ` 1 crore or above), is being or has been committed in the company by its
officers or employees, the auditor shall report the matter to the Central Government
within such time (60 days of forming reasons to believe) and in such manner (Form
ADT-4 addressed to Secretary, MCA.) as may be prescribed.
: 45 :
It is very important to note that these provisions shall also apply, mutatis mutandis,
to a cost auditor and a secretarial auditor during the performance of his duties under
section 148 and section 204 respectively
: 46 :
Q.7. Mention the audit procedures to be adopted under CARO 2016 for fraud reporting
Reporting under Companies (Auditor’s Report) Order, 2016 [CARO, 2016]: The
auditor is also required to report under clause (x) of paragraph 3 of Companies
(Auditor’s Report) Order, 2016, whether any fraud by the company or any fraud on the
Company by its officers or employees has been noticed or reported during the year. If
yes, the nature and the amount involved is to be indicated.
Audit Procedures and Reporting under CARO:
(1) While planning the audit, the auditor should make inquiries of management to
determine whether management is aware of any known fraud or suspected fraud
that the company is investigating.
(2) The auditor should examine the reports of the internal auditor with a view to
ascertain whether any fraud has been reported or noticed by the management.
(3) The auditor should examine the minutes of the audit committee, if available, to
ascertain whether any instance of fraud pertaining to the company has been
reported and actions taken thereon.
(4) The auditor should obtain written representations from management that:
(i) it acknowledges its responsibility for the implementation and operation of
accounting and internal control systems that are designed to prevent and
detect fraud and error;
(ii) it has
(a) disclosed to the auditor all significant facts relating to any frauds or
suspected frauds known to management that may have affected the
entity; and
(b) it has disclosed to the auditor the results of its assessment of the risk
that the financial statements may be materially misstated as a result of
fraud.
Q.8. Mention auditor’s responsibilities when he is unable to continue the engagement.

If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor
encounters exceptional circumstances that bring into question the auditor’s ability to
continue performing the audit, the auditor shall:
(a) Determine the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to report to
the person or persons who made the audit appointment or, in some cases, to
regulatory authorities;
(b) Consider whether it is appropriate to withdraw from the engagement, where
withdrawal is possible under applicable law or regulation; and
(c) If the auditor withdraws:
(i) Discuss with the appropriate level of management and those charged with
governance the auditor’s withdrawal from the engagement and the reasons for
the withdrawal; and
(ii) Determine whether there is a professional or legal requirement to report to the
person or persons who made the audit appointment or, in some cases, to
regulatory authorities, the auditor’s withdrawal from the engagement and the
reasons for the withdrawal.
: 47 :
Q.9. Mention auditor’s Responsibilities for prevention and detection of fraud and
error.
As per SA 240, the primary responsibility for the prevention and detection of fraud rests
with both those charged with governance of the entity and management.
An auditor conducting an audit in accordance with SAs is responsible for obtaining
reasonable assurance that the financial statements taken as a whole are free from
material misstatement, whether caused by fraud or error.
Owing to the inherent limitations of an audit, there is an unavoidable risk that some
material misstatements of the financial statements will not be detected, even though the
audit is properly planned and performed in accordance with the SAs.
The risk of not detecting a material misstatement resulting from fraud is higher than the
risk of not detecting one resulting from error.
The question of whether the auditor has adhered to the basic principles governing an
audit (such as performance of the audit work with requisite skills and competence,
documentation of important matters, details of the audit plan and reliance placed on
internal controls, nature and extent of compliance and substantive tests carried out,
etc.) is determined by the adequacy of the procedures undertaken in the circumstances
and the suitability of the auditor’s report based on the results of these procedures.
The liability of the auditor for failure to detect fraud exists only when such failure is
clearly due to not exercising reasonable care and skill. Thus, in the instant case after
the completion of the statutory audit, if a fraud has been detected, the same by itself
cannot mean that the auditor did not perform his duty properly.
If the auditor can prove with the help of his papers (documentation) that he has followed
adequate procedures necessary for the proper conduct of an audit, he cannot be held
responsible for the same. If however, the same cannot be proved, he would be held
responsible.
: 48 :
J.K.SHAH CLASSES INTER C.A. - AUDIT
AUDIT IN AN AUTOMATED
CHAPTER - 6
ENVIRONMENT
List of Topics as per Module Reference

Relevance of IT in an audit Q1
Understanding the automated environment Q2
Risks involved in IT environment Q3
Impact of IT risk on audit procedures and reporting Q4
Types of controls in an automated environment Q5
Testing methods under automated environment Q6
Data analytics for audit Q7
Reporting Considerations Q8
Q.1. Explain Relevance of Information Technology for audit

When a business operates in a more automated environment it is likely that we
will see several business functions and activities happening within the systems.
Consider the following aspects instead of:
Computation and Calculations are automatically carried out (for example,
bank interest computation and inventory valuation).
Accounting entries are posted automatically (for example, sub-ledger to
GL postings are automatic).
Business policies and procedures, including internal controls, are applied
automatically (for example, delegation of authority for journal approvals,
customer credit limit checks are performed automatically).
Reports used in business are produced from systems. Management and
other stakeholders rely on these reports and information produced (for
example, debtors ageing report).
User access and security are controlled by assigning system roles to
users (for example, segregation of duties can be enforced eff ectively).
Q.2. Factors to be considered while understanding the automated

environment.
Given below are some of the points that an auditor should consider to obtain an
understanding of the company’s automated environment:-Information systems
being used (one or more application systems and what they are).
- Their purpose (financial and non-financial).
- Location of IT systems - local vs global.
- Architecture (desktop based, client-server, web application, cloud based).
- Version (functions and risks could vary in different versions of same
application).
- Interfaces within systems (in case multiple systems exist).
- In-house vs Packaged.
- Outsourced activities (IT maintenance and support).
- Key persons (CIO, CISO, Administrators).
The understanding of a company’s IT environment that is obtained should be
documented [Ref. SA 230 – Audit Documentation] using any standard format or
template.
: 49 :
Q. 3. Mention the risks involved in IT environment
Refer chapter 4 notes.
Q. 4. Mention the change in audit procedures and reporting due to IT risks

The risks involved in IT environment, could have an impact on audit in different
ways as mentioned below:
First, we may not be able to rely on the data obtained from systems where such
risks exist. This means, all forms of data, information or reports that we obtain
from systems for the purpose of audit has to be thoroughly tested and
corroborated for completeness and accuracy.
- Second, we will not be able to rely on automated controls, calculations,
accounting procedures that are built into the applications. Additional audit
work may be required in this case.
- Third, due to the regulatory requirement of auditors to report on internal
financial controls of a company, the audit report also may have to be
modified in some instances.
In all the above scenarios, it is likely that the auditor will be required to obtain
more audit evidence and perform additional audit work. The auditor should also
be able to demonstrate how the risks were identified and what audit evidence
was obtained and validated to address these IT risks
Q. 5. Explain the types of controls under Computerised Environment

General IT Controls: “General IT controls are policies and procedures that
relate to many applications and support the effective functioning of application
controls. It commonly include controls over the following:
- Data center and network operations: To ensure that production systems
are processed to meet financial reporting objectives.
- Program change: To ensure that modified systems continue to meet
financial reporting objectives.
- Access security: To ensure that access to programs and data is
authenticated and authorized to meet financial reporting objectives.
- Application system acquisition, development, and maintenance (Business
Applications): To ensure that systems are developed, configured and
implemented to meet financial reporting objectives.
- Application Controls: Application controls include both automated &
manual controls that operate at a business process level. Examples of
automated applications include edit checks and validation of input data,
sequence number checks, user limit checks, reasonableness checks,
mandatory data fields.
- IT-Dependent Controls
IT dependent controls are basically manual controls that make use of some
form of data or information or report produced from IT systems and
applications. In this case, even though the control is performed manually, the
design and effectiveness of such controls depends on the reliability of source
data. Example: Performing reconciliations based upon computer generated
data.
: 50 :
Q. 6. Mention the procedure for performing tests under IT environments
There are basically four types of audit tests that should be used. They are
inquiry, observation, inspection and reperformance. Inquiry is the most
efficient audit test but it is also gives the least audit evidence. Hence,
inquiry should always be used in combination with any one of the other audit
testing methods. Inquiry alone is not sufficient. Reperformance is most
effective as an audit test and gives the best audit evidence. However,
testing by reperformance could be very time consuming and least efficient
most of the time. Generally, applying inquiry in combination with
inspection gives the most effective and efficient audit evidence.
However, which audit test to use, when and in what combination is a matter
of professional judgement and will vary depending on several factors
including risk assessment, control environment, desired level of evidence
required, history of errors etc.
Some of the more common methods are as follows:
- Obtain an understanding of how an automated transaction is processed
by doing a walkthrough of one end-to-end transaction using a combination
of inquiry, observation and inspection.
- Observe how a user processes transactions under different scenarios.
- Inspect the configuration defined in an application.
- Inspect the system logs to determine any changes made since last audit
testing.
- Carry out a test check (negative testing) and observe the error message
displayed by the application. Conduct reperformance using raw source
data and independently applying formulae, business rules or validations
on the source data
Q. 7.Explain the importance of Data analytics for audit and how it can be
helpful
The combination of processes, tools and techniques that are used to tap vast
amounts of electronic data to obtain meaningful information is called data
analytics. The tools and techniques that auditors use in applying the principles
of data analytics are known as Computer Assisted Auditing Techniques or
CAATs in short.
Data analytics can be used in testing of electronic records and data
residing in IT systems using specialised audit tools viz., IDEA and ACL to
perform the following:
- Check completeness of data and population that is used in either test of
controls or substantive audit tests.
- Selection of audit samples – random sampling, systematic sampling.
- Re-computation of balances – reconstruction of trial balance from
transaction data.
- Reperformance of mathematical calculations – depreciation, bank interest
calculation.
- Analysis of journal entries as required by SA 240.
- Fraud investigation.
- Evaluating impact of control deficiencies.
: 51 :
Q. 8 Discuss reporting considerations with regards to IT environment.
At the conclusion of each audit, it is possible that there will be certain findings
or exceptions in IT environment and IT controls of the company that need to be
assessed and reported to relevant stakeholders including management and
those charged with governance viz., Board of directors, Audit committee etc.
Some points to consider are as follows:
- Are there any weaknesses in IT controls?
- What is the impact of these weaknesses on overall audit?
- Report deficiencies to management – Internal Controls Memo or
Management Letter.
- Communicate in writing any significant deficiencies to Those Charged
With Governance.
The auditor needs to assess each finding or exception to determine impact on
the audit and evaluate if the exception results in a deficiency in internal control
: 52 :
CHAPTER 7 AUDIT SAMPLING

reference
1 Sampling: An Audit Procedure Q1
2 Meaning of audit sampling Q2
3 Approaches to Sampling Q3
4 Sample design and selection of items for testing Q4, Q5, Q6, Q7, Q8
5 Performing Audit Procedures Q9
6 Nature and cause of deviations and Q9
misstatements
7 Projecting Misstatements Q9
8 Evaluating Results of Audit Sampling Q9
Q.1. Is auditor justified in sampling technique? What is the need of sampling
procedure in auditing financial statements?
The extent of the checking to be undertaken is primarily a matter of judgment of the
auditor, there is nothing statutorily stated anywhere which specifies what work is to be
done, how it is to be done and to what extent. It is also not obligatory that the auditor
must adopt the sampling technique. What he is to do is to express his opinion and
become bound by that.
With the shift in favour of formal internal controls in the management of affairs of
organisations, the possibilities of routine errors and frauds have greatly diminished and
auditors often find extensive routine checking as nothing more than a ritual because it
seldom reveals anything material.
To ensure good and reasonable standard of work, he should adopt standards and
techniques that can lead him to an informed professional opinion. On a consideration of
this fact, it can be said that it is in the interest of the auditor that if he decides to form his
opinion on the basis of a part checking, he should adopt standards and techniques
which are widely followed and which have a recognised basis. Since statistical theory of
sampling is based on a scientific law, it can be relied upon to a greater extent than any
arbitrary technique which lacks in basis and acceptability.
Q.2. Define Audit Sampling. Mention the characteristics of the population.

According to SA 530 “Audit sampling”, ‘audit sampling’ refers to 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.
Population
Population refers to the entire set of data from which a sample is selected and about
which the auditor wishes to draw conclusions.
The auditor should select sample items in such a way that the sample can be expected
to be representative of the population.
Characteristics of Population
1. Appropriateness : The auditor will need to determine that the population from
which the sample is drawn is appropriate for the specific audit objective.
2. Completeness : The population also needs to be complete, the population needs
to include all relevant items from throughout the entire period.
3. Reliable : When performing the audit sampling, the auditor performs audit
procedures to ensure that the information upon which the audit sampling is
performed is sufficiently complete and accurate.
: 53 :
Q.3. Explain the approaches to sampling
Audit sampling can be applied using either non-statistical or statistical sampling
approaches.
Statistical sampling is an approach to sampling that has the random selection of the
sample items; and the use of probability theory to evaluate sample results, including
measurement of sampling risk characteristics. A sampling approach that does not have
above characteristics is considered non-statistical sampling.
The decision whether to use a statistical or non-statistical sampling approach is a matter
for the auditor’s judgment; however, sample size is not a valid criterion to distinguish
between statistical and non-statistical approaches.
Whatever may be the approach non-statistical or statistical sampling, the sample
must be representative. This means that it must be closely similar to the whole
population although not necessarily exactly the same. The sample must be large
enough to provide statistically meaningful results.
Audit testing done through statistical approach 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.
The non-statistical sampling is criticized on the grounds that it is neither objective nor
scientific. The expected degree of objectivity cannot be assured in non-statistical
sampling because the risk of personal bias in selection of sample items cannot be
eliminated.
The advantages of statistical sampling may be summarized as follows -
(1) The amount of testing (sample size) does not increase in proportion to the
increase in the size of the area (universe) tested.
(2) The sample selection is more objective and thereby more defensible.
(3) The method provides a means of estimating the minimum sample size associated
with a specified risk and precision.
(4) It provides a means for deriving a “calculated risk” and corresponding precision
(sampling error) i.e. the probable difference in result due to the use of a sample in
lieu of examining all the records in the group (universe), using the same audit
procedures.
Under some audit circumstances, statistical sampling methods may not be appropriate.
The auditor should not attempt to use statistical sampling when another approach is
either necessary or will provide satisfactory information in less time or with less effort,
for instance when exact accuracy is required or in case of legal requirements etc.
The decision whether to use a statistical or non-statistical sampling approach is a matter
for the auditor’s judgment
Q.4. Explain the methods of sampling.

Sampling Methods:
(1) Random Sampling: Random selection ensures that all items in the population or
within each stratum have a known chance of selection. It may involve use of
randomnumber tables. Random sampling includes two very popular methods
which are discussed below–
(i) Simple Random Sampling: Under this method each unit of the whole
population e.g. purchase or sales invoice has an equal chance of being
selected. The mechanics of selection of items may be by choosing numbers
from table of random numbers by computers or picking up numbers randomly
from a drum. It is considered that random number tables are simple and easy
to use and also provide assurance that the bias does not aff ect the selection.
This method is considered appropriate provided the population to be sampled
consists of reasonably similar units and fall within a reasonable range.
: 54 :
(ii) Stratified Sampling: This method involves dividing the whole population to
be tested in a few separate groups called strata and taking a sample from
each of them. Each stratum is treated as if it was a separate population and if
proportionate of items are selected from each of these stratum. The number
of groups into which the whole population has to be divided is determined on
the basis of auditor judgment.
(2) Interval Sampling or Systematic Sampling: Systematic selection is a selection
method in which the number of sampling units in the population is divided by the
sample size to give a sampling interval, for example 50, and having determined a
starting point within the fi rst 50, each 50th sampling unit thereafter is selected.
When using systematic selection, the auditor would need to determine that
sampling units within the population are not structured in such a way that the
sampling interval corresponds with a particular pattern in the population.
(3) Monetary Unit Sampling: It is a type of value-weighted selection in which sample
size, selection and evaluation results in a conclusion in monetary amounts.
(4) Haphazard sampling: Haphazard selection, in which the auditor selects the
sample without following a structured technique. Although no structured technique
is used, the auditor would nonetheless avoid any conscious bias or predictability
(for example, always choosing or avoiding the first or last entries on a page)
and thus attempt to ensure that all items in the population have a chance of
selection. Haphazard selection is not appropriate when using statistical sampling.
(5) Block Sampling: This method involves selection of a block(s) of contiguous items
from within the population. Block selection cannot ordinarily be used in audit
sampling because most populations are structured such that items in a sequence
can be expected to have similar characteristics to each other, but different
characteristics from items elsewhere in the population.
Q.5. Explain Tolerable rate of deviation and tolerable misstatement.

Tolerable misstatement – A monetary amount set by the auditor in respect of which the
auditor seeks to obtain an appropriate level of assurance that the monetary amount set
by the auditor is not exceeded by the actual misstatement in the population.
Tolerable rate of deviation – A rate of deviation from prescribed internal control
procedures set by the auditor in respect of which the auditor seeks to obtain an
appropriate level of assurance that the rate of deviation set by the auditor is not
exceeded by the actual rate of deviation in the population.
The higher the auditor’s assessment of the risk of material misstatement, the larger the
sample size needs to be.
An increase in tolerable misstatement will decrease the sample size as lower the
tolerable misstatement, the larger the sample size needs to be.
The greater the amount of misstatement the auditor expects to find in the population,
the larger the sample size needs to be in order to make a reasonable estimate of the
actual amount of misstatement in the population.
Q.6. Mention the principles of sample design, size and selection of items for testing.
The factors that should be considered for deciding upon the extent of checking on a
sampling plan are following:
(i) Size of the organisation under audit.
(ii) State of the internal control.
(iii) Adequacy and reliability of books and records.
(iv) Tolerable error range.
(v) Degree of the desired confidence.
: 55 :
When designing an audit sample, the auditor shall
1. Consider the purpose of the audit procedures and the characteristics of the
population from which the sample will be drawn.
2. Determine a sample size sufficient to reduce sampling risk to an acceptably low
level.
3. Select items for the sample in such a way that each sampling unit in the population
has a chance of selection.
4. Consider nature of the audit evidence sought
5. Define what constitutes a deviation or misstatement and what population to use
for sampling
6. Determine which sampling method will be appropriate
7. Set the tolerable range of error
Q.7. Explain Sampling Risk

Sampling Risk: 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.
Q.8. Explain non sampling Risk

Non-Sampling Risk. The risk that the auditor reaches an erroneous conclusion for any
reason not related to sampling risk.
Examples of non-sampling risk include use of inappropriate audit procedures, or
misinterpretation of audit evidence and failure to recognize a misstatement or deviation.
Q.9. Explain the process of evaluating sampling result after performing the audit
procedures.
The auditor shall perform audit procedures, appropriate to the purpose, on each item
selected.
In analysing the deviations and misstatements identified, the auditor may observe that
many have a common feature, for example, type of transaction, location, product line or
period of time. In such circumstances, the auditor may decide to identify all items in the
population that possess the common feature, and extend audit procedures to those
: 56 :
items. In addition, such deviations or misstatements may be intentional, and may
indicate the possibility of fraud.
The auditor shall evaluate-
(a) The results of the sample; and
(b) Whether the use of audit sampling has provided a reasonable basis for
conclusions about the population that has been tested.
The auditor shall investigate the nature and causes of any deviations or misstatements
identified, and evaluate their possible effect on the purpose of the audit procedure and
on other areas of the audit. In the extremely rare circumstances when the auditor
considers a misstatement or deviation discovered in a sample to be an anomaly, the
auditor shall obtain a high degree of certainty that such misstatement or deviation is not
representative of the population. The auditor shall obtain this degree of certainty by
performing additional audit procedures to obtain sufficient appropriate audit evidence
that the misstatement or deviation does not affect the remainder of the population.
In case the auditor concludes that audit sampling has not provided a reasonable basis
for conclusions about the population that has been tested, the auditor should tailor the
nature, timing and extent of those further audit procedures to best achieve the required
assurance. For example, in the case of tests of controls, the auditor might extend the
sample size, test an alternative control or modify related substantive procedures.
: 57 :
CHAPTER 8 ANALYTICAL PROCEDURES

reference
1 Meaning of Analytical Procedures Q1
2 Purpose and timing of analytical procedures Q1
3 Substantive Analytical Procedures Q3 Q4 Q5
4 Suitability of Particular Analytical Procedures for
given assertions
5 Extent of Reliance on Analytical Procedures Q2
6 Risk of Material Misstatements Q3
7 Investigating Results of Analytical Procedures Q6
8 Analytical Procedures that assist when forming Q6
an overall conclusion
9 Considerations specific to Public sector entities Note at the end
: 58 :
Q.1. What do you understand by analytical procedures?
Since routine checks cannot be depended upon to disclose all the mistakes or
manipulation that may exist in accounts, certain other procedures also have to be
applied like trend and ratio analysis in addition to reasonable tests.
SA-520 on Analytical Procedures discusses the application of analytical procedures
during an audit.
As per the Standard on Auditing (SA) 520 “Analytical Procedures”, the term “analytical
procedures” means evaluations of financial information through analysis of plausible
relationships among both financial and non-financial data.
Thus, analytical procedures include the consideration of comparisons of the entity’s
financial information with as well as consideration of relationships.
Examples of Analytical Procedures having consideration of comparisons of the
entity’s financial information with are:
- Comparable information for prior periods.
- Anticipated results of the entity, such as budgets or forecasts, or expectations of
the auditor, such as an estimation of depreciation.
Examples of Analytical procedures having consideration of relationships are:
Among elements of financial information that would be expected to conform to a
predictable pattern based on the entity’s experience, such as gross margin
percentages.
Between financial information and relevant non-financial information, such as
payroll costs to number of employees.
: 59 :
Q.2. Mention the Extent of Reliance on Analytical Procedures
The reliability of data is influenced by its source and nature and is dependent on the
circumstances under which it is obtained. Accordingly, the following are relevant when
determining whether data is reliable for purposes of designing substantive analytical
procedures:
(i) Source of the information available. For example, information may be more
reliable when it is obtained from independent sources outside the entity;
(ii) Comparability of the information available.
(iii) Nature and relevance of the information available. For example, whether budgets
have been established as results to be expected rather than as goals to be
achieved; and
(iv) Controls over the preparation of the information that are designed to ensure its
completeness, accuracy and validity. For example, controls over the preparation,
review and maintenance of budgets.
The auditor may consider testing the operating effectiveness of controls, if any, over the
entity’s preparation of information used by the auditor in performing substantive
analytical procedures
Q.3. Mention the general principles of performing analytical procedures

When designing and performing substantive analytical procedures, either alone or in
combination with tests of details, as substantive procedures in accordance with SA 330,
the auditor shall:
(i) Determine the suitability of particular substantive analytical procedures for given
assertions, taking account of the assessed risks of material misstatement and
tests of details, if any, for these assertions;
(ii) Evaluate the reliability of data from which the auditor’s expectation of recorded
amounts or ratios is developed, taking account of source, comparability, and
nature and relevance of information available, and controls over preparation;
(iii) Develop an expectation of recorded amounts or ratios and evaluate whether the
expectation is sufficiently precise to identify a misstatement that, individually or
when aggregated with other misstatements, may cause the financial statements to
be materially misstated; and
(iv) Determine the amount of any difference of recorded amounts from expected
values that is acceptable without further investigation.
The suitability of a particular analytical procedure will depend upon the auditor’s
assessment of how effective it will be in detecting a misstatement.
Q.4. Factors to be considered for performing substantive analytical procedures.

The auditor should consider the following factors for Substantive Audit Procedures:
Availability of Data – The availability of reliable and relevant data will facilitate effective
procedures.
Disaggregation – The degree of disaggregation in available data can directly affect the
degree of its usefulness in detecting misstatements.
: 60 :
Predictability – Substantive analytical procedures are more appropriate when an
account balance or relationships between items of data are predictable (e.g., between
sales and cost of sales or between trade receivables and cash receipts). A predictable
relationship is one that may reasonably be expected to exist and continue over time.
Nature of Assertion – Substantive analytical procedures may be more effective in
providing evidence for some assertions (e.g., completeness or valuation) than for others
(e.g., rights and obligations). Predictive analytical procedures using data analytics can
be used to address completeness, valuation/measurement and occurrence.
Inherent Risk or “What Can Go Wrong” – When we are designing audit procedures
to address an inherent risk or “what can go wrong”, we consider the nature of the risk of
material misstatement in order to determine if a substantive analytical procedure can be
used to obtain audit evidence.
Q.5. Mention the techniques available as substantive analytical procedures.

Trend analysis – A commonly used technique is the comparison of current data with
the prior period balance or with a trend in two or more prior period balances. We
evaluate whether the current balance of an account moves in line with the trend
established with previous balances for that account, or based on an understanding of
factors that may cause the account to change.
Ratio analysis – Ratio analysis is useful for analysing asset and liability accounts as
well as revenue and expense accounts. An individual balance sheet account is difficult
to predict on its own, but its relationship to another account is often more predictable
(e.g., the trade receivables balance related to sales). Ratios can also be compared over
time or to the ratios of separate entities within the group, or with the ratios of other
companies in the same industry.
Reasonableness tests – Unlike trend analysis, this analytical procedure does not rely
on events of prior periods, but upon non-financial data for the audit period under
consideration (e.g., occupancy rates to estimate rental income or interest rates to
estimate interest income or expense). These tests are generally more applicable to
income statement accounts and certain accrual or prepayment accounts.
Structural modelling – A modelling tool constructs a statistical model from financial
and/or non-financial data of prior accounting periods to predict current account balances
(e.g., linear regression).
Q.6. Short note- Investigating results of analytical procedures.

If analytical procedures performed in accordance with SA 520 identify fluctuations or
relationships that are inconsistent with other relevant information or that differ from
expected values by a significant amount, the auditor shall investigate such differences
by:
(i) Inquiring of management and obtaining appropriate audit evidence relevant
to management’s responses: Audit evidence relevant to management’s
responses may be obtained by evaluating those responses taking into account the
auditor’s understanding of the entity and its environment, and with other audit
evidence obtained during the course of the audit.
(ii) Performing other audit procedures as necessary in the circumstances:
The need to perform other audit procedures may arise when, for example,
management is unable to provide an explanation, or the explanation, together with
the audit evidence obtained relevant to management’s response, is not considered
adequate
: 61 :
CONSIDERATIONS SPECIFIC TO PUBLIC SECTOR ENTITIES
The relationships between individual financial statements items traditionally considered in the
audit of business entities may not always be relevant in the audit of governments or other
non-business public sector entities; for example, in many public sector entities there may be
little direct relationship between revenue and expenditure.
In addition, because expenditure on the acquisition of assets may not be capitalized, there
may be no relationship between expenditures on, for example, inventories and fixed assets
and the amount of those assets reported in the financial statements.
Also, industry data or statistics for comparative purposes may not be available in the public
sector. However, other relationships may be relevant, for example, variations in the cost per
kilometer of road construction or the number of vehicles acquired compared with vehicles
retired.
: 62 :
CHAPTER 9 AUDITOF ITEMS OF FINANCIAL STATEMENTS
1) Vouching:
The act of examining vouchers is referred to as vouching. It is the practice followed in
an audit with the objective of establishing the authenticity of the transactions recorded in
the primary books of account. It essentially consists of verifying a transaction recorded
in the books of account with the relevant documentary evidence and the authority on the
basis of which the entry has been made; also confirming that the amount mentioned in
the voucher has been posted to an appropriate account which would disclose the nature
of the transaction on its inclusion in the final statements of account. On these
considerations, the essential points to be borne in mind while examining a voucher are:
(i) that the date of the voucher falls within the accounting period;
(ii) that the voucher is made out in the client’s name;
(iii) that the voucher is duly authorised;
(iv) that the voucher comprised all the relevant documents which could be expected
to have been received or brought into existence on the transactions having been
entered into,
i.e., the voucher is complete in all respects; and
(v) that the account in which the amount of the voucher is adjusted is the one that
would clearly disclose the character of the receipts or payments posted thereto on
its inclusion in the final accounts.
After the examination is over, each voucher should be either impressed with a rubber
stamp or initialed so that it may not be presented again in support of another entry.
2) Verification
The act of examining/establishing the existence and valuation of Assets and Liabilities
may be referred to as Verification. While verifying the assets and liabilities of an entity,
an auditor is required to have knowledge of applicable Accounting Standards, for e.g.,
AS 10 on Fixed Assets, AS 26 on Intangible Assets, etc. The auditor is further required
to check the presentation of various items in the Balance Sheet and Statement of Profit
and Loss, for e.g., as per Schedule III to the Companies Act, 2013 in the case of a
company.
Verification is a process to verify the ownership, valuation, possession and

existence of a particular Asset or liability.
Verification establishes the correspondence of actual facts or details with those
represented in accounts.
Verification relates to the assets and liabilities appearing in the balance sheet.
Verification is generally carried out at the end of year.
To confirms the existence, ownership, possession, completeness, valuation and
disclosure of items relating to balance sheet.
Verification is based on observation as well as documentary examination.
Verification requires experienced people and done by the senior staff.
Verification includes valuation
: 63 :
3) Verification of Asset
Verification of assets is an important audit process: by convention its scope has been
limited to inspection of assets, where it is practicable, and collection of information
about them on an examination of documentary and other evidence so as to confirm:
(a) that the assets were in existence on the date of the balance sheet;
(b) that the assets had been acquired for the purpose of the business and under a
proper authority;
(c) that the right of ownership of the assets vested in or belonged to the undertaking;
(d) that they were free from any lien or charge not disclosed in the balance sheet;
(e) that they had been correctly valued having regard to their physical condition; and
(f) that their values are correctly disclosed in the balance sheet.
Verification of assets is primarily the responsibility of the management
4) Verification of Liability
Verification of liabilities may be carried out by employing the following procedures-
(i) examination of records;
(ii) direct confirmation procedure;
(iii) examination of disclosure;
(iv) analytical review procedures,
(v) obtaining management representations.
The nature, timing and extent of substantive procedures to be performed is, however, a
matter of professional judgement of the auditor which is based, inter alia, on the
auditor’s evaluation of the effectiveness of the related internal controls
Audit the following items:

1. Goods sent out on Sale or Return Basis.
(i) Check whether a separate memoranda record of goods sent out on sale or return
basis is maintained. The party accounts are debited only after the goods have
been sold and the sales account is credited.
(ii) See that price of such goods is unloaded from the sales account and the trade
receivable’s record. Refer to the memoranda record to confirm that on the receipt
of acceptance from each party, his account has been debited and the sales
account correspondingly credited.
(iii) Ensure that the goods in respect of which the period of approval has expired at the
close of the year either have been received back subsequently or customers’
accounts have been debited.
(iv) Confirm that the inventory of goods sent out on approval, the period of approval in
respect of which had not expired till the close of the year lying with the party, has
been included in the closing inventory.
: 64 :
2. Borrowing from Banks:
(i) Reconcile the balances in the overdraft or loan account with that shown in the
pass book(s) and confirm the last mentioned balance by obtaining a certificate
from the bank showing the balance in the accounts as at the end of the year.
(ii) Obtain a certificate from the bank showing particulars of securities deposited with
the bank as security for the loans or of the charge created on an asset or assets of
the concern and confirm that the same has been correctly disclosed and duly
registered with Registrar of Companies and recorded in the Register of charges.
(iii) Verify the authority under which the loan or draft has been raised. In the case of a
company, only the Board of Directors is authorised to raise a loan or borrow from a
bank.
(iv) Confirm, in the case of a company, that the restraint contained in Section 180 of
the Companies Act, 2013 as regards the maximum amount of loan that the
company can raise has not been contravened.
(v) Ascertain the purpose for which loan has been raised and the manner in which it
has been utilised and that this has not prejudicially affected the entity.
3. Goods Sent on Consignment:

(i) Verify the accounts sales submitted by the consignee showing goods sold and
inventory of goods in hand.
(ii) Reconcile the figure of the goods on hand, as given in the last accounts sales, with
the Performa invoices and accounts sales received during the year.
(iii) Obtain confirmation from the consignee for the goods held on consignment on the
balance sheet date.
(iv) Ensure that the quantity of goods in hand with the consignee has been valued at
cost plus proportionate non-recurring expenses, e.g., freight, dock dues, customs
due, etc., unless the value is lower. In case net realisable value is lower, the
inventory in hand of the consignee should be valued at net realisable value. Also
see that the allowance has been made for damaged and obsolete goods in making
the valuation.
(v) See that goods in hand with the consignee have been shown distinctly under
inventories.
4. Foreign Travel Expenses:

(i) Examine Travelling Allowance bills submitted by the employees stating the details
of tour, details of expenses, etc.
(ii) Verify that the tour programme was properly authorised by the competent
authority.
(iii) Check the T.A. bills along with accompanying supporting documents such as air
tickets, travel agents bill and hotel bills with reference to the internal rules for
entitlement of the employees and also make sure that the bills are properly
passed.
(iv) See that the tour report accompanies the T.A. bill. The tour report will show the
purpose of the tour. Satisfy that the purpose of the tour as shown by the tour
report conforms to the authorisation for the tour.
(v) Check Reserve Bank of India’s permission, if necessary, for withdrawing the
foreign exchange. For a company, the amount of foreign exchange spent is to be
disclosed separately in the accounts as per requirement of Schedule III to the
Companies Act, 2013 and Accounting Standard 11 “The Effects of Changes in
Foreign Exchange Rates”.
: 65 :
5. Provision for Income Tax:
(i) Obtain the computation of income prepared by the auditee and verify whether it is
as per the Income-tax Act, 1961 and Rules made thereunder.
(ii) Review adjustments, expenses, disallowed special rebates, etc. with particular
reference to the last available completed assessment.
(iii) Examine relevant records and documents pertaining to advance tax, self
assessment tax and other demands.
(iv) Compute tax payable as per the latest applicable rates in the Finance Act.
(v) Ensure that overall provisions on the date of the balance sheet is adequate having
regard to current year provision, advance tax paid, assessment orders, etc.
(vi) Ensure that the requirements of AS 22 on Accounting for Taxes on Income have
been appropriately followed for the period under audit.
6. Deferred Revenue Expenditure:

While verifying deferred revenue expenditure, the auditor may satisfy himself that:
(i) it is proper to defer the expenditure;
(ii) the period of amortisation of the expenditure is reasonable;
(iii) the expenditure shown to have been incurred during the year actually occurred
during the year and there is proper authority for the expenditure and for its
deferral;
(iv) the criteria which previously justified the deferral of the expenditure continue to be
met and the expected future revenue / other benefits related to the expenditure
continue to exceed the amount of unamortized expenditure.
(v) the necessary principles laid down under AS 26 “Intangible Assets” have been
examined, to ensure whether such kind of deferment is allowed to be made or not.
7. Goodwill:
(i) Ensure that goodwill has been recorded in the books only when some
consideration in money or money's worth has been paid for. Goodwill arises from
business connections, trade name or reputation of an enterprise or from other
intangible benefits enjoyed by an enterprise.
(ii) Check the vendor's agreement on the basis of which assets of the running
business have been acquired by the company at a price existing in the book value
of the assets or where a specific sum has been paid for the goodwill.
(iii) See that only the amount paid to the vendors not represented by tangible assets
has been debited to the goodwill account. Therefore, it is not prudent that goodwill
should be shown in the company's accounts by way of writing up the value of its
assets on revaluation or writing back the amount of goodwill earlier written off by
the company.
(iv) See whether goodwill has been written off as a matter of financial prudence as per
the principles enunciated under AS 26 on Intangible Assets.
8. Sale Proceeds of Scrap Material:

(i) Review the internal control on scrap materials, as regards its generation, storage
and disposal and see whether it was properly followed at every stage.
(ii) Ascertain whether the organisation is maintaining reasonable records for the sale
and disposal of scrap materials.
(iii) Review the production and cost records for determination of the extent of scrap
materials that may arise in a given period.
: 66 :
(iv) Compare the income from the sale of scrap materials with the corresponding
figures of the preceding three years.
(v) Check the rates at which different types of scrap materials have been sold and
compare the same with the rates that prevailed in the preceding year.
(vi) See that scrap materials sold have been billed and check the calculations on the
invoices.
9. Trade Marks and Copyrights:

(i) Obtain schedule of Trade Marks and Copyrights duly signed by the responsible
officer and scrutinise the same and confirm that all of them are shown in the
Balance Sheet.
(ii) Examine the written agreement in case of assignment of Copyrights and
Assignment Deed in case of transfer of trade marks. Also ensure that trade marks
and copyrights have been duly registered.
(iii) Verify existence of copyright by reference to contract between the author & the
entity and note down the terms of payment of royalty.
(iv) See that the value has been determined properly and the costs incurred for the
purpose of obtaining the trade marks and copyrights have been capitalised.
(v) Ascertain that the legal life of the trade marks and copyrights have not expired.
(vi) Ensure that amount paid for both the intangible assets is properly amortised
having regard to appropriate legal and commercial considerations, as per the
principles enunciated under AS 26 on Intangible Assets.
10. Machinery Acquired Under Hire-Purchase System:

(i) Examine the Board’s Minute Book approving the purchase on hire-purchase
terms.
(ii) Examine the hire-purchase agreement carefully and note the description of the
machinery, cost of the machinery, hire purchase charges, and terms of payment
and rate of purchase.
(iii) Assets acquired under Hire Purchase System should be recorded at the full cash
value with corresponding liability of the same amount. In case cash value is not
readily available, it should be calculated presuming an appropriate rate of interest.
(iv) Hire purchased assets are shown in the balance sheet with an appropriate
narration to indicate that the enterprise does not have full ownership thereof. The
interest payable along with each installments, whether separately or included
therein should be debited to the interest account and not to the asset account.
11. Work-in-Progress:
(i) Ascertain that the cost sheets are duly attested by the works engineer and works
manager.
(ii) Test the correctness of the cost as disclosed by the cost records by verification of
quantities and cost of materials, wages and other charges included in the cost
sheets by reference to the records maintained in respect thereof.
(iii) Compare the unit cost or job cost as shown by the cost sheet with the standard
cost or the estimated cost expected.
(iv) Ensure that the allocation of overhead expenses had been made on a rational
basis.
(v) Compare the cost sheet in detail with that of the previous year. If they vary
materially, investigate the cause thereof.
(vi) Ensure that the Work-in-Progress as at Balance Sheet date has been
appropriately disclosed in Balance Sheet as per the requirements of Part I of
Schedule III of the Companies Act, 2013.
: 67 :
12. Bank Balances:
(i) Verify bank balance by reference to bank statements.
(ii) Examine the bank reconciliation statement prepared as on the last day of the year
and see whether (a) cheques issued by the entity but not presented for payment,
and (b) cheques deposited for collection by the entity but not credited in the bank
account have been duly debited/credited in the subsequent period.
(iii) Pay special attention to those items in the reconciliation statements which are
outstanding for an unduly long period. The auditor should ascertain the reasons for
such outstanding items from the management. He should also examine whether
any such items require an adjustment.
(iv) Examine relevant certificates in respect of fixed deposits or any type of deposits
with banks duly supported by bank advices.
(v) Check the disclosure requirement in the Balance Sheet as per Part I of Schedule
III to the Companies Act, 2013 in the case of a company.
13. Bills Payable:

(i) Vouch payments made to retire bills on their maturity or earlier and confirm that
the relevant bills have been duly cancelled.
(ii) Trace all the entries in the Bills Payable Book to the Bills Payable Account to
confirm that the liability in respect of the bills has been correctly recorded.
(iii) Reconcile the total of the schedule of bills payable outstanding at the end of the
year with the balance in the Bills Payable Account.
(iv) Obtain confirmation from the drawers or holders of the bills in respect of amount
due on the bills accepted by the client that are held by them.
(v) Verify that the charge, if any, created on any asset for the due payment of bills has
been appropriately disclosed.
14. Sales Commission Expenditure:

(i) Ascertain agreement, if any, in respect of sales transaction actually occurred
during the year carried out by authorized parties on its behalf. If yes, the
commission should be in accordance with the terms and conditions as specified.
(ii) Check evidence of services rendered by the party to whom commission is paid
with reference to correspondence etc.
(iii) Ensure that the sales in fact have taken place and the same has been charged to
Statement of Profit and Loss.
(iv) Compare the amount incurred in previous years with reference to total turnover.
(v) Check entries regarding TDS on commission at the time of credit to Payee’s
Account, or payment, whichever is earlier.
(vi) Ensure that the payment has been made through cheque only, if limit as stated in
the clause of tax audit is exceeded.
15. Sales Return:

(i) Examine the accounting basis for such transactions with reference to
corresponding Debit Note to Debit Note. The relevant correspondence may also
be examined.
(ii) Verify by reference to relevant corresponding record in good inward book or the
stores records. Further, the figures in these documentary evidences should be
compared with the original invoices for rates and other charges and calculation
should also be checked.
(iii) Examine in depth to eliminate the possibility of fictitious sales returns for covering
bogus sales recorded earlier when such returns outwards are in substantial figure
either at the start or end of the accounting year.
(iv) Cross-check with reference to original invoices any rebates in price or allowances
if any given by buyers on strength of their Debit Notes.
: 68 :
16. Purchase Return:
(i) Examine debit note issued to the supplier which in turn may be confirmed by
corresponding credit note issued by the supplier acknowledging the same. The
relevant correspondence may also be examined.
(ii) Verify by reference to relevant corresponding record in good outward book or the
stores records. Further, the figures in this documentary evidence should be
compared with the supplier’s original invoices for rates and other charges and
calculation should also be checked.
(iii) Examine in depth to eliminate the possibility of fictitious purchase returns for
covering bogus purchases recorded earlier when such returns outwards are in
substantial figure either at the beginning or end of the accounting year.
(iv) Cross-check with reference to original invoices any rebates in price or allowances
if any given by suppliers on strength of their Credit Notes.
17. Premium Paid for Insurance of a Motor Car:

Vouch from the following-
(i) Insurance cover note issued by the insurance company verifying the car no. and
period of insurance coverage.
(ii) Verify that “no claim bonus” is given, where entitled, by the Insurance Company.
(iii) Ensure that proper adjustment is made for prepaid insurance premium.
18. Liability Towards Gratuity:

(i) The liability towards gratuity payable to the employees at the time of cessation of
service should be ascertained and provided for in the accounts when the
employees are in service, it is an ascertained present liability accruing over the
period of service but payable upon cessation of service.
(ii) The auditor should check the quantification of the gratuity liability. He should
ascertain whether the same had been actuarially determined.
(iii) The auditor should treat the actuary as an expert and conduct procedures relevant
to checking the opinion of an expert in accordance with SA 620.
(iv) The auditor should check the technical competence of actuary, the input fed to the
actuary, the assumptions made by the actuary, the methodology adopted by the
actuary, opinion given etc.
(v) The auditor should bear in mind the relevant pronouncements of AS 15 “Employee
benefits” in this regard. He should check whether the expenses of provision for
gratuity are towards a defined benefit plan or contribution plan.
(vi) The contribution should be appropriately disclosed in the accounts as per
Schedule III to the Companies Act, 2013.
19. Expenditure Incurred for Promotion of a Product:

(i) The expenditure incurred for promotion of a new or existing product may entail
future benefits. It may be like advertisement in the papers, television, sales
exhibition, participation in trade fair, issue of promotional pamphlets, free gifts etc.
(ii) The auditor should vouch the authority and accuracy of the transactions. He
should read the contract with advertisement agencies, promotional policies
decided by the management from the board minutes etc.
(iii) He should check the amounts paid to the agencies from bank book. He should
check the accuracy. He should ascertain whether tax had been deducted in
accordance with the tax law provisions if any applicable in this regard.
: 69 :
(iv) He should check whether the unpaid amounts and accrued liability towards
promotional advertisement contracts had been duly provided for in the accounts.
(v) The huge expenditure should not be treated as deferred revenue expenditure.
According to AS 26, these are not intangible assets that may be carried over the
periods of accounting. These must be expensed with in the year in which these
arise.
20. Receipt of Special Backward Area Subsidy from Government:

(i) The claim for backward area subsidy submitted to the authorities should be
studied.
(ii) It should be ascertained whether the grant is of a capital nature for funding assets
or of a revenue nature. Mere computation formula of quantum of grant with
reference to the cost of project of itself will not make the grant a capital nature is to
facto.
(iii) The accounting of grant should be in accordance with AS 12 “Accounting for
Government Grants”. The revenue grant can be taken to income statement, with
appropriate disclosure.
(iv) The capital grant may be adjusted against cost of asset or may be kept in a
capital reserve to be transferred to Statement of Profit and Loss each year in
proportion to depreciation of that asset charged in Statement of Profit and Loss.
(v) The receipt of the grant should be checked with bank statement, remittance
challan etc.
(vi) The conditions attached to grant should be fulfilled by the company. The auditor
should check whether any liability or refund of grant for breach of conditions could
arise.
21. Payment of Revenue Expenses:

(i) See that all payments have been duly authorised by a competent authority.
(ii) Ensure that all payments relates to business.
(iii) Ensure that all payments have been received by the correct payee and
acknowledged by a receipt note or in the voucher itself.
(iv) See that expenses relate to the period under audit.
(v) Ensure that no personal expenses are charged as business expenditure.
(vi) See that all payments have been correctly recorded in the books under
appropriate sub-head.
(vii) See that if the payment relates to prior period it is classified so and the amount
payable is correctly authorised.
22. Rental Receipts:

(i) Check copies of bills or rent receipt issued to the tenant with reference to tenancy
agreement and bills of charges paid by the landlord on behalf of tenants.
(ii) The entries in the rental register in respect of rent accrued should be traced with
reference to copies of rental bills.
(iii) Scrutinize the account of collecting agent when the rent is collected by such agent.
(iv) Vouch the entries for rent received in advance and ensure proper adjustment is
made.
(v) Investigate into abnormal rent outstanding.
: 70 :
23. Assets Acquired on Hire Purchase:
(i) Inspect the hire purchase agreement to ascertain the terms and condition, the
installment and amount of interest included in the installment.
(ii) Ensure that these are treated as assets acquired under finance lease as per AS-
19.
(iii) Verify that initial recognition of lease should be as an asset and a liability at equal
amounts.
(iv) If it is reasonably certain that lessee will get ownership at the end of the term, see
that asset is depreciated over its useful life. Otherwise confirm that asset is
depreciated over the shorter of its useful life and the lease term.
(v) Ensure that it is shown separately in the Balance Sheet.
24. Cash Sales:

(i) Examine the system of internal check to ascertain any loopholes therein.
(ii) Ascertain the practice followed in the matter of issuing cash memos and trace the
memos into cash sale summary.
(iii) Ensure that the date of cash memos tally with the entry in the cash book/summary.
(iv) Verify that prices of goods sold have been correctly recorded and check the
calculation.
(v) Verify the entry in the goods outward book with the sales summary.
(vi) See that the cancelled cash memos are not removed from the receipt book.
25. Recovery of Bad Debts Written Off:

(i) Verify the relevant correspondence with the trade receivable whose accounts were
written off as bad.
(ii) See that the amount recovered is credited to a separate account recovery of bad
debts written off.
(iii) Verify the acknowledgement receipt issued to debtors.
(iv) Examine notification from the court, bankruptcy trustee and all correspondence
from debtors and collecting agencies.
(v) Check credit manager’s file for the amount received and see that the amount has
been deposited in the bank promptly.
(vi) Review the internal control system regarding writing off and recovery of bad debts.
26. Bank Balance of an Educational Institution: For verifying the balances lying with
bank in collection account, the auditor should adopt following procedure:
(i) Examine and compare the pay-in-slips with the entries in the ledger account of the
educational institute.
(ii) Check the casting, carry forwards and balancing of ledger account.
(iii) Compare the entries in the ledger account with the bank statement.
(iv) Review the bank reconciliation statement for its correctness.
(v) Scrutiny the subsequent period bank statement to ensure that items of
reconciliation are subsequently cleared.
(vi) Verify the balance confirmation certificate.
: 71 :
27. Advertisement Expenses:
(i) Verify the bill/invoice from advertising agency to ensure that rates charged for
different types of advertisement are as per contract.
(ii) See that advertisement relates to client’s business.
(iii) Inspect the receipt issued by the agency.
(iv) Ascertain the nature of expenditure – revenue deferred and see that it has been
recorded properly.
(v) Ascertain the period for which payment is made and see that pre-paid is carried
forward to balance sheet.
(vi) Compare the statement of account with the ledger account.
(vii) See that all outstanding advertisement bills have been provided for.
28. Sale of Scrap:

(i) Review the internal control as regards generation, storage and disposal of scrap.
(ii) Check whether the organization is maintaining reasonable record for generation of
Scrap.
(iii) Analyze the raw material used, production and generation pattern of scrap and
compare the same with figures of earlier year.
(iv) Check the rates at which scrap has been sold and compare the rate with previous
year.
(v) Vouch sales, with invoices raised, advertisement for tender, rate contract with
scrap dealers.
29. Insurance Claims: Insurance claims may be in respect of fixed assets or current
assets. While vouching the receipts of insurance claims-
(i) The auditor should examine a copy of the insurance claim lodged with the
insurance company correspondence with the insurance company and with the
insurance agent should also be seen. Counterfoils of the receipts issued to the
insurance company should also be seen.
(ii) The auditor should also determine the adjustment of the amount received in
excess or short of the value of the actual loss as per the insurance policy.
(iii) The copy of certificate/report containing full particulars of the amount of loss
should also be verified.
(iv) The accounting treatment of the amount received should be seen particularly to
ensure that revenue is credited with the appropriate amount and that in respect of
claim against asset, the Statement of Profit and Loss is debited with the short fall
of the claim admitted against book value, if the claim was lodged in the previous
year but no entries were passed, entries in the Statement of Profit and Loss
should be appropriately described.
30. Production Incentive Paid to Workers:

(i) The auditor should trace the total production incentive paid to workers from
Statement of Profit and Loss to prime records/division wise/dept wise records.
(ii) The auditor should get the details of incentive scheme from the management and
see that it is approved and updated by a competent authority.
(iii) The auditor should check the production figures from independent source and
should correlate them with the incentive payment working computed by the
accounts department.
(iv) He should check list of payment and also acquitted disbursement slips of select
departments/periods for scrutiny of various data generated in the fields for their
accuracy and completeness.
(v) The auditor should make an overall analytical procedure of ensuring the expense
booked is commensurate in quantum with statistical data on production and
strength of workers.
: 72 :
31. Bad Debts:
(i) The amount of bad debts should be traced to the schedule of bad debts written off
during the year.
(ii) Major amount of bad debts in the schedule be taken for scrutiny.
(iii) Check that the amount considered in write off had been overdue for long and
scrutinize the correspondence files.
(iv) Check the authority for write off and the level of authority is sufficient higher than
the executive involved in collection.
(v) The bad debts should be properly disclosed in Statement of Profit and Loss
according to its materiality.
(vi) If provision had already been created for bad debts, see that to the extent of actual
bad debts written off, the provision is released.
32. Refund of General Insurance Premium Paid: The refund of insurance premium may
be because of earlier provisional payment of premium or may be a policy might have
been cancelled at a later date. The auditor should take following steps while vouching
such refunds-
(i) Ascertain the reasons for refund of insurance premium.
(ii) Examine insurance policy or cover note to find out the amount of premium.
(iii) Verify advice of refund received from the insurance company. When refund is
admitted, the insurance company sends the advice. This will be evidence as a
covering letter to the cheque for the refund. Sometimes, a cheque is issued after a
receipt is sent in advance to the insurance company.
(iv) Scrutinise correspondence between the insurance company and the client.
(v) Check entries in the bank book or the bank statement. If necessary, the counterfoil
of the pay-in-slips can also be verified.
33. Assets Abroad:

(i) Examine the title deeds of immovable properties abroad.
(ii) Ensure that the immovable properties abroad have been properly classified and
disclosed.
(iii) Where documents of title relating to assets held abroad are not available for
inspection, a certificate should be obtained from the agent or any other party
holding the document.
(iv) Ascertain that certificate has been obtained disclosing unequivocally that they are
free from any charge or encumbrance.
34. Royalties received:

(i) Verify the relevant contract and ascertain the provisions relating to the conditions
of royalty such as rate, mode of calculation and due date.
(ii) Check the periodical statement received in respect of books printed, sold and
inventory lying at different locations.
(iii) Check the computation in the royalty statement and ensure that any deduction or
adjustment made from the royalty due is as per agreement conditions.
(iv) Verify the provisions for the royalty to be received as at the end of the year.
: 73 :
35. Contingent liabilities:
(i) Inspect the minute books of the company to ascertain all contingent liabilities
known to the company.
(ii) Examine the contracts entered into by the company and the likelihood of
contingent liabilities emanating therefrom.
(iii) Scrutinise the lawyer’s bills to track unreported contingent liabilities.
(iv) Examine bank letters in respect of bills discounted and not matured.
(v) Examine bank letters to ascertain guarantees on behalf of other companies or
individuals.
(vi) Discuss with various functional officers of the company about the possibility of
contingent liability existing in their respective field.
(vii) Obtain a certificate from the management that all known contingent liabilities have
been included in the accounts and they have been properly disclosed.
(viii) Ensure that proper disclosure has been made as per Schedule III to the
Companies Act, 2013 and AS 29, “Provisions, Contingent Liabilities and
Contingent Assets”.
36. Endowment Policies:
(i) Ascertain the specific purpose for which the endowment policy is taken, e.g.,
Sinking Fund policies for redemption of debentures, redemption of leases or
policies taken for other similar purposes, etc.
(ii) Verify the terms and conditions of policies and ensure that all such conditions are
in force and being followed.
(iii) Check that premium has been deposited in time and the policy is in force.
(iv) Examine that proper disclosures have been made in the financial statements in
respect of items for which the policy has been taken.
37. Capital work-in-progress.

Capital Work-in-Progress denotes assets under installation. This could either be plant or
machinery under construction, or that construction project for establishment of a new
factory is under progress. The auditor should take the following steps to verify the
same-
(i) Ensure that the capital project is authorised by the Board. See the relevant Board
Minutes for the purpose.
(ii) Obtain the break up in details of the amount shown in the Balance Sheet under
this head.
(iii) Check purchase cost of plant machinery or other assets with reference to the
contract with, and amount paid to the suppliers.
(iv) Examine the allocation of common costs to the Capital Work-in-Progress in case
such items have been constructed internally.
(v) Ensure that the assets already put to commercial use are not included under
Capital Work-in-Progress.
(vi) Verify that only expenses incurred up to pre commissioning stage are capitalised
under this head.
(vii) See that Capital Work-in-Progress is properly disclosed in the Balance Sheet
under the head Fixed Assets as per the presentation and disclosure requirements
of Schedule III to the Companies Act, 2013.
: 74 :
38. Purchase of Quoted Investment:
(i) Ascertain the date of purchase, rate of purchase, nature of investments purchased
and nature of transaction, i.e., error cum-dividend/ interest/right/bonus.
(ii) Compare the rate of purchase with quotation available. Obtain suitable
explanations in case of significant variations.
(iii) Verify the amount paid towards purchase of investments.
(iv) Trace the amount in the cheque book counterfoils and bank statements.
(v) Obtain a schedule of investment from Management for physical verification at the
year end.
(vi) Verify the investment certificate to confirm title.
(vii) Confirm compliance with statutory provisions such as 143(1) of the Companies
Act, 2013.
(viii) Verify whether investments are duly disclosed in financial statements in
accordance with recognized accounting policies and practices and relevant
statutory requirements.
39. Sale of Empties: When the empties or containers in which goods necessarily have to
be supplied are costly, the manufacturer normally agrees to purchase them back at a
reduced price as compared to the one charged for them. Therefore check whether
(i) Separate account of issue and receipt of empties has been prepared.
(ii) In separate maintained a/c check how many empties lies in warehouse and how
many are with customers.
(iii) Check how many empties customers may return after the close of the year.
(iv) Check whether proper provision has been made against the contingency of the
containers being returned by customers and that for the wear and tear.
(v) Check the amount of sale with entry in cash book.
(vi) See the sold empties are reduced from the inventory.
(vii) If the empties are sold on credit, ask for direct confirmation from purchasing party
and confirm the sale.
40. Deferred Tax Liability:

(i) The deferred tax liability is created when there is timing difference which results in
deferred tax payable with reduction in current tax to the same extent. For example,
when more depreciation amount is claimed in Income tax profits than in
accounting profits, the current tax payable will be less with a liability to pay more
tax in future. This is called Deferred Tax Liability.
(ii) Check the creation of Deferred Tax Liability and its actual working.
(iii) Check how much Deferred Tax Liability is reversed during the year.
(iv) Check that Deferred Tax Liability is disclosed as relating to depreciation and as
relating to others.
(v) Check that the provisions of AS 22 “Accounting for Taxes on Income” have been
complied with.
41. Reserves and Provisions:

(i) Reserve is an appropriation of profit whereas provision is a charge against Profit.
(ii) Reserves are not intended to meet any liability, contingency or diminution in the
value of assets. Provisions are made to provide for depreciation, renewal or a
known liability or a disputed claim.
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(iii)Reserves cannot be created unless there is a profit except revaluation reserve and
capital subsidy. Provisions must be created whether or not there is profit.
(iv) Reserves are generally optional except in certain situations – Capital Redemption
reserve, Debenture Redemption Reserve, etc. Provisions are not optional and
have to be made as per generally accepted accounting principles.
(v) Reserves are shown on the liability side. Provisions for depreciation and provision
for doubtful debts are shown as deduction from respective assets. Provision for
liability is shown on the liability side.
42. Verification of Assets Acquired on Lease:

(i) Examine the terms and conditions of the lease deed.
(ii) If a part of the leasehold property has been sublet, examine the tenant’s
agreement.
(iii) Verify relevant document to check the cost of property.
(iv) Ensure assets acquired under finance lease are segregated from the assets
owned.
(v) Ensure that the assets under lease have been properly disclosed as per
requirement of Schedule III to the Companies Act, 2013.
43. Patterns, Dies, Loose Tools, etc.: Several entities have large investments in such
assets which have a relatively short useful life and low unit cost. Evidently, it is a difficult
matter, under the circumstances, to prepare a separate account for each such asset
although a careful control over such property is necessary.
On these considerations, some entities charge off small tools and other similar items to
Production Account as and when they are purchased and do not place any value on the
unused inventory on the Balance Sheet.
The most satisfactory method, however, is that of preparing an inventory of serviceable
articles, at the close of each year, and revaluing the assets on this basis, the various
articles included in the inventory being valued at cost. It should be seen that the
inventory does not include any worn out or defective articles the life of which has
already run out.
44. Investment in Shares and Debentures of Subsidiary:

(i) The auditor should obtain a complete schedule of all such investments held,
showing particulars as regards the name of the subsidiary company, class of
shares or debenture, date of purchase, number of units and denoting numbers,
book value, dividend received etc.
(ii) All the particulars entered in the schedule should be verified with the relevant
account in the General Ledger.
(iii) The auditor should, at the same time, examine all the investments by inspection of
the securities, share scrips or certificates, debenture bonds, etc. If any of the
securities are held by bankers, he should verify them with their certificate which
should disclose the charge, if they are subject to any such charge.
(iv) The provisions contained in Part I of Schedule III to the Companies Act, 2013
requires that the shares held in a subsidiary should be shown separately.
(v) The shares or debentures of a subsidiary are valued at cost.
(vi) If the subsidiary has suffered a loss, then a provision for the proportionate part of
the loss should be made in the accounts of the holding company.
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45. Sweat Equity Shares.
As per section 54 of the Companies Act, 2013, the employees may be compensated in
the form of ‘Sweat Equity Shares”.
“Sweat Equity Shares” means equity shares issued by the company to employees or
directors at a discount or for consideration other than cash for providing know-how or
making available right in the nature of intellectual property rights or value additions, by
whatever name called.
The auditor may see that the Sweat Equity Shares issued by the company are of a
class of shares already issued and following conditions are fulfilled-
(a) the issue is authorised by a special resolution passed by the company;
(b) the resolution specifies the number of shares, the current market price,
consideration, if any, and the class or classes of directors or employees to whom
such equity shares are to be issued;
(c) not less than one year has, at the date of such issue, elapsed since the date on
which the company had commenced business; and
(d) where the equity shares of the company are listed on a recognised stock
exchange, the sweat equity shares are issued in accordance with the regulations
made by the Securities and Exchange Board in this behalf and if they are not so
listed, the sweat equity shares are issued in accordance with such rules as may be
prescribed.
46. Audit of Capital Reserve: A capital reserve is a reserve which is not available for
distribution as dividend. The auditor should examine that the head 'capital reserves'
does not include any amounts as are regarded as free for distribution as dividend. In the
case of a company, if there is a capital profit on reissue of forfeited shares, it is to be
shown under capital reserves.
The following are the duties for the Auditor in connection with the capital profit, which
are not normally available for distribution to the shareholders unless-
(i) The Articles of the company permit such a distribution,
(ii) It has been realised in cash.
(iii) The assets value remaining after distribution of the profit will be not less than the
book value so that share capital and reserves remaining after the distribution will
be fully represented by the remaining assets
47. Utilisation of Share Premium:

Section 52(2) lays down that the securities premium account may be applied by the
company-
(a) in paying up unissued shares of the company to be issued to members of the
company as fully paid bonus shares;
(b) in writing off the preliminary expenses of the company;
(c) in writing off the expenses of, or the commission paid or discount allowed on, any
issue of shares or debentures of the company;
(d) in providing for the premium payable on the redemption of any redeemable
preference shares or of any debentures of the company; or
(e) for the purchase of its own shares or other securities under Section 68.
Thus, it is clear from the above that share premium can be utilised only for specific
purposes.
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48. Power of Company to Buy Back its Own Securities: The Companies Act, 2013
under section 68(1) permits companies to buyback their own shares and other specified
securities out of:
(i) its free reserves; or
(ii) the securities premium account; or
(iii) the proceeds of the issue of any shares or other specified securities.
It may be noted that no buy-back of any kind of shares or other specified securities shall
be made out of the proceeds of an earlier issue of the same kind of shares or same kind
of other specified securities.
The other important provisions relating to the buyback are-
(i) Section 68(2) further states that no company shall purchase its own shares or
other specified securities unless-
(a) the buy-back is authorised by its articles;
(b) a special resolution has been passed in general meeting of the company
authorising the buy-back;
(c) the buy-back is equal or less than 25% of the total paid-up capital and free
reserves of the company:
It may be noted that in respect of the buy-back of equity shares in any
financial year, the reference to 25% shall be construed with respect to its
total paid-up equity capital in that financial year.
(d) the ratio of the debt owed by the company (both secured and unsecured)
after such buy - back is not more than twice the total of its paid up capital and
its free reserves:
However, the Central Government may prescribe a higher ratio of the debt to
capital and free reserves than that specified under this clause for a class or
classes of companies.
(e) all the shares or other specified securities for buy-back are fully paid-up;
(f) the buy-back of the shares or other specified securities listed on any
recognised stock exchange is in accordance with the regulations made by
the Securities and Exchange Board of India in this behalf;
Schedule III to the Companies Act, 2013 Requirements:
Under the head “Share Capital”, a company is required to disclose for the period of five
years immediately preceding the date as at which the Balance Sheet is prepared, the
aggregate number and class of shares bought back.
49. Verification of Issue of Bonus Shares: Section 63 of the Companies Act, 2013 allows
a company to issue fully paid-up bonus shares to its members, in any manner
whatsoever, out of-
(i) its free reserves;
(ii) the securities premium account; or
(iii) the capital redemption reserve account.
The auditor should ensure that no issue of bonus shares shall be made by capitalising
reserves created by the revaluation of assets.
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Further, he should also ensure the compliance of condition for capitalization of profits or
reserves for the issuing fully paid-up bonus shares like -
(i) it is authorised by its articles;
(ii) it has, on the recommendation of the Board, been authorised in the general
meeting of the company;
(iii) it has not defaulted in payment of interest or principal in respect of fixed deposits
or debt securities issued by it;
(iv) it has not defaulted in respect of the payment of statutory dues of the employees,
such as, contribution to provident fund, gratuity and bonus;
(v) the partly paid-up shares, if any outstanding on the date of allotment, are made
fully paid-up;
(vi) it complies with such conditions as may be prescribed like the company which has
once announced the decision of its Board recommending a bonus issue, shall not
subsequently withdraw the same;
(vii) the bonus shares shall not be issued in lieu of dividend.
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CHAPTER - 10 COMPANY AUDIT
Introduction
This chapter is based upon the provisions of Companies Act 2013.
Companies act 2013 is a rule based act divided into chapters and sections.
Companies act 2013 is supported by rules which are issued from time to time.
For company audit chapter- following references are important

1) Chapter X- Audit and Auditors (Sec 139- Sec 148) read with Company (Audit
and Auditors) Rules i.e. CAAR, 2014
The sections discussed in this chapter are applicable from FY 14-15 onwards unless
otherwise specified.
Following topics are covered in this chapter

1) Eligibility and Qualification
2) Disqualifications
3) Appointment
4) Removal
5) Remuneration
6) Rights and duties
7) Penalties
8) Branch Audit
9) Joint Audit
10) Cost Audit
11) CARO, 2016
12) Ceiling limit
Company audit I
1. Eligibility & qualification- Sec 141 (1) & (2)

The provisions relating to eligibility, qualifications and disqualifications of an
auditor are governed by section 141 of the Companies Act, 2013 (hereinafter
referred as the Act). The main provisions are stated below:
(1) A person shall be eligible for appointment as an auditor of a company

only if he is a chartered accountant.
It may be noted that a firm whereof majority of partners practising in India
are qualified for appointment as aforesaid may be appointed by its firm
name to be auditor of a company.
(2) Where a firm including a limited liability partnership is appointed as an

auditor of a company, only the partners who are chartered accountants
shall be authorised to act and sign on behalf of the firm.
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2. Disqualification- Section 141 (3) along with Rule 10 of the CAAR, 2014
The following persons shall not be eligible for appointment as an auditor
of a company, namely-
(a) a body corporate other than a limited liability partnership registered under
the Limited Liability Partnership Act, 2008;
(b) an officer or employee of the company;
(c) a person who is a partner, or who is in the employment, of an officer or
employee of the company;
(d) a person who, or his relative or partner -
(i) is holding any security of or interest in the company or its subsidiary,
or of its holding or associate company or a subsidiary of such
holding company;
It may be noted that the relative may hold security or interest in the
company of face value not exceeding rupees one lakh.
It may also be noted that the condition of rupees one lakh shall,
wherever relevant, be also applicable in the case of a company not
having share capital or other securities.
Students may also note that in the event of acquiring any security or
interest by a relative, above the threshold prescribed, the corrective
action to maintain the limits as specified above shall be taken by the
auditor within 60 days of such acquisition or interest.
[The term “relative”, as defined under the Companies Act, 2013,
means anyone who is related to another as members of a Hindu
Undivided Family; husband and wife; Father (including step- father),
Mother(including step-mother), Son (including step- son), Son’s wife,
Daughter, Daughter’s husband, Brother (including step- brother),
Sister (including step- sister).
(ii) is indebted to the company, or its subsidiary, or its holding or
associate company or a subsidiary of such holding company, in
excess of rupees five lakh; or
(iii) has given a guarantee or provided any security in connection with
the indebtedness of any third person to the Company or its
Subsidiary, or its Holding or Associate Company or a Subsidiary of
such Holding Company, in excess of one lakh rupees.
(e) a person or a firm who, whether directly or indirectly has business
relationship with the Company, or its Subsidiary, or its Holding or
Associate Company or Subsidiary of such holding company or associate
company, of such nature as may be prescribed;
Student may note that for the purpose of clause (e) above the term
“business relationship” shall be construed as any transaction entered into
for a commercial purpose, except –
(i) commercial transactions which are in the nature of professional
services permitted to be rendered by an auditor or audit firm under
the Act and the Chartered Accountants Act, 1949 and the rules or
the regulations made under those Acts;
(ii) commercial transactions which are in the ordinary course of
business of the company at arm’s length price - like sale of products
or services to the auditor, as customer, in the ordinary course of
business, by companies engaged in the business of
telecommunications, airlines, hospitals, hotels and such other similar
businesses.
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(f) a person whose relative is a Director or is in the employment of the
Company as a director or key Managerial Personnel.
(g) a person who is in full time employment elsewhere or a person or a
partner of a firm holding appointment as its auditor, if such person or
partner is at the date of such appointment or reappointment holding
appointment as auditor of more than twenty companies.
(h) a person who has been convicted by a Court of an offence involving fraud
and a period of ten years has not elapsed from the date of such
conviction.
(i) any person whose subsidiary or associate company or any other form of
entity, is engaged as on the date of appointment in consulting and
specialized services as provided in section 144.
Section 144 of the Companies Act, 2013 is a new provision which prescribes
certain services not to be rendered by the auditor. An auditor appointed
under this Act shall provide to the company only such other services as are
approved by the Board of Directors or the audit committee, as the case may be,
but which shall not include any of the following services (whether such services
are rendered directly or indirectly to the company or its holding company or
subsidiary company), namely:
(i) accounting and book keeping services;
(ii) internal audit;
(iii) design and implementation of any financial information system;
(iv) actuarial services;
(v) investment advisory services;
(vi) investment banking services;
(vii) rendering of outsourced financial services;
(viii) management services; and
(ix) any other kind of services as may be prescribed.
In case of auditor being an individual, either himself or through his relative or
any other person connected or associated with such individual or through any
other entity, whatsoever, in which such individual has significant influence or
control, or whose name or trade mark or brand is used by such individual; and
in case of auditor being a firm, either itself or through any of its partners or
through its parent, subsidiary or associate entity or through any other entity,
whatsoever, in which the firm or any partner of the firm has significant influence
or control, or whose name or trade mark or brand is used by the firm or any of
its partners.
NOTE: DISQUALIFICATION
Where a person appointed as an auditor of a company incurs any of the
disqualifications mentioned in sub-section (3) after his appointment, he shall
vacate his office as such auditor and such vacation shall be deemed to be a
casual vacancy in the office of the auditor.
3. Appointment of Auditor- Section 139

APPOINTMENT- BASIC PROVISIONS
(A) Appointment of First Auditors in the case of a company, other than a
Government Company: As per Section 139(6), the first auditor of a
company, other than a Government company, shall be appointed by the
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Board of Directors within 30 days from the date of registration of the
company.
In the case of failure of the Board to appoint the auditor, it shall inform the
members of the company. The members of the company shall within 90
days at an extraordinary general meeting appoint the auditor. Appointed
auditor shall hold office till the conclusion of the first annual general
meeting.
(B) Appointment of First Auditors in the case of Government Company:
Section 139(7) provides that in the case of a Government company or
any other company owned or controlled, directly or indirectly, by the
Central Government, or by any State Government, or Governments, or
partly by the Central Government and partly by one or more State
Governments, the first auditor shall be appointed by the Comptroller and
Auditor-General of India within 60 days from the date of registration of the
company.
In case the Comptroller and Auditor-General of India does not appoint
such auditor within the above said period, the Board of Directors of the
company shall appoint such auditor within the next 30 days. Further, in
the case of failure of the Board to appoint such auditor within next 30
days, it shall inform the members of the company who shall appoint such
auditor within 60 days at an extraordinary general meeting. Auditors shall
hold office till the conclusion of the first annual general meeting.
(C) Appointment of Subsequent Auditors in case of Non Government
Companies: Section 139(1) of the Companies Act, 2013 provides that
every company shall, at the first annual general meeting appoint an
individual or a firm as an auditor who shall hold office from the conclusion
of that meeting till the conclusion of its sixth annual general meeting and
thereafter till the conclusion of every sixth meeting.
The following points need to be noted in this regard-
(i) The company shall place the matter relating to such appointment of
ratification by member at every Annual General Meeting.
(ii) Before such appointment is made, the written consent of the auditor
to such appointment, and a certificate from him or it that the
appointment, if made, shall be in accordance with the conditions as
may be prescribed, shall be obtained from the auditor.
(iii) The certificate shall also indicate whether the auditor satisfies the
criteria provided in section 141.
(iv) The company shall inform the auditor concerned of his or its
appointment, and also file a notice of such appointment with the
Registrar within 15 days of the meeting in which the auditor is
appointed.
(D) Appointment of Subsequent Auditors in case of Government

Companies: As per Section 139(5), in the case of a Government
company or any other company owned or controlled, directly or indirectly,
by the Central Government, or by any State Government or Governments,
or partly by the Central Government and partly by one or more State
Governments, the Comptroller and Auditor-General of India shall, in
respect of a financial year, appoint an auditor duly qualified to be
appointed as an auditor of companies under this Act, within a period of
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180 days from the commencement of the financial year, who shall hold
office till the conclusion of the annual general meeting.
APPOINTMENT- MANNER OF SELECTION OF AUDITOR
Section 139 (11) Read with Rule 3 of CAAR, 2014
(1) In case of a company that is required to constitute an Audit Committee

under section 177, the committee, and, in cases where such a committee
is not required to be constituted, the Board, shall take into consideration the
qualifications and experience of the individual or the firm proposed to be
considered for appointment as auditor and whether such qualifications and
experience are commensurate with the size and requirements of the company.
It may be noted that while considering the appointment, the Audit Committee or
the Board, as the case may be, shall have regard to any order or pending
proceeding relating to professional matters of conduct against the proposed
auditor before the Institute of Chartered Accountants of India or any competent
authority or any Court.
(2) The Audit Committee or the Board, as the case may be, may call for such other
information from the proposed auditor as it may deem fit.
(3) Subject to the provisions of sub-rule (1), where a company is required to
constitute the Audit Committee, the committee shall recommend the name of
an individual or a firm as auditor to the Board for consideration and in other
cases, the Board shall consider and recommend an individual or a firm as
auditor to the members in the annual general meeting for appointment.
(4) If the Board agrees with the recommendation of the Audit Committee, it shall
further recommend the appointment of an individual or a firm as auditor to the
members in the annual general meeting.
(5) If the Board disagrees with the recommendation of the Audit Committee, it shall
refer back the recommendation to the committee for reconsideration citing
reasons for such disagreement.
(6) If the Audit Committee, after considering the reasons given by the Board,
decides not to reconsider its original recommendation, the Board shall record
reasons for its disagreement with the committee and send its own
recommendation for consideration of the members in the annual general
meeting; and if the Board agrees with the recommendations of the Audit
Committee, it shall place the matter for consideration by members in the annual
general meeting.
(7) The auditor appointed in the annual general meeting shall hold office from the
conclusion of that meeting till the conclusion of the sixth annual general
meeting, with the meeting wherein such appointment has been made being
counted as the first meeting:
It may be noted that such appointment shall be subject to ratification in every
annual general meeting till the sixth such meeting by way of passing of an
ordinary resolution.
Explanation- For the purposes of this rule, it is hereby clarified that, if the
appointment is not ratified by the members of the company, the Board of
Directors shall appoint another individual or firm as its auditor or auditors after
following the procedure laid down in this behalf under the Act.
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APPOINTMENT- Rotation of Auditor
Section 139(2), (3) & (4)
Applicability:
Manner of Rotation
As per Section 139(2), no listed company or a company belonging to such class or
classes of companies as mentioned above, shall appoint or re-appoint-
(a) an individual as auditor for more than one term of five consecutive years; and
(b) an audit firm as auditor for more than two terms of five consecutive years.
Provided that -
(i) an individual auditor who has completed his term under clause (a) shall
not be eligible for re-appointment as auditor in the same company for five
years from the completion of his term;
(ii) an audit firm which has completed its term under clause (b), shall not be
eligible for re-appointment as auditor in the same company for five years
from the completion of such term.
The following points merit consideration in this regard-
(1) As on the date of appointment, no audit firm having a common partner or
partners to the other audit firm, whose tenure has expired in a company
immediately preceding the financial year, shall be appointed as auditor of the
same company for a period of five years.
(2) Every company, existing on or before the commencement of this Act which is
required to comply with provisions of this sub-section, shall comply with the
requirements of this sub-section within three years from the date of
commencement of this Act.
(3) It has also been provided that right of the company to remove an auditor or the
right of the auditor to resign from such office of the company shall not be
prejudiced.
(4) Subject to the provisions of this Act, members of a company may resolve to
provide that-
(a) in the audit firm appointed by it, the auditing partner and his team shall be
rotated at such intervals as may be resolved by members; or
(b) the audit shall be conducted by more than one auditor.
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For the purpose of the rotation of auditors-
(i) in case of an auditor (whether an individual or audit firm), the period for which
the individual or the firm has held office as auditor prior to the commencement
of the Act shall be taken into account for calculating the period of five
consecutive years or ten consecutive years, as the case may be;
(ii) the incoming auditor or audit firm shall not be eligible if such auditor or audit
firm is associated with the outgoing auditor or audit firm under the same
network of audit firms.
Explanation I - For the purposes of these rules the term “same network”
includes the firms operating or functioning, hitherto or in future, under the same
brand name, trade name or common control.
Explanation II - For the purpose of rotation of auditors,
(a) a break in the term for a continuous period of five years shall be
considered as fulfilling the requirement of rotation;
(b) if a partner, who is in charge of an audit firm and also certifies the financial
statements of the company, retires from the said firm and joins another
firm of chartered accountants, such other firm shall also be ineligible to be
appointed for a period of five years.
APPOINTMENT- FILLING A CASUAL VACANCY

Section 139 (8)
As per Section 139(8), any casual vacancy in the office of an auditor shall-
(i) In the case of a company other than a company whose accounts are subject to
audit by an auditor appointed by the Comptroller and Auditor-General of India,
be filled by the Board of Directors within 30 days.
If such casual vacancy is as a result of the resignation of an auditor, such
appointment shall also be approved by the company at a general meeting
convened within three months of the recommendation of the Board and he shall
hold the office till the conclusion of the next annual general meeting.
(ii) In the case of a company whose accounts are subject to audit by an auditor
appointed by the Comptroller and Auditor-General of India, be filled by the
Comptroller and Auditor-General of India within 30 days.
It may be noted that in case the Comptroller and Auditor-General of India does
not fill the vacancy within the said period the Board of Directors shall fill the
vacancy within next 30 days.
Casual Vacancy by Resignation: As per section 140(2) the auditor who has
resigned from the company shall file within a period of 30 days from the date of
resignation, a statement in the prescribed Form ADT–3 (as per Rule 8 of CAAR) with
the company and the Registrar, and in case of the companies referred to in section
139(5) i.e. Government company, the auditor shall also file such statement with the
Comptroller and Auditor-General of India, indicating the reasons and other facts as
may be relevant with regard to his resignation. In case of failure the auditor shall be
punishable with fine which shall not be less than fifty thousand rupees but which may
extend to five lakh rupees as per section 140(3).
(4) Remuneration- Sec 142

The remuneration of the auditor of a company shall be fixed in its general
meeting or in such manner as may be determined therein. However, board may
fix remuneration of the first auditor appointed by it.
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Further, the remuneration, in addition to the fee payable to an auditor, include
the expenses, if any, incurred by the auditor in connection with the audit of the
company and any facility extended to him but does not include any
remuneration paid to him for any other service rendered by him at the request
of the company. Therefore, it has been clarified that the remuneration to Auditor
shall also include any facility provided to him.
(5) Removal
Removal of auditor before Expiry of his term
Sec 140(1) read with Rule 7 of CAAR, 2014
(1) The application to the Central Government for removal of auditor shall be
made in Form ADT-2 and shall be accompanied with fees as provided for
this purpose under the Companies (Registration Offices and Fees) Rules,
2014.
(2) The application shall be made to the Central Government within 30 days
of the resolution passed by the Board.
(3) The company shall hold the general meeting within 60 days of receipt of
approval of the Central Government for passing the special resolution.
It is important to note that before taking any action for removal before expiry of
terms, the auditor concerned shall be given a reasonable opportunity of being
heard.
Appointment of Auditor Other Than Retiring Auditor

Sec 140 (4) Read with Sec 139
Appointment of Auditor Other Than Retiring Auditor: Section 140 lays down
procedure to appoint an auditor other than retiring auditor who was removed-
(1) Special notice shall be required for a resolution at an annual general meeting
appointing as auditor a person other than a retiring auditor, or providing
expressly that a retiring auditor shall not be re-appointed, except where the
retiring auditor has completed a consecutive tenure of five years or as the case
may be, ten years, as provided under subsection (2) of section 139.
(2) On receipt of notice of such a resolution, the company shall forthwith send a
copy thereof to the retiring auditor.
(3) Where notice is given of such a resolution and the retiring auditor makes with
respect thereto representation in writing to the company (not exceeding a
reasonable length) and requests its notification to members of the company,
the company shall, unless the representation is received by it too late for it to
do so,-
(a) in any notice of the resolution given to members of the company, state the
fact of the representation having been made; and
(b) send a copy of the representation to every member of the company to
whom notice of the meeting is sent, whether before or after the receipt of
the representation by the company. and if a copy of the representation is
not sent as aforesaid because it was received too late or because of the
company's default, the auditor may (without prejudice to his right to be
heard orally) require that the representation shall be read out at the
meeting:
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(6) Rights and duties
The auditor has the following powers/rights while conducting an audit:
(a)’ Right of access to books, etc. – Section 143(1) of the Act provides that
the auditor of a company, at all times, shall have a right of access to the
books of account and vouchers of the company, whether kept at the
registered office of the company or at any other place and he is entitled to
require from the officers of the company such information and explanation
as he may consider necessary for the performance of his duties as
auditor. The right of access is not limited to those books and records
maintained at the registered or head office so that in the case of a
company with branches, the right also extends to the branch records, if
the auditor considers it necessary to have access thereto as per
Section143(8).
Proviso to section 143(1) further extends the right of the auditor of a
company, which is a holding company, to access to the records of all its
subsidiaries in so far as it relates to the consolidation of its financial
statements with that of its subsidiaries.
(b) Right to obtain information and explanation from officers - This right
of the auditor to obtain from the officers of the company such information
and explanations as he may think necessary for the performance of his
duties as auditor is a wide and important power. In the absence of such
power, the auditor would not be able to obtain details of amount collected
by the directors, etc. from any other company, firm or person as well as of
any benefits in kind derived by the directors from the company, which may
not be known from an examination of the books. It is for the auditor to
decide the matters in respect of which information and explanations are
required by him
(c) Right to receive notices and to attend general meeting – The auditors
of a company are entitled to attend any general meeting of the company
also to receive all the notices and other communications relating to the
general meetings, which members are entitled to receive and to be heard
at any general meeting in any part of the business of the meeting which
concerns them as auditors.
Section 146 of the Companies Act, 2013 discusses right as well as duty of
the auditor. According to the section 146:
“all notices of, and other communications relating to, any general meeting
shall be forwarded to the auditor of the company, and the auditor shall,
unless otherwise exempted by the company, attend either by himself or
through his authorised representative, who shall also be qualified to be an
auditor, any general meeting and shall have right to be heard at such
meeting on any part of the business which concerns him as the auditor.”
Thus, it is right of the auditor to receive notices and other communications
relating to any general meeting and to be heard at such meeting, relating
to the matter of his concern, however, it is duty of the auditor to attend the
same or through his authorised representative unless otherwise
exempted.
(d) Right to report to the members of the company on the accounts
examined by him –
The auditor shall make a report to the members of the company on the
accounts examined by him and on every financial statements which are
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required by or under this Act to be laid before the company in general
meeting and the report shall after taking into account the provisions of this
Act, the accounting and auditing standards and matters which are
required to be included in the audit report under the provisions of this Act
or any rules made there under or under any order made under this section
and to the best of his information and knowledge, the said accounts,
financial statements give a true and fair view of the state of the company’s
affairs as at the end of its financial year and profit or loss and cash flow for
the year and such other matters as may be prescribed.
(e) Right to Lien – In terms of the general principles of law, any person
having the lawful possession of somebody else’s property, on which he
has worked, may retain the property for non-payment of his dues on
account of the work done on the property. On this premise, auditor can
exercise lien on books and documents placed at his possession by the
client for non payment of fees, for work done on the books and
documents. The Institute of Chartered Accountants in England and Wales
has expressed a similar view on the following conditions:
(i) Documents retained must belong to the client who owes the money.
(ii) Documents must have come into possession of the auditor on the
authority of the client. They must not have been received through
irregular or illegal means. In case of a company client, they must be
received on the authority of the Board of Directors.
(iii) The auditor can retain the documents only if he has done work on
the documents assigned to him.
(iv) Such of the documents can be retained which are connected with
the work on which fees have not been paid.
Under section 128 of the Act, books of account of a company must be
kept at the registered office. These provisions ordinarily make it
impracticable for the auditor to have possession of the books and
documents. The company provides reasonable facility to auditor for
inspection of the books of account by directors and others authorised to
inspect under the Act. Taking an overall view of the matter, it seems that
though legally, auditor may exercise right of lien in cases of companies, it
is mostly impracticable.
The auditor has following duties

(1) Duty of Auditor to Inquire on certain matters: It is the duty of auditor to
inquire into the following matters-
(a) whether loans and advances made by the company on the basis of
security have been properly secured and whether the terms on which they
have been made are prejudicial to the interests of the company or its
members;
(b) whether transactions of the company which are represented merely by
book entries are prejudicial to the interests of the company;
(c) where the company not being an investment company or a banking
company, whether so much of the assets of the company as consist of
shares, debentures and other securities have been sold at a price less
than that at which they were purchased by the company;
(d) whether loans and advances made by the company have been shown as
deposits;
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(e) whether personal expenses have been charged to revenue account;
(f) where it is stated in the books and documents of the company that any
shares have been allotted for cash, whether cash has actually been
received in respect of such allotment, and if no cash has actually been so
received, whether the position as stated in the account books and the
balance sheet is correct, regular and not misleading.
“The auditor is not required to report on the matters specified in sub-section (1)
unless he has any special comments to make on any of the items referred to
therein. If he is satisfied as a result of the inquiries, he has no further duty to
report that he is so satisfied.”
(2) Duty to Sign the Audit Report: The person appointed as an auditor of the
company shall sign the auditor's report or sign or certify any other document of
the company, in accordance with the provisions of sub-section (2) of section
141 and the qualifications, observations or comments on financial transactions
or matters, which have any adverse effect on the functioning of the company
mentioned in the auditor's report shall be read before the company in general
meeting and shall be open to inspection by any member of the company.
(3) Duty to comply with Auditing Standards: As per sub-section 9 of section 143
of the Companies Act, 2013, every auditor shall comply with the auditing
standards. Further as per sub-section 10 of section 143 of the Act, the Central
Government may prescribe the standards of auditing or any addendum thereto,
as recommended by the Institute of Chartered Accountants of India, constituted
under section 3 of the Chartered Accountants Act, 1949, in consultation with
and after examination of the recommendations made by the National Financial
Reporting Authority:
Students may note that until any auditing standards are notified, any standard,
or standards of auditing specified by the Institute of Chartered Accountants of
India shall be deemed to be the auditing standards.
(4) Duty to audit report: As per sub-section (3) of section 143, the auditor’s
report shall also state –
(a) whether he has sought and obtained all the information and explanations
which to the best of his knowledge and belief were necessary for the
purpose of his audit and if not, the details thereof and the effect of such
information on the financial statements;
(b) whether, in his opinion, proper books of account as required by law have
been kept by the company so far as appears from his examination of
those books and proper returns adequate for the purposes of his audit
have been received from branches not visited by him;
(c) whether the report on the accounts of any branch office of the company
audited under sub-section (8) by a person other than the company’s
auditors has been sent to him under the proviso to that sub-section and
the manner in which he has dealt with it in preparing his report;
(d) whether the company’s balance sheet and profit and loss account dealt
with in the report are in agreement with the books of account and returns;
(e) whether, in his opinion, the financial statements comply with the
accounting standards;
(f) the observations or comments of the auditors on financial transactions or
matters which have any adverse effect on the functioning of the company;
(g) whether any direct is disqualified from being appointed as a director under
subsection (2) of the section 164;
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(h) any qualification, reservation or adverse remark relating to the
maintenance of accounts and other matters connected therewith;
(i) whether the company has adequate internal financial controls system in
place and the operating effectiveness of such controls;
(j) Rule 11 of the Companies (Audit and Auditors) Rules, 2014 prescribes the
other matters to be included in auditor’s report. The auditor’s report shall
also include their views and comments on the following matters, namely:-
(i) whether the company has disclosed the impact, if any, of pending
litigations on its financial position in its financial statement;
(ii) whether the company has made provision, as required under any
law or accounting standards, for material foreseeable losses, if any,
on long term contracts including derivative contracts;
(iii) whether there has been any delay in transferring amounts, required
to be transferred, to the Investor Education and Protection Fund by
the company.
(5) Duty to report on frauds: As per sub-section (12) of section 143 of the
Companies Act, 2013, if an auditor of a company, in the course of the
performance of his duties as auditor, has reason to believe that an offence
involving fraud is being or has been committed against the company by officers
or employees of the company, he shall immediately report the matter to the
Central Government within such time and in such manner prescribed in rule 13.
Rules 13 of the Companies (Audit and Auditors) Rules, 2014, prescribes that in
case the auditor has sufficient reason to believe that an offence involving fraud,
is being or has been committed against the company by officers or employees
of the company, he shall report the matter to the Central Government
immediately but not later than 60 days of his knowledge and after following the
procedure indicated herein below:
(i) auditor shall forward his report to the Board or the Audit Committee, as
the case may be, immediately after he comes to knowledge of the fraud,
seeking their reply or observations within 45 days;
(ii) on receipt of such reply or observations the auditor shall forward his report
and the reply or observations of the Board or the Audit Committee along
with his comments (on such reply or observations of the Board or the
Audit Committee) to the Central Government within 15 days of receipt of
such reply or observations;
(iii) in case the auditor fails to get any reply or observations from the Board or
the Audit Committee within the stipulated period of 45 days, he shall
forward his report to the Central Government along with a note containing
the details of his report that was earlier forwarded to the Board or the
Audit Committee for which he failed to receive any reply or observations
within the stipulated time.
Further, the report shall be sent to the Secretary, Ministry of Corporate Affairs
in a sealed cover by Registered Post with Acknowledgement Due or by Speed
post followed by an email in confirmation of the same. This report shall be on
the letter-head of the auditor containing postal address, e-mail address and
contact number and be signed by the auditor with his seal and shall indicate his
Membership Number. The report shall be in the form of a statement as
specified in Form ADT-4.
(6) Duty to report on any other matter specified by Central Government: The
Central Government may, in consultation with the National Financial Reporting
Authority, by general or special order, direct, in respect of such class or
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description of companies, as may be specified in the order, that the auditor's
report shall also include a statement on such matters as may be specified
therein.
(7) Duties and powers of the company’s auditor with reference to the audit of
the branch and the branch auditor are discussed separately in the chapter
under heading- branch audit.
(8) Duty to state the reason for qualification or negative report: As per sub-
section 4 of section 143, where any of the matters required to be included in the
audit report is answered in the negative or with a qualification, the report shall
state the reasons there for.
(7) Penalties
Section 147 of the Companies Act, 2013 prescribes following punishments for
contravention:
(1) If any of the provisions of sections 139 to 146 (both inclusive) is
contravened, the company shall be punishable with fine which shall not be
less than twenty-five thousand rupees but which may extend to five lakh
rupees and every officer of the company who is in default shall be
punishable with imprisonment for a term which may extend to one year or
with fine which shall not be less than ten thousand rupees but which may
extend to one lakh rupees, or with both.
(2) If an auditor of a company contravenes any of the provisions of section
139 section 143, section 144 or section 145, the auditor shall be
punishable with fine which shall not be less than twenty-five thousand
rupees but which may extend to five lakh rupees.
It may be noted that if an auditor has contravened such provisions
knowingly or willfully with the intention to deceive the company or its
shareholders or creditors or tax authorities, he shall be punishable with
imprisonment for a term which may extend to one year and with fine which
shall not be less than one lakh rupees but which may extend to twenty-
five lakh rupees.
(3) Where an auditor has been convicted under sub-section (2), he shall be
liable to-
(i) refund the remuneration received by him to the company;
(ii) and pay for damages to the company statutory bodies or authorities
or to any other persons for loss arising out of incorrect or misleading
statements of particulars made in his audit report.
(4) The Central Government shall, by notification, specify any statutory body
or authority of an officer for ensuring prompt payment of damages to the
company or the persons under clause (ii) of sub-section (3) and such
body, authority or officer shall after payment of damages the such
company or persons file a report with the Central Government in respect
of making such damages in such manner as may be specified in the said
notification.
(5) Where, in case of audit of a company being conducted by an audit firm, it
is proved that the partner or partners of the audit firm has or have acted in
a fraudulent manner or abetted or colluded in an fraud by, or in relation to
or by, the company or its directors or officers, the liability, whether civil
criminal as provided in this Act or in any other law for the time being in
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force, for such act shall be the partner or partners concerned of the audit
firm and of the firm jointly and severally.
(8) Branch audit Sec 143 (8)

Where a company has a branch office, the accounts of that office shall be
audited either by the auditor appointed for the company (herein referred to as
the company's auditor) under this Act or by any other person qualified for
appointment as an auditor of the company under this Act and appointed as
such under section 139, or where the branch office is situated in a country
outside India, the accounts of the branch office shall be audited either by the
company's auditor or by an accountant or by any other person duly qualified to
act as an auditor of the accounts of the branch office in accordance with the
laws of that country and the duties and powers of the company' s auditor with
reference to the audit of the branch and the branch auditor, if any, shall be such
as may be prescribed:
It may be noted that the branch auditor shall prepare a report on the accounts
of the branch examined by him and send it to the auditor of the company who
shall deal with it in his report in such manner as he considers necessary.
Further as per rule 12 of the Companies (Audit and Auditors) Rules, 2014, the
branch auditor shall submit his report to the company’s auditor and reporting of
fraud by the auditor shall also extend to such branch auditor to the extent it
relates to the concerned branch.
SA 600 Using the Work of another Auditor: When the accounts of the branch
are audited by a person other than the company’s auditor, there is need for a
clear understanding of the role of such auditor and the company’s auditor in
relation to the audit of the accounts of the branch and the audit of the company
(9) Joint audit- SA 299
It means audit of one entity is performed by more than one auditor. It is
generally implemented in large companies where it is difficult for one auditor to
complete the audit.
Joint auditors need to issue a common report expressing an opinion on true
and fair view of the financial position of the entity.
(A) Advantages and Disadvantages
In specific terms the advantages that flow may be the following:
(i) Sharing of expertise.
(ii) Advantage of mutual consultation.
(iii) Lower workload.
(iv) Better quality of performance.
(v) Improved service to the client.
(vi) In respect of multi-national companies, the work can be spread using
the expertise of the local firms which are in a better position to deal
with detailed work and the local laws and regulations.
(vii) Lower costs to carry out the work.
The general disadvantages may be the following:

(i) The fees being shared.
(ii) Psychological problem where firms of different standing are associated in
the joint audit.
(iii) General superiority complexes of some auditors.
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(iv) Problems of co-ordination of the work.
(v) Areas of work of common concern being neglected.
(B) Responsibility division and work allocation:

All the joint auditors are jointly and severally responsible for
(a) in respect of the audit work which is not divided among the joint
auditors and is carried out by all of them;
(b) in respect of decisions taken by all the joint auditors concerning the
nature, timing or extent of the audit procedures to be performed
(c) in respect of matters which are brought to the notice of the joint
auditors by any one of them and on which there is an agreement
among the joint auditors;
(d) for examining that the financial statements of the entity comply with
the disclosure requirements of the relevant statute; and
(e) for ensuring that the audit report complies with the requirements of
the relevant statute
However, in respect of audit work divided among the joint auditors, each
joint auditor is responsible only for the work allocated to him.
Where joint auditors are appointed, they should, by mutual discussion,
divide the audit work among themselves. The division of work would
usually be in terms of audit of identifiable units or specified areas. In some
cases, due to the nature of the business of the entity under audit, such a
division of
work may not be possible. In such situations, the division of work may be
with reference to items of assets or liabilities or income or expenditure or
with reference to periods of time.
(10) Cost audit- Sec 148

As per section 148 the Central Government may by order specify audit of items
of cost in respect of certain companies.
Applicability of Cost Audit:
Rule 4 of the Companies (Cost Records and Audit) Rules, 2014 states the
provisions related to the applicability of cost audit depending on the turnover of
the company as follows-
(i) Classes of companies specified under item (A) “Regulated Sectors” are
required to get its cost records audited if the overall annual turnover of the
company from all its products and services during the immediately
preceding financial year is ` 50 crore or more and the aggregate turnover
of the individual product(s) or service(s) for which cost records are
required to be maintained under rule 3 is ` 25 crore or more.
(ii) Classes of companies specified under item (B) “Non-Regulated Sectors”
are required to get its cost records audited if the overall annual turnover of
the company from all its products and services during the immediately
preceding financial year is ` 100 crore or more and the aggregate
turnover of the individual product(s) or service(s) for which cost records
are required to be maintained under rule 3 is ` 35 crore or more.
Who can be Cost Auditor: The audit shall be conducted by a Cost Accountant
in Practice who shall be appointed by the Board of such remuneration as may
be determined by the members in such manner as may be prescribed. It may
be noted that no person appointed under section 139 as an auditor of the
company shall be appointed for conducting the audit of cost records.
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It may also be noted that the auditor conducting the cost audit shall comply with
the cost auditing standards ("cost auditing standards" mean such standards as
are issued by the Institute of Cost and Works Accountants of India, constituted
under the Cost and Works Accountants Act, 1959, with the approval of the
Central Government).
Appointment of Cost Auditor: Rule 6 of the Companies (Cost Records and
Audit) Rules, 2014 requires the companies prescribed under the said Rules to
appoint an Auditor within 180 days of the commencement of every financial
year. Every referred company shall inform the cost auditor concerned of his or
its appointment as such and file a notice of such appointment with the Central
Government within a period of 30 days of the Board meeting in which such
appointment is made or within a period of 180 days of the commencement of
the financial year, whichever is earlier, through electronic mode, in Form CRA-
2, along with the fee as specified in Companies (Registration Offices and Fees)
Rules, 2014.
The cost auditor appointed as such shall continue in such capacity till the expiry
of 180 days from the closure of the financial year or till he submits the cost
audit report, for the financial year for which he has been appointed.
Casual Vacancy in the Office of a Cost Auditor: Any casual vacancy in the
office of a Cost Auditor, whether due to resignation, death or removal, shall be
filled by the Board of Directors within 30 days of occurrence of such vacancy
and the company shall inform the central government in Form CRA-2 within 30
days of such appointment of cost auditor.
Remuneration of Cost Auditor: As per rule 14 of the Companies (Audit and
Auditors) Rules, 2014-
(a) in the case of companies which are required to constitute an audit
committee-
(i) the Board shall appoint an individual, who is a cost accountant in
practice, or a firm of cost accountants in practice, as cost auditor on
the recommendations of the Audit committee, which shall also
recommend remuneration for such cost auditor;
(ii) the remuneration recommended by the Audit Committee under (i)
shall be considered and approved by the Board of Directors and
ratified subsequently by the shareholders;
(b) in the case of other companies which are not required to constitute
an audit committee, the Board shall appoint an individual who is a cost
accountant in practice or a firm of cost accountants in practice as cost
auditor and the remuneration of such cost auditor shall be ratified by
shareholders subsequently.
Qualification, Disqualification, Rights, Duties and Obligations of Cost

Auditor: The qualifications, disqualifications, rights, duties and obligations
applicable to auditors under this Chapter shall, so far as may be applicable,
apply to a cost auditor appointed under this section and it shall be the duty of
the company to give all assistance and facilities to the cost auditor appointed
under this section for auditing the cost records of the company.
Submission of Cost Audit Report:

(i) To the Board of Directors of the Company- The cost auditor shall submit
the cost audit report along with his reservations or qualifications or
observations or suggestions, if any, in Form CRA-3. He shall forward his
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report to the Board of Directors of the company within a period of 180
days from the closure of the financial year to which the report relates and
the Board of Directors shall consider and examine such report particularly
any reservation or qualification contained therein.
(ii) To the Central Government- The company shall within 30 days from the
date of receipt of a copy of the cost audit report prepared (in pursuance of
a direction issued by Central Government) furnish the Central
Government with such report along with full information and explanation
on every reservation or qualification contained therein in Form CRA-4.
Duty to Report on Fraud: The provisions of section 143(12) of the Companies
Act, 2013 and the relevant rules on duty to report on fraud shall apply mutatis
mutandis to a cost auditor during performance of his functions under section
148 of the Act and these rules.
Cost Audit Rules Not to Apply in Certain Cases: Sub-rule (3) of rule 4
provides that the requirement for cost audit under these rules shall not be
applicable to a company which is covered under Rule 3, and,
(i) whose revenue from exports, in foreign exchange, exceeds 75% of its
total revenue; or
(ii) which is operating from a special economic zone.
(11) CARO 2016

Companies Auditor’s Report Order, 2016
(Issued by MCA dated 29th March ,2016)
The Order is not intended to limit the duties and responsibilities of auditors but
only requires a statement to be included in the audit report in respect of the
matters specified therein.
The requirements of the Order are supplemental to the existing provisions of
section 143 of the Act regarding the auditor’s report.
Applicability of the Order
The Order applies to all companies including foreign companies as defined
under Companies Act, 2013.
CARO is NOT APPLICABLE to the following:
(i) a banking company as defined under Banking Regulation Act, 1949;
(ii) an insurance company as defined under the Insurance Act, 1938;
(iii) a company licensed to operate under section 8 of the Companies Act,
2013;
(iv) a One person Company as defined under section 2(62) of the Companies
Act, 2013;
(v) a Small Company as defined under 2(85) of the Companies Act 2013;
and
(v) a private limited company, not being a subsidiary or holding company of a
public company, having
(a) a paidup capital and reserves and surplus not more than rupees one
crore as on the balance sheet date and
(b) which does not have total borrowings exceeding rupees one crore
from any bank or financial institution at any point of time during the
financial year and
(c) which does not have a total revenue exceeding rupees ten crores
during the financial year as per the financial statements.
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A private limited company, in order to be exempt from the applicability of
the Order, must satisfy all the conditions mentioned above collectively. In
other words, even if one of the conditions is not satisfied, a private limited
company’s auditor has to report on the matters specified in the Order.
The applicability of the Order would be based on the status of the
company as at the balance sheet date for the financial year under audit.
Consolidated Financial Statements
The Order specifically provides that it shall not apply to the auditor’s report
on consolidated financial statements.
Branches
The Order is also applicable to the audits of branch(es) of a company since
sub-section 8 of section 143 of the Act read with Rule 12 of the Companies
(Audit and Auditors) Rules, 2014 clearly specifies that a branch auditor has the
same duties in respect of audit as the company’s auditor. It is, therefore,
necessary that the report submitted by the branch auditor contains a statement
on all the matters specified in the Order, as applicable to the company.
Matters to be included in the Auditor’s Report
(1) Fixed Assets
(a) whether the company is maintaining proper records showing full
particulars, including quantitative details and situation of fixed
assets;
(b) whether these fixed assets have been physically verified by the
management at reasonable intervals; whether any material
discrepancies were noticed on such verification and if so, whether
the same have been properly dealt with in the books of account;
(c) whether the title deeds of immovable properties are held in the name
of the company. If not, provide the details thereof;
(2) Inventory
whether physical verification of inventory has been conducted at
reasonable intervals by the management and whether any material
discrepancies were noticed and if so, whether they have been properly
dealt with in the books of account;
(3) Loans given by the company (Secured and Unsecured)
Whether the company has granted any loans, secured or unsecured to
companies, firms, Limited Liability Partnerships or other parties covered
in the register maintained under section 189 of the Companies Act, 2013.
If so,
(a) whether the terms and conditions of the grant of such loans are not
prejudicial to the company’s interest;
(b) whether the schedule of repayment of principal and payment of
interest has been stipulated and whether the repayments or receipts
are regular;
(c) if the amount is overdue, state the total amount overdue for more
than ninety days, and whether reasonable steps have been taken by
the company for recovery of the principal and interest;
(4) Compliance of Sec 185 and Sec 186 of Companies Act 2013
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In respect of loans, investments, guarantees, and security whether
provisions of section 185 and 186 of the Companies Act, 2013 have
been complied with. If not, provide the details thereof.
(5) Acceptance of Deposits
(a) In case, the company has accepted deposits, whether the directives
issued by the Reserve Bank of India and the provisions of sections
73 to 76 or any other relevant provisions of the Companies Act, 2013
and the rules framed thereunder, where applicable, have been
complied with? If not, the nature of such contraventions be stated.
(b) If an order has been passed by Company Law Board or National
Company Law Tribunal or Reserve Bank of India or any court or any
other tribunal, whether the same has been complied with or not?
(6) Cost Records
Whether maintenance of cost records has been specified by the Central
Government under sub-section (1) of section 148 of the Companies Act,
2013 and whether such accounts and records have been so made and
maintained.
(7) Statutory Dues
(a) Undisputed Statutory Dues : whether the company is regular in
depositing undisputed statutory dues including provident fund,
employees' state insurance, income-tax, sales-tax, service
tax, duty of customs, duty of excise, value added tax, cess and any
other statutory dues to the appropriate authorities and if not, the
extent of the arrears of outstanding statutory dues as on the last day
of the financial year concerned for a period of more than six months
from the date they became payable, shall be indicated;
(b) Disputed Statutory Dues : where dues of income tax or sales tax or
service tax or duty of customs or duty of excise or value added tax
have not been deposited on account of any dispute, then the
amounts involved and the forum where dispute is pending shall be
mentioned.
(A mere representation to the concerned Department shall not be
treated as a dispute).
(8) Default in repayment of Loans or Borrowings
(a) Whether the company has defaulted in repayment of loans or
borrowing to a financialinstitution, bank, Government or dues to
debenture holders?
If yes, the period and the amount of default to be reported.
(9) Public Offer and money raised by debt and Term Loans
(a) Whether moneys raised by way of initial public offer or further public
offer (including debt instruments) and term loans were applied for
the purposes for which those are raised.
If not, the details together with delays or default and subsequent
rectification, if any, as may be applicable, be reported.
(10) Fraud
(a) Whether any fraud by the company or any fraud on the Company by
its officers or employees has been noticed or reported during the
year.
If yes, the nature and the amount involved is to be indicated.
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(11) Managerial Remuneration
(a) Whether managerial remuneration has been paid or provided in
accordance with the requisite approvals mandated by the provisions
of section 197 read with Schedule V to the Companies Act?
If not, state the amount involved and steps taken by the company for
securing refund of the same.
(12) Nidhi Company

(a) Whether the Nidhi Company has complied with the Net Owned
Funds to Deposits in the ratio of 1: 20 to meet out the liability and
(b) Whether the Nidhi Company is maintaining ten per cent
unencumbered term deposit as specified in the Nidhi Rules, 2014 to
meet out the liability.
(13) Related Parties

(a) Whether all transactions with the related parties are
- in compliance with sections 177 and 188 of Companies Act,
2013 where applicable and
- the details have been disclosed in the Financial Statements
etc., as required by the applicable accounting standards(AS-
18).
(14) Allotment
(a) If the company has made any
- preferential allotment or
- private placement of shares or
- fully or partly convertible debentures
during the year under review then whether
- the requirement of section 42 of the Companies Act, 2013
have been complied with and
- The amount raised have been used for the purposes for which
the funds were raised. (b) If not, provide the details in respect
of the amount involved and nature of non compliance;
(15) Non Cash Transaction

Whether the company has entered into any non-cash transactions with
directors or persons connected with him and if so, whether the provisions
of section 192 of
Companies Act, 2013 have been complied with.
(16) Registration under Reserve Bank of India Act ,1934

Whether the company is required to be registered under section 45-IA of
the Reserve Bank of India Act,1934 and if so, whether the registration
has been obtained.
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Reasons to be stated for unfavourable or qualified answers
(1) Where, in the auditor's report, the answer to any of the questions referred
to in paragraph 3 is unfavourable or qualified, the auditor's report shall
also state the basis for such unfavourable or qualified answer, as the case
may be.
(2) Were the auditor is unable to express any opinion on any specified matter,
his report shall indicate such fact together with the reasons as to why it is
not possible for him to give his opinion on the same.
(12) Ceiling Limit on Number of Audit

Maximum number of companies that can be audited by an individual- 20
companies
Limit needs to be verified as on the date of appointment and reappointment of
the auditor
Companies included
a) Public Companies
b) Private Limited companies with paid up share capital of Rs. 100 crore or
more as on the date of appointment/reappointment
Companies excluded
Any other class of company.
(1) In computing the specified number of audit assignments-
(a) the number of such assignments, which he or any partner of his firm
has accepted whether singly or in combination with any other
chartered accountant in practice or firm of such chartered
accountants, shall be taken into account.
(b) the number of partners of a firm on the date of acceptance of audit
assignment shall be taken into account.
(c) a chartered accountant in full time employment elsewhere shall not
be taken into account.
(2) A chartered accountant in practice as well as firm of chartered
accountants in practice shall maintain a record of the audit assignments
accepted by him or by the firm of chartered accountants, or by any of the
partner of the firm in his individual name or as a partner of any other firm
as far as possible, in the prescribed manner.
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QUESTIONS
Q. 1. Mr. Ram, a relative of a Director was appointed as an auditor of the

company. Comment.
Q. 2. While doing the audit, X, the Statutory Auditor of ABC Ltd. observes that
certain loans and advances were made without proper securities, certain
debtors and creditors were adjusted inter se, and personal expenses were
charged to revenue. Comment.
Q. 3. As an auditor, how would you deal with the following?

In the audit of ABC Private Limited, auditor came across cases of payments
to Directors,
whereby, expenses of a personal nature were re-imbursed.
Q. 4. A company has a branch office which recorded a turnover of ` 1,90,000 in

the financial year 2004-05. No audit of the branch has been carried out. The
statutory auditor of the company has made no reference of the above branch
in his report. The total turnover of the company is ` 10 crores for the year
2004-05. Comment.
Q. 5. An auditor purchased goods worth ` 501,500 on credit from a company being

audited by him. The company allowed him one month’s credit, which it
normally allowed to all known customers.
Q. 6. ‘At the AGM of ICI Ltd., Mr. X was appointed as the statutory auditor. He,
however, resigned after 3 months since he wanted to give up practice and
join industry. State, how the new auditor will be appointed by ICI Ltd and the
conditions to be complied for.
Q. 7. Give your comments and observations on the following:

KBC & Co. a firm of Chartered Accountants has three partners, K, B & C; K
is also in whole time employment elsewhere. The firm is offered the audit of
ABC Ltd. and is
already holding audit of 40 companies.
Q. 8. At an Annual General Meeting of a listed company, Mr. R a retiring auditor

after completing the tenure of five consecutive years of his service claims
that he has been reappointed automatically, as the intended resolution of
which a notice had been given to appoint Mr. P, could not be proceeded
with, due to Mr. P's death.
Q. 9. What will be position of the Auditor in the following case:

A, a chartered accountant has been appointed as auditor of Laxman Ltd. In
the Annual
General Meeting of the company held in September, 2013, which
assignment he accepted. Subsequently in January, 2014 he joined B,
another chartered accountant, who is the Manager Finance of Laxman Ltd.,
as partner.
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Q. 10. What will be position of the Auditor in the following case:
Y, is the auditor of X Pvt. Ltd. In which there are four shareholders only, who
are also the Directors of the company. On account of bad trade and for
reducing the expenses in all directions, the directors asked Y to accept a
reduced fee and for that he has been offered not to carry out such full audit
as he has done in the past. Y accepted the suggestions of the directors.
Q. 11. While conducting the audit of a limited company for the year ended 31st
March, 2014, the auditor wanted to refer to the Minute Books. The Board of
Directors refused to show the Minute Books to the auditor.
Q. 12. Comment on the following:

Due to the resignation of the existing auditor(s), the Board of directors of X
Ltd appointed
Mr. Hari as the auditor. Is the appointment of Hari as auditor valid?

At the Annual General Meeting of the Company, a resolution was passed by
the entire
body of shareholders restricting some of the powers of the Statutory
Auditors. Whether
powers of the Statutory Auditors can be restricted?
Q. 14. State with reasons your views on the following:

Ram and Hanuman Associates, Chartered Accountants in practice have
been appointed as Statutory Auditor of Krishna Ltd. for the accounting year
2013-2014. Mr. Hanuman holds 100 equity shares of Shiva Ltd., a subsidiary
company of Krishna Ltd.
Q. 15. Mr. Rajendra, a fellow member of the Institute of Chartered Accountants of

India, working as Manager of Shrivastav and Co., a Chartered Accountant
firm, signed the audit report of Om Ltd. on behalf of Shrivastav & Co.
Q. 16. As an auditor, comment on the following situations/statements:

The first auditors of Health and Wealth Ltd., a Government company, was
appointed by the Board of Directors.
Q. 17. The auditor of Trilok Ltd. did not report on the matters specified in sub-
section (1) of Section 143 of the Companies Act, 2013, as he was satisfied
that no comment is required.
Q. 18. The members of C. Ltd. preferred a complaint against the auditor stating that
he has failed to send the auditors report to them.
Q. 19. One of the directors of Hitech Ltd. is attracted by the disqualification under
Section 164(2) of the Companies Act, 2013.
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Q. 20. E and S were appointed as Joint Auditors of X and Y Ltd. What will be their
professional responsibility in a case where the company has cleverly
concealed certain transactions that escaped the notice of both the Auditors.
Q. 21. ‘B’ owes ` 5,01,000 to ‘C’ Ltd., of which he is an auditor. Is his appointment
valid? Will it make any difference, if the advance is taken for meeting-out
travelling expenses?
Q. 22. As an auditor, comment on the following situations/statements:

The Board of Directors of a company have filed a complaint with the Institute
of Chartered Accountants of India against their statutory auditors for their
failing to attend the Annual General Meeting of the Shareholders in which
audited accounts were considered.
Q. 23. Give your comments on the following:

Mr. Aditya, a practising chartered accountant is appointed as a “Tax
Consultant” of ABC Ltd., in which his father Mr. Singhvi is the Managing
Director.

You, the Auditor of A Ltd., have been considered for ratification by the
members in the 4th general meeting as the sole auditor, where you were one
of the joint auditors for the immediately preceding three years and the said
joint auditors are not re-appointed.

No Annual General Meeting (AGM) was held for the year ended 31st March,
2014, in XYZ Ltd., Ninu is the auditor for the previous 3 years, whether she
is continuing to hold office for current year or not.
Q. 26. Managing Director of PQR Ltd. himself wants to appoint Shri Ganpati, a
practicing Chartered Accountant, as first auditor of the company. Comment
on the proposed action of the Managing Director.
Q. 27. PBS & Associates, a firm of Chartered Accountants, has three partners P, B
and S. The firm is already having audit of 45 companies. The firm is offered
20 company audits.
Decide and advise whether PBS & Associates will exceed the ceiling
prescribed under
Section 141(3)(g) of the Companies Act, 2013 by accepting the above audit
assignments?
Q. 28. During the year 2013-14, it was decided for the first time that the accounts of
the branch office of AAS Company Limited be audited by qualified Chartered
Accountants other than the company auditor. Accordingly, the Board had
appointed branch auditors for the ensuing year.
One of the shareholders complained to the Central Government that the
appointments was not valid as the Board of Directors do not have power to
appoint auditors, be they Company Auditor or Branch Auditors?
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M/s Young & Co., a Chartered Accountant firm, and Statutory Auditors of Old
Ltd., is dissolved on 1.4.2014 due to differences of opinion among the
partners. The Board of
Directors of Old Ltd. in its meeting on 6.4.2014 appointed another firm M/s
Sharp & Co. as their new auditors for one year.

Mr. Fat, auditor of Thin Ltd., has his office and residence in the building
owned by Thin
Ltd. Mr. Fat has been given 10% concession in rent by the company as
compared to other tenants.

M/s XYZ & Co., auditors of Goodwill Education Foundation, a recognised
nonprofit
organisation feels that the standards on auditing need not to be applied as
Goodwill
Education Foundation is a non-profit making concern.

Nickson Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been
held by Central
Government, 25% by Uttar Pradesh Government and 10% by Madhya
Pradesh Government. Nickson Ltd. appointed Mr. P as statutory auditor for
the year.

Mr. Amar, a Chartered Accountant, bought a car financed at ` 7,00,000 by
Chaudhary Finance Ltd., which is a holding company of Charan Ltd. and
Das Ltd. He has been the
statutory auditor of Das Ltd. and continues to be to even after taking the
loan.
Q. 34. R.K. & Company are the auditors of PQR Company Ltd. The Managing
Director of the Company demands copies of the working papers from the
auditors. Are the auditors bound to oblige the Managing Director?
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ANSWERS
Ans. 1. Appointment of the Auditor: Section 141 of the Companies Act 2013 (herein
after referred as the Act) deals with the eligibility, qualifications and
disqualifications of Auditors. Subsection (3)(f) of the Section 141 of the Act,
explicitly disqualifies a person from being appointed 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.
According to the Code of Ethics there is no direct restriction on a member to
accept the audit of a company where his relative is director. Further, as per
Clause 4 of Part 1 of the Second Schedule to the Chartered Accountants
Act, 1949 there is professional misconduct if the member expresses his
opinion on financial statements of any business or enterprise in which he, his
firm or a partner in his firm has a substantial interest. Here also there is no
mention of relative. But this clause has been inserted for the purpose of
ensuring the independence of the auditor so that his opinion on the financial
statements is an independent opinion free of any interest.
In August 2008, the council has issued a guideline in this respect. As per
that guideline a member of the institute shall desist from expressing his
opinion on financial statements of any business or enterprise in which one or
more persons, who are relatives within the meaning of section 6 of the
Companies Act, 1956 (now Section 2(77) of the Companies Act, 2013), have
either by way of themselves or in conjunction with such members, a
substantial interest in the said business or enterprise. Therefore if the
director has substantial interest in the company then his relative should not
accept the appointment of auditor of that company.
In the instant case, Mr. Ram is the relative of a Director of the Company,
therefore he should not accept the appointment as an auditor of that
company.
Ans.2. Audit Report: Section 143(1) of the Companies Act, 2013 requires the
auditor to make an enquiry in respect of specified matters during the course
of his audit. Since the law requires the auditor to make an enquiry, the
Institute opined that the auditor is not required to report on the matters
specified in sub-section (1) unless he has any special comments to make on
any of the items referred to therein. If the auditor is satisfied as a result of the
enquiries, he has no further duty to report that he is so satisfied. It is to be
noted that the auditor is required to make only enquiries and not investigate
into the matters referred to therein.
Clause (a) of Section 143(1) requires the auditor to inquire: “Whether loans
and advances made by the company on the basis of security have been
properly secured and whether the terms on which they have been made are
prejudicial to the interests of the company or its
members”.
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If the auditor finds that the loans and advances have not been properly
secured, he may enter an adverse comment in the report but cannot
probably doubt the true view of the accounts by reference to this fact so long
the loans and advances are properly described and presented in terms of
Part I of Schedule III to the Companies Act. Further the auditor to inquire
whether or not the terms on which the loans or advances have been made
are prejudicial to the interests of the company or its members. If it is, he
should qualify his report.
If debtors and creditors are adjusted inter se, this amounts to merely book
entries. The auditor, as per clause (b) of section 143(1), should enquire
“whether transactions of the company which are represented merely by book
entries are prejudicial to the interests of the company”. This proposition has
got to be inquired into by reference to the effects of the book entries,
unsupported by transactions, on the legitimate interests of the company. The
auditor has to exercise his judgment based on certain objective standards”.
Regarding Personal Expenses, Clause (e) of section 143(1) requires the
auditor to inquire:
“Whether personal expenses have been charged to revenue account”. The
charging to revenue of such personal expenses, either on the basis of the
company’s contractual obligations, or in accordance with accepted business
practice, is perfectly normal and legitimate or does not call for any special
comment by the auditor. Where, however, personal expenses not covered
by contractual obligations or by accepted business practice are incurred by
the company and charged to revenue account, it would be the duty of the
auditor to report thereon. It suffices to say that if the auditor finds that
personal expenses have been charged to revenue and if the amounts are
material, he should qualify his report also. In the instant case, Mr. X, the
statutory auditor of ABC Ltd., needs to enquire in light of above provisions,
as a result of the enquiries if he is satisfied then there is no further duty to
report on these matters.
Ans. 3. Reimbursement of personal expenses of Director: All payments to Directors

as remuneration or perquisites whether in the case of a public or private
company are required to be authorised both in accordance with the
Companies Act and Articles of Association of the company. Articles may
provide that such remuneration require sanction of the shareholders either
by ordinary or special resolution while in some cases it may require only
approval of Directors. If the terms of appointment of a Director include
payment of expenses of a personal nature, then such expenses can be
incurred by the company; otherwise, no such expense can be incurred or
reimbursed by the company. In the instant case the auditor has to ensure
that the above is complied with, without which, if such expenses are paid, he
has to disclose the fact in his report, as also in the accounts. In this regard
attention is invited to section 143(1)(e) of the Companies Act, 2013 wherein
auditor has to inquire into whether personal expenses have been charged to
revenue.
Ans. 4. As per section 143(8) of the Companies Act, 2013 if a company has a
branch office, the accounts of that office shall be audited either by the
auditor appointed for the company (herein referred to as the company's
auditor) under this Act or by any other person qualified for appointment as an
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auditor of the company under this Act and appointed as such under section
139, or where the branch office is situated in a country outside India, the
accounts of the branch office shall be audited either by the company's
auditor or by an accountant or by any other person duly qualified to act as an
auditor of the accounts of the branch office in accordance with the laws of
that country.
Therefore, the company has to get its branch audited. In case no branch
audit has been carried out, company’s auditor is required to mention this fact
in the audit report and deal appropriately.
Ans. 5. Purchase of goods on credit by the auditor: Section 141(3)(d)(ii) of the

Companies Act, 2013 specifies that a person shall be disqualified to act as
an auditor if he is indebted to the company for an amount exceeding five
lakh rupees.
Where an auditor purchases goods or services from a company audited by
him on credit, he is definitely indebted to the company and if the amount
outstanding exceeds rupees five lakh, he is disqualified for appointment as
an auditor of the company.
It will not make any difference if the company allows him the same period of
credit as it allows to other customers on the normal terms and conditions of
the business. The auditor cannot argue that he is enjoying only the normal
credit period allowed to other customers. In fact, in such a case he has
become indebted to the company and consequently he has deemed to have
vacated his office.
Ans. 6. Appointment of New Auditor in case of Resignation: Section 139(8) of the

Companies Act, 2013 deal with provisions relating to appointment of auditor
caused due to casual vacancy. A casual vacancy normally arises when an
auditor ceases to act as such after he has been validly appointed, e.g.,
death, disqualification, resignation, etc. In the instance case, Mr. X has been
validly appointed and thereafter he had resigned.
The law provides that in case a casual vacancy has been created by the
resignation of the auditor (as in this case), the Board cannot fill in that
vacancy itself, such
appointment shall also be approved by the company at general meeting
convened
within three months of the recommendation of the board and then he shall
hold office till the conclusion of the nest annual general meeting..
In this case the casual vacancy has been created on account of resignation.
Therefore, Board of Directors will have to fill the vacancy within thirty days
and such appointment shall be approved by the company at the general
meeting within three months of the recommendations of the board. . The
new auditor so appointed shall hold office only till the conclusion of the next
annual general meeting.
The provisions of the Companies Act, 2013 applicable for the appointment of
an auditor in place of a retiring auditor would equally applicable in the instant
case are given below:
(i) Section 140(4)(i): Special notice shall be required for a resolution at
an annual general meeting appointing as auditor a person other than
a retiring auditor.
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(ii) Section 115: Special notice is to be given by such number of
members holding not less than one percent of total voting power or
holding shares on which such an aggregate sum of not exceeding
five lakh rupees has been paid upto the date of the notice. The
notice shall be sent by the members to the company at least seven
days before the date of the meeting.
(iii) Section 140(4)(ii): On receipt of notice of such a resolution, the
company shall forthwith send a copy thereof to the retiring auditor.
(iv) Section 140(4)(iii): Representation if any, received from the retiring
auditor should be sent to the members of the company.
(v) Section 139: Before any appointment or reappointment of auditors is
made at an annual general meeting, a written certificate is to be
obtained from the auditor proposed to be appointed that his
appointment will be in accordance with the limits specified in Section
141(3)(g).
(vi) The incoming auditor should also satisfy himself that the notice
provided for under Sections 139 and 140 has been effectively served
on the outgoing auditor.
Ans. 7. Ceiling on Number of Company Audits: As per section 141(3)(g) of the

Companies Act, 2013, a person shall not be eligible for appointment as an
auditor if he is in full time employment elsewhere or a person or a partner of
a firm holding appointment as its auditor, if such person or partner is at the
date of such appointment or reappointment holding appointment as auditor
of more than twenty companies. In the firm of KBC & Co., K is in whole-time
employment elsewhere, therefore, he will be excluded in determining the
number of company audits that the firm can hold. If B and C do not hold any
audits in their personal capacity or as partners of other firms, the total
number of company audits that can be accepted by KBC & Co., is forty, and
in the given case company is already holding forty audits, therefore, KBC &
Co. can’t accept the offer for audit of ABC Ltd.
Ans. 8. Term of Auditor: Section 139(2) of the Companies Act, 2013 deals with the
term of an Auditor which provides that listed companies and other prescribed
class or classes of companies (except one person companies and small
companies) shall not appoint or reappoint an individual as auditor for more
than one term of five consecutive years.
In the given case, notice has been given of an intended resolution to appoint
some person or persons in the place of a retiring auditor, and by reason of
the death, incapacity or disqualification of that person or of all those persons,
as the case may be, the resolution cannot be proceeded with and
consequently casual vacancy in the office has been created." Therefore as
per Section 139(8) of the Companies Act, 2013, casual vacancy to be filled
by the Board of Directors within thirty days. Thus, the claim of Mr. R would
not hold good.
Ans. 9. Disqualifications of an Auditor: Section 141(3)(c) of the Companies Act, 2013

prescribes that any person who is a partner or in employment of an officer or
employee of the company will be disqualified to act as an auditor of a
company.
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Sub-section (4) of Section 141 provides that an auditor who incurs any of the
vacate his office as such auditor. In the present case, A, an auditor of M/s
Laxman Ltd., joined as partner with B, who is Manager Finance of M/s
Laxman Limited, has attracted clause (3) (c) of Section 141 and, therefore,
he shall be deemed to have vacated office of the auditor of M/s Laxman
Limited.
Ans. 10.Restricting Scope of Audit: Y may agree to temporary reduction in audit

fees, if he so wishes, in view of the suggestions made by the directors
(perhaps in accordance with the decision of the company taken in general
meeting). But his duties as a company auditor are laid down by law and no
restriction of any kind can restrict the scope of his work either by the director
or even by the entire body shareholders.
There is no concept of full or part audit under Section 143 of the Companies
Act, 2013. Further, remuneration is a matter of arrangement between the
auditor and the shareholders. Section 142 specifies the remuneration of an
auditor, shall be fixed by the company in general meeting or in such manner
as the company in general meeting may determine.
His duties may not necessarily commensurate with his remuneration. Y,
therefore, should not accept the suggestions of the directors regarding the
scope of the work to be done. Even if Y accepts the suggestions of the
directors regarding the scope of work to be done, it would not reduce his
responsibility as an auditor under the law. Under the circumstances, Y is
violating the provisions of the Companies Act, 2013.
Ans. 11. Right of Access to Minute Books: Section 143 of the Companies Act, 2013
grants powers to the auditor that every auditor has a right of access, at all
times, to the books and account including all statutory records such as
minute books, fixed assets register, etc. of the company for conducting the
audit.
In order to verify actions of the company and to vouch and verify some of the
transactions of the company, it is necessary for the auditor to refer to the
decisions of the shareholders and/or the directors of the company.
It is, therefore, essential for the auditor to refer to the Minute Books. In the
absence of the Minute Books, the auditor may not be able to vouch/verify
certain transactions of the company.
In case the directors have refused to produce the Minute Books, the auditor
may consider extending the audit procedure as also consider qualifying his
report in any appropriate manner.
Ans.12.Board's Powers to Appoint an Auditor: As per Section 139(8) of the

Companies Act, 2013, any casual vacancy in the office of an auditor shall-
(i) In the case of a company other than a company whose accounts are
subject to audit by an auditor appointed by the Comptroller and
Auditor-General of India, be filled by the Board of Directors within
thirty days.
If such casual vacancy is as a result of the resignation of an auditor,
such appointment shall also be approved by the company at a
general meeting convened within three months of the
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recommendation of the Board and he shall hold the office till the
conclusion of the next annual general meeting;
(ii) In the case of a company whose accounts are subject to audit by an
auditor appointed by the Comptroller and Auditor-General of India,
be filled by the Comptroller and Auditor-General of India within thirty
days:
It may be noted that in case the Comptroller and Auditor-General of
India does not fill the vacancy within he said period the Board of
Directors shall fill the vacancy within next thirty days.
Ans. 13.Restrictions on Powers of Statutory Auditors: Section 143 of the Companies
Act, 2013 provides that an auditor of a company shall have right of access at
all times to the books and accounts and vouchers of the company whether
kept at the Head Office or other places and shall be entitled to require from
the offices of the company such information and explanations as the auditor
may think necessary for the purpose of his audit. These specific rights have
been conferred by the statute on the auditor to enable him to carry out his
duties and responsibilities prescribed under the Act, which cannot be
restricted or abridged in any manner.
Hence, any such resolution even if passed by entire body of shareholders is
ultra vires and therefore void.
Ans.14.Auditor holding securities of a company : As per sub-section (3)(d)(i) of

Section 141 of the Companies Act, 2013 along with Rule 10 of the
Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for
appointment as an auditor of a company, who, or his relative or partner is
holding any security of or interest in the company or its subsidiary, or of its
holding or associate company or a subsidiary of such holding company.
Provided that the relative may hold security or interest in the company of
face value not exceeding rupees one lakh.
Also, as per sub-section 4 of Section 141 of the Companies Act, 2013,
where a person appointed as an auditor of a company incurs any of the
vacate his office as such auditor and such vacation shall be deemed to be a
casual vacancy in the office of the auditor.
In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s
Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd. which
is a subsidiary of Krishna Ltd. Threfore, the firm, M/s Ram and Hanuman
Associates would be disqualified to be appointed as statutory auditor of
Krishna Ltd., which is the holding company of Shiva Ltd., because one of the
partner Mr. Hanuman is holding equity shares of its subsidiary.
Ans.15. Signature on Audit Report: Section 145 of the Companies Act, 2013 requires
that the person appointed as an auditor of the company shall sign the
auditor’s report or sign or certify any other document of the company in
accordance with the provisions of sub-section (2) of section 141 i.e. where a
firm including a limited liability partnership is appointed as an auditor of a
company, only the partners who are chartered accountants shall be
authorized to act and sign on behalf of the firm.
Therefore, Mr. Rajendra, a fellow member of the Institute and a manager of
M/s Shrivastav & Co., Chartered Accountants, cannot sign on behalf of the
firm in view of the specific requirements of the Companies Act, 2013. If any
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auditor’s report or any document of the company is signed or authenticated
otherwise than in conformity with the requirements of Section 145, the
auditor concerned and the person, if any, other than the auditor who signs
the report or signs or authenticates the document shall, if the default is
willful, be punishable with a fine.
Ans.16.Appointment of the First Auditor by the Board of Directors: Section 139(6) of

the Companies Act, 2013 (the Act) lays down that “the first auditor or
auditors of a company shall be appointed by the Board of directors within 30
days from the date of registration of the company”. Thus, the first auditor of a
company can be appointed by the Board of Directors within 30 days from the
date of registration of the company. However, in the case of a Government
Company, the appointment of first auditor is governed by the provisions of
Section 139(7) of the Companies Act, 2013. Hence in the case of M/s Health
and Wealth Ltd., being a government company, the first auditors shall be
appointed by the Comptroller and Auditor General of India.
Thus, the appointment of first auditors made by the Board of Directors of M/s
Health and Wealth Ltd., is null and void.
Ans. 17.Comment on Matters Contained under Section 143(1) of the Companies Act,
2013:
Section 143(1) of the Act deals with duties of an auditors requiring auditor to
make an enquiry in respect of specified matters. The matters in respect of
which the enquiry has to be made by the auditor include relating to loans and
advances, transactions represented merely by book entries, investments
sold at less than cost price, loans and advances shown as deposits, etc.
Since the law requires the auditor to make an enquiry, the Institute opined
that the auditor is not required to report on the matters specified in sub-
section (1) unless he has any special comments to make on any of the items
referred to therein. If the auditor is satisfied as a result of the enquiries, he
has no further duty to report that he is so satisfied. Therefore, the auditor of
Trilok Ltd. is correct in non-reporting on the matters specified in Section
143(1).
Ans. 18.Dispatch of Auditor’s Report to Shareholders: Section 143 of the Companies

Act, 2013 lays down the powers and duties of auditor. As per provisions of
the law, it is no part of the auditor’s duty to send a copy of his report to
members of the company. The auditor’s duty concludes once he forwards
his report to the company. It is the responsibility of company to send the
report to every member of the company. In Re Allen Graig and Company
(London) Ltd., 1934 it was held that duty of the auditor after having signed
the report to be annexed to a balance sheet is confirmed only to forwarding
his report to the secretary of the company. It will be for the secretary or the
director to convene a general meeting and send the balance sheet and
report to the members (or other person) entitled to receive it.
Hence in the given case, the auditor cannot be held liable for the failure to
send the report to the shareholders.
Ans. 19.Disqualification of a Director under section 164(2) of the Companies Act,

2013:
: 111:
Section 143(3)(g) of the Companies Act, 2013 imposes a specific duty on the
auditor to report whether any director is disqualified from being appointed as
directors under section 164(2) of the Companies Act, 2013. The auditor has
to ensure that written representation have been obtained by the Board from
each director that one is not hit by Section 164(2).
Since in this case, one of the director is attracted by disqualification under
section 164(2) of the Act, the auditor shall state in his report as per section
143 about the disqualification of the particular director.
Ans. 20.Responsibilities of Joint Auditors: In conducting a joint audit, the auditor(s)

should bear in mind the possibility of existence of any fraud or error or any
other irregularities in the accounts under audit. The principles laid down in
SA 200, SA 240 and SA 299 need to be read together for arriving at any
conclusion. The principle of joint audit involves that each auditor is entitled
to assume that other joint auditor has carried out his part of work properly.
However, in this case, if it can be assumed that the joint auditors E and S
have exercised reasonable care and skill in auditing the accounts of X & Y
Ltd. and yet the concealment of transaction has taken place, both joint
auditors cannot be held responsible for professional negligence. However, if
such concealment could have been discovered by the exercise of
reasonable care and skill, the auditors would be responsible for professional
negligence. Therefore, it has to be seen that while dividing the work, the joint
auditors have not left any area unattended and exercised reasonable care
and skill while doing their work.
Ans 21.Indebtedness to the Company: As per Section 141(3)(d)(ii) of the Companies

Act, 2013, a person who, or his relative or partner is indebted to the
company, or its subsidiary, or its holding or associate company, or a
subsidiary of its holding company, for an amount exceeding ` 500000/- then
he is not qualified for appointment as an auditor of a company. Accordingly,
B’s appointment is not valid and he is disqualified as the amount of debt
exceeds ` 500000. Even if the advance was taken for meeting out travelling
expenses particularly before commencement of audit work, his appointment
is not valid because in such a case also the auditor shall be indebted to the
company. The auditor is entitled to recover fees on a progressive basis only.
Ans.22. Auditor’s Attendance at Annual General Meeting: Section 143 of the

Companies Act, 2013 confers right on the auditor to attend the general
meeting.
The said section provides that all notices and other communications relating
to any general meeting of a company also to be forwarded to the auditor.
Further, it has been provided that the auditor shall be, unless otherwise
exempted, entitled to attend any general meeting and to be heard at such
general meeting which he attends on any part of the business which
concerns him as an auditor.
Thus, it is right of the auditor to receive notices and other communications
relating to any general meeting and to be heard at such meeting, relating to
the matter of his concern, however, it is duty of the auditor to attend the
same or through his authorised representative unless otherwise exempted.
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Ans. 23.Appointment of a Practising CA as ‘Tax Consultant’: A chartered accountant

appointed as an auditor of a company, should ensure the independence in
respect of his appointment as an auditor, else it would amount to
"misconduct" under the Chartered Accountants Act, 1949 read with
Guidance Note on Independence of Auditors.
In this case, Mr. Aditya is a "Tax Consultant" and not a "Statutory Auditor" or
"Tax Auditor" of ABC Ltd., hence he is not subject to the above
requirements.
Ans. 24.Appointment of Sole Auditor: When one of the joint auditors of the previous
years is considered for ratification by the members as the sole auditor for the
next year, it is similar to non re-appointment of one of the retiring joint
auditors. As per subsection 4 of section 140 of the Companies Act, 2013,
special notice shall be required for a resolution at an annual general meeting
appointing as auditor a person other than a retiring auditor, or providing
expressly that a retiring auditor shall not be re-appointed, except where the
retiring auditor has completed a consecutive tenure of five years or, as the
case may be, ten years, as provided under sub-section (2) of section 139 of
the said Act.
Accordingly, provisions of the Companies Act, 2013 to be complied with are
as under:
1. Ascertain that special notice u/s 140(2) of the Companies Act, 2013
was received by the company from such number of members
holding not less than one percent of total voting power or holding
shares on which an aggregate sum of not less than five lakh rupees
has been paid up on the date of the notice not earlier than three
months but at least 14 days before the AGM date as per Section 115
of the Companies Act, 2013 read with rule 23(1) and 23(2) of the
Companies (Management and Administration) Rules, 2014
2. Check whether the said notice has been sent to all the members at
least 7 days before the date of the AGM as per Section 115 of the
Companies Act, 2013 read with rule 23(3) of the Companies
(Management and Administration) Rules, 2014.
3. Verify the notice contains an express intention of a member for
proposing the resolution for appointing a sole auditor in place of both
the joint auditors who retire at the meeting but are eligible for re-
appointment.
4. The notice is also sent to the retiring auditor as per Section 140(4)(ii)
of the Companies Act, 2013.
5. Verify whether any representation, received from the retiring auditor
was sent to the members of the company.
6. Verify from the minutes book whether the representation received
from the retiring joint auditor was considered at the AGM.
Ans.25.Tenure of Appointment: Section139(1) of the Companies Act, 2013 provides

that every company shall, at the first annual general meeting appoint an
individual or afirm as an auditor who shall hold office from the conclusion of
that meeting till the conclusion of its sixth annual general meeting and
thereafter till the conclusion of every sixth meeting. But in this regard it is to
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be noted that the company shall place the matter relating to such
appointment of ratification by member at every
Annual General Meeting. In case the annual general meeting is not held
within the period prescribed, the auditor will continue in office till the annual
general meeting is actually held and concluded. Therefore, Ninu shall
continue to hold office till the conclusion of the annual general meeting.
Ans.26.Appointment of First Auditor of Company: Section 139(6) of the Companies

Act, 2013 (the Act) lays down that “the first auditor or auditors of a company
shall be appointed by the Board of directors within 30 days from the date of
registration of the company”. In the instant case, the appointment of Shri
Ganapati, a practicing Chartered Accountant as first auditors by the
Managing Director of PQR Ltd by himself is in violation of Section 139(6) of
the Companies Act, 2013, which authorizes the Board of Directors to appoint
the first auditor first auditor of the company within one month of registration
of the company.
In view of the above, the Managing Director of PQR Ltd should be advised
not to appoint the first auditor of the company.
Ans. 27.Ceiling on number of audits: Before appointment is given to any auditor, the
company must obtain a certificate from him to the effect that the
appointment, if made, will not result in an excess holding of company audit
by the auditor concerned over the limit laid down in section 141(3)(g) of the
Act which prescribes that a person who is in full time employment elsewhere
or a person or a partner of a firm holding appointment as its auditor, if such
person or partner is at the date of such appointment or reappointment
holding appointment as auditor of more than twenty companies.
In the case of a firm of auditors, it has been further provided that ‘specified
number of companies’ shall be construed as the number of companies
specified for every partner of the firm who is not in full time employment
elsewhere.
If Mr. P, B and S do not hold any audits in their personal capacity or as
partners of other firms, the total number of company audits that can be
accepted by M/s PBS & Associates is 60. But, the firm is already having
audit of 45 companies. So the firm can accept the audit of 15 companies
only, which is well within the limit, specified by Section 141(3)(g) of the
Companies Act, 2013.
Ans.28.Appointment of Branch Auditor: The Companies Act, 2013 leaves it to the

company to designate or not to designate any establishment of the company
as 'branch office'.
Under the Companies Act, 2013, only establishment "described as such by
the company" shall be treated as a 'branch office'.
Further, as per Section 143(8) of the Companies Act, 2013, where a
company has a branch office, the accounts of that office shall be audited
either by the auditor appointed for the company (herein referred to as the
company's auditor) under this Act or by any other person qualified for
appointment as an auditor of the company under this Act and appointed as
such under section 139, or where the branch office is situated in a country
outside India, the accounts of the branch office shall be audited either by the
company's auditor or by an accountant or by any other person duly qualified
: 114:
to act as an auditor of the accounts of the branch office in accordance with
the laws of that country and the duties and powers of the company's auditor
with reference to the audit of the branch and the branch auditor, if any, shall
be such as may be prescribed:
Provided that the branch auditor shall prepare a report on the accounts of
the branch examined by him and send it to the auditor of the company who
shall deal with it in his report in such manner as he considers necessary.
Section 139(1) of the Companies Act, 2013 provides that every company
shall, at the first annual general meeting, appoint an individual or a firm as
an auditor who shall hold office from the conclusion of that meeting till the
conclusion of its sixth annual general meeting and thereafter till the
conclusion of every sixth meeting.
The shareholders in general meeting, instead of appointing branch auditor,
may authorize the board of directors to appoint branch auditors.
In the present case, the board has appointed branch auditors without
obtaining authorization from the shareholders in general meeting. The board
had appointed the auditor where it did not have authority to do so. As such,
the appointment is invalid.
The shareholder’s complaint is right.
The branch auditor should ascertain before accepting the audit whether his
appointment is valid.
Ans.29.Section 139(8) of the Companies Act, 2013 lays down that the Board of
Directors may fill any casual vacancy in the office of an auditor provided that
where such vacancy is caused by the resignation of an auditor, the vacancy
shall be filled in general meeting.
The expression “casual vacancy” has not been defined in that Act. Talking its
natural meaning it may arise due to a variety of reasons which include death,
resignation, disqualification, dissolution of the firm etc.
Furthermore Section 139(8) stipulates that any auditor appointed in a casual
vacancy shall hold office until the conclusion of the next AGM.
In the instant case the action of the board of directors in appointing M/s
Sharp & Co. to fill up the casual vacancy due to dissolution of M/s Young &
Co., is correct.
However, the board of directors are not correct in giving them appointment
for one year. M/s Sharp & Co. can hold office until the conclusion of next
AGM only.
Ans 30. As per SA 200, “Overall Objectives of the Independent Auditor and the
conduct of an audit in accordance with standards on auditing”, In the case of
an audit engagement it is in the public interest and, therefore, required by
the Code of Ethics, that the auditor be independent of the entity subject to
the audit. The Code describes independence as comprising both
independence of mind and independence in appearance. The auditor’s
independence from the entity safeguards the auditor’s ability to form an audit
opinion without being affected by influences that might compromise that
opinion. Independence enhances the auditor’s ability to act with integrity, to
be objective and to maintain an attitude of professional skepticism. In the
instant case, Mr. Fat has his office and residence in the building owned by
Thin Ltd. who are subject to audit by Mr. Fat. Giving 10% concession in rent
: 115:
may be due to some other reasons other than holding auditor ship of Thin
Ltd. It may be due to being very old tenant or due to office and residence in
the same building or Mr. Fat might have carried out major renovation and so
on. Thus in the instant case unless and until there is direct proof, giving 10%
concession in rent does not affect independence of the auditor in expressing
his opinion on the audit of Thin Ltd.
Ans 31. Compliance with Standards on Auditing : As per sub section 9 of section 143
of the Companies Act, 2013, every auditor shall comply with the auditing
standards.
Further as per sub section 10 of section 143 of the Act, the Central
Government may prescribe the standards of auditing or any addendum
thereto, as recommended by the Institute of Chartered Accountants of India,
constituted under section 3 of the Chartered Accountants Act, 1949, in
consultation with and after examination of the recommendations made by
the National Financial Reporting Authority:
Provided that until any auditing standards are notified, any standard, or
standards of auditing specified by the Institute of Chartered Accountants of
India shall be deemed to be the auditing standards.
Further, the Preface to Standards on Auditing gives the scope of the
Standards on Auditing. As per the Preface, the SAs will apply whenever an
independent audit is carried out; that is, in the independent examination of
financial statements/information of any entity; whether profit oriented or not
and irrespective of its size, or legal form (unless specified otherwise) when
such an examination is conducted with a view to expressing an opinion
thereon. Also while discharging their attest function; it is the duty of the
Chartered Accountant to ensure that SAs are followed in the audit of
financial information covered by their audit reports.
In the given case, even though the client is a non-profit oriented entity the
SAs shall apply and the auditor shall be guilty of professional misconduct for
failing to discharge his duty in case of non-compliance with SAs.
Ans.32.According to Section 139 (7) of the Companies Act, 2013, a Government

company is defined “as any company in which not less than 51% of the paid-
up share capital is held by the Central Government or by any State
Government or Governments or partly by the Central Government and partly
by one or more State Governments and includes a company which is a
subsidiary of a Government Company as thus defined”. The auditors of a
government company shall be appointed or reappointed by the Comptroller
and Auditor General of India.
In the given case Ajanta Ltd is a government company as its 20% shares
have been held by Central Govt, 25% by U.P. State Government and 10%
by M.P. State Govt.
Total 55% shares have been held by Central and State governments.
Therefore, it
is a Government company. Nickson Ltd. is a subsidiary company of Ajanta
Ltd. Hence Nickson Ltd. covers in the definition of a government company.
Hence the Auditor of Nicksons Ltd. can be appointed only by C &
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AG.Therefore, appointment of ‘P’ is invalid and ‘P’ should not give
acceptance to the Directors of Nicksons Ltd.
Ans.33. According to section 141 (3)(d) (ii) of the Companies Act, 2013, a person is
not eligible for appointment as auditor of any company, If he is indebted to
the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company, in excess of rupees five lakh.
In the given case Mr. Amar is disqualified to act as an auditor under
section141 (3)(d) (ii)) as he is indebted to M/s Chaudhary Finance Ltd. for
more than ` 5,00,000
Also according to Section141 (3)(d) (ii) he cannot act as an auditor of any
subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in
Charan Ltd. & Das Ltd. Therefore he has to vacate his office in Das Ltd.
Even though it is a subsidiary of Chaudhary Finance Ltd.
Hence audit work performed by Mr. Amar as an auditor is invalid, he should
vacate his office immediately and Das Ltd must have to appoint any other
CA as an auditor of the company.
Ans.34.Ownership and custody of working papers: As per SA-230 “Audit

Documentation”, the working papers are the property of the auditor, the
auditor may, at his discretion make portion of or extracts from his working
papers available to the client.
In the instant case the managing director of the company has demanded
copies of the working papers from the auditor. He has no right to obtain
copies of the working papers from the auditor because they are the property
of the auditor. However the auditor may at his discretion make portions of or
extracts from the working paper to the managing director of PQR &
Company Ltd.
Conclusion: The auditor is not bound to oblige the managing director by
supplying copies of the audit working papers.
: 117:
CHAPTER 11 AUDIT REPORT

Elements of Audit Report Q1
Modified opinion Q2
Emphasis of Matter and Other Matter Paragraph Q3
Key Matter Paragraph Q4
Types of Report Q5
SA 710 Refer SA
: 118 :
Q.1. Mention the elements of Audit Report
Basic Elements of an Audit Report are given below:
(a) A title.
(b) An addressee, as required by the circumstances of the engagement.
(c) An Opinion section containing an expression of opinion on the financial statements
and a reference to the applicable financial reporting framework used to prepare
the financial statements.
(d) An identification of the entity’s financial statements that have been audited.
(e) A statement that the auditor is independent of the entity in accordance with the
relevant ethical requirements relating to the audit, and has fulfilled the auditor’s
other ethical responsibilities in accordance with these requirements.
The statement shall refer to the Code of Ethics issued by ICAI.
(f) Where applicable, a section that addresses, and is not inconsistent with, the
reporting requirements relating to going concern as per SA 570 (Revised).
(g) Where applicable, a Basis for Qualified (or Adverse) Opinion section that
addresses, and is not inconsistent with, the reporting requirements relating to
going concern as per SA 570 (Revised).
(h) Where applicable, a section that includes the information required by SA 701, or
additional information about the audit that is prescribed by law or regulation and
that addresses, and is not inconsistent with, the reporting requirements in that SA.
(i) A description of management’s responsibilities for the preparation of the financial
statements and an identification of those responsible for the oversight of the
financial reporting process that addresses, and is not inconsistent with, the
requirements as contained in this SA 700.
(j) A reference to Standards on Auditing and the law or regulation, and a description
of the auditor’s responsibilities for an audit of the financial statements that
addresses, and is not inconsistent with, the requirements as contained in this SA
700.
(k) The auditor’s signature.
(l) The Place of signature.
(m) The date of the auditor’s report.
1 Title: The auditor’s report shall have a title that clearly indicates that it is the report
of an independent auditor. For example, “Independent Auditor’s Report,”
distinguishes the independent auditor’s report from reports issued by others.
2. Addressee: The auditor’s report shall be addressed, as appropriate, based on the
circumstances of the engagement. Law, regulation or the terms of the engagement
may specify to whom the auditor’s report is to be addressed. The auditor’s report
is normally addressed to those for whom the report is prepared, often either to the
shareholders or to those charged with governance of the entity whose financial
statements are being audited.
3. Auditor’s Opinion: The first section of the auditor’s report shall include the
auditor’s opinion, and shall have the heading “Opinion.” The Opinion section of the
auditor’s report shall also:
(a) Identify the entity whose financial statements have been audited;
(b) State that the financial statements have been audited;
(c) Identify the title of each statement comprising the financial statements;
(d) Refer to the notes, including the summary of significant accounting policies;
and
(e) Specify the date of, or period covered by, each financial statement
comprising the financial statements.
: 119 :
4. Basis for Opinion:
The auditor’s report shall include a section, directly following the Opinion section,
with the heading “Basis for Opinion”, that:
(a) States that the audit was conducted in accordance with Standards on
Auditing;
(b) Refers to the section of the auditor’s report that describes the auditor’s
responsibilities under the SAs;
(c) Includes a statement that the auditor is independent of the entity in
accordance with the relevant ethical requirements relating to the audit and
has fulfilled the auditor’s other ethical responsibilities in accordance with
these requirements.
(d) States whether the auditor believes that the audit evidence the auditor has
obtained is sufficient and appropriate to provide a basis for the auditor’s
opinion.
5. Going Concern: Where applicable, the auditor shall report in accordance with SA
570 (Revised).
6. Key Audit Matters: For audits of complete sets of general purpose financial
statements of listed entities, the auditor shall communicate key audit matters in the
auditor’s report in accordance with SA 701.
When the auditor is otherwise required by law or regulation or decides to
communicate key audit matters in the auditor’s report, the auditor shall do so in
accordance with SA 701.
Law or regulation may require communication of key audit matters for audits of
entities other than listed entities.
The auditor may also decide to communicate key audit matters for other entities,
including those that may be of significant public interest, for example because they
have a large number and wide range of stakeholders and considering the nature
and size of the business.
7. Responsibilities for the Financial Statements: The auditor’s report shall include
a section with a heading “Responsibilities of Management for the Financial
Statements.”
SA 200 explains the premise, relating to the responsibilities of management and,
where appropriate, those charged with governance, on which an audit in
accordance with SAs is conducted. Management and, where appropriate, those
charged with governance accept responsibility for the preparation of the financial
statements. Management also accepts responsibility for such internal control as it
determines is necessary to enable the preparation of financial statements that are
free from material misstatement, whether due to fraud or error. The description of
management’s responsibilities in the auditor’s report includes reference to both
responsibilities as it helps to explain to users the premise on which an audit is
conducted.
8. Auditor’s Responsibilities for the Audit of the Financial Statements:
This section of the auditor’s report shall:
(a) State that the objectives of the auditor are to:
(i) Obtain reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to fraud or
error; and
(ii) Issue an auditor’s report that includes the auditor’s opinion.
: 120 :
(b) State that reasonable assurance is a high level of assurance, but is not a
guarantee that an audit conducted in accordance with SAs will always detect
a material misstatement when it exists; and
(c) State that misstatements can arise from fraud or error, and either:
(i) Describe that they are considered material if, individually or in the
aggregate, they could reasonably be expected to influence the
economic decisions of users taken on the basis of these financial
statements; or
(ii) Provide a definition or description of materiality in accordance with the
applicable financial reporting framework.
9. Other Reporting Responsibilities: If the auditor addresses other reporting
responsibilities in the auditor’s report on the financial statements that are in
addition to the auditor’s responsibilities under the SAs, these other reporting
responsibilities shall be addressed in a separate section in the auditor’s report with
a heading titled-
“Report on Other Legal and Regulatory Requirements” or otherwise as appropriate
to the content of the section, unless these other reporting responsibilities address
the same topics as those presented under the reporting responsibilities required
by the SAs in which case the other reporting responsibilities may be presented in
the same section as the related report elements required by the SAs.
10. Signature of the Auditor: The auditor’s report shall be signed. The report is
signed by the auditor (i.e. the engagement partner) in his personal name. Where
the firm is appointed as the auditor, the report is signed in the personal name of
the auditor and in the name of the audit firm.
The partner/proprietor signing the audit report also needs to mention the
membership number assigned by the Institute of Chartered Accountants of India.
They also include the registration number of the firm, wherever applicable, as
allotted by ICAI, in the audit reports signed by them.
11. Auditor’s Address: The auditor’s report shall name specific location, which is
ordinarily the city where the audit report is signed.
12. Date of the Auditor’s Report: The auditor’s report shall be dated no earlier than
the date on which the auditor has obtained sufficient appropriate audit evidence on
which to base the auditor’s opinion.
Q.2. Mention the Matters affecting opinion

The auditor shall modify the opinion in the auditor’s report when:
(a) The auditor concludes that, based on the audit evidence obtained, the financial
statements as a whole are not free from material misstatement; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude
that the financial statements as a whole are free from material misstatement.
There are three types of modified opinions, namely-
1. A qualified opinion
2. An adverse opinion
3. A disclaimer of opinion
: 121 :
Qualified Opinion
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are material, but not pervasive, to
the financial statements; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to
base the opinion, but the auditor concludes that the possible effects on the
financial statements of undetected misstatements, if any, could be material but not
pervasive.
Adverse Opinion
The auditor shall express an adverse opinion when the auditor, having obtained
sufficient appropriate audit evidence, concludes that misstatements, individually or in
the aggregate, are both material and pervasive to the financial statements.
Disclaimer of Opinion The auditor shall disclaim an opinion when the auditor is unable
to obtain sufficient appropriate audit evidence on which to base the opinion, and the
auditor concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be both material and pervasive.
The auditor shall disclaim an opinion when, in extremely rare circumstances involving
multiple uncertainties.
When the auditor modifies the opinion on the financial statements, the auditor shall,
in addition to the specific elements required by SA 700 (Revised):
(a) Amend the heading “Basis for Opinion” required by para of SA 700 (Revised) to
“Basis for Qualified Opinion,” “Basis for Adverse Opinion,” or “Basis for Disclaimer
of Opinion,” as appropriate; and
(b) Within this section, include a description of the matter giving rise to the
modification.
Q.3. Mention the Matters not affecting opinion

As per SA 706 (Revised) on “Emphasis of Matter Paragraphs and Other Matter
Paragraphs In The Independent Auditor’s Report”,the objective of the auditor,
having formed an opinion on the financial statements, is to draw users’ attention, when
in the auditor’s judgment it is necessary to do so, by way of clear additional
communication in the auditor’s report, to:
(a) A matter, although appropriately presented or disclosed in the financial
statements, that is of such importance that it is fundamental to users’
understanding of the financial statements; or
(b) As appropriate, any other matter that is relevant to users’ understanding of the
audit, the auditor’s responsibilities or the auditor’s report.
: 122 :
Emphasis of Matter paragraph – A paragraph included in the auditor’s report that
refers to a matter appropriately presented or disclosed in the financial statements that,
in the auditor’s judgment, is of such importance that it is fundamental to users’
understanding of the financial statements.
Other Matter paragraph – A paragraph included in the auditor’s report that refers to a
matter other than those presented or disclosed in the financial statements that, in the
auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report.
Q.4. Mention the concept of “Key Matters Paragraph”

As per SA 701, “Communicating Key Audit Matters in the Auditor’s Report”, the purpose
of communicating key audit matters is to enhance the communicative value of the
auditor’s report by providing greater transparency about the audit that was performed.
Communicating key audit matters provides additional information to intended users of
the financial statements to assist them in understanding those matters that, in the
auditor’s professional judgment, were of most significance in the audit of the financial
statements of the current period. Communicating key audit matters may also assist
intended users in understanding the entity and areas of significant management
judgment in the audited financial statements.
The auditor shall describe each key audit matter, using an appropriate subheading, in a
separate section of the auditor’s report under the heading “Key Audit Matters”. The
introductory language in this section of the auditor’s report shall state that:
(a) Key audit matters are those matters that, in the auditor’s professional judgment,
were of most significance in the audit of the financial statements [of the current
period]; and
(b) These matters were addressed in the context of the audit of the financial
statements as a whole, and in forming the auditor’s opinion thereon, and the
auditor does not provide a separate opinion on these matters.
Communicating key audit matters in the auditor’s report is in the context of the auditor
having formed an opinion on the financial statements as a whole. Communicating key
audit matters in the auditor’s report is not:
(a) A substitute for disclosures in the financial statements that the applicable financial
reporting framework requires management to make, or that are otherwise
necessary to achieve fair presentation;
(b) A substitute for the auditor expressing a modified opinion when required by the
circumstances of a specific audit engagement in accordance with SA 705
(Revised);
(c) A substitute for reporting in accordance with SA 570 when a material uncertainty
exists relating to events or conditions that may cast significant doubt on an entity’s
ability to continue as a going concern; or
(d) A separate opinion on individual matters.
: 123 :
Q.5. Mention the types of Audit Report.
: 124 :
CHAPTER 12 AUDIT OF BANKS

Basics Q1-Q2
Form and Content of Financial Statements Q3
Audit of accounts Q4
Auditor’s Report Q5
Advances and its Audit Q6-13
Audit of Income & Expenses Q14-Q15
Bank Audit Approach Q16
: 125 :
Q.1. Mention the types of banks. What are the peculiarities of banking system
Peculiarities involved:
Huge volumes and complexity of transactions,
Wide geographical spread of banks’ network,
Large range of products and services offered,
Extensive use of technology,
Strict vigilance by the banking regulator etc.
Q.2. State the regulatory framework governing banking system in India.
Q.3. Short note- Form and content of financial statements

Sub-sections (1) and (2) of section 29 of the Act deal with the form and content of
financial statements of a banking company and their authentication. These subsections
are also applicable to nationalised banks, State Bank of India, subsidiaries of the State
Bank of India, and Regional Rural Banks.
Every banking company is required to prepare a Balance Sheet and a Profit and Loss
Account in the forms set out in the Third Schedule to the Act or as near thereto as the
circumstances admit. Form A of the Third Schedule to the Banking Regulation Act,
1949, contains the form of Balance Sheet and Form B contains the form of Profit and
Loss Account.
Every banking company needs to comply with the disclosure requirements under the
various Accounting Standards, as specified under section 133 of the Companies Act,
2013.
: 126 :
Q.4. Mention provisions related to Eligibility and appointment of auditor of banking
companies
a) Eligibility, Qualification and disqualification- As per Companies Act, 2013
b) Appointment of Auditor- As per the provisions of the relevant enactments, the
auditor of a banking company is to be appointed at the annual general meeting of
the shareholders, whereas the auditor of a nationalised bank is to be appointed
by the bank concerned acting through its Board of Directors.
In either case, approval of the Reserve Bank is required before the appointment
is made. The auditors of the State Bank of India are to be appointed by the
Comptroller and Auditor General of India in consultation with the Central
Government.
The auditors of the subsidiaries of the State Bank of India are to be appointed
by the State Bank of India.
The auditors of regional rural banks are to be appointed by the bank concerned
with the approval of the Central Government.
c) REMUNERATION OF AUDITOR
The remuneration of auditor of a banking company is to be fixed in accordance
with the provisions of section 142 of the Companies Act, 2013 (i.e., by the
company in general meeting or in such manner as the company in general
meeting may determine). The remuneration of auditors of nationalised banks and
State Bank of India is to be fixed by the Reserve Bank of India in consultation with
the Central Government.
Q.5. Explain in Detail Audit Report requirements in case of Banking companies
The auditors, central as well as branch, should also ensure that the audit report
issued by them complies with the requirements of Standards on Auditing
The auditor of a banking company is also required to state in his report in respect of
matters covered by Section 143 of the Companies Act, 2013.
The reporting requirements relating to the Companies (Auditor’s Report) Order, 2016
is not applicable to a banking company
Besides the audit report as per the statutory requirements discussed above require the
auditors also need to furnish a long form audit report (LFAR). The matters which
the banks require their auditors to deal with in the long form audit report have been
specified by the Reserve Bank of India (to be submitted before 30th June every
year.)
: 127 :
Advances
Q.6. What do advances comprise of?

Advances comprises of funded amounts by way of :
Term loans
Cash credits, Overdrafts, Demand Loans
Bills Discounted and Purchased
Adverse balances in Deposit Accounts
Participation on Risk Sharing basis
Interest bearing Staff Loans
Q.7. Mention the legal requirements of disclosure of advances in Balance sheet

A. (i) Bills purchased and discounted
(ii) Cash credits, Overdrafts and loans repayable on demand
(iii) Term Loans
B. (i) Secured by tangible assets
(ii) Covered by Bank/Government guarantees
(iii) Unsecured
C. I. Advances in India:
(i) Priority sectors
(ii) Public sector
(iii) Banks
(iv) Others
C. II. Advances outside India:
(i) Due from Banks
(ii) Due from Others:
(a) Bills Purchased and discounted
(b) Syndicated loans
(c) Others
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Q8. Short note- Classification of advances
: 129 :
Q.9. Short note- Nature of Security
A. Primary security refers to the security off ered by the borrower for bank finance
or the one against which credit has been extended by the bank. This security is
the principal security for an advance.
B. Collateral security is an additional security. Security can be in any form i.e.
tangible or intangible asset, movable or immovable asset.
Examples of most common types of securities accepted by banks are the
following.
Personal Security of Guarantor
Goods/Stocks/Debtors /Trade Receivables
Gold Ornaments and Bullion
Immovable Property
Q.10.Explain the following terms

(i) Mortgage: Mortgage are of several kinds but the most important are the
Registered Mortgage and the Equitable Mortgage.
A Registered Mortgage can be affected by a registered instrument called the
‘Mortgage Deed’ signed by the mortgagor. It registers the property to the
mortgagee as a security.
Equitable mortgage, on the other hand, is effected by a mere delivery of title
deeds or other documents of title with intent to create security thereof.
(ii) Pledge: A pledge thus involves bailment or delivery of goods by the borrower to
the lending bank with the intention of creating a charge thereon as security for the
advance. The legal ownership of the goods remains with the pledger while the
lending banker gets certain defined interests in the goods. The pledge of goods
constitutes a specific (or fixed) charge.
(iii) Hypothecation: The hypothecation is the creation of an equitable charge (i.e., a
charge created not by an express enactment but by equity and reason), which is
created in favour of the lending bank by execution of hypothecation agreement in
respect of the moveable securities belonging to the borrower.
Neither ownership nor possession is transferred to the bank. However, the
borrower holds the physical possession of the goods as an agent/trustee of the
bank.
(iv) Assignment: Assignment represents a transfer of an existing or future debt, right
or property belonging to a person in favour of another person. Book debts and life
insurance policies are accepted by banks as security by way of assignment.
An assignment gives the assignee absolute right over the moneys/debts assigned
to him.
(v) Set-off : Set-off is a statutory right of a creditor to adjust, wholly or partly, the debit
balance in the debtor’s account against any credit balance lying in another account
of the debtor. The right of set-off enables a bank to combine two accounts (a
deposit account and a loan account) of the same person provided both the
accounts are in the same name and in the same right
(vi) Lien: Lien is creation of a legal charge with consent of the owner, which gives
lender a legal right to seize and dispose / liquidate the asset under lien.
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Q.11.Explain the criteria for non-performing asset
(i) General Rule: A non-performing asset (NPA) is a loan or an advance where -:
interest and/ or instalment of principal remain overdue for a period of more
than 90 days in respect of a term loan,
the account remains ‘out of order’ in respect of an Overdraft/Cash Credit
(OD/CC),
the bill remains overdue for a period of more than 90 days in the case of bills
purchased and discounted,
(ii) Out of Order: An account should be treated as ‘out of order’ if the outstanding
balance remains continuously in excess of the sanctioned limit/drawing power. In
cases where the outstanding balance in the principal operating account is less
than the sanctioned limit/drawing power, but there are no credits continuously for
90 days as on the date of Balance Sheet or credits are not enough to cover the
interest debited during the same period, these accounts should be treated as ‘out
of order’.
(iii) Agricultual advances:
The following NPA norms would apply to agricultural advances (including Crop
Term Loans):
A loan granted for short duration crops will be treated as NPA, if the
instalment of principal or interest thereon remains overdue for two crop
seasons and,
A loan granted for long duration crops will be treated as NPA, if the
instalment of principal or interest thereon remains overdue for one crop
season.
The crop season for each crop, which means the period up to harvesting of the
crops raised, would be as determined by the State Level Bankers’ Committee in
each State.
Master Circular issued by the RBI deals elaborately with the classification and
income recognition issues due to impairment caused by natural calamities. Banks
may decide on their own relief measures subject to the guidelines contained in
RBI’s latest Master Circular on Prudential Norms on Income Recognition, Asset
Classification and provisioning pertaining to Advances. In such cases, the NPA
classification would be governed by such rescheduled terms.
(iv) Central Govt. guaranteed Advances would be classified as Standard Assets, but
regarded as NPA for Income Recognition purpose.
: 131 :
Q.12.Short note- Reversal of Income

If any advance, including bills purchased and discounted, becomes NPA as at the close
of any year, the entire interest accrued and credited to income account in the past
periods, should be reversed or provided for if the same is not realised. This will apply to
Government guaranteed accounts also.
In respect of NPAs, fees, commission and similar income that have accrued should
cease to accrue in the current period and should be reversed or provided for with
respect to past periods, if uncollected.
Further, in case of banks which have wrongly recognised income in the past should
reverse the interest if it was recognised as income during the current year or make a
provision for an equivalent amount if it was recognized as income in the previous
year(s).
Furthermore, the auditor should enquire if there are any large debits in the Interest
Income account that have not been explained. It should be enquired is there are any
communications from borrowers pointing out differences in Interest charge, and whether
action as justified has been taken in this regard.
Q.13. Audit of Advances Obtaining evidence about the following:

(a) Amounts included in balance sheet in respect of advances are outstanding at the
date of the balance sheet.
(b) Advances represent amount due to the bank.
(c) Amounts due to the bank are appropriately supported by Loan documents and
other documents as applicable to the nature of advances.
(d) There are no unrecorded advances.
(e) The stated basis of valuation of advances is appropriate and properly applied, and
that the recoverability of advances is recognised in their valuation.
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(f) The advances are disclosed, classified and described in accordance with
recognised accounting policies and practices and relevant statutory and regulatory
requirements.
(g) Appropriate provisions towards advances have been made as per the RBI norms,
Accounting Standards and generally accepted accounting practices.
(h) All accounts should be kept within both the drawing power and the sanctioned limit
at all times. The accounts which exceed the sanctioned limit or drawing power or
are against unapproved securities or are otherwise irregular should be brought to
the notice of the Management/Head Office regularly.
(i) The audited Annual Report submitted by the borrower should be scrutinised
properly. The monthly stock statement of the month for which the audited accounts
are prepared and submitted should be compared and the reasons for deviations, if
any, should be ascertained.
Audit of other Items

Q.14.Audit of Revenue Items
The following items are included under this head:
Interest Earned & Other Income
In carrying out an audit of income, the auditor is primarily concerned with obtaining
reasonable assurance that the recorded income arose from transactions, which took
place during the relevant period and pertain to the bank, that there is no unrecorded
income, and that income is recorded in proper amounts and is allocated to the proper
period.
RBI has advised that in respect of any income which exceeds one percent of the
total income of the bank if the income is reckoned on a gross basis or one percent
of the net profit before taxes if the income is reckoned net of costs, should be
considered on accrual as per AS-9.
If any item of income is not considered to be material as per the above norms, it
may be recognised when received and the auditors need not qualify the
statements in that situation.
Banks recognise income (such as interest, fees and commission) on accrual basis,
i.e., as it is earned. It is an essential condition for accrual of income that it should
not be unreasonable to expect its ultimate collection. In modern day banking, the
entries for interest income on advances are automatically generated through a
batch process in the CBS system.
In view of the significant uncertainty regarding ultimate collection of income arising
in respect of non-performing assets, the guidelines require that banks should not
recognize income on non-performing assets until it is actually realised. When a
credit facility is classified as non-performing for the first time, interest accrued and
credited to the income account in the corresponding previous year which has not
been realized should be reversed or provided for. This will apply to Government
guaranteed accounts also.
Interest on advances against Term Deposits, National Savings Certifi cates
(NSCs), Indira Vikas Patras (IVPs), Kisan Vikas Patras (KVPs) and Life policies
: 133 :
may be taken to income account on the due date, provided adequate margin is
available in the accounts.
In the case of bills purchased outstanding at the close of the year the discount
received thereon should be properly apportioned between the two years. [The
Unexpired discount / rebate on bills discounted i.e., where part of receipt
comprising discount charges on bills purchased relate to the period beyond the
year-end, should be recorded as “Other Liabilities”]. Interest (discount) component
paid by Bank/Branch on rediscount of bills from other financial institutions, is not to
be netted off from the discount earned on bills discounted.
In the case of bills for collection, the auditor should also examine the procedure for
crediting the party on whose behalf the bill has been collected. The procedure is
usually such that the customer’s account is credited only after the bill has actually
been collected from the drawee either by the bank itself or through its agents, etc.
This procedure is in consonance with the nature of obligations of the bank in
respect of bills for collection. The commission of the branch becomes due only
when the bill has been collected.
Fees and commissions earned by the banks as a result of re-negotiations or
rescheduling of outstanding debts should be recognised on an accrual basis over
the period of time covered by the re-negotiated or rescheduled extension of credit.
Test checks the Interest earned by the banks for sample items.
Test check the Fees and commissions earned by the banks made for commission
on Bills for collection; Letters of credit; Bank Guarantees.
Q.15.Audit of Expenses
Expenditure is to be shown under three broad heads (1):Interest expended; (2)
Operating expenses; and (3) Provisions and contingencies.
Audit Approach and Procedures
In carrying out an audit of Interest expended, the auditor is primarily concerned
with assessing the overall reasonableness of the amount of interest expense by
analysing ratios of interest paid on different types of deposits and borrowings to
the average quantum of the respective liabilities during the year. In modern day
banking, the entries for interest expended are automatically generated through a
batch process in the CBS system.
The auditor should obtain from the bank an analysis of various types of deposits
outstanding at the end of each quarter. From such information, the auditor may
work out a weighted average interest rate. The auditor may then compare this rate
with the actual average rate of interest paid on the relevant deposits as per the
annual accounts and enquire into the difference, if material.
The auditor should also compare the average rate of interest paid on the relevant
deposits with the corresponding figures for the previous years and analyse any
material differences. The auditor should obtain general ledger break-up for the
interest expense incurred on deposits (savings and term deposits) and borrowing
each month/quarter. The auditor should analyse month on month (or quarter) cost
analysis and document the reasons for the variances as per the benchmark
stated. He should examine whether the interest expense considered in the cost
: 134 :
analysis agrees with the general ledger. The auditor should understand the
process of computation of the average balance and re-compute the same on
sample basis.
The auditor should, on a test check basis, verify the calculation of interest and
satisfy himself that:
(a) Interest has been provided on all deposits upto the date of the balance sheet;
and verify whether there is any excess or short credit of material amount.
(b) Interest rates are in accordance with the bank’s internal regulations, of the
RBI directives, and agreements with the respective depositors;
(c) In case of Fixed Deposits it should be examined whether the Interest Rate in
the accounting system are in accordance with the Interest Rate mentioned in
the Fixed Deposit Receipt/Certificate.
(d) Interest on Savings Account should be checked on a test check basis in
accordance with the rules framed by the bank in this behalf.
(e) Interest on inter–branch balances has been provided at the rates prescribed
by the head office.
(f) Interest on overdue/ matured term deposits should be estimated and
provided for.
Q.16.Explain Bank audit Approach in brief.

Banks may be divided into three board categorises based on the level of
computerisation:
Non-computerised banks.
Partially Computerised banks.
Fully computerised banks.
In the Computerised environment, it is imperative that the auditor is familiar with, and is
satisfied that, all the norms/parameters as per the latest applicable RBI guidelines are
incorporated and built into the system that generates information.
A bank should have appropriate controls to manage its risks, including effective
segregation of duties.
Engagement Team Discussions
The engagement team should hold discussions to gain better understanding of the bank
and its environment, including internal control, and also to assess the potential for
material misstatements of the financial statements. All these discussions should be
appropriately documented for future reference.
Other aspects to be considered:
1. Assessment of Engagement Risk
2. Establish the Engagement Team
3. Understanding the Bank and its Environment
4. Identifying and Assessing the Risks of Material Misstatements
5. Understanding the Bank and Its Environment including Internal Control
6. Understand the Bank’s Accounting Process
7. Determine Audit Materiality
: 135 :
CHAPTER 13 AUDIT OF DIFFERENT TYPES OF ENTITIES)
Sr.No List of topics as per module JKSC reference

1 Government Audit Q1-Q7
2 Local Bodies Q8
3 Audit of NGO Q9
4 Audit of Sole trader Read once from the
module
5 Audit of Firm
6 Basics of LLP audit Q10
7 Audit of Charitable institution Q9
8 Audit of Educational Institution Q11
9 Audit of Hospital Q12
10 Audit of Club Q17
11 Audit of Cinema Q13
12 Audit of Hire Purchase and Leasing Companies Q16
13 Audit of Hotels Q14
14 Audit of Co-operative Society Q15
: 136 :
Q.1. Explain Government Audit in brief.
Government audit serves as a mechanism or process for public accounting of
government funds. It also provides public accounting of the operational, management,
programme and policy aspects of public administration as well as accountability of the
officials administering them. Audit observations based on factual data collection also
serve to highlight the lapses of the lower hierarchy, thus helping supervisory level
officers to take corrective measures.
It aims to ensure accountability of the executive in respect of public revenue and
expenditure. Primarily, the Parliament and in case of States, the State legislatures
control all government expenditure through insistence upon demand for grants.
In India, the function of Government Audit is discharged by the independent statutory
authority of the Comptroller and Auditor General through the agency of the Indian Audit
and Accounts Department.
The Comptroller and Auditor General (C&AG), in the discharge of his functions, watches
that the various authorities act in regard to fi nancial matters in accordance with the
Constitution and the laws made by Parliament, and conform to the rules or orders made
thereunder.
Q.2. Independence of CAG of India has been safeguarded by the constitutional

provisions.
The Constitution of India contains specific provisions regarding the appointment, salary
and duties and powers of the C&AG.
The constitution guarantees the independence of the C&AG of India by prescribing that
he shall be appointed by the President of India and shall not be removed from office
except on the ground of proven mis-behaviour or incapacity.
He can be removed only when each House of Parliament decides to do so by a majority
of not less than 2/3rd of the members of the House present and voting.
The Constitution further provides that the conditions of service of person serving in the
Indian Audit and Accounts Department and the administrative powers of the C&AG shall
be determined by the President after consultation with him.
The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act,
1971 passed in pursuance of the provisions of the Constitution lays down a fixed tenure
of the office prescribing that he shall be paid a salary which is equal to the salary of the
Judge of the Supreme Court thereby further strengthening his independence.
Q.3. Rights of Comptroller and auditor general of India

The C&AG Act gives the following powers to the C&AG in connection with the
performance of his duties-
(a) To inspect any office of accounts under the control of the Union or a State
Government including office responsible for the creation of the initial or subsidiary
accounts.
: 137 :
(b) To require that any accounts, books, papers and other documents which deal with
or are otherwise relevant to the transactions under audit, be sent to specified
places.
(c) To put such questions or make such observations as he may consider necessary
to the person in charge of the office and to call for such information as he may
require for the preparation of any account or report which is his duty to prepare.
In carrying out the audit, the C&AG has the power to dispense with any part of detailed
audit of any accounts or class of transactions and to apply such limited checks in
relation to such accounts or transactions as he may determine.
Q.4. Duties of Comptroller and auditor general of India

Duties of the C&AG:
(i) Compile and submit Accounts of Union and States - The Comptroller and
Auditor General shall be responsible for compiling the accounts of the Union and
of each State from the initial and subsidiary accounts rendered to the audit and
accounts offices under his control by treasuries, offices or departments
responsible for the keeping of such account.
Annual receipts and disbursements for the purpose of the Union, of each State
and of each Union Territory having a Legislative Assembly, and shall submit those
accounts to the President or the Governor of a State or Administrator of the Union
Territory having a Legislative Assembly, as the case may be, on or before such
dates as he may, with the concurrence of the Government concerned, determine.
(ii) Audit of Receipts and Expenditure - Where anybody or authority is substantially
financed by grants or loans from the Consolidated Fund of India or of any State or
of any Union Territory having a Legislative Assembly, the Comptroller and Auditor
General shall, subject to the provisions of any law for the time being in force
applicable to the body or authority, as the case may be, audit all receipts and
expenditure of that body or authority and to report on the receipts and expenditure
audited by him.
(iii) Audit of Grants or Loans - Where any grant or loan is given for any specific
purpose from the Consolidated Fund of India or of any State or of any Union
Territory having a Legislative Assembly to any authority or body the Comptroller
and Auditor General shall scrutinise the procedures by which the sanctioning
authority satisfies itself as to the fulfillment of the conditions subject to which such
grants or loans were given and shall for this purpose have right of access.
(iv) Audit of Receipts of Union or States - It shall be the duty of the Comptroller and
Auditor General to audit all receipts which are payable into the Consolidated Fund
of India and of each State and of each Union Territory having a Legislative
Assembly and to satisfy himself that the rules and procedures in that behalf are
designed to secure an effective check on the assessment, collection and proper
allocation of revenue and are being duly observed and to make for this purpose
such examination of the accounts as he thinks fi t and report thereon.
: 138 :
(v) Audit of Accounts of Stores and Inventory - The Comptroller and Auditor
General shall have authority to audit and report on the accounts of stores and
inventory kept in any office or department of the Union or of a State.
(vi) Audit of Government Companies and Corporations - The duties and powers of
the Comptroller and Auditor General in relation to the audit of the accounts of
government companies shall be performed and exercised by him in accordance
with the provisions of the Companies Act, 2013.
Q.5. Explain audit of expenditure.

The audit of government expenditure is one of the major components of government
audit. The basic standards set for audit of expenditure are to ensure that there is
provision funds authorised by competent authority fixing the limits within which
expenditure can be incurred. These standards are—
(i) that the expenditure incurred conforms to the relevant provisions of the statutory
enactment and in accordance with the Financial Rules and Regulations framed by
the competent authority. Such an audit is called as the audit against ‘rules and
orders’.
(ii) that there is sanction, either special or general, accorded by competent authority
authorising the expenditure. Such an audit is called as the audit of sanctions.
(iii) that there is a provision of funds out of which expenditure can be incurred and the
same has been authorised by competent authority. Such an audit is called as audit
against provision of funds.
(iv) that the expenditure is incurred with due regard to broad and general principles of
financial propriety. Such an audit is also called as propriety audit.
(v) that the various programmes, schemes and projects where large financial
expenditure has been incurred are being run economically and are yielding results
expected of them. Such an audit is termed as the performance audit.
Q.6. Explain audit of receipts

The audit of receipts is neither all pervasive or as old as audit of expenditure but has
come to stay in some countries. Such an audit provides for checking;
(i) whether all revenues or other debts due to government have been correctly
assessed, realised and credited to government account by the designated
authorities;
(ii) whether adequate regulations and procedures have been framed by the
department/agency concerned to secure an effective check on assessment,
collection and proper allocation of cases;
(iii) whether such regulations and procedures are actually being carried out;
(iv) whether adequate checks are imposed to ensure the prompt detection and
investigation of irregularities, double refunds, fraudulent or forged refund vouchers
or other loss of revenue through fraud or willful omission or negligence to levy or
collect taxes or to issue refunds; and
(v) review of systems and procedures to see that the internal procedures adequately
secure correct and regular accounting of demands collection and refunds and
pursuant of dues up to final settlement and to suggest improvement.
: 139 :
Q.7. Explain Audit of Stores and Inventories.
1. Audit of the accounts of stores and inventories has been developed as a part of
expenditure audit with reference to the duties and responsibilities entrusted to
C&AG.
2. Audit is conducted to ascertain whether the Regulations governing purchase,
receipt and issue, custody, sale and inventory taking of stores are well de vised
and properly carried out.
3. The aim is also to bring to the notice of the government any deficiencies in
quantities of stores held or any defects in the system of control.
4. The auditor has to ensure that the prices paid are reasonable and are in
agreement with those shown in the contract for the supply of stores.
5. The certificates of quality and quantity are furnished by the inspecting and
receiving units.
6. Cases of uneconomical purchase of stores and losses attributable to defective or
inferior quality of stores are specifically brought by the audit.
Q.8. Explain Audit of Local Bodies.

Property taxes and octroi are the major sources of revenue of the municipal authorities;
other municipal taxes are profession tax, non-mechanised vehicles tax, taxes on
advertisements, taxes on animals and boats, tolls, show-tax, etc. Local bodies may
receive diff erent types of grants from the state administration as well. Broadly, the
revenue grants are of three categories:
(a) General purpose grants: These are primarily intended to substantially bridge the
gap between the needs and resources of the local bodies.
(b) Specific purpose grants: These grants which are tied to the provision of certain
services or performance of certain tasks.
(c) Statutory and compensatory grants: These grants, under various enactments,
are given to local bodies as compensation on account of loss of any revenue on
taking over a tax by state government from local government.
Expenditure incurred by the municipalities and corporations can be broadly
classified under the following heads: (a) general administration and revenue
collection, (b) public health, (c) public safety, (d) education, (e) public works, and
(f) others such as interest payments, etc.
(i) The auditor while auditing the local bodies should report on the fairness of
the contents and presentation of financial statements, the strengths and
weaknesses of system of financial control, the adherence to legal and/or
administrative requirements; whether value is being fully received on money
spent. His objective should be to detect errors and fraud and misuse of
resources.
(ii) The auditor should ensure that the expenditure incurred conforms to the
relevant provisions of the law and is in accordance with the financial rules
and regulations framed by the competent authority.
: 140 :
(iii) He should ensure that all types of sanctions, either special or general,
accorded by the competent authority.
(iv) He should ensure that there is a provision of funds and the expenditure is
incurred from the provision and the same has been authorized by the
competent authority.
(v) The auditor should check that the different schemes, programmes and
projects, where large financial expenditure has been incurred, are running
economically and getting the expected results.
Q.9. Explain Audit of NGO

While planning the audit, the auditor may concentrate on the following:
(i) Knowledge of the NGO’s work, its mission and vision, areas of operations and
environment in which it operate.
(ii) Updating knowledge of relevant statutes especially with regard to recent
amendments, circulars, judicial decisions viz. Foreign Contribution (Regulation)
Act 1976, Societies Registration Act, 1860, Income Tax Act 1961 etc. and the
Rules related to the statutes.
(iii) Reviewing the legal form of the Organisation and its Memorandum of Association,
Articles of Association, Rules and Regulations.
(iv) Reviewing the NGO’s Organisation chart, then Financial and Administrative
Manuals, Project and Programme Guidelines, Funding Agencies Requirements
and formats, budgetary policies if any.
(v) Examination of minutes of the Board/Managing Committee/Governing
Body/Management and Committees thereof to ascertain the impact of any
decisions on the financial records.
(vi) Study the accounting system, procedures, internal controls and internal checks
existing for the NGO and verify their applicability.
(vii) Setting of materiality levels for audit purposes.
(viii) The nature and timing of reports or other communications.
(ix) The involvement of experts and their reports.
(x) Review the previous year’s Audit Report.
The receipt of income of NGO may be checked on the following lines:

(i) Contributions and Grants for projects and programmes: Check agreements
with donors and grants letters to ensure that funds received have been accounted
for. Check that all foreign contribution receipts are deposited in the foreign
contribution bank account as notified under the Foreign Contribution (Regulation)
Act, 1976.
(ii) Receipts from fund raising programmes: Verify in detail the internal control
system and ascertain who are the persons responsible for collection of funds and
mode of receipt. Ensure that collections are counted and deposited in the bank
daily.
: 141 :
(iii) Membership Fees: Check fees received with Membership Register. Ensure
proper classification is made between entrance and annual fees and life
membership fees. Reconcile fees received with fees to be received during the
year.
(iv) Subscriptions: Check with subscription register and receipts issued. Reconcile
subscription received with printing and dispatch of corresponding magazine /
circulars / periodicals. Check the receipts with subscription rate schedule.
(v) Interest and Dividends: Check the interest and dividends received and
receivable with investments held during the year.
Q.10.Audit of Limited Liability partnership

Appointment of Auditor: The auditor may be appointed by the designated partners of
the LLP –
1. At any time for the first financial year but before the end of first financial year,
2. At least thirty days prior to the end of each financial year(other than the first
financial year),
3. To fill the causal vacancy in the office of auditor,
4. To fill the casual vacancy caused by removal of auditor.
The partners may appoint the auditors if the designated partners have failed to appoint
them.
Advantages / Purpose / Need of Audit
1. Auditing the accounts of a LLP helps in detecting errors & frauds & verification of
2. Disputes, if any between any partners in the matter of accounts can be settled with
the help of audited accounts.
3. Banks & financial institutions lend money to the firms only on the basis of audited
accounts.
4. Periodical visits & suggestions by the auditor will be helpful in improving the
management of the LLP.
5. For settling accounts between partners at the time of admission, death, retirement,
insolvency, insanity, etc audited accounts are accepted by those concerned who
have dealings with the LLP.
Auditor’s Duty Regarding Audit of LLP

1. The auditor should get definite instructions in writing as to the work to be
performed by him.
2. The auditor should mention
(a) Whether the records of the firm appear to be correct & reliable.
(b) Whether he was able to obtain all information & explanation necessary for his
work.
(c) Whether any restriction was imposed upon him.
: 142 :
Q11. Audit of Educational Institution
What are the special steps involved in conducting the audit of Educational Institutions?
Ans. 1. Examine the constitution of the school / college. See whether it is run by a
charitable institution.
2. If it is run by a Trust then check the provisions of the respective Trust Act.
3. Examine the rules and regulations of the institution, especially those clauses that
affect the accounts directly or indirectly.
4. Verify the minutes of the meetings of the managing committees / board of trustees
to know any important decision affecting the accounts.
5. Study and evaluate the accounting system and internal controls in order to
determine the extent of audit procedures to be performed.
6. Fees from Students
(i) The fees received from the students should be checked with reference to the
counterfoils of the receipts issued. Collection of other fees like admission and
laboratory fees should also be verified in the same manner.
(ii) Check up the system of depositing the collection of fees regularly with the
bank.
(iii) Inquire into the reasons of non receipt of fees if any recoverable fees are to
be written off. Check whether writing off is permitted by the managing
committee.
(iv) Outstanding and fees received in advance should be accounted for
separately.
7. Other Receipts :
(i) Recovery of fines should be vouched with reference to the copies of
receipts issued.
(ii) Donations received should be checked with the copies of receipts. See the
resolutions of the committee for the acceptance of the deposits, if any. See
whether any conditions are attached to the donations.
(iii) Grants received from the Government or other authorities should be
vouched with reference to all the complete correspondence.
(iv) Other receipts like interest from securities, rent etc. should be checked.
8. Deposits Received and refunded :
Deposits such as caution money, security, laboratory security etc. are received
from students. Such deposits should not be mixed up with the fees. They should
be credited to the proper accounts. When these deposits are refunded, the
respective accounts should be debited. Receipts and refunds of deposits should
be vouched with the copies of receipts issued or receipts received as the case
may be.
9. Vouch the salaries to the teaching and non-teaching staff. Check up the salary
registers. See that the salaries and allowances are as per the prevailing rules and
regulations. See that the deductions are properly accounted for. See that the
provident fund and gratuity dues are deposited separately as per regulations.
: 143 :
10. Check up the other expenditure like printing and stationery, conveyance etc. with
reference to the vouchers, invoices and receipts, cash memos etc.
11. See the payments free ships, prizes, scholarships etc. with reference to receipts.
Such payments should be authorised by a responsible official.
While vouching expenditure see that a distinction is made between capital and
revenue expenditure.
It is the duty of the auditor to verify additions to fixed assets and check whether
adequate depreciation has been charged. It is necessary to carry out physical
verification of investments. Verify authority for making loans and advances to
employees, students and others. Examine the possibility of doubtful recovery and
verify total amount outstanding in the books with copies of balance
confirmation certificates issued to the concerned person.
Q12. Audit of Hospital

What special steps will you take into consideration in auditing the accounts of a
Hospital?
OR
What steps would you take into consideration in auditing the receipts from
patients of a Hospital?
Ans. 1. Whether the hospital is owned by a Trust, company, partnership firm.
2. Note down the provisions of the applicable statutes, particularly those affecting
the provision of accounts.
3. Examine the minute books of directors / partners / governing body
4. Ascertain whether there is any system of internal control
5. Study past audit reports
6. Obtain a list of books of accounts and a list of authorised officials.
7. Examine the system of charging patients
8. Examine whether patients are promptly debited as and when services are
rendered and recoveries are made on a timely basis.
9. Examine the system where cashless treatment is given in accordance with
mediclaim schemes of general insurance companies.
10. Check whether the OPD slips given to patients are serially numbered to ensure
numerical control.
11. Examine internal controls on purchase of stores, medicines, linens, chemicals,
clothing, apparatus etc.
12. Conduct an audit of all bills for any small period selected at random. Trace the
transactions from the first record right upto the discharge of the patient.
13. Verify the bills prepared with records of various services rendered in various
departments like Consultation, Pathology, Cardiology etc.
14. Check to ensure that concessions or free treatments are granted only against
proper authorisation.
15. Vouch receipt entries in the cash book with copies of receipts issued, bills
and records.
16. Verify settlements with medical insurers under the cashless system and with credit
card companies for settlement through credit cards.
17. Verify interest/dividend/rent/grants in the usual manner.
: 144 :
18. Verify the assets and liabilities in the usual manner.
19. Calculate occupancy ratio of man-days, cost of various tests to income
realised therefrom, cost of medicines to income realised and compare them with
the preceding year’s ratios.
Q.13. Audit of Cinema Hall

Cinema Hall?
Ans. 1. Check whether the cinema hall is owned by a trust, company, partnership firm.
2. Note the provisions of the trust deed / partnership deed / MOA / AOA affecting the
cinema hall, particularly those affecting the provisions of accounts.
3. Examine the minute book of Directors / Partners / Governing Body.
4. Ascertain whether there is any internal audit
5. Study past audit reports
6. Obtain a list of books of accounts and a list of authorised officials.
7. Verify that entrance to the cinema hall during the show is only through printed
tickets.
8. Verify that the tickets are serially numbered and bound into books.
9. Verify that the number of tickets issued for each show and class are different.
10. Verify that the stock of tickets is kept in the custody of a responsible official.
11. Entertainment Tax – Auditor should ensure that the entertainment tax collected is
properly deposited with the government.
12. Ticket Sales – Vouch the cash collected through the cash book. Check daily
statements with record of tickets issued for different shows held.
13. Verify the charges collected for advertisement slides, and shots by reference to
the Register of Slides and Shorts Exhibited kept at the Cinema Hall, as well as
with agreements entered into with the advertisers in this regard.
14. Depreciation – Confirm whether depreciation on machinery and furniture has
been charged at an appropriate rate which are higher, as compared to those
admissible in the case of other businesses.
15. Film Hire Payment – Vouch payments on account of film hire with bills of
distributors and in the process agreements concerned should be referred to.
Examine unadjusted balance out of advance paid to the distributors against film
hire contracts to see that they are good and recoverable. If any film in respect
of which an advance was paid has already run, it should be enquired as to why the
advance has not been adjusted. The management should be asked to make a
provision in respect of advances that are considered as irrecoverable.
16. Restaurant Income – The arrangement for collection of the share in the
restaurant income should be enquired into. Either a fixed sum or a fixed
percentage of the takings may be received annually. In case the restaurant is run
by the Cinema Hall itself, its accounts should be checked. The audit should cover
sale of various items of foodstuffs, purchase of foodstuffs, cold drinks, cigarettes
etc.
17. Verify that advance bookings for shows to be held in the next financial year have
been carried forward and shown as liabilities.
: 145 :
Q.14.Audit of Hotel
Hotel?
Ans. 1. Ascertain the legal status of a hotel i.e. whether it is a sole trading organisation,
partnership or a company.
2. Examine the Articles and Memorandum of Association, or partnership deed and
note down important provisions which may have some bearing on the audit work.
3. Examine the minutes of B.O.D. to note decisions which may affect the audit work.
4. Evaluate the system of internal control particularly with regards to system billing
the guests, services availed by the guests from laundry, bar and restaurants etc.
5. Room Sales :
(i) Verify the room sales collections with the guest register.
(ii) Ensure standard rates have been charged in various guests’ bills and the
standard room rate should be investigated to ensure that they have been
properly authorised.
(iii) Test check daily occupancy reports prepared by housekeeper with guest
register and individual guest’s bill.
6. Other Receipts :
(i) Examine the bills raised or letting out of banquet hall with reference to
agreement signed with the customer / fixed tariff structure, cash book, bank
pass book and relevant register.
(ii) Examine copies of bills raised to agencies using space and other facilities of
the hotel e.g. Shopkeeper, tour operator etc.
(iii) Verify whether various taxes collected like service tax, luxury tax etc. have
been timely deposited with respective authorities.
(iv) Verify restaurant bills by reference to Kitchen Order Tickets (K.O.T.)
7. Ensure that wages paid to casual labour are shown properly.
8. Ensure that money has been recovered from the travel agents as per the
terms of credit allowed.
9. Vouch the commission paid to agents by reference to the agreement.
10. Ensure that proper distinction is made between capital and revenue expenditure.
11. Find whether depreciation has been properly charged on Furniture, Vehicles, linen
etc.
12. Physically verify the fixed assets and find the discrepancies between the results of
physical verification and the books of accounts.
13. Examine whether all the assets and liabilities have been properly disclosed.
14. FEMA – If the hotel operates a counter to facilitate foreign exchange conversion,
the auditor should ensure compliance with the various provisions of FEMA, 1999,
and the provisions of FEDAI.
: 146 :
Q.15.Audit of co-operative Society
A) The following points should be kept in mind in connection with the audit of a
cooperative society:
1. Qualifications of Auditors - Apart from a chartered accountant within the
meaning of the Chartered Accountants Act, 1949, some of the State Co-operative
Acts have permitted persons holding a government diploma in co-operative
accounts or in co-operation and accountancy and also a person who has served
as an auditor in the co-operative department of a government to act as an auditor.
2. Appointment of the Auditor - An auditor of a co-operative society is appointed by
the Registrar of Co-operative Societies and the auditor so appointed conducts the
audit on behalf of the Registrar and submits his report to him as also to the
society.
The audit fees are paid by the society on the basis of statutory scale of fees
prescribed by the Registrar, according to the category of the society audited.
3. Restrictions on share holdings - According to section 5 of the Central Act, in the
case of a society where the liability of a member of the society is limited, no
member of a society other than a registered society can hold such portion of the
share capital of the society as would exceed a maximum of twenty percent of the
total number of shares or of the value of shareholding to ` 1,000/-. The auditor of a
co-operative society will be concerned with this provision so as to watch any
breach relating to holding of shares. One should also watch whether any provision
in the bye-laws of the society is not contrary to this statutory position. The State
Acts may provide limits as to the shareholding, other than that provided in the
Central Act.
4. Restrictions on loans - Section 29 of the Central Act puts restriction on loan. It
states that a registered society shall not make a loan to any person other than a
member. However, with the special sanction of the Registrar, a registered society
may make a loan to another registered society.
The State Government may further put such restrictions as it thinks fit on the
loaning powers of the society to its members or to other societies in the interest of
the society concerned and its members.
5. Investment of funds - According to section 32 of the Central Act, a society may
invest its funds in any one or more of the following:
(a) In the Central or State Co-operative Bank.
(b) In any of the securities specified in section 20 of the Indian Trusts Act, 1882.
(c) In the shares, securities, bonds or debentures of any other society with
limited liability.
(d) In any co-operative bank, other than a Central or State co-operative bank, as
approved by the Registrar on specified terms and conditions.
(e) In any other moneys permitted by the Central or State Government.
6. Appropriation of profits - According to section 33 of the Central Act, a prescribed
percentage of the profits should be transferred to Reserve Fund, before
distribution as dividends or bonus to members.
7. Contributions to Charitable Purposes - According to section 34, a registered
society may, with the sanction of the Registrar, contribute an amount not
exceeding10% of the net profits remaining after the compulsory transfer to the
reserve fund for any charitable purpose as defined in section 2 of the Charitable
Endowments Act, 1890.
: 147 :
B) Special Features of Co-operative Society audit
1. Examination of overdue debts - Overdue debts for a period from 6 months to 5
years and more than 5 years will have to be classified and shall have to be
reported by an auditor. The auditor will have to ascertain whether proper
provisions for doubtful debts are made and whether the same is satisfactory.
2. Overdue Interest - Overdue interest should be excluded from interest outstanding
and accrued due while calculating profit. Overdue interest is interest accrued or
accruing in accounts, the amount of which the principal is overdue. In practice an
overdue interest reserve is created and the credit of overdue interest credited to
interest account is reduced.
3. Certification of Bad Debts - A peculiar feature regarding the writing off of the bad
debts as per Maharashtra State Co-operative Rules, 1961, is very interesting to
note. As per the said rules, bad debts can be written off only when they are
certified as bad by the auditor
4. Valuation of Assets and Liabilities - Regarding valuation of assets there are no
specific provisions or instructions under the Act and Rules and as such due regard
shall be had to the general principles of accounting and auditing conventions and
standards adopted.
5. Adherence to Co-operative Principles - The auditor will have to ascertain in
general, how far the objects, for which the co-operative organisation is set up,
have been achieved in the course of its working
6. Observations of the Provisions of the Act and Rules - An auditor of a co-
operative society is required to point out the infringement with the provisions of
Co-operative Societies Act and Rules and bye-laws.
7. Verification of Members’ Register and examination of their pass books
- Examination of entries in members pass books regarding the loan given and
its repayments, and confirmation of loan balances in person is very much
important in a co-operative organisation to assure that the entries in the
books of accounts are free from manipulation
8. Special report to the Registrar - During the course of audit, if the auditor notices
that there are some serious irregularities in the working of the society he may
report these special matters to the Registrar.
In the following cases, for instance, a special report may become necessary:
(i) Personal profiteering by members of managing committee in transactions of
the society, which are ultimately detrimental to the interest of the society.
(ii) Detection of fraud relating to expenses, purchases, property and stores of the
society.
(iii) Specific examples of mis-management. Decisions of management against
cooperative principles.
9. Audit classification of society - After a judgement of an overall performance of
the society, the auditor has to award a class to the society. This judgement is to be
based on the criteria specified by the Registrar.
: 148 :
10. Discussion of draft audit report with managing committee - On conclusion of
the audit, the auditor should ask the Secretary of the society to convene the
managing committee meeting to discuss the audit draft report.
C) Audit, Inquiry and Inspection of Multi-State Co-Operative Societies
The Multi-State Co-operative Societies Act, 2002, which came into force in August,
2002 applies to co-operative societies whose objects are not confined to one State.
Qualification, disqualification and appointment of auditor are same as prescribed under
Companies Act, 2013.
Q.16.Audit of Hire Purchase and leasing companies While checking the hire- purchase
transaction, the auditor may examine the following:
(i) Hire purchase agreement is in writing and is signed by all parties.
(ii) Hire purchase agreement specifies clearly-
(a) The hire-purchase price of the goods to which the agreement relates;
(b) The cash price of the goods, that is to say, the price at which the goods may
be purchased by the hirer for cash;
(c) The date on which the agreement shall be deemed to have commenced;
(d) The number of instalments by which the hire- purchase price is to be paid,
the amount of each of those instalments, and the date, or the mode of
determining the date, upon which it is payable, and the person to whom and
the place where it is payable; and
(e) The goods to which the agreement relates, in a manner sufficient to identify
them.
(iii) Ensure that instalment payments are being received regularly as per the
agreement.
In respect of leasing transaction entered into by the leasing company, the
following procedures may be adopted by the auditor:
(1) The object clause of leasing company to see that the goods like capital goods,
consumer durables etc. in respect of which the company can undertake such
activities. Further, to ensure that whether company can undertake fi nuancing
activities or not.
(2) Whether there exists a procedure to ascertain the credit analysis of lessee like
lessee’s ability to meet the commitment under lease, past credit record, capital
strength, availability of collateral security, etc.
(3) The lease agreement should be examined and the following points may be noted:
(i) the description of the lessor, the lessee, the equipment and the location
where the equipment is to be installed.
(ii) the amount of tenure of lease, dates of payment, late charges, deposits or
advances etc. should be noted.
(iii) whether the equipment shall be returned to the lessor on termination of the
agreement and the cost shall be borne by the lessee.
(iv) whether the agreement prohibits the lessee from assigning the subletting the
equipment and authorises the lessor to do so.
: 149 :
Q.17.Audit of Club
The special steps involved in such an audit are stated below-
(1) Vouch the receipt on account of entrance fees with members’ applications,
counterfoils issued to them, as well as on a reference to minutes of the Managing
Committee.
(2) Vouch members’ subscriptions with the counterfoils of receipt issued to them,
trace receipts for a selected period to the Register of Members; also reconcile the
amount of total subscriptions due with the amount collected and that outstanding.
(3) Ensure that arrears of subscriptions for the previous year have been correctly
brought over and arrears for the year under audit and subscriptions received in
advance have been correctly adjusted.
(4) Check totals of various columns of the Register of members and tally them across.
(5) See the Register of Members to ascertain the Member’s dues which are in arrear
and enquire whether necessary steps have been taken for their recovery; the
amount considered irrecoverable should be mentioned in the Audit Report.
(6) Verify the internal check as regards members being charged with the price of
foodstuff s and drinks provided to them and their guests, as well as, with the fees
chargeable for the special services rendered, such as billiards, tennis, etc.
(7) Trace debits for a selected period from subsidiary registers maintained in respect
of supplies and services to members to confirm that the account of every member
has been debited with amounts recoverable from him.
(8) Vouch purchase of sports items, furniture, crockery, etc. and trace their entries into
the respective inventory registers.
(9) Vouch purchases of foodstuff s, cigars, wines, etc., and test their sale price so as
to confirm that the normal rates of gross profit have been earned on their sales.
The inventory of unsold provisions and stores, at the end of year, should be
verified physically and its valuation checked.
(10) Check the inventory of furniture, sports material and other assets physically with
the respective inventory registers or inventories prepared at the end of the year.
(11) Inspect the share scrips and bonds in respect of investments, check their current
values for disclosure in final accounts; also ascertain that the arrangements for
their safe custody are satisfactory.
(12) Examine the financial powers of the secretary and, if these have been exceeded,
report specific case for confirmation by the Managing Committee.
: 150 :
AUDITING AND ASSURANCE STANDARDS
S.No AAS Title Page No.

1 SA 200 Overall Objectives of Independent Auditor and conduct of 151 – 154
audit in accordance with Standards on Auditing
2 SA 210 Agreeing to the terms of audit engagement 155 – 159
3 SA 220 Quality Control for an Audit of Financial Statements 160 – 165
4 SA 230 Audit Documentation 166 - 169
5 SA 240 The Auditor’s responsibilities Relating to Fraud in an Audit 170 – 176
of Financial Statements
6 SA 250 Consideration of Laws and Regulations in an Audit of 177 – 181
Financial Statements
7 SA 260 Communication with Those Charged with Governance 182 – 185
8 SA 265 Communicating Deficiencies in Internal Control to Those 186 – 187
Charged with Governance and Management
9 SA 299 Responsibility of Joint Auditors 188 – 191
10 SA 300 Planning an Audit of Financial Statements 192 – 196
11 SA 315 Identifying and Assessing the Risks of Material 197 – 200
Misstatement through Understanding the Entity and its
Environment
12 SA 320 Materiality in Planning and Performing an Audit 201 – 202
13 SA 330 The Auditor’s Responses to Assessed Risks 203 – 208
14 SA 402 Audit Considerations Relating to an Entity Using a Service 209 – 214
Organization
15 SA 450 Evaluation of Misstatements Identified during the Audits 215 – 217
16 SA 500 Audit Evidence 218 – 222
17 SA 501 Audit Evidence - Specific Considerations for Selected 223 – 226
Items
18 SA 505 External Confirmations 227 - 231
19 SA 510 Initial Audit Engagements-Opening Balances 232 – 235
20 SA 520 Analytical Procedures 236 – 238
21 SA 530 Audit Sampling 239 – 243
22 SA 540 Auditing Accounting Estimates, Including Fair Value 244 – 246
Accounting Estimates, and Related Disclosures
23 SA 550 Related Parties 247 – 253
24 SA 560 Subsequent Events 254 – 257
25 SA 570 Going Concern 258 – 264
26 SA 580 Written Representations 265 – 269
27 SA 600 Using the Work of Another Auditor 270 – 272
28 SA 610 Using the Work of Internal Auditors 273 – 276
29 SA 620 Using the Work of an Auditor’s Expert 277 – 279
30 SA 700 Forming an Opinion and Reporting on Financial 280 – 284
Statements
31 SA 701 Communicating Key Audit Matters in the Independent 285 - 286
Auditor’s Report
32 SA 705 Modifications to the Opinion in the Independent 287 – 288
Auditor’s Report
33 SA 706 Emphasis of Matter Paragraphs and Other Matter 289 – 295
Paragraphs in the Independent Auditor’s Report
34 SA 710 Comparative Information – Corresponding 296 – 300
Figures and Comparative Financial Statements
35 SA 720 The Auditor’s Responsibility in Relation to Other 301 – 302
Information in Documents Containing Audited
SA 200: OVERALL OBJECTIVES OF INDEPENDENT AUDITOR AND CONDUCT
OF AUDIT IN ACCORDANCE WITH STANDARDS ON AUDITING
A) Introduction
This Standard on Auditing (SA) establishes the independent auditor’s overall
responsibilities when conducting an audit of financial statements in accordance
with SAs.
Specifically, it sets out the overall objectives of the independent auditor, and
explains the nature and scope of an audit designed to enable the independent
auditor to meet those objectives.
It also explains the scope, authority and structure of the SAs, and includes
requirements establishing the general responsibilities of the independent
auditor applicable in all audits, including the obligation to comply with the SAs.
SAs are written in the context of an audit of financial statements by an auditor.
They are to be adapted as necessary in the circumstances when applied to
audits of other historical financial information.
An Audit of Financial Statements

1. The purpose of an audit is to enhance the degree of confidence of intended
users in the financial statements. This is achieved by the expression of an
opinion by the auditor on whether the financial statements are prepared, in all
material respects, in accordance with an applicable financial reporting
framework.
2. In the case of most general purpose frameworks, that opinion is on whether the
financial statements are presented fairly, in all material respects, or give a true
and fair view in accordance with the framework.
3. The audit of the financial statements does not relieve management or those
charged with governance of those responsibilities.
4. As the basis for the auditor’s opinion, SAs require the auditor to obtain
reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error.
Reasonable assurance is a high level of assurance. It is obtained when the
auditor has obtained sufficient appropriate audit evidence to reduce audit risk
(i.e., the risk that the auditor expresses an inappropriate opinion when the
financial statements are materially misstated) to an acceptably low level.
However, reasonable assurance is not an absolute level of assurance, because
there are inherent limitations of an audit which result in most of the audit
evidence on which the auditor draws conclusions and bases the auditor’s
opinion being persuasive rather than conclusive.
B) Effective Date
This SA is effective for audits of financial statements for periods beginning on
or after April 1, 2010.
: 151 :
C) Objective:
a) To obtain reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to fraud or
error, thereby enabling the auditor to express an opinion on whether the
financial statements are prepared, in all material respects, in accordance
with an applicable financial reporting framework; and
b) To report on the financial statements, and communicate as required by
the SAs, in accordance with the auditor’s findings.
D) Definitions
a) Audit evidence – Information used by the auditor in arriving at the
conclusions on which the auditor’s opinion is based. Audit evidence
includes both information contained in the accounting records underlying
the financial statements and other information. For purposes of the SAs:
Sufficiency of audit evidence is the measure of the quantity of audit
evidence. The quantity of the audit evidence needed is affected by the
auditor’s assessment of the risks of material misstatement and also by the
quality of such audit evidence.
Appropriateness of audit evidence is the measure of the quality of audit
evidence; that is, its relevance and its reliability in providing support for
the conclusions on which the auditor’s opinion is based.
b) Audit risk – The risk that the auditor expresses an inappropriate audit
opinion when the financial statements are materially misstated. Audit risk
is a function of the risks of material misstatement and detection risk.
Risk of material misstatement – The risk that the financial statements
are materially misstated prior to audit. This consists of two components,
described as follows at the assertion level:
Inherent risk – The susceptibility of an assertion about a class of
transaction, account balance or disclosure to a misstatement that could be
material, either individually or when aggregated with other misstatements,
before consideration of any related controls.
Control risk – The risk that a misstatement that could occur in an
assertion about a class of transaction, account balance or disclosure and
that could be material, either individually or when aggregated with other
misstatements, will not be prevented, or detected and corrected, on a
timely basis by the entity’s internal control.
Detection risk – The risk that the procedures performed by the auditor to
reduce audit risk to an acceptably low level will not detect a misstatement
that exists and that could be material, either individually or when
aggregated with other misstatements.
c) Misstatement – A difference between the amount, classification,

presentation, or disclosure of a reported financial statement item and the
amount, classification, presentation, or disclosure that is required for the
: 152 :
item to be in accordance with the applicable financial reporting framework.
Misstatements can arise from error or fraud.
d) Professional skepticism – An attitude that includes a questioning mind,
being alert to conditions which may indicate possible misstatement due to
error or fraud, and a critical assessment of audit evidence
e) Premise, relating to the responsibilities of management and, where
appropriate, those charged with governance, on which an audit is
conducted – That management and, where appropriate, those charged
with governance have the following responsibilities that are fundamental
to the conduct of an audit in accordance with SAs. That is, responsibility:
a) For the preparation and presentation of the financial statements in
accordance with the applicable financial reporting framework; this
includes the design, implementation and maintenance of internal
control relevant to the preparation and presentation of financial
statements that are free from material misstatement, whether due to
fraud or error; and
b) To provide the auditor with:
(a) All information, such as records and documentation, and other
matters that are relevant to the preparation and presentation of
(b) Any additional information that the auditor may request from
management and, where appropriate, those charged with
governance; and
(c) Unrestricted access to those within the entity from whom the
auditor determines it necessary to obtain audit evidence.
E) Requirements
1) Ethical Requirements Relating to an Audit of Financial Statements
The auditor shall comply with relevant ethical requirements, including
those pertaining to independence, relating to financial statement audit
engagements.
2) Professional Skepticism
The auditor shall plan and perform an audit with professional skepticism
recognising that circumstances may exist that cause the financial
statements to be materially misstated.
3) Professional Judgment
The auditor shall exercise professional judgment in planning and
performing an audit of financial statements.
4) Sufficient Appropriate Audit Evidence and Audit Risk
To obtain reasonable assurance, the auditor shall obtain sufficient
appropriate audit evidence to reduce audit risk to an acceptably low level
and thereby enable the auditor to draw reasonable conclusions on which
to base the auditor’s opinion.
: 153 :
5) Conduct of an Audit in Accordance with SAs
1. Complying with SAs Relevant to the Audit: The auditor shall comply
with all SAs relevant to the audit. An SA is relevant to the audit when
the SA is in effect and the circumstances addressed by the SA exist.
The auditor shall have an understanding of the entire text of an SA,
including its application and other explanatory material, to
understand its objectives and to apply its requirements properly.
The auditor shall not represent compliance with SAs in the auditor’s
report unless the auditor has complied with the requirements of this
SA and all other SAs relevant to the audit.
2. Objectives Stated in IndividuaI SAs: To achieve the overall
objectives of the auditor, the auditor shall use the objectives stated in
relevant SAs in planning and performing the audit, having regard to
the interrelationships among the SAs, to:
a) Determine whether any audit procedures in addition to those
required by the SAs are necessary in pursuance of the
objectives stated in the SAs; and
b) Evaluate whether sufficient appropriate audit evidence has
been obtained.
3. Complying with Relevant Requirements: The auditor shall comply
with each requirement of an SA unless, in the circumstances of the
audit:
a) The entire SA is not relevant; or
b) The requirement is not relevant because it is conditional and
the condition does not exist.
4. In exceptional circumstances, the auditor may judge it necessary to
depart from a relevant requirement in an SA. In such circumstances,
the auditor shall perform alternative audit procedures to achieve the
aim of that requirement. The need for the auditor to depart from a
relevant requirement is expected to arise only where the requirement
is for a specific procedure to be performed and, in the specific
circumstances of the audit, that procedure would be ineffective in
achieving the aim of the requirement.
6. Failure to Achieve an Objective

If an objective in a relevant SA cannot be achieved, the auditor shall
evaluate whether this prevents the auditor from achieving the overall
objectives of the auditor and thereby requires the auditor, in accordance
with the SAs, to modify the auditor’s opinion or withdraw from the
engagement. Failure to achieve an objective represents a significant
matter requiring documentation in accordance with SA 230
: 154 :
SA 210 AGREEING TO THE TERMS OF AUDIT ENGAGEMENT
A) Introduction
This Standard on Auditing (SA) deals with the auditor‟s responsibilities in
agreeing the terms of the audit engagement with management and, where
appropriate, those charged with governance. This includes establishing that
certain preconditions for an audit, responsibility for which rests with
management and, where appropriate, those charged with governance, are
present. SA 2203 deals with those aspects of engagement acceptance that are
within the control of the auditor.
B) Effective Date
C) Objective
The objective of the auditor is to accept or continue an audit engagement only
when the basis upon which it is to be performed has been agreed, through:
(a) Establishing whether the preconditions for an audit are present; and
(b) Confirming that there is a common understanding between the auditor
and management and, where appropriate, those charged with governance
of the terms of the audit engagement.
D) Definitions
Preconditions for an audit – The use by management of an acceptable
financial reporting framework4 in the preparation of the financial statements
and the agreement of management and, where appropriate, those charged with
governance to the premise5 on which an audit is conducted.
E) Requirements
1. Preconditions for an Audit
In order to establish whether the preconditions for an audit are present,
the auditor shall:
(a) Determine whether the financial reporting framework to be applied in
the preparation of the financial statements is acceptable
(b) Obtain the agreement of management that it acknowledges and
understands its responsibility:
(i) For the preparation of the financial statements in accordance with
the applicable financial reporting framework, including where
relevant their fair presentation
(ii) For such internal control as management determines is necessary to
enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error
(iii) To provide the auditor with:
a. Access to all information of which management is aware that is
relevant to the preparation of the financial statements such as
records, documentation and other matters;
b. Additional information that the auditor may request from
management for the purpose of the audit; and
c. Unrestricted access to persons within the entity from whom the
auditor determines it necessary to obtain audit evidence.
: 155 :
If the preconditions for an audit are not present, the auditor shall discuss
the matter with management. Unless required by law or regulation to do
so, the auditor shall not accept the proposed audit engagement.
2. Limitation on Scope Prior to Audit Engagement Acceptance

If management or those charged with governance impose a limitation on
the scope of the auditor‟s work in the terms of a proposed audit
engagement such that the auditor believes the limitation will result in the
auditor disclaiming an opinion on the financial statements, the auditor
shall not accept such a limited engagement as an audit engagement,
unless required by law or regulation to do so.
3. Agreement on Engagement Terms- Letter of Engagement
The agreed terms of the audit engagement shall be recorded in an audit
engagement letter or other suitable form of written agreement and shall
include:
(a) The objective and scope of the audit of the financial statements;
(b) The responsibilities of the auditor;
(c) The responsibilities of management;
(d) Identification of the applicable financial reporting framework for the
preparation of the financial statements; and
(e) Reference to the expected form and content of any reports to be
issued by the auditor and a statement that there may be
circumstances in which a report may differ from its expected form
and content.
Note 1: If law or regulation prescribes in sufficient detail the terms of the
audit engagement, the auditor need not record them in a written
agreement, except for the fact that such law or regulation applies and that
management acknowledges and understands its responsibilities as
discussed earlier
Note 2: On recurring audits, the auditor shall assess whether
circumstances require the terms of the audit engagement to be revised
and whether there is a need to remind the entity of the existing terms of
the audit engagement.
4. Acceptance of a Change in the Terms of the Audit Engagement
- The auditor shall not agree to a change in the terms of the audit
engagement where there is no reasonable justification for doing so
- If, prior to completing the audit engagement, the auditor is requested
to change the audit engagement to an engagement that conveys a
lower level of assurance, the auditor shall determine whether there is
reasonable justification for doing so.
- If the terms of the audit engagement are changed, the auditor and
management shall agree on and record the new terms of the
engagement in an engagement letter or other suitable form of written
agreement
- If the auditor is unable to agree to a change of the terms of the audit
engagement and is not permitted by management to continue the
original audit engagement, the auditor shall:
(a) Withdraw from the audit engagement where possible under
applicable law or regulation; and
(b) Determine whether there is any obligation, either contractual or
otherwise, to report the circumstances to other parties, such as
those charged with governance, owners or regulators.
: 156 :
5. Additional Considerations in Engagement Acceptance
a) Financial Reporting Standards Supplemented by Law or Regulation
If financial reporting standards established by an authorised or
recognised standards setting organization are supplemented by law
or regulation, the auditor shall determine whether there are any
conflicts between the financial reporting standards and the
additional requirements.
If such conflicts exist, the auditor shall discuss with management the
nature of the additional requirements and shall agree whether:
(a) The additional requirements can be met through additional
disclosures in the financial statements; or
(b) The description of the applicable financial reporting framework
in the financial statements can be amended accordingly.
If neither of the above actions is possible, the auditor shall
determine whether it will be necessary to modify the auditor’s
opinion
b) Auditor’s Report Prescribed by Law or Regulation
In some cases, the law or regulation applicable to the entity prescribes the
layout or wording of the auditor’s report in a form or in terms that are
significantly different from the requirements of SAs. In these
circumstances, the auditor shall evaluate:
(a) Whether users might misunderstand the assurance obtained from
the audit of the financial statements and, if so,
(b) Whether additional explanation in the auditor’s report can mitigate
possible misunderstanding.
If the auditor concludes that additional explanation in the auditor’s
report cannot mitigate possible misunderstanding, the auditor shall
not accept the audit engagement, unless required by law or
regulation to do so.
An audit conducted in accordance with such law or regulation does
not comply with SAs. Accordingly, the auditor shall not include any
reference within the auditor’s report to the audit having been
conducted in accordance with SAs
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QUESTIONS:
Q.1. Mention the factors to be considered in determining the acceptability of
financial reporting framework to be applied in preparation of financial
statements.
Factors that are relevant to the auditor’s determination of the acceptability of
the financial reporting framework to be applied in the preparation of the
financial statements include:
● The nature of the entity (for example, whether it is a business enterprise,
or a not for profit organization);
● The purpose of the financial statements (for example, whether they are
prepared to meet the common financial information needs of a wide range
of users or the financial information needs of specific users);
● The nature of the financial statements (for example, whether the financial
statements are a complete set of financial statements or a single financial
statement); and
● Whether law or regulation prescribes the applicable financial reporting
framework.
Q.2. Mention the additional Matters which can be included in engagement

letter apart from the contents which are required by SA 210.
An audit engagement letter may make reference to, for example:
● Elaboration of the scope of the audit, including reference to applicable
legislation, regulations, SAs, and ethical and other pronouncements of
professional bodies to which the auditor adheres.
● The form of any other communication of results of the audit engagement.
● The fact that because of the inherent limitations of an audit, together with
the inherent limitations of internal control, there is an unavoidable risk that
some material misstatements may not be detected, even though the audit
is properly planned and performed in accordance with SAs.
● Arrangements regarding the planning and performance of the audit,
including the composition of the audit team.
● The expectation that management will provide written representations
● The agreement of management to make available to the auditor draft
financial statements and any accompanying other information in time to
allow the auditor to complete the audit in accordance with the proposed
timetable.
● The agreement of management to inform the auditor of facts that may
affect the financial statements, of which management may become aware
during the period from the date of the auditor’s report to the date the
financial statements are issued.
● The basis on which fees are computed and any billing arrangements.
● A request for management to acknowledge receipt of the audit
engagement letter and to agree to the terms of the engagement outlined
therein.
● The fact that the audit process may be subjected to a peer review under
the Chartered Accountants Act, 1949.
: 158 :
Q.3. Mention the factors that may influence the decision whether to send a
separate audit engagement letter to the component.
When the auditor of a parent entity is also the auditor of a component, the
factors that may influence the decision whether to send a separate audit
engagement letter to the component include the following:
● Who appoints the component auditor;
● Whether a separate auditor’s report is to be issued on the component;
● Legal requirements in relation to audit appointments;
● Degree of ownership by parent; and
● Degree of independence of the component management from the parent
entity.
Q.4. Give examples of sending revised letter of engagement in case of

recurring audits
The auditor may decide not to send a new audit engagement letter or other
written agreement each period. However, the following factors may make it
appropriate to revise the terms of the audit engagement or to remind the entity
of existing terms:
● Any indication that the entity misunderstands the objective and scope of
the audit.
● Any revised or special terms of the audit engagement.
● A recent change of senior management.
● A significant change in ownership.
● A significant change in nature or size of the entity‟s business.
● A change in legal or regulatory requirements.
● A change in the financial reporting framework adopted in the preparation
of the financial statements.
● A change in other reporting requirements
: 159 :
J.KSHAH CLASES INTER C.A. - AUDIT
SA 220 QUALITY CONTROL FOR AN AUDIT OF
FINANCIAL STATEMENTS
A) Introduction
This Standard on Auditing (SA) deals with the specific responsibilities of the
auditor regarding quality control procedures for an audit of financial statements
B) Effective Date
C) Objectives
The objective of the auditor is to implement quality control procedures at the
engagement level that provide the auditor with reasonable assurance that:
(a) The audit complies with professional standards and regulatory and legal
requirements; and
(b) The auditor’s report issued is appropriate in the circumstances.
D) Definition
(a) Engagement partner – the partner or other person in the firm who is a
member of the Institute of Chartered Accountants of India and is in full
time practice and is responsible for the engagement and its performance,
and for the report that is issued on behalf of the firm, and who, where
required, has the appropriate authority from a professional, legal or
regulatory body.
(b) Engagement quality control review – a process designed to provide an
objective evaluation, before the report is issued, of the significant
judgments the engagement team made and the conclusions they reached
in formulating the report.
(c) Engagement quality control reviewer – a partner, other person4 in the
firm, suitably qualified external person, or a team made up of such
individuals, with sufficient and appropriate experience and authority to
objectively evaluate, before the report is issued, the significant judgments
the engagement team made and the conclusions they reached in
formulating the report. However, in case the review is done by a team of
individuals, such team should be headed by a member of the Institute.
(d) Engagement team – all personnel performing an engagement, including
any experts contracted by the firm in connection with that engagement.
E) Requirements
1) Leadership Responsibilities for Quality on Audits
The engagement partner shall take responsibility for the overall quality on
each audit engagement to which that partner is assigned.
The actions of the engagement partner and appropriate messages to the
other members of the engagement team, in taking responsibility for the
overall quality on each audit engagement, emphasise:
(a) The importance to audit quality of:
(i) Performing work that complies with professional standards and
regulatory and legal requirements;
(ii) Complying with the firm’s quality control policies and
procedures as applicable;
(iii) Issuing auditor’s reports that are appropriate in the
circumstances; and
: 160 :
(iv) The engagement team’s ability to raise concerns without fear of
reprisals; and
(b) The fact that quality is essential in performing audit engagements.
2) Compliance with Ethical Requirements

1. Throughout the audit engagement, the engagement partner shall
remain alert, through observation and making inquiries as
necessary, for evidence of non-compliance with relevant ethical
requirements by members of the engagement team.
2. If matters come to the engagement partner’s attention through the
firm’s system of quality control or otherwise that indicate that
members of the engagement team have not complied with relevant
ethical requirements, the engagement partner, in consultation with
others in the firm, shall determine the appropriate action
3. The engagement partner shall form a conclusion on compliance with
independence requirements that apply to the audit engagement. In
doing so, the engagement partner shall:
(a) Obtain relevant information from the firm and, where
applicable, network firms, to identify and evaluate
circumstances and relationships that create threats to
independence;
(b) Evaluate information on identified breaches, if any, of the firm’s
independence policies and procedures to determine whether
they create a threat to independence for the audit engagement;
and
(c) Take appropriate action to eliminate such threats or reduce
them to an acceptable level by applying safeguards, or, if
considered appropriate, to withdraw from the audit engagement
3) Acceptance and Continuance of Client Relationships and Audit

Engagements
1. The engagement partner shall be satisfied that appropriate
procedures regarding the acceptance and continuance of client
relationships and audit engagements have been followed, and shall
determine that conclusions reached in this regard are appropriate.
2. If the engagement partner obtains information that would have
caused the firm to decline the audit engagement had that information
been available earlier, the engagement partner shall communicate
that information promptly to the firm, so that the firm and the
engagement partner can take the necessary action
3. Information such as the following assists the engagement partner in
determining whether the conclusions reached regarding the
acceptance and continuance of client relationships and audit
engagements are appropriate:
- The integrity of the principal owners, key management and
those charged with governance of the entity;
- Whether the engagement team is competent to perform the
audit engagement and has the necessary capabilities, including
time and resources;
- Whether the firm and the engagement team can comply with
relevant ethical requirements; and
- Significant matters that have arisen during the current or
previous audit engagement, and their implications for
continuing the relationship.
: 161 :
4) Assignment of Engagement Teams
The engagement partner shall be satisfied that the engagement team, and any
auditor’s experts who are not part of the engagement team, collectively have
the appropriate competence and capabilities to:
(a) Perform the audit engagement in accordance with professional standards
and regulatory and legal requirements; and
(b) Enable an auditor’s report that is appropriate in the circumstances to be
issued
5) Engagement Performance
1. Direction, Supervision and Performance
The engagement partner shall take responsibility for:
(a) The direction, supervision and performance of the audit engagement
in compliance with professional standards and regulatory and legal
requirements; and
(b) The auditor’s report being appropriate in the circumstances
2. Reviews
1. The engagement partner shall take responsibility for reviews being
performed in accordance with the firm’s review policies and
procedures
2. On or before the date of the auditor’s report, the engagement partner
shall, through a review of the audit documentation and discussion
with the engagement team, be satisfied that sufficient appropriate
audit evidence has been obtained to support the conclusions
reached and for the auditor’s report to be issued
3. Consultation
The engagement partner shall:
(a) Take responsibility for the engagement team undertaking
appropriate consultation on difficult or contentious matters;
(b) Be satisfied that members of the engagement team have undertaken
appropriate consultation during the course of the engagement
4. Differences of Opinion
If differences of opinion arise within the engagement team, with those
consulted or, where applicable, between the engagement partner and the
engagement quality control reviewer, the engagement team shall follow
the firm’s policies and procedures for dealing with and resolving
differences of opinion.
6) Engagement Quality Control Review

1. For audits of financial statements of listed entities, and those other audit
engagements, if any, for which the firm has determined that an
engagement quality control review is required, the engagement partner
shall :
(a) Determine that an engagement quality control reviewer has been
appointed;
(b) Discuss significant matters arising during the audit engagement,
including those identified during the engagement quality control
review, with the engagement quality control reviewer; and
(c) Not date the auditor’s report until the completion of the engagement
quality control review.
2. Engagement Quality Control Review will involve:
(a) Discussion of significant matters with the engagement partner;
(b) Review of the financial statements and the proposed auditor’s report;
: 162 :
(c) Review of selected audit documentation relating to the significant
judgments the engagement team made and the conclusions it
reached; and
(d) Evaluation of the conclusions reached in formulating the auditor’s
report and consideration of whether the proposed auditor’s report is
appropriate.
7) Documentation
1. The auditor shall document:
(a) Issues identified with respect to compliance with relevant ethical
requirements and how they were resolved.
(b) Conclusions on compliance with independence requirements that
apply to the audit engagement, and any relevant discussions with
the firm that support these conclusions.
(c) Conclusions reached regarding the acceptance and continuance of
client relationships and audit engagements.
(d) The nature and scope of, and conclusions resulting from,
consultations undertaken during the course of the audit engagement.
2. The engagement quality control reviewer shall document, for the audit
engagement reviewed, that:
(a) The procedures required by the firm’s policies on engagement
quality control review have been performed;
(b) The engagement quality control review has been completed on or
before the date of the auditor’s report; and
(c) The reviewer is not aware of any unresolved matters that would
cause the reviewer to believe that the significant judgments the
engagement team made and the conclusions they reached were not
appropriate
: 163 :
QUESTION BANK:
Q.1. What does direction by engagement partner include as per SA 220.

Direction of the engagement team involves informing the members of the
engagement team of matters such as:
- Their responsibilities, including the need to comply with relevant ethical
requirements, and to plan and perform an audit with professional
skepticism as required by SA 200.
- Responsibilities of respective partners where more than one partner is
involved in the conduct of an audit engagement.
- The objectives of the work to be performed.
- The nature of the entity’s business.
- Risk-related issues.
- Problems that may arise.
- The detailed approach to the performance of the engagement.
Q. 2. What does “Supervision” include as per SA 220.
Supervision includes matters such as:
- Tracking the progress of the audit engagement.
- Considering the competence and capabilities of individual members of the
engagement team, including whether they have sufficient time to carry out
their work, whether they understand their instructions, and whether the
work is being carried out in accordance with the planned approach to the
audit engagement.
- Addressing significant matters arising during the audit engagement,
considering their significance and modifying the planned approach
appropriately.
- Identifying matters for consultation or consideration by more experienced
engagement team members during the audit engagement
Q.3. Explain Engagement Partner’s review of the work performed by

Engagement Team as per SA 220.
Answer:
Under SQC 1, the firm’s review responsibility policies and procedures are
determined on the basis that work of less experienced team members is reviewed by
more experienced team members.
Timely reviews of the following by the engagement partner at appropriate stages
during the engagement allow significant matters to be resolved on a timely basis to
the engagement partner’s satisfaction on or before the date of the auditor’s report:
-Critical areas of judgment, especially those relating to difficult or contentious matters
identified during the course of the engagement;
-Significant risks; and
-Other areas the engagement partner considers important.
The engagement partner need not review all audit documentation, but may do so.
However, as required by SA 230, the partner documents the extent and timing of the
reviews.
: 164 :
Q.4. M/s Sureshchandra & Co. has been appointed as an auditor of SC Ltd. for
the financial year 2014-15. CA. Suresh, one of the partners of M/s
Sureshchandra & Co., completed entire routine audit work by 29th May,
2015. Unfortunately, on the very next morning, while roving towards office
of SC Ltd. to sign final audit report, he met with a road accident and died.
CA. Chandra, another partner of M/s Sureshchandra & Co., therefore,
signed the accounts of SC Ltd., without reviewing the work performed by
CA. Suresh. State with reasons whether CA. Chandra is right in
expressing an opinion on financial statements the audit of which is
performed by another auditor.
Answer:
Relying on Work Performed by Another Auditor: As per SA 220 “Quality Control for
an Audit of Financial Statements”, an engagement partner taking over an audit
during the engagement may apply the review procedures such as the work has been
performed in accordance with professional standards and regulatory and
legal requirements; significant matters have been raised for further consideration;
appropriate consultations have taken place and the resulting conclusions have been
documented and implemented; there is a need to revise the nature, timing and
extent of work performed; the work performed supports the conclusions reached and
is appropriately documented; the evidence obtained is sufficient and appropriate to
support the auditor’s report; and the objectives of the engagement procedures have
been achieved.
Further, one of the basic principles, which govern the auditor’s professional
responsibilities and which should be complied with wherever an audit is carried, is
that when the auditor delegates work to assistants or uses work performed by other
auditor and experts, he will continue to be responsible for forming and expressing his
opinion on the financial information. However, he will be entitled to rely on work
performed by others, provided he exercises adequate skill and care and is not aware
of any reason to believe that he should not have so relied. This is the fundamental
principle which is ethically required as per Code of Ethics. However, the auditor
should carefully direct, supervise and review work delegated. He should obtain
reasonable assurance that work performed by other auditors/experts and assistants
is adequate for his purpose.
In the given case, all the auditing procedures before the moment of signing of final
report have been performed by CA. Suresh. However, the report could not be signed
by him due to his unfortunate death. Later on, CA. Chandra signed the report relying
on the work performed by CA. Suresh. Here, CA. Chandra is allowed
to sign the audit report, though, will be responsible for expressing the opinion. He
may rely on the work performed by CA. Suresh provided he further exercises
adequate skill and due care and review the work performed by him.
: 165 :
SA 230 AUDIT DOCUMENTATION
A) Introduction
1. This Standard on Auditing (SA) deals with the auditor’s responsibility to
prepare audit documentation for an audit of financial statements. It is to be
adapted as necessary in the circumstances when applied to audits of
other historical financial information. The specific documentation
requirements of other SAs do not limit the application of this SA. Laws or
regulations may establish additional documentation requirements.
2. Nature and Purposes of Audit Documentation

Audit documentation that meets the requirements of this SA and the
specific documentation requirements of other relevant SAs provides:
(a) Evidence of the auditor’s basis for a conclusion about the
achievement of the overall objectives of the auditor;
(b) Evidence that the audit was planned and performed in accordance
with SAs and applicable legal and regulatory requirements.
c) Assisting the engagement team to plan and perform the audit.
(d) Assisting members of the engagement team responsible for
supervision to direct and supervise the audit work, and to discharge
their review responsibilities in accordance with SA 220.
(e) Enabling the engagement team to be accountable for its work.
(f) Retaining a record of matters of continuing significance to future
audits.
(g) Enabling the conduct of quality control reviews and inspections in
accordance with SQC
(h) Enabling the conduct of external inspections in accordance with
applicable legal, regulatory or other requirements.
B) Effective Date
or after April 1, 2009
C) Objectives
The objective of the auditor is to prepare documentation that provides:
(a) A sufficient and appropriate record of the basis for the auditor’s report;
and
(b) Evidence that the audit was planned and performed in accordance with
SAs and applicable legal and regulatory requirements.
D) Definition
(a) Audit documentation – The record of audit procedures performed, relevant
audit evidence obtained, and conclusions the auditor reached (terms such
as “working papers” or “workpapers” are also sometimes used).
(b) Audit file – One or more folders or other storage media, in physical or
electronic form, containing the records that comprise the audit
documentation for a specific engagement.
E) Requirement
1) The auditor shall prepare audit documentation on a timely basis.
Preparing sufficient and appropriate audit documentation on a timely basis
: 166 :
helps to enhance the quality of the audit and facilitates the effective
review and
evaluation of the audit evidence obtained and conclusions reached before
the auditor’s report is finalised. Documentation prepared after the audit
work has been performed is likely to be less accurate than documentation
prepared at the time such work is performed.
2) Form, content and Extent of Audit Documentation
(a) The nature, timing, and extent of the audit procedures performed to
comply with the SAs and applicable legal and regulatory
requirements;
(b) The results of the audit procedures performed, and the audit
evidence obtained; and
(c) Significant matters arising during the audit, the conclusions reached
thereon, and significant professional judgments made in reaching
those conclusions.
In documenting the nature, timing and extent of audit procedures
performed, the auditor shall record:
(a) The identifying characteristics of the specific items or matters tested;
(b) Who performed the audit work and the date such work was
completed; and
(c) Who reviewed the audit work performed and the date and extent of
such review.
3) The auditor shall document discussions of significant matters with
management, those charged with governance, and others, including the
nature of the significant matters discussed and when and with whom the
discussions took place
4) If the auditor identified information that is inconsistent with the auditor’s
final conclusion regarding a significant matter, the auditor shall
document how the auditor addressed the inconsistency
5) If, in exceptional circumstances, the auditor judges it necessary to depart
from a relevant requirement in a SA, the auditor shall document how the
alternative audit procedures performed achieve the aim of that
requirement, and the reasons for the departure
6) If, in exceptional circumstances, the auditor performs new or additional
audit procedures or draws new conclusions after the date of the
auditor’s report, the auditor shall document:
(a) The circumstances encountered;
(b) The new or additional audit procedures performed, audit evidence
obtained, and conclusions reached, and their effect on the auditor’s
report; and
(c) When and by whom the resulting changes to audit documentation
were made and reviewed.
7) The auditor shall assemble the audit documentation in an audit file and
complete the administrative process of assembling the final audit file on a
timely basis after the date of the auditor’s report. An appropriate time limit
within which to complete the assembly of the final audit file is ordinarily not
more than 60 days after the date of the auditor’s report.
8) After the assembly of the final audit file has been completed, the auditor shall
not delete or discard audit documentation of any nature before the end of its
retention period.
: 167 :
QUESTION BANK
1) Mention the factors affecting form content and Extent of Audit
Documentation
The form, content and extent of audit documentation depend on factors such
as:
- The size and complexity of the entity.
- The nature of the audit procedures to be performed.
- The identified risks of material misstatement.
- The significance of the audit evidence obtained.
- The nature and extent of exceptions identified.
- The need to document a conclusion or the basis for a conclusion not
readily determinable from the documentation of the work performed or
audit evidence obtained.
- The audit methodology and tools used
2) Judging the significance of a matter requires an objective analysis of the

facts and circumstances. Give Examples.
Judging the significance of a matter requires an objective analysis of the facts
and circumstances. Examples of significant matters include:
- Matters that give rise to significant risks (as defined in SA 315)
- Results of audit procedures indicating (a) that the financial statements
could be materially misstated, or (b) a need to revise the auditor’s
previous assessment of the risks of material misstatement and the
auditor’s responses to those risks.
- Circumstances that cause the auditor significant difficulty in applying
necessary audit procedures.
- Findings that could result in a modification to the audit opinion or the
inclusion of an Emphasis of Matter paragraph in the auditor’s report.
An important factor in determining the form, content and extent of audit
documentation of significant matters is the extent of professional judgment
exercised in performing the work and evaluating the results.
3) Discuss the Auditor’s responsibility to provide access to his audit

working papers to Regulators and third parties.
Audit Working Paper:
The auditor should not provide access to working papers to any third party
without specific authority or unless there is a legal or professional duty to
disclose. Clause (1) of Part I of Second Schedule to the Chartered Accountants
Act, 1949 states that a Chartered Accountant in practice shall be
deemed to be guilty of professional misconduct if he discloses information
acquired in the course of his professional engagement to any person other than
his client, without the consent of his client or otherwise than as required by law
for the time being in force.
SA 200 on “Overall Objectives of the Independent Auditor and the conduct of
an audit in accordance with Standards on Auditing” also reiterates that, “the
auditor should respect the confidentiality of the information obtained and should
not disclose any such information to any third party without specific authority or
unless there is a legal or professional duty to disclose”.
If there is a request to provide access by the regulator based on the legal
requirement,
: 168 :
the same has to be complied with after informing the client about the same.
Further, Standard on Quality Control (SQC) 1, “Quality Control for Firms that
Perform Audits and Reviews of Historical Financial Information, and Other
Assurance and Related Services Engagements”, provides that, unless
otherwise specified by law or regulation, audit documentation is the property of
the auditor.
He may at his discretion, make portions of, or extracts from, audit
documentation available to clients, provided such disclosure does not
undermine the validity of the work performed, or, in the case of assurance
engagements, the independence of the auditor or of his personnel.
As per SA 230, Audit documentation serves a number of additional purposes,
including the enabling the conduct of external inspections in accordance with
applicable legal, regulatory or other requirements.
Therefore, it is auditor’s responsibility to provide access to his audit working
papers to Regulators whereas it’s at auditor’s discretion, to make portions of, or
extract from his working paper to third parties.
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SA 240 AUDITOR’S RESPONSIBILITIES IN
RELATION TO FRAUD
A) Introduction
1. This Standard on Auditing (SA) deals with the auditor’s responsibilities relating
to fraud in an audit of financial statements. Specifically, it expands on how SA
315, “Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and Its Environment,” and SA 330, “The Auditor’s
Res1ponses to Assessed Risks,” are to be applied in relation to risks of
material misstatement due to fraud.
2. Misstatements in the financial statements can arise from either fraud or error.
The distinguishing factor between fraud and error is whether the underlying
action that results in the misstatement of the financial statements is intentional
or unintentional.
3. Two types of intentional misstatements are relevant to the auditor–
misstatements resulting from fraudulent financial reporting and misstatements
resulting from misappropriation of assets.
4. The primary responsibility for the prevention and detection of fraud rests with
both those charged with governance of the entity and management.
5. Owing to the inherent limitations of an audit, there is an unavoidable risk that
some material misstatements of the financial statements may not be detected,
even though the audit is properly planned and performed in accordance with
the SAs.
6. The risk of not detecting a material misstatement resulting from fraud is higher
than the risk of not detecting one resulting from error.
7. Furthermore, the risk of the auditor not detecting a material misstatement
resulting from management fraud is greater than for employee fraud, because
management is frequently in a position to directly or indirectly manipulate
accounting records
B) Effective Date
This SA is effective for audits of financial statements for periods beginning on or
after 1st April, 2009
C) Objectives
The objectives of the auditor are:
(a) To identify and assess the risks of material misstatement in the financial
statements due to fraud;
(b) To obtain sufficient appropriate audit evidence about the assessed risks of
material misstatement due to fraud, through designing and implementing
appropriate responses; and
(c) To respond appropriately to identified or suspected fraud.
D) Definition
(a) Fraud - An intentional act by one or more individuals among management,
those charged with governance, employees, or third parties, involving the use
of deception to obtain an unjust or illegal advantage.
(b) Fraud risk factors - Events or conditions that indicate an incentive or pressure
to commit fraud or provide an opportunity to commit fraud.
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E) Requirements
1. Professional Skepticism
1. The auditor shall maintain professional skepticism throughout the audit,
recognizing the possibility that a material misstatement due to fraud
could exist, notwithstanding the auditor’s past experience of the honesty
and integrity of the entity’s management and those charged with
governance.
2. Unless the auditor has reason to believe the contrary, the auditor may
accept records and documents as genuine. If conditions identified during
the audit cause the auditor to believe that a document may not be
authentic or that terms in a document have been modified but not
disclosed to the auditor, the auditor shall investigate further.
3. Where responses to inquiries of management or those charged with
governance are inconsistent, the auditor shall investigate the
inconsistencies.
2. Risk Assessment Procedures and Related Activities
When performing risk assessment procedures and related activities to obtain
an understanding of the entity and its environment, including the entity’s
internal control, required by SA 315 the auditor shall perform following
procedures:
1. The auditor shall make inquiries of management regarding:
(a) Management’s assessment of the risk that the financial statements
may be materially misstated due to fraud, including the nature,
extent and frequency of such assessments
(b) Management’s process for identifying and responding to the risks of
fraud in the entity, including any specific risks of fraud that
management has identified or that have been brought to its
attention, or classes of transactions, account balances, or
disclosures for which a risk of fraud is likely to exist
(c) Management’s communication, if any, to those charged with
governance regarding its processes for identifying and responding
to the risks of fraud in the entity; and
(d) Management’s communication, if any, to employees regarding its
views on business practices and ethical behavior.
2. The auditor shall make inquiries of management, and others within the
entity as appropriate, to determine whether they have knowledge of any
actual, suspected or alleged fraud affecting the entity
3. The auditor shall obtain an understanding of how those charged with
governance exercise oversight of management’s processes for
identifying and responding to the risks of fraud in the entity and the
internal control that management has established to mitigate these risks
4. The auditor shall make inquiries of those charged with governance to
determine whether they have knowledge of any actual, suspected or
alleged fraud affecting the entity.
5. The auditor shall evaluate whether the information obtained from the
other risk assessment procedures and related activities performed
indicates that one or more fraud risk factors are present.
3. Responses to the Assessed Risk
1. The auditor shall:
(a) Assign and supervise personnel taking account of the knowledge,
skill and ability of the individuals to be given significant engagement
responsibilities and the auditor’s assessment of the risks of material
misstatement due to fraud for the engagement;
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(b) Evaluate whether the selection and application of accounting
policies by the entity, particularly those related to subjective
measurements and complex transactions, may be indicative of
fraudulent financial reporting resulting from management’s effort to
manage earnings; and
(c) Incorporate an element of unpredictability in the selection of the
nature, timing and extent of audit procedures.
2. Test the appropriateness of journal entries recorded in the general ledger
and other adjustments made in the preparation of the financial
statements. In designing and performing audit procedures for such tests,
the auditor shall:
(i) Make inquiries of individuals involved in the financial reporting
process about inappropriate or unusual activity relating to the
processing of journal entries and other adjustments;
(ii) Select journal entries and other adjustments made at the end of a
reporting period; and
(iii) Consider the need to test journal entries and other adjustments
throughout the period.
3. For significant transactions that are outside the normal course of
business for the entity, or that otherwise appear to be unusual given the
auditor’s understanding of the entity and its environment and other
information obtained during the audit, the auditor shall evaluate whether
the business rationale (or the lack thereof) of the transactions suggests
reporting or to conceal misappropriation of assets.
4. When the auditor identifies a misstatement, the auditor shall evaluate
whether such a misstatement is indicative of fraud. If there is such an
indication, the auditor shall evaluate the implications of the misstatement
in relation to other aspects of the audit
4. Withdrawal from the engagement team
If the auditor withdraws:
(i) Discuss with the appropriate level of management and those charged
with governance, the auditor’s withdrawal from the engagement and the
reasons for the withdrawal; and
(ii) Determine whether there is a professional or legal requirement to report
to the person or persons who made the audit appointment or, in some
cases, to regulatory authorities, the auditor’s withdrawal from the
engagement and the reasons for the withdrawal
5. Obtain Written Representations
The auditor shall obtain written representations from management and, where
applicable, those charged with governance that:
(a) They acknowledge their responsibility for the design, implementation and
maintenance of internal control to prevent and detect fraud;
(b) They have disclosed to the auditor the results of management’s
assessment of the risk that the financial statements may be materially
misstated as a result of fraud;
(c) They have disclosed to the auditor their knowledge of fraud or suspected
fraud affecting the entity involving:
(i) Management;
(ii) Employees who have significant roles in internal control; or
(iii) Others where the fraud could have a material effect on the financial
statements
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QUESTION BANK
1. Mention the Fraud Risk Factors

The fact that fraud is usually concealed can make it very difficult to detect.
Nevertheless, the auditor may identify events or conditions that indicate an
incentive or pressure to commit fraud or provide an opportunity to commit fraud
(fraud risk factors). For example:
A) Incentives/Pressures
Financial stability or profitability is threatened by economic, industry, or entity
operating conditions, such as (or as indicated by):
 High degree of competition or market saturation, accompanied by
declining margins.
 High vulnerability to rapid changes, such as changes in technology,
product obsolescence, or interest rates.
 Significant declines in customer demand and increasing business
failures in either the industry or overall economy.
B) Opportunities
The nature of the industry or the entity’s operations provides opportunities to
engage in fraudulent financial reporting that can arise from the following:
 Significant related-party transactions not in the ordinary course of
business or with related entities not audited or audited by another firm.
A strong financial presence or ability to dominate a certain industry
sector that allows the entity to dictate terms or conditions to suppliers or
customers that may result in inappropriate or non-arm’s-length
transactions.
 Assets, liabilities, revenues, or expenses based on significant estimates
that involve subjective judgments or uncertainties that are difficult to
corroborate.
 Significant, unusual, or highly complex transactions, especially those
close to period end that pose difficult “substance over form” questions.’
C) Attitudes/Rationalizations
 Communication, implementation, support, or enforcement of the entity’s
values or ethical standards by management, or the communication of
inappropriate values or ethical standards, that are not effective.
 Non-financial management’s excessive participation in or preoccupation
with the selection of accounting policies or the determination of
significant estimates.
 Known history of violations of securities laws or other laws and
regulations, or claims against the entity, its senior management, or those
charged with governance alleging fraud or violations of laws and
regulations.
2. Explain the term management override of controls and its techniques.

Fraudulent financial reporting often involves management override of controls that
otherwise may appear to be operating effectively. Fraud can be committed by
management overriding controls using such techniques as:
· Recording fictitious journal entries, particularly close to the end of an
accounting period, to manipulate operating results or achieve other objectives.
· Inappropriately adjusting assumptions and changing judgments used to
estimate account balances.
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· Omitting, advancing or delaying recognition in the financial statements of
events and transactions that have occurred during the reporting period.
· Concealing, or not disclosing, facts that could affect the amounts recorded in
· Engaging in complex transactions that are structured to misrepresent the
financial position or financial performance of the entity.
· Altering records and terms related to significant and unusual transactions
3. M/s Honest Limited has entered into a transaction on 5th March, 2015, near
year-end, whereby it has agreed to pay ` 5 lakhs per month to Mr. Y as annual
retainer-ship fee for "engineering consultation". No amount was actually paid,
but ` 60 lakhs is provided in books of account as on March 31, 2015. Your
inquiry elicits a response that need-based consultation was obtained round
the year, but there is no documentary or other evidence of receipt of the
service. As the auditor of M/s Honest Limited, what would be your approach?
Answer
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements”, fraud can be committed by management overriding controls
using such techniques as Recording fictitious journal entries, particularly close to the end
of an accounting period, to manipulate operating results or achieve other objectives.
Keeping in view the above, it is clear that Company has passed fictitious journal entries
near year end to manipulate the operating results. Also Auditor’s enquiry elicited a
response that need-based consultation was obtained round the year, but there is no
documentary or other evidence of receipt of the service, is not acceptable.
Accordingly, the auditor would adopt the following approach-
encounters exceptional circumstances that bring into question the auditor’s ability to
continue performing the audit, the auditor shall:
(i) Determine the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to report to
the person or persons who made the audit appointment or, in some cases, to
regulatory authorities;
(ii) Consider whether it is appropriate to withdraw from the engagement, where
withdrawal from the engagement is legally permitted
Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company,
in the course of the performance of his duties as auditor, has reason to believe that an
offence involving fraud is being or has been committed against the company by officers
or employees of the company, he shall immediately report the matter to the Central
Government within 60 days of his knowledge and after following the prescribed
procedure
The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016, if
there is any fraud on or by the company has been noticed or reported during the year.
The nature and the amount involved are to be indicated.
4. In the course of audit of K Ltd., its auditor Mr. 'N' observed that there was a
special audit conducted at the instance of the management on a possible
suspicion of a fraud and requested for a copy of the report to enable him to
report on the fraud aspects. Despite many reminders it was not provided. In
absence of the special audit report, Mr. 'N' insisted that he be provided with at
least a written representation in respect of fraud on/by the company. For this
request also, the management remained silent. Please guide Mr. 'N'.
: 174 :
Auditor’s Responsibilities Relating to Fraud: As per SA 240 on “The Auditor’s
Responsibilities Relating to Fraud in an Audit of 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.
As per SA 580 “Written Representations”, if management modifies or does not
provide the requested written representations, it may alert the auditor to the
possibility that one or more significant issues may exist.
In the instant case, the auditor observed that there was a special audit
conducted at the instance of the management on a possible suspicion of fraud.
Therefore, the auditor requested for special audit report which was not provided by
the management despite of many reminders. The auditor also insisted for written
representation in respect of fraud on/by the company. For this request also
management remained silent.
It may be noted that, if management does not provide one or more of the
requested written representations, the auditor shall discuss the matter with
management; re-evaluate the integrity of management and evaluate the effect
that this may have on the reliability of representations (oral or written) and audit
evidence in general; and take appropriate actions, including determining the
possible effect on the opinion in the auditor’s report.
In addition, as per section 143(12) of the Companies Act, 2013, if an auditor of a
company, in the course of the performance of his duties as auditor, has reason to
believe that an offence involving fraud is being or has been committed against the
company by officers or employees of the company, he shall immediately report the
matter to the Central Government within 60 days of his knowledge and after
following the prescribed procedure.
The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO,
2016, if there is any fraud on or by the company has been noticed or reported
during the year. The nature and the amount involved are to be indicated.
encounters exceptional circumstances that bring into question the auditor’s
ability to continue performing the audit, the auditor shall:
(i) Determine the professional and legal responsibilities applicable in the
circumstances, including whether there is a requirement for the auditor to
report to the person or persons who made the audit appointment or, in some
cases, to regulatory authorities;
(ii) Consider whether it is appropriate to withdraw from the engagement, where
withdrawal from the engagement is legally permitted;
5. In the course of audit of A Ltd. you suspect the management has indulged in
fraudulent financial reporting. State the possible source of such fraudulent
financial reporting.
Answer:
Possible Sources of Fraudulent Financial Reporting: As per SA 240, “The Auditor’s
responsibilities relating to Fraud in an Audit of Financial Statements”, fraudulent financial
reporting involves intentional misstatements or omissions of amounts or disclosures in
financial statements to deceive financial statement users.
It may be accomplished by manipulation, falsification, or alteration of accounting
records or supporting documents from which the financial statements are
prepared or Misrepresentation in, or intentional omission from, the financial statements
of events, transactions or other significant information or intentional misstatements
: 175 :
involve intentional misapplication of accounting principles relating to measurement,
recognition, classification, presentation, or disclosure etc
Fraud can be committed by management overriding controls using such
techniques as:
(i) Recording fictitious journal entries, particularly close to the end of an accounting
period, to manipulate operating results or achieve other objectives.
(ii) Inappropriately adjusting assumptions and changing judgments used to estimate
account balances.
(iii) Omitting, advancing or delaying recognition in the financial statements of events
and transactions that have occurred during the reporting period.
(iv) Concealing, or not disclosing, facts that could affect the amounts recorded in the
(v) Engaging in complex transactions that are structured to misrepresent the financial
position or financial performance of the entity.
6. As per SA 240, explain broad principles with regards to auditor’s

responsibilities in relation to fraud.
Answer
Broadly, the general principles laid down in the SA may be noted as under:
1. An auditor conducting an audit in accordance with SAs is responsible for obtaining
2. As described in SA 200, “Overall Objectives,” owing to the inherent limitations of
an audit, there is an unavoidable risk that some material misstatements of the
financial statements will not be detected, even though the audit is properly planned
and performed in accordance with the SAs.
3. The risk of not detecting a material misstatement resulting from fraud is higher than
the risk of not detecting one resulting from error.
4. Furthermore, the risk of the auditor not detecting a material misstatement resulting
from management fraud is greater than for employee fraud, because management
is frequently in a position to directly or indirectly manipulate accounting records
5. As per SA 240, the primary responsibility for the prevention and detection of fraud
rests with both those charged with governance of the entity and management
In addition, as per section 143(12) of the Companies Act, 2013, if an auditor of a

company, in the course of the performance of his duties as auditor, has reason to believe
that an offence involving fraud is being or has been committed against the company by
officers or employees of the company, he shall immediately report the matter to the
Central Government within 60 days of his knowledge and after following the prescribed
procedure.
The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO,
2016, if there is any fraud on or by the company has been noticed or reported during the
year. The nature and the amount involved are to be indicated.
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SA 250 CONSIDERATION OF LAWS AND REGULATIONS IN AN
AUDIT OF FINANCIAL STATEMENTS
A) Introduction
consider laws and regulations when performing an audit of financial
statements. This SA does not apply to other assurance engagements in
which the auditor is specifically engaged to test and report separately on
compliance with specific laws or regulations
2. Effect of Laws and Regulations
The provisions of some laws or regulations have a direct effect on the
financial statements in that they determine the reported amounts and
disclosures in an entity’s financial statements.
Other laws or regulations are to be complied with by management or set
the provisions under which the entity is allowed to conduct its business
but do not have a direct effect on an entity’s financial statements. Some
entities operate in heavily regulated industries (such as banks and
chemical companies).
Others are subject only to the many laws and regulations that relate
generally to the operating aspects of the business (such as those related
to occupational safety
and health). Non-compliance with laws and regulations may result in fines,
litigation or other consequences for the entity that may have a material
effect on the financial statements.
3. 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
4. Auditor’s Responsibility
The requirements in this SA are designed to assist the auditor in
identifying material misstatement of the financial statements due to non-
compliance with laws and regulations. However, the auditor is not
responsible for preventing noncompliance and cannot be expected to
detect non-compliance with all laws and regulations.
5. This SA distinguishes the auditor’s responsibilities in relation to
compliance with two different categories of laws and regulations as
follows:
(a) The provisions of those laws and regulations generally recognised to
have a direct effect on the determination of material amounts and
disclosures in the financial statements such as tax and labour laws;
and
(b) Other laws and regulations that do not have a direct effect on the
determination of the amounts and disclosures in the financial
statements, but compliance with which may be fundamental to the
operating aspects of the business, to an entity’s ability to continue its
business, or to avoid material penalties (for example, compliance
with the terms of an operating license, compliance with regulatory
solvency requirements, or compliance with environmental
regulations
B) Effective Date
: 177 :
C) Objective
(a) To obtain sufficient appropriate audit evidence regarding compliance with
the provisions of those laws and regulations generally recognised to have
a direct effect on the determination of material amounts and disclosures in
(b) To perform specified audit procedures to help identify instances of
noncompliance with other laws and regulations that may have a material
effect on the financial statements; and
(c) To respond appropriately to non-compliance or suspected non-
compliance with laws and regulations identified during the audit.
D) Definition
--
E) Requirements
1. As part of obtaining an understanding of the entity and its environment in
accordance with SA 315,6 the auditor shall obtain a general
understanding of:
(a) The legal and regulatory framework applicable to the entity and the
industry or sector in which the entity operates; and
(b) How the entity is complying with that framework.
2. The auditor shall obtain sufficient appropriate audit evidence regarding
compliance with the provisions of those laws and regulations generally
recognised to have a direct effect on the determination of material
amounts and disclosures in the financial statements
3. The auditor shall perform the following audit procedures to help identify
instances of non-compliance with other laws and regulations that may
have a material effect on the financial statements:
(a) Inquiring of management and, where appropriate, those charged
with governance, as to whether the entity is in compliance with such
laws and regulations; and
(b) Inspecting correspondence, if any, with the relevant licensing or
regulatory authorities.
4. The auditor shall request management and, where appropriate, those
charged with governance to provide written representations that all known
instances of non-compliance or suspected non-compliance with laws and
regulations have been disclosed to the auditor
5. Audit Procedures When Non-Compliance is Identified or Suspected

a. If the auditor becomes aware of information concerning an instance
of noncompliance or suspected non-compliance with laws and
regulations, the auditor shall obtain:
(a) An understanding of the nature of the act and the
circumstances in which it has occurred; and
(b) Further information to evaluate the possible effect on the
financial statements
b. If the auditor suspects there may be non-compliance, the auditor
shall discuss the matter with management and, where appropriate,
: 178 :
c. If management or, as appropriate, those charged with governance
do not provide sufficient information that supports that the entity is in
compliance with laws and regulations and, in the auditor’s judgment,
the effect of the suspected non-compliance may be material to the
financial statements, the auditor shall consider the need to obtain
legal advice
d. If sufficient information about suspected non-compliance cannot be
obtained, the auditor shall evaluate the effect of the lack of sufficient
appropriate audit evidence on the auditor’s opinion
6. Reporting of Identified or Suspected Non-Compliance

a. Reporting Non-Compliance to Those Charged with Governance
(i) The auditor shall communicate with those charged with
governance matters involving noncompliance Vwith laws and
regulations that come to the auditor’s attention during the
course of the audit, other than when the matters are clearly
inconsequential.
(ii) 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.
b. Reporting Non-Compliance in the Auditor’s Report on the
(i) 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.
(ii) 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.
(iii) 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.
c. 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.
: 179 :
QUESTION BANK.
Q1. While verifying the employee records in a company, it was found that a
major portion of the labour employed was child labour. On questioning
the management, the auditor was told that it was outside his scope of the
financial audit to look into the compliance with other laws.
Compliance with Other Laws: As per SA 250, “Consideration of Laws and
Regulations in an Audit of Financial Statements”, the auditor shall obtain
sufficient appropriate audit evidence regarding compliance with the provisions
of those laws and regulations generally recognised to have a direct effect on
the determination of material amounts and disclosures in the financial
statements including tax and labour laws.
Further, non-compliance with other laws and regulations may result in fines,
litigation or other consequences for the entity, the costs of which may need to
be provided for in the financial statements, but are not considered to have a
direct effect on the financial statements.
In the instant case, major portion of the labour employed in the company was
child labour. While questioning by auditor, reply of the management that it was
outside his scope of financial audit to look into the compliance with other laws is
not acceptable as it may have a material effect on financial statements.
Thus, auditor should ensure the disclosure of above fact and provision for the
cost of fines, litigation or other consequences for the entity. In case if the
auditor concludes that 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
statement.
Q2. State the reporting responsibility of an auditor in the context of non-

compliance of Law and Regulation in an audit of Financial Statement.
ANSWER:
Reporting of Identified or Suspected Non-Compliance
a. Reporting Non-Compliance to Those Charged with Governance
(i) The auditor shall communicate with those charged with governance
matters involving noncompliance 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.
(ii) 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.
b. Reporting Non-Compliance in the Auditor’s Report on the Financial
Statements
(i) 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.
(ii) If the auditor is precluded by management or those charged with
governance from obtaining sufficient appropriate audit evidence to
: 180 :
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.
(iii) 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.
c. 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.
Q3. What are the roles and responsibilities of the statutory auditors in relation
to compliance with the laws and regulations by the entity?
ANSWER:
Roles and Responsibilities of the Auditor in relation to compliance with the Laws and
Regulations: As per SA 250 “Consideration of Laws and Regulations in an Audit
of Financial Statements”, as part of obtaining an understanding of the entity and its
environment the auditor shall obtain a general understanding of:
(i) The legal and regulatory framework applicable to the entity and the industry or
sector in which the entity operates; and
(ii) How the entity is complying with that framework.
The auditor shall obtain sufficient appropriate audit evidence regarding compliance
with the provisions of those laws and regulations generally recognised to have a
direct effect on the determination of material amounts and disclosures in the financial
statements.
The auditor shall perform the following audit procedures to help identify instances of
non-compliance with other laws and regulations that may have a material effect on
the financial statements:
(i) Inquiring of management and, where appropriate, those charged with
governance, as to whether the entity is in compliance with such laws and
regulations; and
(ii) Inspecting correspondence, if any, with the relevant licensing or regulatory
authorities.
During the audit, the auditor shall remain alert to the possibility that other audit
procedures applied may bring instances of non-compliance or suspected
noncompliance with laws and regulations to the auditor’s attention.
The auditor shall request management and, where appropriate, those charged with
governance to provide written representations that all known instances of non-
compliance or suspected non-compliance with laws and regulations whose effects
should be considered when preparing financial statements have been disclosed to
the auditor.
Thus, 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.
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SA 260 COMMUNICATION WITH THOSE
CHARGED WITH GOVERNANCE.
A) Introduction
This Standard on Auditing (SA) deals with the auditor‟s responsibility to

communicate with those charged with governance in an audit of financial
statements. Although this SA applies irrespective of an entity‟s governance
structure or size.
This SA focuses primarily on communications from the auditor to those charged

with governance. Nevertheless, effective two-way communication is important
in assisting:
a. The auditor and those charged with governance in understanding matters
related to the audit in context, and in developing a constructive working
relationship. This relationship is developed while maintaining the auditor‟s
independence and objectivity;
b. The auditor in obtaining from those charged with governance information
relevant to the audit. For example, those charged with governance may
assist the auditor in understanding the entity and its environment, in
identifying appropriate sources of audit evidence, and in providing
information about specific transactions or events; and
c. Those charged with governance in fulfilling their responsibility to oversee
the financial reporting process, thereby reducing the risks of material
misstatement of the financial statements.
B) Effective Date

C) Objectives
(a) To communicate clearly with those charged with governance the
responsibilities of the auditor in relation to the financial statement audit,
and an overview of the planned scope and timing of the audit;
(b) To obtain from those charged with governance information relevant to the
audit;
(c) To provide those charged with governance with timely observations
arising from the audit that are significant and relevant to their
responsibility to oversee the financial reporting process; and
(d) To promote effective two-way communication between the auditor and
D) Definition
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E) Requirements
1. The auditor shall determine the appropriate person(s) within the entity‟s
governance structure with whom to communicate.
2. If the auditor communicates with a subgroup of those charged with
governance, for example, an audit committee, or an individual, the auditor
shall determine whether the auditor also needs to communicate with the
governing body.
3. Matters to be communicated
A. The Auditor’s Responsibilities in Relation to the Financial Statement
Audit
The auditor shall communicate with those charged with governance
the responsibilities of the auditor in relation to the financial statement
audit, including that:
(a) The auditor is responsible for forming and expressing an
opinion on the financial statements that have been prepared by
management with the oversight of those charged with
governance; and
(b) The audit of the financial statements does not relieve
management or those charged with governance of their
responsibilities.
B. Planned Scope and Timing of the Audit
Matters communicated may include:
(a) How the auditor plans to address the significant risks of
material misstatement, whether due to fraud or error.
(b) How the auditor plans to address areas of higher assessed
risks of material misstatement.
(c) The auditor’s approach to internal control relevant to the audit.
(d) The application of the concept of materiality in the context of an
audit.
(e) The nature and extent of specialized skill or knowledge needed
to perform the planned audit procedures or evaluate the audit
results, including the use of an auditor’s expert.
(f) When SA 701 applies, the auditor’s preliminary views about
matters that may be areas of significant auditor attention in the
audit and therefore may be key audit matters.
C. Significant Findings from the Audit
Matters communicated may include:
(a) The auditor’s views about significant qualitative aspects of the
entity’s accounting practices, including accounting policies,
accounting estimates and financial statement disclosures
(b) Significant difficulties, if any, encountered during the audit. It
may include such matters as:
(i) Significant delays by management, the unavailability of
entity personnel, or an unwillingness by management to
provide information necessary for the auditor to perform
the auditor’s procedures.
(ii) An unreasonably brief time within which to complete the
audit.
(iii) Extensive unexpected effort required to obtain sufficient
appropriate audit evidence.
(iv) The unavailability of expected information.
(v) Restrictions imposed on the auditor by management.
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(vi) Management’s unwillingness to make or extend its
assessment of the entity’s ability to continue as a going
concern when requested.
d. Auditor’s Independence
In the case of listed entities, the auditor shall communicate with
those charged with governance:
(a) A statement that the engagement team and others in the
firm as appropriate, the firm and, when applicable,
network firms have complied with relevant ethical
requirements regarding independence
4. Forms of Communication
The auditor shall communicate in writing with those charged with
governance regarding significant findings from the audit if, in the auditor’s
professional judgment, oral communication would not be adequate.
Written communications need not include all matters that arose during the
course of the audit.
The auditor shall communicate in writing with those charged with
governance regarding auditor independence.
5. Timing of Communications
The auditor shall communicate with those charged with governance on a timely
basis.
6. Adequacy of the Communication Process

The auditor shall evaluate whether the two-way communication between the
auditor and those charged with governance has been adequate for the purpose
of the audit. If it has not, the auditor shall evaluate the effect, if any, on the
auditor’s assessment of the risks of material misstatement and ability to obtain
sufficient appropriate audit evidence, and shall take appropriate action.
7. Documentation
Where matters required by this SA to be communicated are communicated
orally, the auditor shall include them in the audit documentation, and when and
to whom they were communicated. Where matters have been communicated in
writing, the auditor shall retain a copy of the communication as part of the audit
documentation.
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QUESTION BANK
1. The auditors should communicate audit matters of governance interest
arising from the audit of financial statements with those charged with the
governance of an entity”. Briefly state the matters to be included in such
Communication.
Communications of audit matters with those charged with governance: As
per SA 260 “Communication with those Charged with Governance”, the auditor
shall communicate with those charged with governance, the responsibilities of
the auditor in relation to the financial statement audit, including that:
(a) The auditor is responsible for forming and expressing an opinion on the
financial statements that have been prepared by management with the
oversight of those charged with governance; and
(b) The audit of the financial statements does not relieve management or
those charged with governance of their responsibilities.
The auditor shall communicate with those charged with governance the
following:
(a) The auditor’s views about significant qualitative aspects of the
entity’s accounting practices, including accounting policies,
accounting estimates and financial statement disclosures. When
applicable, the auditor shall explain to those charged with
governance why the auditor considers a significant accounting
practice, that is acceptable under the applicable financial reporting
framework, not to be most appropriate to the particular
circumstances of the entity;
(b) Significant difficulties, if any, encountered during the audit;
(c) Unless all of those charged with governance are involved in
managing the entity:
(i) Significant matters, if any, arising from the audit that were
discussed, or subject to correspondence with management;
and
(ii) Written representations the auditor is requesting; and
(d) Other matters, if any, arising from the audit that, in the auditor’s
professional judgment, are significant to the oversight of the financial
reporting process.
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SA 265 COMMUNICATING DEFICIENCIES IN INTERNAL CONTROL TO
THOSE CHARGED WITH GOVERNANCE AND MANAGEMENT
A) Introduction
communicate appropriately to those charged with governance and
management deficiencies in internal control3 that the auditor has
identified in an audit of financial statements.
2. This SA specifies which identified deficiencies the auditor is required to
communicate to those charged with governance and management.
B) Effective date
C) Objectives
The objective of the auditor is to communicate appropriately to those charged
with governance and management deficiencies in internal control that the
auditor has identified during the audit and that, in the auditor’s professional
judgment, are of sufficient importance to merit their respective attentions.
D) Definition
For purposes of the SAs, the following terms have the meanings attributed
below:
(a) Deficiency in internal control – This exists when:
(i) A control is designed, implemented or operated in such a way that it
is unable to prevent, or detect and correct, misstatements in the
financial statements on a timely basis; or
(ii) A control necessary to prevent, or detect and correct, misstatements
in the financial statements on a timely basis is missing.
E) Requirement
1. The auditor shall determine whether, on the basis of the audit work
performed, the auditor has identified one or more deficiencies in internal
control.
2. If the auditor has identified one or more deficiencies in internal control, the
auditor shall determine, on the basis of the audit work performed,
whether, individually or in combination, they constitute significant
deficiencies.
Examples of matters that the auditor may consider in determining
whether a deficiency or combination of deficiencies in internal control
constitutes a significant deficiency include:
● The likelihood of the deficiencies leading to material misstatements in the
financial statements in the future.
● The susceptibility to loss or fraud of the related asset or liability.
● The subjectivity and complexity of determining estimated amounts, such
as fair value accounting estimates.
● The financial statement amounts exposed to the deficiencies.
● The volume of activity that has occurred or could occur in the account
balance or class of transactions exposed to the deficiency or deficiencies.
● The importance of the controls to the financial reporting process.
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3. The auditor shall communicate in writing significant deficiencies in internal
control identified during the audit to those charged with governance on a
timely basis.
4. The auditor shall also communicate to management at an appropriate
level of responsibility on a timely basis:
(a) In writing, significant deficiencies in internal control that the auditor
has communicated or intends to communicate to those charged with
governance, unless it would be inappropriate to communicate
directly to management in the circumstances; and
(b) Other deficiencies in internal control identified during the audit that
have not been communicated to management by other parties and
that, in the auditor’s professional judgment, are of sufficient
importance to merit management’s attention
5. Contents of Communication:
(a) A description of the deficiencies and an explanation of their potential
effects; and
(b) Sufficient information to enable those charged with governance and
management to understand the context of the communication. In
particular, the auditor shall explain that:
(i) The purpose of the audit was for the auditor to express an opinion on
(ii) The audit included consideration of internal control relevant to the
preparation of the financial statements in order to design audit
procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of internal
control; and
(iii) The matters being reported are limited to those deficiencies that the
auditor has identified during the audit and that the auditor has
concluded are of sufficient importance to merit being reported to
6. Factors to be considered in determining the level of detail required in the

communication
● The nature of the entity. For instance, the communication required for a
public interest entity may be different from that for a non-public interest
entity.
● The size and complexity of the entity. For instance, the communication
required for a complex entity may be different from that for an entity
operating a simple business.
● The nature of significant deficiencies that the auditor has identified.
● The entity’s governance composition. For instance, more detail may be
needed if those charged with governance include members who do not
have significant experience in the entity’s industry or in the affected areas.
● Legal or regulatory requirements regarding the communication of specific
types of deficiency in internal control.
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SA 299 RESPONSIBILITIES OF JOINT AUDITORS
A) Introduction
This Standard deals with the professional responsibilities which the auditors
undertake in accepting such appointments as joint auditors. The Standard does
not deal with the relationship between a principal auditor who is appointed to
report on the financial statements of an entity and another auditor who is
appointed to report on the financial statements of one or more divisions or
branches included in the financial statements of the entity
B) Effective Date
This Standard on Auditing becomes operative in respect of all audits relating to
accounting periods beginning on or after April 1, 1996.
C) Requirements
1. Work Division
Where joint auditors are appointed, they should, by mutual discussion,
divide the audit work among themselves. The division of work would
usually be in terms of audit of identifiable units or specified areas.
In some cases, due to the nature of the business of the entity under audit,
such a division of work may not be possible.
In such situations, the division of work may be with reference to items of
assets or liabilities or income or expenditure or with reference to periods
of time.
Certain areas of work, owing to their importance or owing to the nature of
the work involved, would often not be divided and would be covered by all
the joint auditors.
The division of work among joint auditors as well as the areas of work to
be covered by all of them should be adequately documented and
preferably communicated to the entity.
2. Coordination
Where, in the course of his work, a joint auditor comes across matters
which are relevant to the areas of responsibility of other joint auditors and
which deserve their attention, or which require disclosure or require
discussion with, or application of judgement by, other joint auditors, he
should communicate the same to all the other joint auditors in writing.
This should be done by the submission of a report or note prior to the
finalisation of the audit.
3. Relationship among Joint Auditors
In respect of audit work divided among the joint auditors, each joint
auditor is responsible only for the work allocated to him, whether or not he
has prepared a separate report on the work performed by him. On the
other hand, all the joint auditors are jointly and severally responsible –
(a) in respect of the audit work which is not divided among the joint
auditors and is carried out by all of them;
(b) in respect of decisions taken by all the joint auditors concerning the
nature, timing or extent of the audit procedures to be performed by
any of the joint auditors. It may, however, be clarified that all the joint
auditors are responsible only in respect of the appropriateness of the
decisions concerning the nature, timing or extent of the audit
procedures agreed upon among them; proper execution of these
audit procedures is the separate and specific responsibility of the
joint auditor concerned;
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(c) in respect of matters which are brought to the notice of the joint
auditors by any one of them and on which there is an agreement
among the joint auditors;
(d) for examining that the financial statements of the entity comply with
the disclosure requirements of the relevant statute; and
(e) for ensuring that the audit report complies with the requirements of
the relevant statute.
Each joint auditor is entitled to assume that the other joint auditors have
carried out their part of the audit work in accordance with the generally
accepted audit procedures. It is not necessary for a joint auditor to review
the work performed by other joint auditors or perform any tests in order to
ascertain whether the work has actually been performed in such a
manner. Each joint auditor is entitled to rely upon the other joint auditors
for bringing to his notice any departure from generally accepted
accounting principles or any material error noticed in the course of the
audit.
4. Reporting Responsibilities
Normally, the joint auditors are able to arrive at an agreed report.
However, where the joint auditors are in disagreement with regard to any
matters to be covered by the report, each one of them should express his
own opinion through a separate report. A joint auditor is not bound by the
views of the majority of the joint auditors regarding matters to be covered
in the report and should express his opinion in a separate report in case of
a disagreement
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QUESTION BANK
1. KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z
as joint auditors to conduct auditing for the financial year 2014-15. For the
valuation of gratuity scheme of the company, Mr. X, Mr. Y and Mr. Z
wanted to refer their own known Actuaries. Due to difference of opinion,
all the joint auditors consulted their respective Actuaries. Subsequently,
major difference was found in the actuary reports. However, Mr. X agreed
to Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr.
Y’s actuary report shall be considered in audit report due to majority of
votes. Now, Mr. Z is in dilemma.
(I) You are required to briefly explain the responsibilities of auditors
when they are jointly and severally responsible in respect of audit
conducted by them and also guide Mr. Z in such situation.
(II) Explain the responsibility of auditors, in case, report made by Mr. Y’s
actuary, later on, found faulty.
Answer:
Difference of Opinion Among Joint Auditors: SA 299 on, “Responsibility of Joint
Auditors” deals with the professional responsibilities, which the auditors undertake in
accepting such appointments as joint auditors. In respect of the work divided
amongst the joint auditors, each joint auditor is responsible only for the work
allocated to him, whether or not he has made a separate report on the work
performed by him. On the other hand the joint auditors are jointly and severally
responsible in respect of the audit conducted by them as under:
(i) in respect of the audit work which is not divided among the joint auditors and is
carried out by all of them;
(ii) in respect of decisions taken by all the joint auditors concerning the nature,
timing or extent of the audit procedures to be performed by any of the joint
auditors;
(iii) in respect of matters which are brought to the notice of the joint auditors by any
one of them and on which there is an agreement among the joint auditors;
(iv) for examining that the financial statements of the entity comply with the
disclosure requirements of the relevant statute;
(v) for ensuring that the audit report complies with the requirements of the relevant
statute;
(vi) it is the separate and specific responsibility of each joint auditor to study and
evaluate the prevailing system of internal control relating to the work allocated
to him, the extent of enquiries to be made in the course of his audit;
(vii) the responsibility of obtaining and evaluating information and explanation from
the management is generally a joint responsibility of all the auditors;
(viii) each joint auditor is entitled to assure that the other joint auditors have carried
out their part of work in accordance with the generally accepted audit
procedures and therefore it would not be necessary for joint auditor to review
the work performed by other joint auditors.
Normally, the joint auditors are able to arrive at an agreed report. However where the
joint auditors are in disagreement with regard to any matters to be covered by the
report, each one of them should express their own opinion through a separate report.
A joint auditor is not bound by the views of majority of joint auditors regarding
matters to be covered in the report and should express his opinion in a separate
report in case of a disagreement.
In the instant case, there are three auditors, namely, Mr. X, Mr. Y and Mr. Z, jointly
appointed as an auditor of KRP Ltd. For the valuation of gratuity scheme of the
Company they referred their own known Actuaries. Mr. Z (one of the joint auditor) is
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not satisfied with the report submitted by Mr. Y’s referred actuary. He is not agreed
with the matters to be covered by the report whereas Mr. X agreed with the same.
Hence, as per SA 299, Mr. Z is suggested to express his own opinion through a
separate report whereas Mr. X and Mr. Y may provide their joint report for the same.
(II) Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of
an Auditor’s Expert”, the expertise of an expert may be required in the
actuarial calculation of liabilities associated with insurance contracts or
employee benefit plans etc., however, the auditor has sole responsibility for the
audit opinion expressed, and that responsibility is not reduced by the auditor’s
use of the work of an auditor’s expert.
The auditor shall evaluate the adequacy of the auditor’s expert’s work for the
auditor’s purposes, including the relevance and reasonableness of that expert’s
findings or conclusions, and their consistency with other audit evidence as per
SA 500.
Further, in view of SA 620, if the expert’s work involves use of significant
assumptions and methods, then the relevance and reasonableness of those
assumptions and methods must be ensured by the auditor and if the expert’s
work involves the use of source data that is significant to that expert’s work, the
relevance, completeness, and accuracy of that source data in the
circumstances must be verified by the auditor.
In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of
KRP Ltd., referred their own known Actuaries for valuation of gratuity scheme.
Actuaries are an auditor’s expert as per SA 620. Mr. Y’s referred actuary has
provided the gratuity valuation report, which later on found faulty. Further, Mr. Z
is not agreed with this report therefore he submitted a separate audit report
specifically for such gratuity valuation.
In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity
valuation report of Actuary, to ensure the relevance and reasonableness of
assumptions and methods used. They were also required to examine the
relevance, completeness and accuracy of source data used for such report
before expressing their opinion.
Mr. X and Mr. Y will be held responsible for grossly negligence and using such
faulty report without examining the adequacy of expert actuary’s work whereas
Mr. Z will not be held liable for the same due to separate opinion expressed by
him.
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SA 300 PLANNING AN AUDIT OF FINANCIAL STATEMENTS
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibility to plan an
audit of financial statements. This SA is framed in the context of recurring
audits. Additional considerations in initial audit engagements are separately
identified.
B) Effective Date
or after 1st April 2008.
C) Objectives
The objective of the auditor is to plan the audit so that it will be performed in an
effective manner.
D) Requirements
1. The engagement partner and other key members of the engagement team shall
be involved in planning the audit, including planning and participating in the
discussion among engagement team members.
Planning is not a discrete phase of an audit, but rather a continual and iterative
process that often begins shortly after (or in connection with) the completion of
the previous audit and continues until the completion of the current audit
engagement.
Planning, however, includes consideration of the timing of certain
activities and audit procedures that need to be completed prior to the
performance of further audit procedures. For example, planning includes
the need to consider, prior to the auditor’s identification and assessment
of the risks of material misstatement.
2. Preliminary Engagement Activities
The auditor shall undertake the following activities at the beginning of the
current audit engagement:
(a) Performing procedures required by SA 220, “Quality Control for an Audit
of Financial Statements” regarding the continuance of the client
relationship and the specific audit engagement;
(b) Evaluating compliance with ethical requirements, including independence,
as required by SA 2204; and
(c) Establishing an understanding of the terms of the engagement, as
required by SA 210.
Performing these preliminary engagement activities enables the auditor to plan

an audit engagement for which, for example:
 The auditor maintains the necessary independence and ability to perform
the engagement.
 There are no issues with management integrity that may affect the
auditor’s willingness to continue the engagement.
 There is no misunderstanding with the client as to the terms of the
engagement.
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3. Planning Activities
(i) The auditor shall establish an overall audit strategy that sets the scope,
timing and direction of the audit, and that guides the development of the
audit plan. In establishing the overall audit strategy, the auditor shall:
(a) Identify the characteristics of the engagement that define its scope;
(b) Ascertain the reporting objectives of the engagement to plan the
timing of the audit and the nature of the communications required;
(c) Consider the factors that, in the auditor’s professional judgment, are
significant in directing the engagement team’s efforts;
(d) Consider the results of preliminary engagement activities and, where
applicable, whether knowledge gained on other engagements
performed by the engagement partner for the entity is relevant; and
(e) Ascertain the nature, timing and extent of resources necessary to
perform the engagement.
(ii) The auditor shall develop an audit plan that shall include a description of:
(a) The nature, timing and extent of planned risk assessment
procedures, as determined under SA 315 “Identifying and Assessing
the Risks of Material Misstatement through Understanding the Entity
and Its Environment”.
(b) The nature, timing and extent of planned further audit procedures at
the assertion level, as determined under SA 330 “The Auditor’s
Responses to Assessed Risks”.
(c) Other planned audit procedures that are required to be carried out so
that the engagement complies with SAs.
4. Additional Considerations in Initial Audit Engagements

The auditor shall undertake the following activities prior to starting an initial
audit:
(a) Performing procedures required by SA 220 regarding the acceptance of
the client relationship and the specific audit engagement6; and
(b) Communicating with the predecessor auditor, where there has been a
change of auditors, in compliance with relevant ethical requirements.
QUESTION BANK
1. Short note- Planning benefits

Planning an audit involves establishing the overall audit strategy for the
engagement and developing an audit plan. Adequate planning benefits the
audit of financial statements in several ways, including the following:
 Helping the auditor to devote appropriate attention to important areas of
the audit.
 Helping the auditor identify and resolve potential problems on a timely
basis.
 Helping the auditor properly organize and manage the audit engagement
so that it is performed in an effective and efficient manner.
 Assisting in the selection of engagement team members with appropriate
levels of capabilities and competence to respond to anticipated risks, and
the proper assignment of work to them.
 Facilitating the direction and supervision of engagement team members
and the review of their work.
Assisting, where applicable, in coordination of work done by auditors of
components and experts.
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2. You have been appointed as the auditor of a Multiplex Cinema House.
Draw an audit programme in respect of its Revenue and Expenditure.
Answer:
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.
3. A & Co. was appointed as auditor of Great Airways Ltd. As the audit
partner what factors shall be considered in the development of overall
audit plan?
Answer:
Development of an overall plan - Overall plan is basically intended to provide
direction for audit work programming and includes the determination of timing,
manpower development and co-ordination of work with the client, other auditors and
other experts. The auditor should consider the following matters in developing his
overall plan for the expected scope and conduct of the audit:
(i) Terms of his engagement and any statutory responsibilities.
(ii) Nature and timing of reports or other communications.
(iii) Applicable Legal or Statutory requirements.
(iv) Accounting policies adopted by the clients and changes, if any, in those
policies.
(v) The effects of new accounting and auditing pronouncement on the audit.
(vi) Identification of significant audit areas.
(vii) Setting of materiality levels for the audit purpose.
(viii) Conditions requiring special attention such as the possibility of material error
or fraud or involvement of parties in whom directors or persons who are
substantial owners of the entity are interested and with whom transactions
are likely.
(ix) Degree of reliance to be placed on the accounting system and internal
control.
(x) Possible rotation of emphasis on specific audit areas.
(xi) Nature and extent of audit evidence to be obtained.
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(xii) Work of the internal auditors and the extent of reliance on their work, if any in
the audit.
(xiii) Involvement of other auditors in the audit of subsidiaries or branches of the
client and involvement of experts.
(xiv) Allocation of works to be undertaken between joint auditors and the
procedures for its control and review.
(xv) Establishing and coordinating staffing requirements.
4. As an internal auditor of a Cement Manufacturing Company, draft an audit

programme for verification of transportation charges for dispatches from
the factory.
Answer:
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.
5. Designing an Audit Strategy is the backbone of the “Audit Planning”

process. Discuss.
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,
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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
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SA 315 IDENTIFYING AND ASSESSING RISK OF MATERIAL
MISSTATEMENT THROUGH UNDERSTANDING THE ENTITY AND
ITS ENVIRONMENT
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibility to identify
and assess the risks of material misstatement in the financial statements,
through understanding the entity and its environment, including the entity’s
internal control.
B) Effective Date
C) Objectives
The objective of the auditor is to identify and assess the risks of material
misstatement, whether due to fraud or error, at the financial statement and
assertion levels, through understanding the entity and its environment,
including the entity’s internal control, thereby providing a basis for designing
and implementing responses to the assessed risks of material misstatement.
This will help the auditor to reduce the risk of material misstatement to an
acceptably low level.
D) Definition
below:
(a) Assertions – Representations by management, explicit or otherwise, that
are embodied in the financial statements, as used by the auditor to
consider the different types of potential misstatements that may occur.
(b) Business risk – A risk resulting from significant conditions, events,
circumstances, actions or inactions that could adversely affect an entity’s
ability to achieve its objectives and execute its strategies, or from the
setting of inappropriate objectives and strategies.
(c) Risk assessment procedures – The audit procedures performed to obtain
an understanding of the entity and its environment, including the entity’s
internal control, to identify and assess the risks of material misstatement,
whether due to fraud or error, at the financial statement and assertion
levels.
E) Requirements
1. The auditor shall perform risk assessment procedures to provide a basis
for the identification and assessment of risks of material misstatement at
the financial statement and assertion levels.
2. Risk assessment procedures by themselves, however, do not provide
sufficient appropriate audit evidence on which to base the audit opinion.
3. The risk assessment procedures shall include the following:
(a) Inquiries of management and of others within the entity who in the
auditor’s judgment may have information that is likely to assist in
identifying risks of material misstatement due to fraud or error
(b) Analytical procedures.
(c) Observation and inspection.
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4. The auditor shall consider whether information obtained from the auditor’s
client acceptance or continuance process is relevant to identifying risks of
material misstatement.
5. Where the engagement partner has performed other engagements for the
entity, the engagement partner shall consider whether information
obtained is relevant to identifying risks of material misstatement.
6. When the auditor intends to use information obtained from the auditor’s
previous experience with the entity and from audit procedures performed
in previous audits, the auditor shall determine whether changes have
occurred since the previous audit that may affect its relevance to the
current audit.
7. Understanding the entity and its environment:

The auditor shall obtain an understanding of the following:
(a) Relevant industry, regulatory, and other external factors including the
(b) The nature of the entity, including:
(i) its operations;
(ii) its ownership and governance structures;
(iii) the types of investments that the entity is making and plans to make,
(iv) the way that the entity is structured and how it is financed;
(c) The entity’s selection and application of accounting policies, including the
reasons for changes thereto. The auditor shall evaluate whether the
entity’s accounting policies are appropriate for its business and consistent
with the applicable financial reporting framework and accounting policies
used in the relevant industry.
(d) The entity’s objectives and strategies, and those related business risks
that may result in risks of material misstatement.
(e) The measurement and review of the entity’s financial performance.
8. Components of Internal Control:

The division of internal control into the following five components provides a
useful framework for auditors to consider how different aspects of an entity’s
internal control may affect the audit:
(A) The control environment;
The control environment includes:
(i) the governance and management functions and
(ii) the attitudes, awareness, and actions of those charged with
governance and management .
Elements of the control environment that may be relevant when obtaining an
understanding of the control environment include the following:
(a) Communication and enforcement of integrity and ethical values–
These are essential elements that influence the effectiveness of the
design, administration and monitoring of controls.
(b) Commitment to competence– Matters such as management’s
consideration of the competence levels for particular jobs and how those
levels translate into requisite skills and knowledge.
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(c) Participation by those charged with governance– Attributes of those
charged with governance such as:
Their independence from management.
Their experience and stature.
(d) Management’s philosophy and operating style– Characteristics such
as management’s:
· Approach to taking and managing business risks.
· Attitudes and actions toward financial reporting.
· Attitudes toward information processing and accounting functions
and personnel.
(e) Organisational structure– The framework within which an entity’s
activities for achieving its objectives are planned, executed, controlled,
and reviewed.
(f) Assignment of authority and responsibility– Matters such as how
authority and responsibility for operating activities are assigned and how
reporting relationships and authorisation hierarchies are established.
(g) Human resource policies and practices– Policies and practices that
relate to, for example, recruitment, orientation, training, evaluation,
counselling, promotion, compensation, and remedial actions
(B) The entity’s risk assessment process

The auditor shall obtain an understanding of whether the entity has a process
for:
(a) Identifying business risks relevant to financial reporting objectives;
(b) Estimating the significance of the risks;
(c) Assessing the likelihood of their occurrence; and
(d) Deciding about actions to address those risks.
The entity’s risk assessment process forms the basis for the risks to be
managed. If that process is appropriate, it would assists the auditor in
identifying risks of material misstatement. Whether the entity’s risk assessment
process is appropriate to the circumstances is a matter of judgment.
(C) The information system, including the related business processes, relevant to
financial reporting, and communication
The auditor shall obtain an understanding of the information system, including
the related business processes, relevant to financial reporting, including the
following are as:
(a) The classes of transactions in the entity’s operations that are significant to
(b) The procedures by which those transactions are initiated, recorded,
processed, corrected as necessary, transferred to the general ledger and
reported in the financial statements;
(c) The related accounting records, supporting information and specific
accounts in the financial statements that are used to initiate, record,
process and report transactions;
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(D) Control activities
Control activities, whether within IT or manual systems, have various objectives
and are applied at various organisational and functional levels.
The auditor shall obtain an understanding of control activities relevant to the
audit, which the auditor considers necessary to assess the risks of material
misstatement. An audit requires an understanding of only those control
activities related to significant class of transactions, account balance, and
disclosure in the financial statements.
(E) Monitoring of controls.

Monitoring of controls is a process to assess the effectiveness of internal
control performance over time.
(i) Helps in assessing the effectiveness of controls on a timely basis: It
involves assessing the effectiveness of controls on a timely basis and
taking necessary remedial actions.
(ii) Management accomplishes through ongoing activities, separate
evaluations etc.: Management accomplishes monitoring of controls
through ongoing activities, separate evaluations, or a combination of the
two. Ongoing monitoring activities are often built into the normal recurring
activities of an entity and include regular management and supervisory
activities.
9. Risks that require special audit consideration

In exercising judgment as to which risks are significant risks, the auditor shall
consider at least the following:
(a) Whether the risk is a risk of fraud;
(b) Whether the risk is related to recent significant economic, accounting, or
other developments like changes in regulatory environment, etc., and,
therefore, requires specific attention;
(c) The complexity of transactions;
(d) Whether the risk involves significant transactions with related parties;
(e) The degree of subjectivity in the measurement of financial information
related to the risk, especially those measurements involving a wide range
of measurement uncertainty; and
(f) Whether the risk involves significant transactions that are outside the
normal course of business for the entity, or that otherwise appear to be
unusual.
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SA 320 Materiality in Planning and performing an audit (effective date for audits of
financial statements for periods beginning on or after April 1, 2010)
1. This Standard on Auditing (SA) deals with the auditor’s responsibility to apply
the concept of materiality in planning and performing an audit of financial
statements.
2. Auditor must ensure that material items are shown separately in financial
statements. Auditor Must Gather as much evidence as possible in support of
material items.
3. Material items are relatively important items i.e the knowledge of which would
influence the decisions of the users of financial statements. [AS - 1]
4. Materiality of an item depends upon particular circumstances & facts of each
case. It is not possible to lay down precisely as to what amount or what account
may be material in all circumstances. Materiality is a relative term & what may
be material in one circumstance may not be material in another.
5. Determining materiality involves the exercise of professional judgment. A
percentage is often applied to a chosen benchmark as a starting point in
determining materiality for the financial statements as a whole. Factors
that may affect the identification of an appropriate benchmark include the
following:
a. The elements of the financial statements (for example, assets,
liabilities, equity, revenue, expenses);
b. Whether there are items on which the attention of the users of the
particular entity’s financial statements tends to be focused (for example,
for the purpose of evaluating financial performance users may tend to
focus on profit, revenue or net assets);
c. The nature of the entity, where the entity is at in its life cycle, and the
industry and economic environment in which the entity operates;
d. The entity’s ownership structure and the way it is financed (for example, if
an entity is financed solely by debt rather than equity, users may put more
emphasis on assets, and claims on them, than on the entity’s earnings);
e. Examples of benchmark: profit before tax, total revenue, gross profit
and total expenses, total equity or net asset value
6. Auditor has right to assume following things: i) Users of financial statements
have reasonable knowledge of business of the company, & have basic
knowledge of accounting. ii) Users of financial statements understand that
financial statements are prepared, presented & audited to the levels of
materiality. iii) Users of financial statements know that there is uncertainty in
estimates & other judgments in the financial statements.
7. Performance Materiality: In order to perform audit of financial statements,
auditor needs to set a level of materiality after selecting appropriate benchmark.
However during the course of audit, auditor intends to lower the risk of not
detecting a material misstatement and hence he may verify certain transactions
or financial items which may be below the set level of materiality however such
transactions are important either due to nature of the account or due to
aggregate size of the amount. Such level (which is below the materiality level)
at which auditor performs his procedures is known as performance materiality
level.
8. Materiality for the financial statements as a whole or for particular class of
transactions may need to be revised as a result of a change in circumstances
that occurred during the audit (for example, a decision to dispose of a major
part of the entity’s business), new information, or a change in the auditor’s
understanding of the entity and its operations as a result of performing further
audit procedures.
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QUESTION BANK
1. As an auditor of RST Ltd. Mr. P applied the concept of materiality for the
financial statements as a whole. On the basis of obtaining additional
information of significant contractual arrangements that draw attention to
a particular aspect of a company's business, he wants to re-evaluate the
materiality concept. Please, guide him.
Answer:
Re-evaluation of the Materiality Concept: In the instant case, Mr. P, as an auditor
of RST Ltd. has applied the concept of materiality for the financial statements as a
whole. But he wants to re-evaluate the materiality concept on the basis of additional
information of significant contractual arrangements which draws attention to a
particular aspect of the company’s business.
As per SA 320 “Materiality in Planning and Performing an Audit”, while establishing
the overall audit strategy, the auditor shall determine materiality for the financial
statement as a whole. He should set the benchmark on the basis of which he
performs his audit procedure. If, in the specific circumstances of the entity, there is
one or more particular classes of transactions, account balances or disclosures for
which misstatements of lesser amounts than the materiality for the financial
statements as a whole could reasonably be expected to influence the economic
decisions of users taken on the basis of the financial statements, the auditor shall
also determine the materiality level or levels to be applied to those particular classes
of transactions, account balances or disclosures.
The auditor shall revise materiality for the financial statements in the event of
becoming aware of information during the audit that would have caused the auditor
to have determined a different amount (or amounts) initially.
If the auditor concludes a lower materiality for the same, then he should consider the
fact that whether it is necessary to revise performance materiality and whether the
nature, timing and extent of the further audit procedures remain appropriate.
Thus, Mr. P can re-evaluate the materiality concepts after considering the necessity
of such revision.
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SA 330 AUDITOR’S RESPONSES TO ASSESSED RISK
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibility to design
and implement responses to the risks of material misstatement identified and
assessed by the auditor in accordance with SA 315, “Identifying and Assessing
Risks of Material Misstatement Through Understanding the Entity and Its
Environment” in a financial statement audit.
B) Effective Date
C) Objectives
The objective of the auditor is to obtain sufficient appropriate audit evidence
about the assessed risks of material misstatement, through designing and
implementing appropriate responses to those risks.
D) Definition
below:
(a) Substantive procedure – An audit procedure designed to detect material
misstatements at the assertion level. Substantive procedures comprise:
(i) Tests of details (of classes of transactions, account balances, and
disclosures), and
(ii) Substantive analytical procedures.
(b) Test of controls – An audit procedure designed to evaluate the operating
effectiveness of controls in preventing, or detecting and correcting,
material misstatements at the assertion level.
E) Requirements
1. The auditor shall design and implement overall responses to address the
assessed risks of material misstatement at the financial statement level.
2. In designing the further audit procedures to be performed, the auditor
shall:
(a) Consider the reasons for the assessment given to the risk of material
misstatement at the assertion level for each class of transactions,
account balance, and disclosure, including:
(i) The likelihood of material misstatement due to the particular
characteristics of the relevant class of transactions, account
balance, or disclosure (i.e., the inherent risk); and
(ii) Whether the risk assessment takes into account the relevant
controls (i.e., the control risk), thereby requiring the auditor to
obtain audit evidence to determine whether the controls are
operating effectively (i.e., the auditor intends to rely on the
operating effectiveness of controls in determining the nature,
timing and extent of substantive procedures)
(b) Obtain more persuasive audit evidence the higher the auditor’s
assessment of risk.
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3. Test of Controls:
A. In designing and performing tests of controls, the auditor shall:
(a) Perform other audit procedures in combination with inquiry to
obtain audit evidence about the operating effectiveness of the
controls, including:
(i) How the controls were applied at relevant times during the
period under audit.
(ii) he consistency with which they were applied.
(iii) By whom or by what means they were applied.
(b) Determine whether the controls to be tested depend upon other
controls (indirect controls), and if so, whether it is necessary to
obtain audit evidence supporting the effective operation of
those indirect controls.
B. The auditor shall test controls for the particular time, or throughout
the period. When the auditor obtains audit evidence about the
operating effectiveness of controls during an interim period, the
auditor shall:
(a) Obtain audit evidence about significant changes to those controls
subsequent to the interim period; and
(b) Determine the additional audit evidence to be obtained for the
remaining period.
C. If the auditor plans to use audit evidence from a previous audit about
the operating effectiveness of specific controls, the auditor shall
establish the continuing relevance of that evidence by obtaining
audit evidence about whether significant changes in those controls
have occurred subsequent to the previous audit.
D. When deviations from controls upon which the auditor intends to rely
are detected, the auditor shall make specific inquiries to understand
these matters and their potential consequences, and shall determine
whether:
(a) The tests of controls that have been performed provide an
appropriate basis for reliance on the controls;
(b) Additional tests of controls are necessary; or
(c) The potential risks of misstatement need to be addressed using
substantive procedures
4. Substantive Procedures- Test of Details

a. Irrespective of the assessed risks of material misstatement, the auditor
shall design and perform substantive procedures for each material class
of transactions, account balance, and disclosure
b. The auditor shall consider whether external confirmation procedures are
to be performed as substantive audit procedures.
c. The auditor’s substantive procedures shall include the following audit
procedures related to the financial statement closing process:
(a) Agreeing or reconciling the financial statements with the underlying
accounting records; and
(b) Examining material journal entries and other adjustments made
during the course of preparing the financial statements.
d. When substantive procedures are performed at an interim date, the
auditor shall cover the remaining period by performing:
(a) substantive procedures, combined with tests of controls for the
intervening period; or
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(b) if the auditor determines that it is sufficient, further substantive
procedures only;
that provide a reasonable basis for extending the audit conclusions from
the interim date to the period end.
e. The auditor shall perform audit procedures to evaluate whether the overall
presentation of the financial statements, including the related disclosures,
is in accordance with the applicable financial reporting framework
f. If the auditor has not obtained sufficient appropriate audit evidence as to a
material financial statement assertion, the auditor shall attempt to obtain
further audit evidence. If the auditor is unable to obtain sufficient
appropriate audit evidence, the auditor shall express a qualified opinion or
a disclaimer of opinion.
5. Overall responses to address the assessed risks of material misstatement at

the financial statement level may include:
Emphasizing to the audit team the need to maintain professional
skepticism.
 Assigning more experienced staff or those with special skills or using
experts.
 Providing more supervision.
 Incorporating additional elements of unpredictability in the selection of
further audit procedures to be performed.
 Making general changes to the nature, timing or extent of audit
procedures, for example: performing substantive procedures at the period
end instead of at an interim date; or modifying the nature of audit
procedures to obtain more persuasive audit evidence.
QUESTION BANK- SA 315 AND SA 330.
1. 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?’
Answer:
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.
Such knowledge would 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. 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
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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.
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.
2. Write short notes on the following:

(a) Walk through Tests
(b) Cut-off Procedures.
Answer:
(a) 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.
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(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.
3. What are the points to be considered while evaluating the “Knowledge of

the Business” in the conduct of an audit?
Answer:
The broad matters to be considered while obtaining knowledge of business for a new
audit assignment are set out in SA 315 Identifying and Assessing the Risks of
Material Misstatement through Understanding the Entity and its Environment. These
are:
(i) Relevant industry, regulatory, economic and other external factors including the
(ii) The nature of the entity, including:
(1) its operations;
(2) its ownership and governance structures;
(3) the types of investments that the entity is making and plans to make,
(4) the way that the entity is structured and how it is financed; to enable the
auditor to understand the classes of transactions, account balances, and
disclosures to be expected in the financial statements.
(iii) The entity’s selection and application of accounting policies.
(iv) The entity’s objectives and strategies, and those related business risks that
may result in risks of material misstatement.
(v) The measurement and review of the entity’s financial performance.
In addition to the importance of knowledge of the client’s business in
establishing the overall audit plan, such knowledge helps the auditor to identify
areas of special audit consideration, to evaluate the reasonableness both of
accounting estimates and management representations, and to make
judgement regarding the appropriateness of accounting policies and
disclosures.
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4. While commencing the statutory audit of B Company Limited, the auditor
undertook the risk assessment and found that the detection risk relating
to certain class of transactions cannot be reduced to acceptance level.
Answer:
Assessment of Risk and Acceptable Level: 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” establishes
standards on the procedures to be followed to obtain an understanding of the
accounting and internal control systems and on audit risk and its components:
inherent risk, control risk and detection risk.
SA 315 and SA 330 require that 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. “Detection risk” is the risk that an auditor’s substantive
procedures will not detect a misstatement that exists in an account balance or class
of transactions that could be material.
The higher the assessment of inherent and control risks, the more audit evidence the
auditor should obtain from the performance of substantive procedures. When both
inherent and control risks are assessed as high, the auditor needs to consider
whether substantive procedures can provide sufficient appropriate audit evidence to
reduce detection risk, and therefore audit risk, to an acceptably low level.
The auditor should use his professional judgement to assess audit risk and to design
audit procedures to ensure that it is reduced to an acceptably low level. If it cannot
be reduced to an acceptable level, the auditor should express a qualified opinion or a
disclaimer of opinion as may be appropriate.
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SA 402- AUDIT CONSIDERATIONS RELATING TO AN ENTITY
USING A SERVICE ORGANIZATION
A) Introduction
1. This Standard on Auditing (SA) deals with the user auditor’s responsibility
to obtain sufficient appropriate audit evidence when a user entity uses the
services of one or more service organisations.
2. Specifically, it expands on how the user auditor applies SA 315 and SA
330 in obtaining an understanding of the user entity, including internal
control relevant to the audit.
3. Services provided by a service organisation are relevant to the audit of a
user entity’s financial statements when those services, and the controls
over them, are part of the user entity’s information system, including
related business processes, relevant to financial reporting
B) Effective date
C) Objectives
The objectives of the user auditor, when the user entity uses the services of a
service organisation, are:
(a) To obtain an understanding of the nature and significance of the services
provided by the service organisation and their effect on the user entity’s
internal control relevant to the audit, sufficient to identify and assess the
risks of material misstatement; and
(b) To design and perform audit procedures responsive to those risks.
D) Definition
(a) Complementary user entity controls – Controls that the service
organisation assumes, in the design of its service, will be implemented by
user entities, and which, if necessary to achieve control objectives, are
identified in the description of its system
(b) Report on the description and design of controls at a service
organisation (referred to in this SA as a Type 1 report) – A report that
comprises:
(i) A description, prepared by management of the service organisation,
of the service organisation’s system, control objectives and related
controls that have been designed and implemented as at a specified
date; and
(ii) A report by the service auditor with the objective of conveying
reasonable assurance that includes the service auditor’s opinion on
the description of the service organisation’s system, control
objectives and related controls and the suitability of the design of the
controls to achieve the specified control objectives.
(c) Report on the description, design, and operating effectiveness of controls

at a service organisation (referred to in this SA as a Type 2 report) – A
report that comprises:
(i) A description, prepared by management of the service organisation, of the
service organisation’s system, control objectives and related controls,
their design and implementation as at a specified date or throughout a
specified period and, in some cases, their operating effectiveness
throughout a specified period; and
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(ii) A report by the service auditor with the objective of conveying reasonable
assurance that includes:
a. The service auditor’s opinion on the description of the service
organisation’s system, control objectives and related controls, the
suitability of the design of the controls to achieve the specified
control objectives, and the operating effectiveness of the controls;
and
b. A description of the service auditor’s tests of the controls and the
results thereof.
(d) Service auditor – An auditor who, at the request of the service organisation,
provides an assurance report on the controls of a service organisation.
(e) Service organisation – A third-party organisation (or segment of a third party
organisation) that provides services to user entities that are part of those
entities’ information systems relevant to financial reporting.
(f) Subservice organisation – A service organisation used by another service
organisation to perform some of the services provided to user entities that are
part of those user entities’ information systems relevant to financial reporting.
(g) User auditor – An auditor who audits and reports on the financial statements of
a user entity.
(h) User entity – An entity that uses a service organisation and whose financial
statements are being audited.
E) Requirements
1. Risk assessment Procedure
When obtaining an understanding of the user entity in accordance with SA 315,
the user auditor shall obtain an understanding of how a user entity uses the
services of a service organisation in the user entity’s operations, including:
(a) The nature of the services provided by the service organisation and the
significance of those services to the user entity, including the effect
thereof on the user entity’s internal control;
Information on the nature of the services provided by a service
organisation may be available from a wide variety of sources, such as:
 User manuals.
 System overviews.
 The contract or service level agreement between the user entity and
the service organisation.
 Reports by service organisations, internal auditors or regulatory
authorities on controls at the service organisation.
 Reports by the service auditor, including management letters, if
available
(b) The nature and materiality of the transactions processed or accounts
or financial reporting processes affected by the service organisation;
(c) The degree of interaction between the activities of the service
organisation and those of the user entity; and
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(d) The nature of the relationship between the user entity and the service
organisation, including the relevant contractual terms for the activities
undertaken by the service organisation.
The contract or service level agreement between the user entity and the service
organisation may provide for matters such as:
 The information to be provided to the user entity and responsibilities for
initiating transactions relating to the activities undertaken by the service
organisation;
 The application of requirements of regulatory bodies concerning the form
of records to be maintained, or access to them;
The indemnification, if any, to be provided to the user entity in the event of
a performance failure;
The user auditor shall determine whether a sufficient understanding of the

nature and significance of the services provided by the service organisation and
their effect on the user entity’s internal control relevant to the audit has been
obtained to provide a basis for the identification and assessment of risks of
material misstatement.
2. Responding to the Assessed Risk of Material Misstatement

1. In responding to assessed risks in accordance with SA 330, the user
auditor shall:
(a) Determine whether sufficient appropriate audit evidence concerning
the relevant financial statement assertions is available from records
held at the user entity; and, if not,
(b) Perform further audit procedures to obtain sufficient appropriate
audit evidence or use another auditor to perform those procedures at
the service organisation on the user auditor’s behalf
2. Tests of Controls:
(a) Obtaining a Type 2 report, if available;
The user auditor shall determine whether the service auditor’s report
provides sufficient appropriate
audit evidence about the effectiveness of the controls by performing
following procedures:
(a) Evaluating whether the description, design and operating
effectiveness of controls at the service organisation is at a date
or for a period that is appropriate for the user auditor’s
purposes;
(b) Determining whether complementary user entity controls
identified by the service organisation are relevant to the user
entity and, if so, obtaining an understanding of whether the
user entity has designed and implemented such controls and, if
so, testing their operating effectiveness;
(c) Evaluating the adequacy of the time period covered by the
tests of controls and the time elapsed since the performance of
the tests of controls
(b) Performing appropriate tests of controls at the service
organisation; or
(c) Using another auditor to perform tests of controls at the service
organisation on behalf of the user auditor
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3. Sub- Service organisation:
(a) If a service organisation uses a subservice organisation, the service
auditor’s report may either include or exclude the subservice
organisation’s relevant control objectives and related controls in the
service organisation’s description of its system and in the scope of
the service auditor’s engagement. These two methods of reporting
are known as the inclusive method and the carve-out method,
respectively.
(b) If the Type 1 or Type 2 report excludes the controls at a subservice
organisation, and the services provided by the subservice
organisation are relevant to the audit of the user entity’s financial
statements, the user auditor is required to apply the requirements of
this SA in respect of the subservice organisation.
(c) The nature and extent of work to be performed by the user auditor
regarding the services provided by a subservice organisation depend
on the nature and significance of those services to the user entity
and the relevance of those services to the audit.
4. The user auditor shall inquire of management of the user entity whether
the service organisation has reported to the user entity, or whether the
user entity is otherwise aware of, any fraud, non-compliance with laws
and regulations or uncorrected misstatements affecting the financial
statements of the user entity.
5. The user auditor shall modify the opinion in the user auditor’s report in
accordance with SA 705 if the user auditor is unable to obtain sufficient
appropriate audit evidence regarding the services provided by the service
organisation relevant to the audit of the user entity’s financial statements.
6. Reference to Service Auditor’s report in the Audit report of User
Auditor:
The user auditor shall not refer to the work of a service auditor in the user
auditor’s report containing an unmodified opinion unless required by law
or regulation to do so.
If reference to the work of a service auditor is relevant to an
understanding of a modification to the user auditor’s opinion then he may
refer to the work of service auditor.
The user auditor’s report shall indicate that such reference does not
diminish the user auditor’s responsibility for that opinion.
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QUESTION BANK:
1. G Ltd. is a mobile phone operating company. Barring the marketing

function it had outsourced the entire operations like maintenance of
mobile infrastructure, customer billing, payroll, accounting functions, etc.
Assist the auditor of G Ltd. as to how he can obtain an understanding of
how G Ltd. uses the services of the outsourced agency in its operations.
Answer:
As per SA 402 on “Audit Considerations Relating to an Entity Using a Service
Organisation”, when obtaining an understanding of the user entity in accordance
with SA 315 “Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment”, the user auditor shall obtain an
Understanding of how a user entity uses the services of a service organisation in the
user entity’s operations, including:
(i) The nature of the services provided by the service organisation and the
significance of those services to the user entity, including the effect thereof on
the user entity’s internal control;
(ii) The nature and materiality of the transactions processed or accounts or
financial reporting processes affected by the service organisation;
(iii) The degree of interaction between the activities of the service organisation and
those of the user entity; and
(iv) The nature of the relationship between the user entity and the service
organisation, including the relevant contractual terms for the activities
undertaken by the service organisation.
2. When a sub-service organization performs services for a service

organization, there are two alternative methods of presenting the
description of controls. The service organization determines which
method will be used. As a user auditor what information would you obtain
about controls at a sub-service organization?
Answer:
Controls at a Sub-Service Organisation: In accordance with SA 402 “Audit
Considerations relating to an Entity Using a Service Organisation”, a user entity may
use a service organisation that in turn uses a sub-service organisation to provide
some of the services provided to a user entity that are part of the user entity’s
information system relevant to financial reporting.
The sub-service organisation may be a separate entity from the service organisation
or may be related to the service organisation.
A user auditor may need to consider controls at the sub-service organisation. In
situations where one or more sub-service organisations are used, the interaction
between the activities of the user entity and those of the service organisation is
expanded to include the interaction between the user entity, the service organisation
and the sub-service organisations. The degree of this interaction, as well as the
nature and materiality of the transactions processed by the service organisation and
the sub-service organisations are the most important factors for the user auditor to
consider in determining the significance of the service organisation’s and sub-service
organisation’s controls to the user entity’s controls.
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Further, the user auditor shall determine whether a sufficient understanding of the
nature and significance of the services provided by the service organisation and their
effect on the user entity's internal control relevant to the audit has been obtained to
provide a basis for the identification and assessment of risks of material
misstatement.
If the user auditor is unable to obtain a sufficient understanding from the user entity,
the user auditor shall obtain that understanding by application of the following two
methods of presenting description of internal controls i.e. (i) Type 1 report; or (ii)
Type 2 report.
If a service organisation uses a subservice organisation, the service auditor's report
may either include or exclude the subservice organisation's relevant control
objectives and related controls in the service organisation's description of its system
and in the scope of the service auditor's engagement. These two methods of
reporting are known as the inclusive method and the carve-out method respectively.
In either method, the service organisation includes in its description of controls a
description of the functions and nature of the processing performed by the
subservice
organisation.
If the Type 1 or Type 2 report excludes the control at a subservice organization and
the services provided by the subservice organization are relevant to the audit of the
user entity’s financial statements, the user auditor is required to apply the
requirements of the SA 402 in respect of the subservice organization.
The nature and extent of work to be performed by the user auditor regarding the
services provided by a subservice organization depend on the nature and
significance of those services to the user entity and relevance of those services to
the audit.
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SA 450- EVALUATION OF MISSTATEMENTS IDENTIFIED
A) Introduction
evaluate the effect of identified misstatements on the audit and of
uncorrected misstatements, if any, on the financial statements.
2. SA 320 deals with the auditor’s responsibility to apply the concept of
materiality appropriately in planning and performing an audit of financial
statements.
B) Effective date
C) Objectives
The objective of the auditor is to evaluate:
(a) The effect of identified misstatements on the audit; and
(b) The effect of uncorrected misstatements, if any, on the financial
statements.
D) Definition
--
E) Requirements
1. The auditor shall accumulate misstatements identified during the audit,
other than those that are clearly trivial.
Misstatements may result from:
(a) An inaccuracy in gathering or processing data from which the
financial statements are prepared;
(b) An omission of an amount or disclosure;
(c) An incorrect accounting estimate arising from overlooking, or clear
misinterpretation of, facts; and
(d) Judgments of management concerning accounting estimates that
the auditor considers unreasonable or the selection and application
of accounting policies that the auditor considers inappropriate.
2. The auditor shall determine whether the overall audit strategy and audit
plan need to be revised if:
(a) The nature of identified misstatements and the circumstances of
their occurrence indicate that other misstatements may exist that,
when aggregated with misstatements accumulated during the audit,
could be material; or
(b) The aggregate of misstatements accumulated during the audit
approaches materiality determined in accordance with SA 320.
3. If, at the auditor’s request, management has examined a class of
transactions, account balance or disclosure and corrected misstatements
that were detected, the auditor shall perform additional audit procedures
to determine whether misstatements remain.
4. The auditor shall communicate on a timely basis all misstatements
accumulated during the audit with the appropriate level of management,
unless prohibited by law or regulation. The auditor shall request
management to correct those misstatements.
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5. If management refuses to correct some or all of the misstatements
communicated by the auditor, the auditor shall obtain an understanding of
management’s reasons for not making the corrections and shall take that
understanding into account when evaluating whether the financial
statements as a whole are free from material misstatement.
6. The auditor shall communicate with those charged with governance
uncorrected misstatements and the effect that they, individually or in
aggregate, may have on the opinion in the auditor’s report, unless
prohibited by law or
Regulation. The auditor shall request that uncorrected misstatements be
corrected.
7. The auditor shall request a written representation from management and,
where appropriate, those charged with governance whether they believe
the effects of uncorrected misstatements are immaterial, individually and
in aggregate, to the financial statements as a whole. A summary of such
items shall be included in or attached to the written representation.
8. The audit documentation shall include:

(a) The amount below which misstatements would be regarded as
clearly trivial
(b) All misstatements accumulated during the audit and whether they
have been corrected and
(c) The auditor’s conclusion as to whether uncorrected misstatements
are material, individually or in aggregate, and the basis for that
conclusion.
QUESTION BANK
1. Mention the circumstances under which auditor may consider

misstatements as material even though they are below the level of
materiality.
Answer:
The circumstances related to some misstatements may cause the auditor to evaluate
them as material, individually or when considered together with other misstatements
accumulated during the audit, even if they are lower than the materiality for the
financial statements as a whole. Circumstances that may affect the evaluation
include the extent to which the misstatement:
· Affects compliance with regulatory requirements;
· Affects compliance with debt covenants or other contractual requirements;
· Relates to the incorrect selection or application of an accounting policy that has
an immaterial effect on the current period’s financial statements but is likely to
have a material effect on future periods’ financial statements;
· Makes a change in earnings or other trends, especially in the context of general
economic and industry conditions;
· Affects ratios used to evaluate the entity’s financial position, results of
operations or cash flows;
· Affects segment information presented in the financial statements (for example,
the significance of the matter to a segment or other portion of the entity’s
business that has been identified as playing a significant role in the entity’s
operations or profitability);
· Has the effect of increasing management compensation, for example, by
ensuring that the requirements for the award of bonuses or other incentives are
satisfied;
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· Is significant having regard to the auditor’s understanding of known previous
communications to users, for example in relation to forecast earnings;
· Relates to items involving particular parties (for example, whether external
parties to the transaction are related to members of the entity’s management);
· Is an omission of information not specifically required by the applicable financial
reporting framework but which, in the judgment of the auditor, is important to
the users’ understanding of the financial position, financial
· performance or cash flows of the entity;
2. Discuss the impact of uncorrected misstatements identified during the

audit and the auditor's response to the same.
Answer:
Uncorrected Misstatements identified during the Audit: In accordance with SA 450
“Evaluation of Misstatements identified during the Audit”, the auditor shall determine
whether uncorrected misstatements are material, individually or in aggregate. In
making this determination, the auditor shall consider-
(i) The size and nature of the misstatements, both in relation to particular classes
of transactions, account balances or disclosures and the financial statements
as a whole, and the particular circumstances of their occurrence;
and
(ii) The effect of uncorrected misstatements related to prior periods on the relevant
classes of transactions, account balances or disclosures, and the financial
statements as a whole.
The auditor shall communicate this with those charged with governance uncorrected
misstatements and the effect that they, individually or in aggregate, may have on the
opinion in the auditor’s report, unless prohibited by law or regulation.
The auditor’s communication shall identify material uncorrected misstatements
individually. The auditor shall request that uncorrected misstatements be corrected.
Prior to evaluating the effect of uncorrected misstatements, the auditor shall
reassess materiality determined in accordance with SA 320, to confirm whether it
remains appropriate in the context of the entity’s actual financial results.
As per management, if effect of such uncorrected misstatement is immaterial then
the auditor shall request for a written representation from management and, where
appropriate, those charged with governance that whether they believe the effects of
uncorrected misstatements are immaterial, individually and in aggregate, to the
financial statements as a whole. A summary of such items shall be included in or
attached to the written representation.
If the management refuses to adjust the financial information and the results of
extended audit procedures do not enable the auditor to conclude that the aggregate
of uncorrected misstatements is not material, the auditor should report accordingly.
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SA 500 AUDIT EVIDENCE
A) Introduction
This Standard on Auditing (SA) explains what constitutes audit evidence in an
audit of financial statements, and deals with the auditor’s responsibility to design
and perform audit procedures to obtain sufficient appropriate audit evidence to be
able to draw reasonable conclusions on which to base the auditor’s opinion.
This SA is applicable to all the audit evidence obtained during the course of the
audit. Other SAs deal with specific aspects of the audit and with specific
procedures to be applied in the given situation.
B) Effective date
after April 1, 2009.
C) Objectives
The objective of the auditor is to design and perform audit procedures in such a
way as to enable the auditor to obtain sufficient appropriate audit evidence to be
able to draw reasonable conclusions on which to base the auditor’s opinion.
D) Definition
(a) Audit evidence – Information used by the auditor in arriving at the
conclusions on which the auditor’s opinion is based. Audit evidence includes
both information contained in the accounting records underlying the financial
statements and other information.
(b) Sufficiency (of audit evidence) – The measure of the quantity of audit
evidence. The quantity of the audit evidence needed is affected by the
auditor’s assessment of the risks of material misstatement and also by the
quality of such audit evidence
(c) Appropriateness (of audit evidence) – The measure of the quality of audit
evidence; that is, its relevance and its reliability in providing support for the
conclusions on which the auditor’s opinion is based.
(d) Management’s expert – An individual or organisation possessing expertise
in a field other than accounting or auditing, whose work in that field is used
by the entity to assist the entity in preparing the financial statements.
E) Requirements
1. The auditor shall design and perform audit procedures that are appropriate in
the circumstances for the purpose of obtaining sufficient appropriate audit
evidence. The sufficiency and appropriateness of audit evidence are
interrelated.
Sufficiency is the measure of the quantity of audit evidence. The quantity of
audit evidence needed is affected by the auditor’s assessment of the risks of
misstatement (the higher the assessed risks, the more audit evidence is
likely to be required) and also by the quality of such audit evidence (the
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higher the quality, the less may be required). Obtaining more audit evidence,
however, may not compensate for its poor quality.
Appropriateness is the measure of the quality of audit evidence; that is, its
relevance and its reliability in providing support for the conclusions on which
the auditor’s opinion is based. The reliability of evidence is influenced by its
source and by its nature, and is dependent on the individual circumstances
under which it is obtained.
2. When designing and performing audit procedures, the auditor shall consider
the relevance and reliability of the information to be used as audit evidence.
Relevance deals with the logical connection with, or bearing upon, the
purpose of the audit procedure and, where appropriate, the assertion under
consideration. A given set of audit procedures may provide audit evidence
that is relevant to certain assertions, but not others. For example, inspection
of documents related to the collection of receivables after the period end may
provide audit evidence regarding existence and valuation, but not necessarily
cut-off.
The reliability of information to be used as audit evidence, and therefore of the
audit evidence itself, is influenced by its source and its nature, and the
circumstances under which it is obtained, including the controls over its
preparation and maintenance where relevant.
· The reliability of audit evidence is increased when it is obtained from
independent sources outside the entity.
· The reliability of audit evidence that is generated internally is increased when
the related controls, including those over its preparation and maintenance,
imposed by the entity are effective.
· Audit evidence obtained directly by the auditor (for example, observation of
the application of a control) is more reliable than audit evidence obtained
indirectly or by inference (for example, inquiry about the application of a
control).
· Audit evidence in documentary form, whether paper, electronic, or other
medium, is more reliable than evidence obtained orally (for example, a
written record of a meeting is more reliable than a subsequent oral
representation of the matters discussed).
· Audit evidence provided by original documents is more reliable than audit
evidence provided by photocopies or facsimiles, or documents that have
been filmed, digitised or otherwise transformed into electronic form, the
reliability of which may depend on the controls over their preparation and
maintenance.
·
3. When information to be used as audit evidence has been prepared using the
work of a management’s expert, the auditor shall, to the extent necessary,
having regard to the significance of that expert’s work for the auditor’s
purposes,:
(a) Evaluate the competence, capabilities and objectivity of that expert;
(b) Obtain an understanding of the work of that expert; and
(c) Evaluate the appropriateness of that expert’s work as audit evidence for
the relevant assertion.
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Considerations when evaluating the appropriateness of the management’s
expert’s work as audit evidence for the relevant assertion may include:
· The relevance and reasonableness of that expert’s findings or
conclusions, their consistency with other audit evidence, and whether
they have been appropriately reflected in the financial statements;
· If that expert’s work involves use of significant assumptions and
methods, the relevance and reasonableness of those assumptions and
methods; and
· If that expert’s work involves significant use of source data, the
relevance, completeness, and accuracy of that source data
4. When designing tests of controls and tests of details, the auditor shall
determine means of selecting items for testing that are effective in meeting
the purpose of the audit procedure.
5. If:
(a) audit evidence obtained from one source is inconsistent with that
obtained from another; or
(b) the auditor has doubts over the reliability of information to be used as
audit evidence,
The auditor shall determine what modifications or additions to audit
procedures are necessary to resolve the matter, and shall consider the effect
of the matter, if any, on other aspects of the audit.
QUESTION BANK
1. Y Ltd. engaged an actuary to ascertain its employee cost, gratuity and leave
encashment liabilities. As the auditor of Y Ltd., you would like to use the
report of the actuary as an audit evidence. How do you evaluate the work of
the actuary?
Answer:
Evaluating the Work of Management’s Expert: As per SA 500 “Audit Evidence”, when
information to be used as audit evidence has been prepared using the work of a
management’s expert, the auditor shall, to the extent necessary, having regard to the
significance of that expert’s work for the auditor’s purposes,-
(a) Evaluate the competence, capabilities and objectivity of that expert;
(b) Obtain an understanding of the work of that expert; and
(c) Evaluate the appropriateness of that expert’s work as audit evidence for the
relevant assertion.
The auditor may obtain information regarding the competence, capabilities and
objectivity of a management’s expert from a variety of sources, such as personal
experience with previous work of that expert; discussions with that expert;
discussions with others who are familiar with that expert’s work; knowledge of that
expert’s qualifications; published papers or books written by that expert.
Aspects of the management’s expert’s field relevant to the auditor’s understanding
may include what assumptions and methods are used by the management’s
expert, and whether they are generally accepted within that expert’s field and
appropriate for financial reporting purposes.
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2. Obtaining audit evidence in performing compliance and substantive
procedures. Comment.
Answer:
Obtaining Audit Evidence: As per SA 500 “Audit Evidence”, in performing compliance

and substantive procedures, the auditor may obtain audit evidence by following
methods-
(i) Inspection: Inspection involves examining records or documents, whether internal

or external, in paper form, electronic form, or other media, or a physical
examination of an asset. Inspection of records and documents provides audit
evidence of varying degrees of reliability, depending on their nature and source
and, in the case of internal records and documents, on the effectiveness of the
controls over their production. An example of inspection used as a test of controls
is inspection of records for evidence of authorisation.
Some documents represent direct audit evidence of the existence of an asset, for
example, a document constituting a financial instrument such as a stock or bond.
Inspection of such documents may not necessarily provide audit evidence about
ownership or value. In addition, inspecting an executed contract may provide audit
evidence relevant to the entity’s application of accounting policies, such as
revenue recognition.
Inspection of tangible assets may provide reliable audit evidence with respect to
their existence, but not necessarily about the entity’s rights and obligations or the
valuation of the assets. Inspection of individual inventory items may accompany
the observation of inventory counting.
(ii) Observation: Observation consists of looking at a process or procedure being

performed by the others. For example, the auditor’s observation of inventory
counting by the entity’s personnel, or of the performance of control activities.
Observation provides audit evidence about the performance of a process or
procedure, but is limited to the point in time at which the observation takes place,
and by the fact that the act of being observed may affect how the process or
procedure is performed.
(iii) External Confirmation: An external confirmation represents audit evidence

obtained by the auditor as a direct written response to the auditor from a third
party (the confirming party), in paper form, or by electronic or other medium.
External confirmation procedures frequently are relevant when addressing
assertions associated with certain account balances and their elements. However,
external confirmations need not be restricted to account balances only. For
example, the auditor may request confirmation of the terms of agreements or
transactions an entity has with third parties; the confirmation request may be
designed to ask if any modifications have been made to the agreement and, if so,
what the relevant details are. External confirmation procedures also are used to
obtain audit evidence about the absence of certain conditions, for example, the
absence of a “side agreement” that may influence revenue recognition.
(iv) Recalculation: Recalculation consists of checking the arithmetical accuracy of

documents or records. Recalculation may be performed manually or electronically.
(v) Reperformance: It involves the auditor’s independent execution of procedures or

controls that were originally performed as part of the entity’s internal control.
: 221 :
(vi) Analytical Procedure: Analytical procedures consist of evaluations of financial
information made by a study of plausible relationships among both financial and
non -financial data. Analytical procedures also encompass the investigation of
identified fluctuations and relationships that are inconsistent with other relevant
information or deviate significantly from predicted amounts.
(vii) Inquiry: Inquiry consists of seeking information of knowledgeable persons, both

financial and non- financial, within the entity or outside the entity. Inquiry is used
extensively throughout the audit in addition to other audit procedures. Inquiries
may range from formal written inquiries to informal oral inquiries. Evaluating
responses to inquiries is an integral part of the inquiry process.
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SA 501 AUDIT EVIDENCE- SPECIFIC CONSIDERATIONS
FOR SELECTED ITEMS
A) Introduction
This Standard on Auditing (SA) deals with specific considerations by the auditor in
obtaining sufficient appropriate audit evidence in accordance with SA 330, SA 500
and other relevant SAs, with respect to certain aspects of inventory, litigation and
claims involving the entity, and segment information in an audit of financial
statements.
B) Effective date
C) Objectives
regarding the:
(a) Existence and condition of inventory;
(b) Completeness of litigation and claims involving the entity; and
(c) Presentation and disclosure of segment information in accordance with the
applicable financial reporting framework
D) Definition
--
E) Requirements
1. Inventory
1. When inventory is material to the financial statements, the auditor shall
obtain sufficient appropriate audit evidence regarding the existence and
condition of inventory by:
(a) Attendance at physical inventory counting, unless impracticable,
to:
(i) Evaluate management’s instructions and procedures for
recording and controlling the results of the entity’s physical
inventory counting;
(ii) Observe the performance of management’s count
procedures;
(iii) Inspect the inventory; and
(iv) Perform test counts; and
(b) Performing audit procedures over the entity’s final inventory
records to determine whether they accurately reflect actual
inventory count results.
2. If physical inventory counting is conducted at a date other than the date
of the financial statements, the auditor shall, in addition to the
procedures required above, perform audit procedures to obtain audit
evidence about whether changes in inventory between the count date
and the date of the financial statements are properly recorded.
3. If the auditor is unable to attend physical inventory counting due to
unforeseen circumstances, the auditor shall make or observe some
physical counts on an alternative date, and perform audit procedures
on intervening transactions.
4. If attendance at physical inventory counting is impracticable, the auditor
shall perform alternative audit procedures to obtain sufficient
appropriate audit evidence regarding the existence and condition of
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inventory. If it is not possible to do so, the auditor shall modify the
opinion in the auditor’s report in accordance with SA 705
5. When inventory under the custody and control of a third party is
material to the financial statements, the auditor shall obtain sufficient
appropriate audit evidence regarding the existence and condition of that
inventory by performing one or both of the following:
(a) Request confirmation from the third party as to the quantities and
condition of inventory held on behalf of the entity.
(b) Perform inspection or other audit procedures appropriate in the
circumstances.
2. Litigation and Claims

1. The auditor shall design and perform audit procedures in order to
identify litigation and claims involving the entity which may give rise to a
risk of material misstatement, including:
(a) Inquiry of management and, where applicable, others within
the entity, including in-house legal counsel;
(b) Reviewing minutes of meetings of those charged with governance
and correspondence between the entity and its external legal
counsel; and
(c) Reviewing legal expense accounts.
2. When audit procedures performed indicate that other material litigation
or claims may exist, the auditor shall, in addition to the procedures
required by other SAs, seek direct communication with the entity’s
external legal counsel. The auditor shall do so through a letter of
inquiry, prepared by management and sent by the auditor, requesting
the entity’s external legal counsel to communicate directly with the
auditor.
If law, regulation or the respective legal professional body prohibits the
entity’s external legal counsel from communicating directly with the
auditor, the auditor shall perform alternative audit procedures.
3 If:
(a) management refuses to give the auditor permission to
communicate or meet with the entity’s external legal counsel, or
the entity’s external legal counsel refuses to respond appropriately
to the letter of inquiry, or is prohibited from responding; and
(b) the auditor is unable to obtain sufficient appropriate audit evidence
by performing alternative audit procedures, the auditor shall
modify the opinion in the auditor’s report in accordance with SA
705.
4. The auditor shall request management and, where appropriate, those
charged with governance to provide written representations that all
known actual or possible litigation and claims whose effects should be
considered when preparing the financial statements have been
disclosed to the auditor and appropriately accounted for and disclosed
in accordance with the applicable financial reporting framework.
3. Segment Information
The auditor shall obtain sufficient appropriate audit evidence regarding the
presentation and disclosure of segment information in accordance with the
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QUESTION BANK
1. You are the auditor of Easy Communications Ltd. for the year 2014–15. The
inventory as at the end of the year i.e. 31.3.15 was ` 2.25 crores. Due to
unavoideable circumstances, you could not be present at the time of annual
physical verification. Under the above circumstances how would you ensure
that the physical verification conducted by the management was in order?
Answer:
As per SA 501 “Audit Evidence – Additional Considerations for Specific Items”,
the auditor should perform audit procedures, designed to obtain sufficient appropriate
audit evidence during his attendance at physical inventory counting. SA 501 is
additional guidance to that contained in SA 500, “Audit Evidence”, with respect to
certain specific financial statement amounts and other disclosures.
If the auditor is unable to be present at the physical inventory count on the date planned
due to unforeseen circumstances, the auditor should take or observe some physical
counts on an alternative date and where necessary, perform alternative audit
procedures to assess whether the changes in inventory between the date of physical
count and the period end date are correctly recorded.
The auditor would also verify the procedure adopted, treatment given for the
discrepancies noticed during the physical count.
The auditor would also ensure that appropriate cut off procedures were followed by the
management.
He should also get management’s written representation on (a) the completeness of
information provided regarding the inventory, and (b) assurance with regard to
adherence to laid down procedures for physical inventory count. By following the above
procedure it will be ensured that the physical verification conducted by the management
was in order.
2. LMN Ltd. supplies navy uniforms across the country. The company has 4
warehouses at different locations throughout the India and 5 warehouses at
the borders. The major stocks are generally supplied from the borders. LMN
Ltd. appointed M/s OPQ & Co. to conduct its audit for the financial year
2014-15. Mr. O, partner of M/s OPQ & Co., attended all the physical inventory
counting conducted throughout the India but could not attend the same at
borders due to some unavoidable reason. You are required to advise M/s
OPQ & Co.,
(i) How sufficient appropriate audit evidence regarding the existence and
condition of inventory may be obtained?
(ii) How an auditor is supposed to deal when attendance at physical inventory
counting is impracticable?
Answer:
(i) Special Consideration with Regard to Inventory: As per SA 501 “Audit Evidence-
Specific Considerations for Selected Items”, when inventory is material to the
financial statements, the auditor shall obtain sufficient appropriate audit evidence
regarding the existence and condition of inventory by:
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(a) Attendance at physical inventory counting, unless impracticable, to:
(1) Evaluate management’s instructions and procedures for recording and
controlling the results of the entity’s physical inventory counting;
(2) Observe the performance of management’s count procedures;
(3) Inspect the inventory; and
(4) Perform test counts; and
(b) Performing audit procedures over the entity’s final inventory records to
determine whether they accurately reflect actual inventory count results.
(ii) Attendance at Physical Inventory Counting Not Practicable: In some cases,
attendance at physical inventory counting may be impracticable. This may be due
to factors such as the nature and location of the inventory, for example, where
inventory is held in a location that may pose threats to the safety of the auditor.
The matter of general inconvenience to the auditor, however, is not sufficient to
support a decision by the auditor that attendance is impracticable. Further, as
explained in SA 200 “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing”, the matter of
difficulty, time, or cost involved is not in itself a valid basis for the auditor to omit an
audit procedure for which there is no alternative or to be satisfied with audit
evidence that is less than persuasive.
Further, where attendance is impracticable, alternative audit procedures, for
example, inspection of documentation of the subsequent sale of specific inventory
items acquired or purchased prior to the physical inventory counting, may provide
sufficient appropriate audit evidence about the existence and condition of
inventory.
In some cases, though, it may not be possible to obtain sufficient appropriate audit
evidence regarding the existence and condition of inventory by performing
alternative audit procedures. In such cases, SA 705 on Modifications to the
Opinion in the Independent Auditor’s Report, requires the auditor to modify the
opinion in the auditor’s report as a result of the scope limitation.
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SA 505 EXTERNAL CONFIRMATION
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s use of external
confirmation procedures to obtain audit evidence in accordance with the
requirements of SA 330 and SA 500.
Depending on the circumstances of the audit, audit evidence in the form of
external confirmations received directly by the auditor from confirming parties may
be more reliable than evidence generated internally by the entity. This SA is
intended to assist the auditor in designing and performing external confirmations
procedures to obtain relevant and reliable audit evidence.
B) Effective date
This SA is effective for audit of financial statements for period beginning on or
C) Objectives
The objective of the auditor, when using external confirmation procedures, is to
design and perform such procedures to obtain relevant and reliable audit
evidence.
D) Definition
a) External confirmation – Audit evidence obtained as a direct written response
to the auditor from a third party (the confirming party), in paper form, or by
electronic or other medium.
b) Positive confirmation request – A request that the confirming party respond
directly to the auditor indicating whether the confirming party agrees or
disagrees with the information in the request, or providing the requested
information.
c) Negative confirmation request – A request that the confirming party respond
directly to the auditor only if the confirming party disagrees with the
information provided in the request.
d) Non-response – A failure of the confirming party to respond, or fully respond,
to a positive confirmation request, or a confirmation request returned
undelivered.
e) Exception – A response that indicates a difference between information
requested to be confirmed, or contained in the entity’s records, and
information provided by the confirming party.
E) Requirements
1. When using external confirmation procedures, the auditor shall maintain
control over external confirmation requests, including:
(a) Determining the information to be confirmed or requested;
(b) Selecting the appropriate confirming party
(c) Designing the confirmation requests, including determining that
requests are properly addressed and contain return information for
responses to be sent directly to the auditor; and
(d) Sending the requests, including follow-up requests when applicable, to
the confirming party
2. Management’s Refusal to Allow the Auditor to Send a Confirmation Request
If management refuses to allow the auditor to send a confirmation request,
the auditor shall:
(a) Inquire as to management’s reasons for the refusal, and seek audit
evidence as to their validity and reasonableness
: 227 :
(b) Evaluate the implications of management’s refusal on the auditor’s
assessment of the relevant risks of material misstatement, including the
risk of fraud, and on the nature, timing and extent of other audit
procedures;
and
(c) Perform alternative audit procedures designed to obtain relevant and
reliable audit evidence
If the auditor concludes that management’s refusal to allow the auditor
to send a confirmation request is unreasonable, or the auditor is unable
to obtain relevant and reliable audit evidence from alternative audit
procedures, the auditor shall communicate with those charged with
governance in accordance with SA 260. The auditor also shall
determine the implications for the audit and the auditor’s opinion in
3. Negative confirmations provide less persuasive audit evidence than positive
confirmations. Accordingly, the auditor shall not use negative confirmation
requests as the sole substantive audit procedure to address an assessed
risk of material misstatement at the assertion level unless all of the following
are present:
(a) The auditor has assessed the risk of material misstatement as low and
has obtained sufficient appropriate audit evidence regarding the
operating effectiveness of controls relevant to the assertion;
(b) The population of items subject to negative confirmation procedures
comprises a large number of small, homogeneous, account balances,
transactions or conditions;
(c) A very low exception rate is expected; and
(d) The auditor is not aware of circumstances or conditions that would ause
recipients of negative confirmation requests to disregard such requests.
4. Results of External Confirmation Procedures
If the auditor identifies factors that give rise to doubts about the reliability of
the response to a confirmation request, the auditor shall obtain further audit
evidence to resolve those doubts
In the case of each non-response, the auditor shall perform alternative audit
procedures to obtain relevant and reliable audit evidence.
If the auditor has determined that a response to a positive confirmation
request is necessary to obtain sufficient appropriate audit evidence,
alternative audit procedures will not provide the audit evidence the auditor
requires. If the auditor does not obtain such confirmation, the auditor shall
determine the implications for the audit and the auditor’s opinion in
The auditor shall investigate exceptions to determine whether or not they are
indicative of misstatements.
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QUESTION BANK
1. Mention the factors to be considered while designing a confirmation

request.
The design of a confirmation request may directly affect the confirmation response
rate, and the reliability and the nature of the audit evidence obtained from
responses.
Factors to consider when designing confirmation requests include:
- Specific identified risks of material misstatement, including fraud risks.
- The layout and presentation of the confirmation request.
- Prior experience on the audit or similar engagements.
- The assertions being addressed.
- The method of communication [for example, in paper form, or by electronic
mode (like e-mail) or other medium].
- Management’s authorisation or encouragement to the confirming parties to
respond to the auditor. Confirming parties may only be willing to respond to a
confirmation request containing management’s authorisation.
- The ability of the intended confirming party to confirm or provide the
requested information (for example, individual invoice amount versus total
balance).
2. The auditor of H Ltd. wanted to obtain confirmation from its trade payables.
But the management made a request to the auditor not to seek confirmation
from certain trade payables citing disputes. Can the auditor of H Ltd. accede
to this request?
Answer:
SA 505, “External Confirmations”, establishes standards on the auditor’s use of
external confirmation as a means of obtaining audit evidence. It requires that the auditor
should employ external confirmation procedures in consultation with the management.
The auditor may come across certain situations in which the management may request
him not to seek external confirmation from certain parties because of dispute with the
trade payables, etc. The management, for example, might make such a request on the
grounds that due to a dispute with the particular trade payable, the request for
confirmation might aggravate the sensitive negotiations between the entity and the
trade payables.
In such cases, when an auditor agrees to management’s request not to seek external
confirmation regarding certain trade payables, the auditor should consider validity of
grounds for such a request and assess management’s integrity and obtain evidence to
support the same. The auditor should also ask the management to submit its request in
a written form, detailing therein the reasons for such a request.
If the auditor of H Ltd. Agrees to management’s request not to seek external
confirmation regarding a particular matter, the auditor should document the reasons for
acceding to the management’s request and should apply alternative procedures to
obtain sufficient appropriate evidence regarding that matter. While considering the
validity of request, in case the auditor of H Ltd. reaches at a conclusion that the same
was not valid, he may appropriately modify the report.
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3. During the course of audit of Star Limited the auditor received some of the
confirmation of the balances of trade payables outstanding in the balance
sheet through external confirmation by negative confirmation request. In the
list of trade payables, there are number of trade payables of small balances
except one, old outstanding of ` 15 Lacs, of whom, no confirmation on the
credit balance received. Comment with respect to Standard of Auditing.
Answer:
External Confirmation: As per SA 505, “External Confirmation”, Negative Confirmation
is a request that the confirming party respond directly to the auditor only if the
confirming party disagrees with the information provided in the request. Negative
confirmations provide less persuasive audit evidence than positive confirmations.
The failure to receive a response to a negative confirmation request does not explicitly
indicate receipt by the intended confirming party of the confirmation request or
verification of the accuracy of the information contained in the request. Accordingly, a
failure of a confirming party to respond to a negative confirmation request provides
significantly less persuasive audit evidence than does a response to a positive
confirmation request. Confirming parties also may be more likely to respond indicating
their disagreement with a confirmation request when the information in the request is
not in their favor, and less likely to respond otherwise.
In the instant case, the auditor sent the negative confirmation requesting the trade
payables having outstanding balances in the balance sheet while doing audit of Star
Limited. One of the old outstanding of ` 15 lacs has not sent the confirmation on the
credit balance. In case of non response, the auditor may examine subsequent cash
disbursements or correspondence from third parties, and other records, such as goods
received notes. Further non response for negative confirmation request does not means
that there is some misstatement as negative confirmation request itself is to respond to
the auditor only if the confirming party disagrees with the information provided in the
request.
But, if the auditor identifies factors that give rise to doubts about the reliability of the
response to the confirmation request, he shall obtain further audit evidence to resolve
those doubts.
4. The accountant of C Ltd. has requested you, not to send balance

confirmations to a particular group of trade receivables since the said
balances are under dispute and the matter is pending in the Court. As a
Statutory Auditor, how would you deal?
Answer:
SA 505 “External Confirmations”, establishes standards on the auditor’s use of
external confirmation as a means of obtaining audit evidence. If the management
refuses to allow the auditor to a send a confirmation request, the auditor shall:
(i) Inquire as to Management’s reasons for the refusal, and seek audit evidence as to
their validity and reasonableness,
(ii) Evaluate the implications of management’s refusal on the auditor’s assessment of
the relevant risks of material misstatement, including the risk of fraud, and on the
nature, timing and extent of other audit procedures, and
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(iii) Perform alternative audit procedures designed to obtain relevant and reliable audit
evidence.
If the auditor concludes that management’s refusal to allow the auditor to send a
confirmation request is unreasonable or the auditor is unable to obtain relevant and
reliable audit evidence from alternative audit procedures, the auditor shall communicate
with those in charge of governance and also determine its implication for the audit and
his opinion.
5. Moon Limited replaced its statutory auditor for the Financial year 2014-15.
During the course of audit, the new auditor found a credit item of ` 5 lakhs.
On enquiry, the company explained him that it is, a very old credit balance.
The trade payable had neither approached for the payment nor he is
traceable. Under the circumstances no confirmation of the credit balance is
available.
Answer:
External Confirmation: This is a case of external confirmation, covered by SA 505
“External Confirmations”. The identities of trade payables are not traceable to confirm
the credit balance as appearing in the financial statement of the company. It is also not
a case of pending litigation.
It might be a case that an income of ` 5 lakhs had been hidden in previous year/s. The
statutory auditor should examine the validity of the credit balance as appeared in the
company’s financial statements. He should obtain sufficient evidence in support of the
balance. He should apply alternative audit procedures to get documentary proof for the
transaction/s and should not rely entirely on the management representation. Finally, he
should include the matter by way of a qualification in his audit report to the members.
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SA 510 INITIAL AUDIT ENGAGEMENT- VERIFICATION
OF OPENING BALANCES
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibilities relating to
opening balances when conducting an initial audit engagement. In addition to
financial statement amounts, opening balances include matters requiring
disclosure that existed at the beginning of the period, such as contingencies and
commitments.
When the financial statements include comparative financial information, the
requirements and guidance in SA 710 also apply.
B) Effective date
C) Objectives
In conducting an initial audit engagement, the objective of the auditor with respect
to opening balances is to obtain sufficient appropriate audit evidence about
whether:
(a) Opening balances contain misstatements that materially affect the current
period’s financial statements; and
(b) Appropriate accounting policies reflected in the opening balances have been
consistently applied in the current period’s financial statements, or changes
thereto are properly accounted for and adequately presented and disclosed
in accordance with the applicable financial reporting framework.
D) Definition
Initial audit engagement – An engagement in which either:
auditor.
E) Requirements
Audit Procedures:
1. The auditor shall read the most recent financial statements, if any, and the
predecessor auditor’s report thereon, if any, for information relevant to
opening balances, including disclosures.
If the prior period’s financial statements were audited by a predecessor
auditor and there was a modification to the opinion, the auditor shall evaluate
the effect of the matter giving rise to the modification in assessing the risks of
material misstatement in the current period’s financial statements in
2. The auditor shall obtain sufficient appropriate audit evidence about whether
the opening balances contain misstatements that materially affect the current
period’s financial statements by:
(a) Determining whether the prior period’s closing balances have been
correctly brought forward to the current period or, when appropriate,
any adjustments have been disclosed as prior period items in the
current year’s Statement of Profit and Loss;
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(b) Determining whether the opening balances reflect the application of
appropriate accounting policies; whether the accounting policies
reflected in the opening balances have been consistently applied in the
current period’s financial statements, and whether changes in the
accounting policies have been properly accounted for and adequately
presented and disclosed in accordance with the applicable financial
reporting framework
Audit Conclusions and Reporting:

1. If the auditor is unable to obtain sufficient appropriate audit evidence
regarding the opening balances, the auditor shall express a qualified opinion
or a disclaimer of opinion, as appropriate
2. If the auditor concludes that the opening balances contain a misstatement
that materially affects the current period’s financial statements, and the effect
of the misstatement is not properly accounted for or not adequately
presented or disclosed, the auditor shall express a qualified opinion or an
adverse opinion, as appropriate
3. If the auditor concludes that:
(a) the current period’s accounting policies are not consistently applied in
relation to opening balances in accordance with the applicable financial
reporting framework; or
(b) a change in accounting policies is not properly accounted for or not
adequately presented or disclosed in accordance with the applicable
financial reporting framework, the auditor shall express a qualified
opinion or an adverse opinion as appropriate
4. If the predecessor auditor’s opinion regarding the prior period’s financial
statements included a modification to the auditor’s opinion that remains
relevant and material to the current period’s financial statements, the auditor
shall modify the auditor’s opinion on the current period’s financial statements.
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QUESTION BANK
1. You have been appointed as the auditor of Good Health Ltd. for 2014-15
which was audited by CA Trustworthy in 2013-14. As the Auditor of the
company state the steps you would take to ensure that the Closing Balances
of 2013-14 have been brought to account in 2014-15 as Opening Balances
and the Opening Balances do not contain misstatements.
Answer:
As per SA 510 “Initial Audit Engagements—Opening Balances”, in conducting an
initial audit engagement, the objective of the auditor with respect to opening balances is
to obtain sufficient appropriate audit evidence about whether:
(i) Opening balances contain misstatements that materially affect the current period’s
financial statements; and
(ii) Appropriate accounting policies reflected in the opening balances have been
thereto are properly accounted for and adequately presented and disclosed in
accordance with the applicable financial reporting framework.
Being new assignment audit evidence regarding opening balances can be
obtained by perusing the copies of the audited financial statements.
For current assets and liabilities some audit evidence can ordinarily be obtained
as part of audit procedures during the current period. For example, the
collection/payment of opening balances of receivables and payables will provide
audit evidence as to their existence, rights and obligations, completeness and
valuation at the beginning of the period.
In respect of other assets and liabilities such as fixed assets, investments long
term debt, the auditor will examine the records relating to opening balances. The
auditor may also be able to get confirmation from third parties (e.g., balances of
long term loan obtained from banks).
2. (a) What are ‘Initial Audit Engagements’?

(b) In an initial audit engagement the auditor will have to satisfy about the
sufficiency and appropriateness of ‘Opening Balances’ to ensure that
they are free from misstatements, which may materially affect the
current financial statements. Lay down the audit procedure, you will
follow in cases (i) when the financial statements are audited for the
preceding period by another auditor; and (ii) when financial statements
are audited for the first time.
(c) If, after performing the procedure, you are not satisfied about the
correctness of ‘Opening Balances’; what approach you will adopt in
drafting your audit report in two situations mentioned in (b) above?
Answer:
(a) Initial Audit Engagement: As per SA 510 “Initial Audit Engagements - Opening
Balances”, initial audit engagement is an engagement in which either:
auditor.
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(b) (i) Financial Statements Audited by another Auditor – Audit Procedure: If
the prior period’s financial statements were audited by a predecessor auditor,
the auditor may be able to obtain sufficient appropriate audit evidence
regarding the opening balances by perusing the copies of the audited
financial statements including the other relevant documents relating to the
prior period financial statements such as supporting schedules to the audited
financial statements. Ordinarily, the current auditor can place reliance on the
closing balances contained in the financial statements for the preceding
period, except when during the performance of audit procedures for the
current period the possibility of misstatements in opening balances is
indicated.
(ii) Audit of Financial Statements for the First Time – Audit Procedure:
When the audit of financial statements is being conducted for the first time,
the auditor has to perform auditing procedures to obtain sufficient
appropriate audit evidence. Since opening balances represent effect of
transaction and events of the preceding period and accounting policies
applied in the preceding period, the auditor need to obtain evidence having
regard to nature of opening balances, materiality of the opening balances
and accounting policies. Since it will not be possible for auditor to perform
certain procedures, e.g., observing physical verification of inventories, etc.
the auditor may obtain confirmation, etc. and perform suitable procedures in
respect of fixed assets, investments, etc. The auditor can also obtain
management representation with regards to the opening balances.
(c) Drafting Audit Report: If the auditor is unable to obtain sufficient appropriate
audit evidence regarding the opening balances, the auditor shall express a
qualified opinion or a disclaimer of opinion, as appropriate. Further, If the auditor
concludes that the opening balances contain a misstatement that materially
affects the current period’s financial statements, and the effect of the misstatement
is not properly accounted for or not adequately presented or disclosed, the auditor
shall express a qualified opinion or an adverse opinion.
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SA 520 ANALYTICAL PROCEDURES
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s use of analytical
procedures as substantive procedures (“substantive analytical procedures”), and
as procedures near the end of the audit that assist the auditor when forming an
overall conclusion on the financial statements.
The use of analytical procedures as risk assessment procedures is dealt with in
SA 315.
B) Effective date
C) Objectives
(a) To obtain relevant and reliable audit evidence when using substantive
analytical procedures; and
(b) To design and perform analytical procedures near the end of the audit that
assist the auditor when forming an overall conclusion as to whether the
financial statements are consistent with the auditor’s understanding of the
entity
D) Definition
For the purposes of the SAs, the term “analytical procedures” means
evaluations of financial information through analysis of plausible relationships
among both financial and non-financial data. Analytical procedures also
encompass such investigation as is necessary of identified fluctuations or
relationships that are inconsistent with other relevant information or that differ from
expected values by a significant amount. The auditor’s choice of procedures,
methods and level of application is a matter of professional judgement.
E) Requirements
1. When designing and performing substantive analytical procedures, either
alone or in combination with tests of details, as substantive procedures in
accordance with SA 330, the auditor shall:
(a) Determine the suitability of particular substantive analytical procedures
for given assertions, taking account of the assessed risks of material
misstatement and tests of details, if any, for these assertions;
(b) Evaluate the reliability of data from which the auditor’s expectation of
recorded amounts or ratios is developed, taking account of source,
comparability, and nature and relevance of information available, and
controls over preparation;
(c) Develop an expectation of recorded amounts or ratios and evaluate
whether the expectation is sufficiently precise to identify a misstatement
that, individually or when aggregated with other misstatements, may
cause the financial statements to be materially misstated; and
(d) Determine the amount of any difference of recorded amounts from
expected values that is acceptable without further investigation.
: 236 :
2. Analytical procedures include the consideration of comparisons of the entity’s
financial information with, for example:
· Comparable information for prior periods.
· Anticipated results of the entity, such as budgets or forecasts, or
expectations of the auditor, such as an estimation of depreciation.
· Similar industry information, such as a comparison of the entity’s ratio
of sales to accounts receivable with industry averages or with other
entities of comparable size in the same industry.
· Analytical procedures also include consideration of relationships, for
example:
· Among elements of financial information that would be expected to
conform to a predictable pattern based on the entity’s experience, such
as gross margin percentages.
· Between financial information and relevant non-financial information,
such as payroll costs to number of employees
3. The auditor shall design and perform analytical procedures near the end of
the audit that assist the auditor when forming an overall conclusion as to
whether the financial statements are consistent with the auditor’s
understanding of the entity.
4. If analytical procedures performed in accordance with this SA identify
fluctuations or relationships that are inconsistent with other relevant
information or that differ from expected values by a significant amount, the
auditor shall investigate such differences by:
(a) Inquiring of management and obtaining appropriate audit evidence
relevant to management’s responses; and
(b) Performing other audit procedures as necessary in the circumstances
QUESTION BANK
1. Mention the techniques to be used for performing analytical procedures

Techniques Available as Substantive Analytical Procedures
The design of a substantive analytical procedure is limited only by the availability
of reliable data and the experience and creativity of the audit team. Substantive
analytical procedures generally take one of the following forms:
Trend analysis – A commonly used technique is the comparison of current data
with the prior period balance or with a trend in two or more prior period balances.
We evaluate whether the current balance of an account moves in line with the
trend established with previous balances for that account, or based on an
understanding of factors that may cause the account to change.
Ratio analysis – Ratio analysis is useful for analysing asset and liability accounts
as well as revenue and expense accounts. An individual balance sheet account is
difficult to predict on its own, but its relationship to another account is often more
predictable (e.g., the trade receivables balance related to sales). Ratios can also
be compared over time or to the ratios of separate entities within the group, or with
the ratios of other companies in the same industry.
: 237 :
Reasonableness tests – Unlike trend analysis, this analytical procedure does not
rely on events of prior periods, but upon non-financial data for the audit period
under consideration (e.g., occupancy rates to estimate rental income or interest
rates to estimate interest income or expense). These tests are generally more
applicable to income statement accounts and certain accrual or prepayment
accounts.
Structural modelling – A modelling tool constructs a statistical model from
financial and/or non-financial data of prior accounting periods to predict current
account balances (e.g., linear regression).
2. Mention the extent of reliance on analytical procedures

The reliability of data is influenced by its source and nature and is dependent on
the circumstances under which it is obtained. Accordingly, the following are
relevant when determining whether data is reliable for purposes of designing
substantive analytical procedures:
(i) Source of the information available. For example, information may be more
reliable when it is obtained from independent sources outside the entity;
(ii) Comparability of the information available. For example, broad industry data may
need to be supplemented to be comparable to that of an entity that produces and
sells specialised products;
(iii) Nature and relevance of the information available. For example, whether budgets
have been established as results to be expected rather than as goals to be
achieved; and
(iv) Controls over the preparation of the information that are designed to ensure its
completeness, accuracy and validity. For example, controls over the preparation,
review and maintenance of budgets.
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SA 530 AUDIT SAMPLING
A) Introduction
This Standard on Auditing (SA) applies when the auditor has decided to use
audit sampling in performing audit procedures. It deals with the auditor’s use of
statistical and non-statistical sampling when designing and selecting the audit
sample, performing tests of controls and tests of details, and evaluating the
results from the sample.
This SA complements SA 500, which deals with the auditor’s responsibility to
design and perform audit procedures to obtain sufficient appropriate audit
evidence to be able to draw reasonable conclusions on which to base the audit
opinion.
B) Effective date
C) Objectives
The objective of the auditor when using audit sampling is to provide a
reasonable basis for the auditor to draw conclusions about the population from
which the sample is selected.
D) Definition
(a) Audit sampling (sampling) – 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.
(b) Population – The entire set of data from which a sample is selected and
about which the auditor wishes to draw conclusions.
(c) Sampling risk – 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.
(d) Non-sampling risk – The risk that the auditor reaches an erroneous
conclusion for any reason not related to sampling risk.
(e) Anomaly – A misstatement or deviation that is demonstrably not
representative of misstatements or deviations in a population.
: 239 :
(f) Tolerable misstatement – A monetary amount set by the auditor in respect
of which the auditor seeks to obtain an appropriate level of assurance that
the monetary amount set by the auditor is not exceeded by the actual
misstatement in the population.
(g) Tolerable rate of deviation – A rate of deviation from prescribed internal
control procedures set by the auditor in respect of which the auditor seeks
to obtain an appropriate level of assurance that the rate of deviation set by
the auditor is not exceeded by the actual rate of deviation in the
population.
E) Requirements
1. When designing an audit sample, the auditor shall consider the purpose of
the audit procedure and the characteristics of the population from which
the sample will be drawn.
2. The auditor shall determine a sample size sufficient to reduce sampling
risk to an acceptably low level
3. The auditor shall select items for the sample in such a way that each
sampling unit in the population has a chance of selection.
4. The auditor shall perform audit procedures, appropriate to the purpose, on
each item selected.
5. In the extremely rare circumstances when the auditor considers a
misstatement or deviation discovered in a sample to be an anomaly, the
auditor shall obtain a high degree of certainty that such misstatement or
deviation is not representative of the population. The auditor shall obtain
this degree of certainty by performing additional audit procedures to
obtain sufficient appropriate audit evidence that the misstatement or
deviation does not affect the remainder of the population.
6. For tests of details, the auditor shall project misstatements found in the
sample to the population.
When a misstatement has been established as an anomaly, it may be
excluded when projecting misstatements to the population. However, the
effect of any such misstatement, if uncorrected, still needs to be
considered in addition to the projection of the non-anomalous
misstatements.
7. The auditor shall evaluate:
(a) The results of the sample; and
(b) Whether the use of audit sampling has provided a reasonable basis
forconclusions about the population that has been tested.
8. Sampling Methods:
(1) Random Sampling: Random selection ensures that all items in the
population or within each stratum have a known chance of selection.
It may involve use of randomnumber tables. Random sampling
includes two very popular methods which are discussed below–
(i) Simple Random Sampling: Under this method each unit of
the whole population e.g. purchase or sales invoice has an
equal chance of being selected. The mechanics of selection of
items may be by choosing numbers from table of random
numbers by computers or picking up numbers randomly from a
drum. It is considered that random number tables are simple
and easy to use and also provide assurance that the bias does
not aff ect the selection. This method is considered appropriate
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provided the population to be sampled consists of reasonably
similar units and fall within a reasonable range.
(ii) Stratified Sampling: This method involves dividing the whole
population to be tested in a few separate groups called strata
and taking a sample from each of them. Each stratum is treated
as if it was a separate population and if proportionate of items
are selected from each of these stratum. The number of groups
into which the whole population has to be divided is determined
on the basis of auditor judgment.
(2) Interval Sampling or Systematic Sampling: Systematic selection
is a selection method in which the number of sampling units in the
population is divided by the sample size to give a sampling interval,
for example 50, and having determined a starting point within the fi
rst 50, each 50th sampling unit thereafter is selected. When using
systematic selection, the auditor would need to determine that
sampling units within the population are not structured in such a way
that the sampling interval corresponds with a particular pattern in the
population.
(3) Monetary Unit Sampling: It is a type of value-weighted selection in
which sample size, selection and evaluation results in a conclusion
in monetary amounts.
(4) Haphazard sampling: Haphazard selection, in which the auditor
selects the sample without following a structured technique.
Although no structured technique is used, the auditor would
nonetheless avoid any conscious bias or predictability (for example,
always choosing or avoiding the first or last entries on a page)
and thus attempt to ensure that all items in the population have a
chance of selection. Haphazard selection is not appropriate when
using statistical sampling.
(5) Block Sampling: This method involves selection of a block(s) of
contiguous items from within the population. Block selection cannot
ordinarily be used in audit sampling because most populations are
structured such that items in a sequence can be expected to have
similar characteristics to each other, but different characteristics from
items elsewhere in the population.
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QUESTION BANK
1. “An auditor while analysing the errors in a sample need not consider the
qualitative aspects of errors detected.” Please comment.
Answer:
Characteristics of Sampling Errors: SA 530, “Audit Sampling”, requires that while

evaluating sample results, the auditor should analyse any errors detected in the
samples having regard to appropriateness of the audit objective. An auditor while
evaluating the errors detected in a sample selected by him from the total audit
population, should analyse the nature of the errors, the projected errors in the total
population and the sampling risk attached to it. While designing an audit sample, the
auditor would also need to define the conditions that constitute the error keeping in
view the audit objectives.
Flowing from the above, the auditor, therefore, would also need to consider the
qualitative aspects of the errors detected by him. This will include the nature and
reasons for the error and its possible effect on other phases. In case a repetitive
pattern emerges from such analysis, for example, type of transaction, location,
product line or period of time, the auditor would need to identify all items in the
population, which contain such errors, resulting in a total population. The auditor
would then need to carry out a separate analysis based on the examination carried
out by him for each such sub-population. Accordingly, the auditor cannot be satisfied
by detecting errors only but also would need to consider the qualitative aspects of
such errors.
2. Write short notes on Statistical and Non-Statistical Sampling.
Answer:
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,
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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.
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SA 540 ACCOUNTING ESTIMATES- FAIR VALUE
ESTIMATES AND RELATED DISCLOSURES
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibilities regarding
accounting estimates, including fair value accounting estimates, and related
disclosures in an audit of financial statements. Specifically, it expands on how SA
315 and SA 330 and other relevant SAs are to be applied in relation to
accounting estimates.
It also includes requirements and guidance on misstatements of individual
accounting estimates, and indicators of possible management bias.
B) Effective date
C) Objectives
whether in the context of the applicable financial reporting framework:
(a) accounting estimates, including fair value accounting estimates, in the
financial statements, whether recognised or disclosed, are reasonable;
and
(b) related disclosures in the financial statements are adequate
D) Definition
(a) Auditor’s point estimate or auditor’s range – The amount, or range of
amounts, respectively, derived from audit evidence for use in evaluating
management’s point estimate.
(b) Estimation uncertainty – The susceptibility of an accounting estimate and
related disclosures to an inherent lack of precision in its measurement.
(c) Management bias – A lack of neutrality by management in the preparation
and presentation of information.
(d) Management’s point estimate – The amount selected by management for
recognition or disclosure in the financial statements as an accounting
estimate.
E) Requirements
Risk assessment procedures
The auditor shall obtain an understanding of the following in order to provide a
basis for the identification and assessment of the risks of material misstatement
for accounting estimates:
(a) The requirements of the applicable financial reporting framework relevant to
accounting estimates, including related disclosures.
(b) How management identifies those transactions, events and conditions that
may give rise to the need for accounting estimates to be recognised or
disclosed in the financial statements. In obtaining this understanding, the
auditor shall make inquiries of management about changes in
circumstances that may give rise to new, or the need to revise existing,
(c) How management makes the accounting estimates, and an understanding
of the data on which they are based, including:
(i) The method, including where applicable the model, used in making the
accounting estimate;
(ii) Relevant controls;
(iii) Whether management has used an expert;
(iv) The assumptions underlying the accounting estimates;
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(v) Whether there has been or ought to have been a change from the prior
period in the methods for making the accounting estimates, and if so, why;
and
(vi) Whether and, if so, how management has assessed the effect of estimation
uncertainty.
Responses to the assessed Risks of Material Misstatement

1. Based on the assessed risks of material misstatement, the auditor shall
determine:
(a) Whether management has appropriately applied the requirements of the
applicable financial reporting framework relevant to the accounting estimate
(b) Whether the methods for making the accounting estimates are appropriate
and have been applied consistently, and whether changes, if any, in
accounting estimates or in the method for making them from the prior
period are appropriate in the circumstances.
(c) whether events occurring up to the date of the auditor’s report provide audit
evidence regarding the accounting estimate.
(d) how management made the accounting estimate and the data on which it is
based and test the same.
(i) The method of measurement used is appropriate in the
circumstances; and
(ii) The assumptions used by management are reasonable in light of the
measurement objectives of the applicable financial reporting
framework.
2. Test the operating effectiveness of the controls over how management made the
accounting estimate, together with appropriate substantive procedures.
3. The auditor shall develop a point estimate or a range to evaluate management’s
point estimate. For this purpose:
(i) When the auditor uses assumptions or methods that differ from
management’s, the auditor shall obtain an understanding of management’s
assumptions or methods sufficient to establish that the auditor’s point
estimate or range takes into account relevant variables and to evaluate any
significant differences from management’s point estimate.
4. The auditor shall consider whether specialised skills or knowledge in relation to
one or more aspects of the accounting estimates are required in order to obtain
sufficient appropriate audit evidence.
5. The auditor shall consider the following regarding estimation uncertainty:
(a) How management has considered alternative assumptions or outcomes,
and why it has rejected them, or how management has otherwise
addressed estimation uncertainty in making the accounting estimate.
(b) Whether the significant assumptions used by management are reasonable.
If, in the auditor’s judgment, management has not adequately addressed the
effects of estimation uncertainty on the accounting estimates that give rise to
significant risks, the auditor shall, if considered necessary, develop a range with
which to evaluate the reasonableness of the accounting estimate.
6. The auditor shall obtain sufficient appropriate audit evidence about whether the
disclosures in the financial statements related to accounting estimates are in
accordance with the requirements of the applicable financial reporting
framework.
7. The auditor shall obtain written representations from management and,
where appropriate, those charged with governance whether they believe
significant assumptions used in making accounting estimates are reasonable.
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QUESTION BANK
1. Examples of accounting estimates as per SA 540.

Some accounting estimates involve relatively low estimation uncertainty and may
give rise to lower risks of material misstatements, for example:
 Accounting estimates arising in entities that engage in business activities
that are not complex.
 Accounting estimates that are frequently made and updated because they
relate to routine transactions.
 Accounting estimates derived from data that is readily available, such as
published interest rate data or exchange-traded prices of securities. Such
data may be referred to as “observable” in the context of a fair value
accounting estimate.
 Fair value accounting estimates where the method of measurement
prescribed by the applicable financial reporting framework is simple and
applied easily to the asset or liability requiring measurement at fair value.
Fair value accounting estimates where the model used to measure the
accounting estimate is well-known or generally accepted, provided that the
assumptions or inputs to the model are observable.
For some accounting estimates, however, there may be relatively high estimation
uncertainty, particularly where they are based on significant assumptions, for
example:
Accounting estimates relating to the outcome of litigation.
 Fair value accounting estimates for derivative financial instruments not
publicly traded.
 Fair value accounting estimates for which a highly specialised entity
developed model is used or for which there are assumptions or inputs that
cannot be observed in the marketplace
2. While auditing Z Ltd., you observe certain material financial statement
assertions have been based on estimates made by the management. As the
auditor how do you minimize the risk of material misstatements?
Answer:
As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting
Estimates, and Related Disclosures”, the auditor shall obtain an understanding of
the following in order to provide a basis for the identification and assessment of the
risks of material misstatements for accounting estimates:
(i) The requirements of the applicable financial reporting framework relevant to the
accounting estimates, including related disclosures.
(ii) How Management identifies those transactions, events and conditions that may
give rise to the need for accounting estimates to be recognised or disclosed, in
the financial statements. In obtaining this understanding, the auditor shall make
inquiries of management about changes in circumstances that may give rise to
new, or the need to revise existing, accounting estimates.
(iii) The estimation making process adopted by the management including-
(1) The method, including where applicable the model, used in making the
(2) Relevant controls.
(3) Whether management has used an expert?
(4) The assumption underlying the accounting estimates.
(5) Whether there has been or ought to have been a change from the prior
period in the methods for making the accounting estimates, and if so, why;
and
(6) Whether and, if so, how the management has assessed the effect of
estimation uncertainty.
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SA 550 RELATED PARTY
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibilities regarding
related party relationships and transactions when performing an audit of financial
statements. Specifically, it expands on how SA 315, SA 330 and SA 240 are to
be applied in relation to risks of material misstatement associated with related
party relationships and transactions.
The nature of related party relationships and transactions may, in some
circumstances, give rise to higher risks of material misstatement of the financial
statements than transactions with unrelated parties. For example:
· Related parties may operate through an extensive and complex range of
relationships and structures, with a corresponding increase in the
complexity of related party transactions.
· Information systems may be ineffective at identifying or summarising
transactions and outstanding balances between an entity and its related
parties.
· Related party transactions may not be conducted under normal market
terms and conditions; for example, some related party transactions may be
conducted with no exchange of consideration.
Because related parties are not independent of each other, many financial
reporting frameworks establish specific accounting and disclosure requirements
for related party relationships, transactions and balances to enable users of the
financial statements to understand their nature and actual or potential effects on
In the context of related parties, the potential effects of inherent limitations on the
auditor’s ability to detect material misstatements are greater for such reasons as
the following:
· Management may be unaware of the existence of all related party
relationships and transactions, particularly if the applicable financial
reporting framework does not establish related party requirements.
· Related party relationships may present a greater opportunity for collusion,
concealment or manipulation by management.
B) Effective date
C) Objectives
(a) Irrespective of whether the applicable financial reporting framework
establishes related party requirements, to obtain an understanding of
related party relationships and transactions sufficient to be able:
(i) To recognise fraud risk factors, if any, arising from related party
relationships and transactions that are relevant to the identification
and assessment of the risks of material misstatement due to fraud;
and
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(ii) To conclude whether the financial statements, insofar as they are
affected by those relationships and transactions:
a. Achieve a true and fair presentation or
b. Are not misleading and
(b) In addition, where the applicable financial reporting framework establishes
related party requirements, to obtain sufficient appropriate audit evidence
about whether related party relationships and transactions have been
appropriately identified, accounted for and disclosed in the financial
statements in accordance with the framework.
D) Definition
(a) Arm’s length transaction–A transaction conducted on such terms and
conditions as between a willing buyer and a willing seller who are unrelated
and are acting independently of each other and pursuing their own best
interests.
(b) Related party – A party that is either:
(i) A related party as defined in the applicable financial reporting
framework
(ii) Where the applicable financial reporting framework establishes
minimal or no related party requirements:
a. A person or other entity that has control or significant influence,
directly or indirectly through one or more intermediaries, over the
reporting entity;
b. Another entity over which the reporting entity has control or
significant influence, directly or indirectly through one or more
intermediaries; or
c. Another entity that is under common control with the reporting
entity through having:
i. Common controlling ownership;
ii. Owners who are close family members; or
iii. Common key management.
However, entities that are under common control by a state (i.e., a national,
regional or local government) are not considered related unless they
engage in significant transactions or share resources to a significant extent
with one another.
E) Requirements
1. The auditor shall inquire of management regarding:
(a) The identity of the entity’s related parties, including changes from the
prior period;
(b) The nature of the relationships between the entity and these related
parties; and
(c) Whether the entity entered into any transactions with these related
parties during the period and, if so, the type and purpose of the
transactions.
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2. The auditor shall inquire of management and others within the entity, and
perform other risk assessment procedures considered appropriate, to
obtain an understanding of the controls, if any, that management has
established to:
(a) Identify, account for, and disclose related party relationships and
transactions in accordance with the applicable financial reporting
framework;
(b) Authorise and approve significant transactions and arrangements with
related parties;
(c) Authorise and approve significant transactions and arrangements
outside the normal course of business.
3. During the audit, the auditor shall remain alert, when inspecting records or
documents, for arrangements or other information that may indicate the
existence of related party relationships or transactions that management
has not previously identified or disclosed to the auditor.
Responses to the assessed risks of material misstatement

1. Identification of Previously Unidentified or Undisclosed Related Parties or
Significant Related Party Transactions:
If the auditor identifies arrangements or information that suggests the existence
of related party relationships or transactions that management has not previously
identified or disclosed to the auditor, the auditor shall determine whether the
underlying circumstances confirm the existence of those relationships or
transactions.
During the audit, the auditor may inspect records or documents that may provide
information about related party relationships and transactions, for example:
· Entity income tax returns.
· Information supplied by the entity to regulatory authorities.
· Shareholder registers to identify the entity’s principal shareholders.
· Statements of conflicts of interest from management and those charged
with governance.
· Records of the entity’s investments and those of its pension plans.
· Contracts and agreements with key management or those charged with
governance.
· Significant contracts and agreements not in the entity’s ordinary course of
business.
· Specific invoices and correspondence from the entity’s professional
advisors.
· Life insurance policies acquired by the entity.
· Significant contracts re-negotiated by the entity during the period.
2. For identified significant related party transactions outside the entity’s normal
course of business, the auditor shall:
(a) Inspect the underlying contracts or agreements, if any, and evaluate
whether:
(i) The business rationale (or lack thereof) of the transactions suggests
reporting or to conceal misappropriation of assets;
(ii) The terms of the transactions are consistent with management’s
explanations
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(iii) The transactions have been appropriately accounted for and disclosed
in accordance with the applicable financial reporting framework; and
(b) Obtain audit evidence that the transactions have been appropriately
authorised and approved
3. Assertions That Related Party Transactions Were Conducted on Terms
Equivalent to Those Prevailing in an Arm’s Length Transaction:
When management has made an assertion in the financial statements to the
effect that a related party transaction was conducted on terms equivalent to
those prevailing in an arm’s length transaction, the auditor shall obtain sufficient
appropriate audit evidence about the assertion.
4. In forming an opinion on the financial statements in accordance with SA 700, the

auditor shall evaluate:
(a) Whether the identified related party relationships and transactions have
been appropriately accounted for and disclosed in accordance with the
applicable financial reporting framework
(b) Whether the effects of the related party relationships and transactions:
(i) Prevent the financial statements from achieving true and fair
presentation
(ii) Cause the financial statements to be misleading
5. Where the applicable financial reporting framework establishes related party
requirements, the auditor shall obtain written representations from management
and, where appropriate, those charged with governance that:
(a) They have disclosed to the auditor the identity of the entity’s related parties
and all the related party relationships and transactions of which they are
aware; and
(b) They have appropriately accounted for and disclosed such relationships
and transactions in accordance with the requirements of the framework.
6. In meeting the documentation requirements of SA 230 and other SAs, the
auditor shall include in the audit documentation the names of the identified
related parties and the nature of the related party relationships.
QUESTION BANK
1. Elaborate how the Statutory Auditor can verify the existence of related
parties for the purpose of reporting under Accounting Standard 18.
Answer:
Verification of Existence of Related Parties: As per SA 550 “Related Parties”,
during the audit, the auditor shall remain alert, when inspecting records or documents,
for arrangements or other information that may indicate the existence of related party
relationships or transactions that management has not previously identified or
disclosed to the auditor.
Example-
(i) Entity Income Tax Returns.
(ii) Information supplied by the entity to regulatory authorities.
(iii) Shareholder registers to identify the entity’s principal shareholders.
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(iv) Statements of conflicts of interest from management and those charged with
governance.
(v) Records of the entity’s investments and those of its pension plans.
(vi) Contracts and agreements with key management or those charged with
governance.
(vii) Significant contracts and agreements not in the entity’s ordinary course of
business.
(viii) Specific invoices and correspondence from the entity’s professional advisors.
(ix) Life insurance policies acquired by the entity.
(x) Significant contracts re-negotiated by the entity during the period.
(xi) Internal auditors’ reports.
(xii) Documents associated with the entity’s filings with a securities regulator (e.g.
prospectuses).
Arrangements that may indicate the existence of previously unidentified or
undisclosed related
party relationships or transactions.
In particular, the auditor shall inspect the following for indications of the existence
of related party relationships or transactions that management has not previously
identified or disclosed to the auditor:
(i) Bank, legal and third party confirmations obtained as part of the auditor’s
procedures;
(ii) Minutes of meetings of shareholders and of those charged with
governance; and
(iii) Such other records or documents as the auditor considers necessary in the
circumstances of the entity.
2. In the course of audit of Q Ltd, its statutory auditor wants to be sure of the
adequacy of related party disclosures? Kindly guide the auditor in
identifying the possible source of related party information.
Answer:
Identification of possible sources for Related Parties’ information: As per SA 550
on, “Related Parties”, the auditor should review information provided by the
management of the entity identifying the names of all known related parties. However,
it is the management, which is primarily responsible for identification of related parties.
The duties of an auditor with regard to reporting of related party transaction as
required by Accounting Standard 18 “Related Party Disclosures” is given in SA 550.
(i) SA 550 requires that to identify names of all known related parties, the auditor
may inspect records or documents that may provide information about related
party relationships and transactions, for example entity income tax returns,
information supplied by the entity to regulatory authorities, shareholder registers
to identify the entity’s principal shareholders, statements of conflicts of interest
from management and those charged with governance, records of the entity’s
investments and those of its pension plans, contracts and agreements with key
management or those charged with governance, significant contracts and
agreements not in the entity’s ordinary course of business, specific invoices and
correspondence from the entity’s professional advisors, life insurance policies
acquired by the entity, significant contracts re-negotiated by the entity during the
period, internal auditors’ reports, documents associated with the entity’s filings
with a securities regulator (e.g., prospectuses).
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(ii) Some arrangements that may indicate the existence of previously unidentified or
undisclosed related party relationships or transactions as an arrangement
involves a formal or informal agreement between the entity and one or more
other parties for such purposes as the establishment of a business relationship
through appropriate vehicles or structures, the conduct of certain types of
transactions under specific terms and conditions or the provision of designated
services or financial support. Examples of arrangements that may indicate the
existence of related party relationships or transactions that management has not
previously identified or disclosed to the auditor include participation in
unincorporated partnerships with other parties, agreements for the provision of
services to certain parties under terms and conditions that are outside the entity’s
normal course of business, guarantees and guarantor relationships etc.
(iii) Obtaining further information on significant transactions outside the entity’s
normal course of business enables the auditor to evaluate whether fraud risk
factors, if any, are present and, where the applicable financial reporting
framework establishes related party requirements, to identify the risks of material
misstatement. In addition, the auditor needs to be alert for transactions which
appear unusual in the circumstances and which may indicate the existence of
previously unidentified related parties. Examples of transactions outside the
entity’s normal course of business may include complex equity transactions,
such as corporate restructurings or acquisitions, transactions with offshore
entities in jurisdictions with weak corporate laws, the leasing of premises or the
rendering of management services by the entity to another party if no
consideration is exchanged, sales transactions with unusually large discounts or
returns, transactions with circular arrangements, for example, sales with a
commitment to repurchase, transactions under contracts whose terms are
changed before expiry etc.
(iv) Finally, the auditor should also obtain a written representation from the
management concerning the completeness of information provided regarding the
identification of related parties.
3. In the course of your audit you have come across a related party
transaction which prima facie appears to be biased. How would you deal
with this?
Answer:
Related Parties: The duties of an auditor with regard to reporting of transactions with
related parties as required by Accounting Standard 18 are given in SA 550 on Related
Parties. As per SA 550 on, “Related Parties”, the auditor should review information
provided by the management of the entity identifying the names of all known related
parties. Since it is the management, which is primarily responsible for identification of
related parties, SA 550 requires that to identify names of all known related parties, the
auditor may inspect records or documents that may provide information about related
party relationships and transactions.
In this case, the auditor is finding a related party transaction which prima facie
appears to be biased. So the auditor is required to confirm the same. For identified
significant related party transactions outside the entity’s normal course of business,
the auditor shall inspect the underlying contracts or agreements, if any, and evaluate
whether:
(i) The business rationale (or lack thereof) of the transactions suggests that they
may have been entered into to engage in fraudulent financial reporting or to
conceal misappropriation of assets,
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(ii) The terms of the transactions are consistent with management’s explanations;
and
(iii) The transactions have been appropriately accounted for and disclosed in
The auditor should also obtain audit evidence that the transactions have been
appropriately authorised and approved. After obtaining further information on
significant transactions outside the entity’s normal course of business enables the
auditor to evaluate whether fraud risk factors, if any, are present and, where the
applicable financial reporting framework establishes related party requirements, to
identify the risks of material misstatement.
In addition, the auditor needs to be alert for transactions which appear unusual in the
circumstances and which may indicate the existence of previously unidentified related
parties. Where the applicable financial reporting framework establishes related party
requirements, the auditor shall obtain written representations from management and,
where appropriate, those charged with governance that they have disclosed to the
auditor the identity of the entity’s related parties and all the related party relationships
and transactions of which they are aware; and they have appropriately accounted for
and disclosed such relationships and transactions in accordance with the
requirements of the framework.
Finally, the auditor should report on the basis of this fact that the related party
relationships and transactions prevent the financial statements from achieving true
and fair presentation; or they are not cause for the financial statements to be
misleading.
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SA 560 SUBSEQUENT EVENTS
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibilities relating to
subsequent events in an audit of financial statements.
B) Effective date
C) Objectives
The objectives of the auditor are to:
(a) Obtain sufficient appropriate audit evidence about whether events occurring
between the date of the financial statements and the date of the auditor’s
report that require adjustment of, or disclosure in, the financial statements
are appropriately reflected in those financial statements; and
(b) Respond appropriately to facts that become known to the auditor after the
date of the auditor’s report, that, had they been known to the auditor at that
date, may have caused the auditor to amend the auditor’s report.
D) Definition
(a) Date of the financial statements – The date of the end of the latest period
covered by the financial statements.
(b) Date of approval of the financial statements – The date on which all the
statements that comprise the financial statements, including the related
notes, have been prepared and those with the recognised authority have
asserted that they have taken responsibility for those financial statements.
(c) Date of the auditor’s report – The date the auditor dates the report on the
financial statements in accordance with SA 700.
(d) Date the financial statements are issued – The date that the auditor’s report
and audited financial statements are made available to third parties.
(e) Subsequent events – Events occurring between the date of the financial
statements and the date of the auditor’s report, and facts that become
known to the auditor after the date of the auditor’s report.
E) Requirements
I. Events Occurring Between the Date of the Financial Statements and the
Date of the Auditor’s Report:
The auditor shall:
(a) Obtaining an understanding of any procedures management has
established to ensure that subsequent events are identified.
(b) Inquiring of management and, where appropriate, those charged with
governance as to whether any subsequent events have occurred
which might affect the financial statements.
(c) Reading minutes, if any, of the meetings, of the entity’s owners,
management and those charged with governance, that have been
held after the date of the financial statements
(d) Reading the entity’s latest subsequent interim financial statements, if
any.
(e) Obtain written representations as per SA 580, that all events occurring
subsequent to the date of the financial statements and for which the
applicable financial reporting framework requires adjustment or
disclosure have been adjusted or disclosed.
: 254 :
II. Facts Which Become Known to the Auditor After the Date of the
Auditor’s Report but Before the Date the Financial Statements are
Issued
The auditor shall:
(a) Discuss the matter with management and, where appropriate, those
charged with governance.
(b) Determine whether the financial statements need amendment and, if
so,
statements.
The auditor shall either:
(a) Amend the auditor’s report to include an additional date restricted to
that amendment that thereby indicates that the auditor’s procedures
on subsequent events are restricted solely to the amendment of the
financial statements described in the relevant note to the financial
statements
(b) Provide a new or amended auditor’s report that includes a statement
in an Emphasis of Matter paragraph or Other Matter(s) paragraph that
conveys that auditor’s procedures on subsequent events are restricted
solely to the amendment of the financial statements as described in
the relevant note to the financial statements.
III. Facts Which Become Known to the Auditor After the Financial
Statements have been Issued
The auditor shall:
(a) Discuss the matter with management and, where appropriate, those
charged with governance.
(b) Determine whether the financial statements need amendment and, if
so,
statements.
If management does not take the necessary steps to ensure that anyone in
receipt of the previously issued financial statements is informed of the
situation and does not amend the financial statements in circumstances
where the auditor believes they need to be amended, the auditor shall
notify management and, unless all of those charged with governance7 are
involved in managing the entity, those charged with governance, that the
auditor will seek to prevent future reliance on the auditor’s report. If, despite
such notification, management or those charged with governance do not
take these necessary steps, the auditor shall take appropriate action to
seek to prevent reliance on the auditor’s report.
: 255 :
QUESTION BANK
1. A fire broke out on 15th May, 2014, in which material worth ` 50 lakhs which
was lying in inventory since 1st March, 2014 was totally destroyed. The
financial statements of the company have not been adopted till the date of
fire. The management of the company argues that since the loss occurred
in the year, 2014-15, no provision for the loss needs to be made in the
financial statements for 2013-14.
Answer:
Event occurring after the balance sheet date: This case requires attention to SA
560 “Subsequent Events” and AS 4 “Contingencies and Events occurring after the
Balance Sheet Date”.
As per AS 4 “Contingencies and Events occurring after the Balance Sheet Date”,
adjustments to assets and liabilities are required for events occurring after the balance
sheet date that provide additional information materially affecting the determination of
the amounts relating to conditions existing at the balance sheet date or that indicate
that the fundamental accounting assumption of going concern (i.e., the continuance of
existence or substratum of the enterprise) is not appropriate.
AS 4 also requires disclosure of the non-adjusting event, in the report of the approving
authority. Further, as per SA 560 “Subsequent Events”, the auditor should assure that
all events occurring subsequent to the date of the financial statements and for which
the applicable financial reporting framework requires adjustment or disclosure have
been adjusted or disclosed.
The event took place after the close of the accounting year and does not relate to
conditions existing at the balance sheet date. Thus, it will have no effect on items
appearing at the balance sheet date because as per AS 4 “Contingencies and Events
Occurring after Balance Sheet Date” have to be adjusted that provide evidence of
conditions existing as at the balance sheet date. However, the auditor has to ensure
that this loss will not materially affect the substratum of the enterprises as per its size,
nature and complexity of operations.
Thus, subject to satisfaction in respect of non-violation of going concern concept, the
company has correctly accounted by not providing provision. However, the auditor is
required to ensure the proper disclosure of abovementioned event.
2. A Co. Ltd. has not included in the Balance Sheet as on 31-03-2015 a sum of
` 1.50 crores being amount in the arrears of salaries and wages payable to
the staff for the last 2 years as a result of successful negotiations which
were going on during the last 18 months and concluded on 30-04-2015. The
auditor wants to sign the said Balance Sheet and give the audit report on
31-05-2015. The auditor came to know the result of the negotiations on 15-
05-2015. Comment.
Answer:
Subsequent Events: This case requires attention to SA 560 “Subsequent Events”,
AS 4 Contingencies and Events occurring after the Balance Sheet Date” and AS 29
"Provisions, Contingent liabilities and Contingent Assets".
As per AS 4 “Contingencies and Events occurring after the Balance Sheet Date”,
adjustments to assets and liabilities are required for events occurring after the balance
sheet date that provide additional information materially affecting the determination of
: 256 :
the amounts relating to conditions existing at the balance sheet date. Similarly as per
AS 29 "Provisions, Contingent liabilities and Contingent Assets", 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 will occur.
In the instant case, the amount of ` 1.50 crores is a material amount and it is the result
of an event, which has occurred after the Balance Sheet date. The facts have become
known to the auditor before the date of issue of the Audit Report and Financial
Statements. The auditor has to perform the procedure to obtain sufficient, appropriate
evidence covering the period from the date of the financial statements i.e. 31-3-2015
to the date of Auditors Report ie. 31-05-2015. It will be observed that as a result of
long pending negotiations a sum of ` 1.50 cores representing arrears of salaries of the
year 2013-14 and 2014-15 have not been included in the financial statements. It is
quite clear that the obligation requires provision for outstanding expenses as per AS 4
and AS 29.
As per SA 560 “Subsequent Events”, the auditor should assure that all events
occurring subsequent to the date of the financial statements and for which the
applicable financial reporting framework requires adjustment or disclosure have been
adjusted or disclosed. So the auditor should request the management to adjust the
sum of ` 1.50 crores by making provision for expenses. If the management does not
accept the request the auditor should qualify the audit report.
: 257 :
SA 570 GOING CONCERN
A) Introduction
1. This Standard on Auditing (SA) deals with the auditor’s responsibilities in
the audit of financial statements relating to going concern and the
implications for the auditor’s report.
2. Under the going concern basis of accounting, the financial statements are
prepared on the assumption that the entity is a going concern and will
continue its operations for the foreseeable future.
3. When the use of the going concern basis of accounting is appropriate,
assets and liabilities are recorded on the basis that the entity will be able
to realize its assets and discharge its liabilities in the normal course of
business
4. The detailed requirements regarding management’s responsibility to
assess the entity’s ability to continue as a going concern and related
financial statement disclosures may also be set out in law or regulation.
5. The preparation of the financial statements requires management to
assess the entity’s ability to continue as a going concern even if the
financial reporting framework does not include an explicit requirement to
do so.
6. The auditor’s responsibilities are to obtain sufficient appropriate audit
evidence regarding, and conclude on, the appropriateness of
management’s use of the going concern basis of accounting in the
preparation of the financial statements, and to conclude, based on the
audit evidence obtained, whether a material uncertainty exists about the
entity’s ability to continue as a going concern.
7. The auditor cannot predict future events or conditions. Accordingly, the
absence of any reference to a material uncertainty about the entity’s
ability to continue as a going concern in an auditor’s report cannot be
viewed as a guarantee as to the entity’s ability to continue as a going
concern.
B) Effective date
C) Objectives
(a) To obtain sufficient appropriate audit evidence regarding, and conclude
on, the appropriateness of management’s use of the going concern basis
of accounting in the preparation of the financial statements;
(b) To conclude, based on the audit evidence obtained, whether a material
uncertainty exists related to events or conditions that may cast significant
doubt on the entity’s ability to continue as a going concern; and
(c) To report in accordance with this SA.
D) Definition
E) Requirements
1. When performing risk assessment procedures as required by SA 315, the
auditor shall consider whether events or conditions exist that may cast
: 258 :
significant doubt on the entity’s ability to continue as a going concern. In
so doing, the auditor shall determine whether management has already
performed a preliminary assessment of the entity’s ability to continue as a
going concern
2. If such an assessment has been performed, the auditor shall discuss the
assessment with management and determine whether management has
identified events or conditions that, individually or collectively, may cast
significant doubt on the entity’s ability to continue as a going concern and,
if so, management’s plans to address them;
3. If such an assessment has not yet been performed, the auditor shall
discuss with management the basis for the intended use of the going
concern basis of accounting, and inquire of management whether events
or conditions exist that, individually or collectively, may cast significant
doubt on the entity’s ability to continue as a going concern.
Further Audit Procedures i.e. Responses to the Assessed Risk
1. In evaluating management’s assessment of the entity’s ability to continue
as a going concern, the auditor shall cover the same period as that used
by management to make its assessment as required by the applicable
financial reporting framework, or by law or regulation if it specifies a longer
period. If management’s assessment of the entity’s ability to continue as a
going concern covers less than twelve months from the date of the
financial statements, the auditor shall request management to extend its
assessment period to at least twelve months from that date.
2. The auditor shall inquire of management as to its knowledge of events or
conditions beyond the period of management’s assessment that may cast
significant doubt on the entity’s ability to continue as a going concern.
3. Where the entity has prepared a cash flow forecast, and analysis of the
forecast is a significant factor in considering the future outcome of events
or conditions in the evaluation of management’s plans for future actions:
(i) Evaluating the reliability of the underlying data generated to prepare
the forecast; and
(ii) Determining whether there is adequate support for the assumptions
underlying the forecast
4. Considering whether any additional facts or information have become
available since the date on which management made its assessment.
5. Requesting written representations from management and, where
appropriate, those charged with governance, regarding their plans for
future actions and the feasibility of these plans.
Conclusions
1. Based on the audit evidence obtained, the auditor shall conclude whether,
in the auditor’s judgment, a material uncertainty exists related to events or
conditions that, individually or collectively, may cast significant doubt on
the entity’s ability to continue as a going concern.
2. If the auditor concludes that management’s use of the going concern
basis of accounting is appropriate in the circumstances but a material
uncertainty exists, the auditor shall determine whether the financial
statements:
(a) Adequately disclose 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
: 259 :
(b) 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.
3. If events or conditions have been identified that may cast significant doubt
on the entity’s ability to continue as a going concern but, based on the
audit evidence obtained the auditor concludes that no material uncertainty
exists, the auditor shall evaluate whether, in view of the requirements of
the applicable financial reporting framework, the financial statements
provide adequate disclosures about these events or conditions.
4. In certain circumstances, the auditor may believe it necessary to request
management to make or extend its assessment. If management is
unwilling to do so, a qualified opinion or a disclaimer of opinion in the
auditor’s report may be appropriate, because it may not be possible for
the auditor to obtain sufficient appropriate audit evidence regarding
management’s use of the going concern basis of accounting in the
preparation of the financial statements, such as audit evidence regarding
the existence of plans management has put in place or the existence of
other mitigating factors.
5. If adequate disclosure about the material uncertainty is not made in the
financial statements, the auditor shall:
(a) Express a qualified opinion or adverse opinion, as appropriate; and
(b) In the Basis for Qualified (Adverse) Opinion section of the auditor’s
report, state that a material uncertainty exists that may cast
significant doubt on the entity’s ability to continue as a going concern
and that the financial statements do not adequately disclose this
matter
: 260 :
QUESTION BANK
1. Mention the Indicators of Material Uncertainty as per Risk assessment

procedures performed under SA 570.
Answer:
Financial
· Net liability or net current liability position.
· Fixed-term borrowings approaching maturity without realistic prospects of
renewal or repayment; or excessive reliance on short-term borrowings to
finance long-term assets.
· I ndications of withdrawal of financial support by creditors.
· Negative operating cash flows indicated by historical or prospective financial
statements.
· Adverse key financial ratios.
· Substantial operating losses or significant deterioration in the value of assets
used to generate cash flows.
· Arrears or discontinuance of dividends.
· Inability to pay creditors on due dates.
· Inability to comply with the terms of loan agreements.
· Change from credit to cash-on-delivery transactions with suppliers.
· Inability to obtain financing for essential new product development or other
essential investments.
Operating
· Management intentions to liquidate the entity or to cease operations.
· Loss of key management without replacement.
· Loss of a major market, key customer(s), franchise, license, or principal
supplier(s).
· Labor difficulties.
· Shortages of important supplies.
· Emergence of a highly successful competitor.
Other
· Non-compliance with capital or other statutory or regulatory requirements, such
as solvency or liquidity requirements for financial institutions.
· 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.
· Changes in law or regulation or government policy expected to adversely affect
the entity.
· Uninsured or underinsured catastrophes when they occur.
The significance of such events or conditions often can be mitigated by other

factors. For example, the effect of an entity being unable to make its normal debt
repayments may be counter-balanced by management’s plans to maintain adequate
cash flows by alternative means, such as by disposing of assets, rescheduling loan
repayments, or obtaining additional capital. Similarly, the loss of a principal supplier
may be mitigated by the availability of a suitable alternative source of supply.
: 261 :
2. X Ltd closed its manufacturing operations and sold all its manufacturing
fixed assets during the financial year ended 31st March, 2016. However, it
intends continue its operations as a trading company. In respect of other
fixed assets, the company carried out a physical verification as at the end
of 31st March, 2016 and found a material discrepancy to the tune of ` 1
lac, which was written off and is disclosed separately in the Statement of
Profit and Loss. Kindly incorporate the above in your audit report.
Answer
Disclosure in Audit Report: As per SA 570 “Going Concern”, 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-
(i) Adequately describe the principal events or conditions that may cast significant
doubt on the entity’s ability to continue as a going concern and management’s
plans to deal with these events or conditions; and
(ii) 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.
The auditor is further required to specifically include certain matters as per
CARO, 2016 under section 143 of the Companies Act, 2013. According to
clause (i)(b) of Para 3 of CARO, the auditor has to comment whether the fixed
assets have been physically verified by the management at reasonable
intervals; whether any material discrepancies were noticed on such verification
and if so, whether the same have been properly dealt with in the books of
account.
In the given case, X Ltd. has sold out its manufacturing fixed assets during the
year. However, it intends to continue its operations as a trading company.
Therefore, selling of manufacturing fixed assets does not affect the going
concern assumption of the company. Additionally, while carrying out physical
verification of fixed assets, a material discrepancy to the tune of ` 1 lac was
found, which was written off and disclosed separately in the Statement of
Profit and Loss. Hence, this fact needs to be disclosed in the Audit Report
as follows:
Para in the Audit Report-
We have made our viewpoint from the facts of the case and on the basis of
guidance drawn from AS 1. We report as under-
As per Accounting Standard (AS) 1, “Disclosure of Accounting Policies”, “the
enterprise is normally viewed as a going concern that is as continuing its
operation for the foreseeable future. It is assumed that the enterprise has
neither the intention nor the necessity of liquidation or of curtailing materially
the scale of its operations.” Although the company has disposed off its
manufacturing fixed assets during the financial year ending on 31-03-2016, it is
still a going concern in the form of a trading company. We also report that on
physical verification of other fixed assets, a material discrepancy to the tune of `
1 Lac was noticed and that the same has been properly dealt with in the books
of account.
: 262 :
Q.3. 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?
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.
4. A Company's net worth is eroded and trade payables are unpaid due to
liquidity constraints. The management represents to the statutory auditor
that the promoter's wife is expected to give an unsecured loan to meet the
liquidity constraints and that negotiations are underway to secure large
export orders
Answer:
Going Concern Assumption: In this case, it is subjective, but prima-facie a mere
expectation of future cash flows from the promoter’s wife without any firm
commitment and the possibility of an export order being negotiated, may not that be
sufficient appropriate audit evidence of mitigating factors for resolving the going
concerns question under SA 570 “Going Concern”.
: 263 :
5. M/s T K Projects Limited, a manufacturing company in the Steel industry
was allegedly involved in some irregularity relating to allotment of coal
blocks for which a complaint was lodged against the company by the
government. The financial institutions stopped additional working capital
finance which caused a financial crisis resulting in stoppage of
production. The company incurred a massive loss during the year 2015-
16. There were delays in salary and other payments. Certain key
managerial personnel including GM Finance and certain other employees
left the company. The company has no sound action plan to mitigate
these situations. Guide the statutory auditor on how he should deal with
this situation.
Answer:
Inability to Continue as a Going Concern: As per SA 570 on “Going Concern”, it is
the responsibility of the auditor to obtain sufficient appropriate audit evidence about
the appropriateness of management’s use of the going concern assumption in the
preparation and presentation of the financial statements and to conclude whether
there is a material uncertainty about the entity’s ability to continue as a going
concern. The auditor shall evaluate management’s assessment of the entity’s ability
to continue as a going concern. In evaluating management’s assessment, the auditor
shall consider whether management’s assessment includes all relevant information
of which the auditor is aware as a result of the audit.
In the instant case, M/s T K Projects Limited has incurred massive loss during the
year 2015-16 as the financial institutions have stopped financing additional working
capital to the company because of a complaint which was lodged against the
company by government for involvement in some irregularity relating to allotment of
coal blocks. There were delays in salary and other payments. Besides this, certain
key managerial personnel, GM Finance and certain other employees have also left
the company. The company, in addition, has no sound action plan to mitigate these
situations.
Thus, there are clear indications that there is danger to entity’s ability to continue in
future. Considering the fact that there is no sound plan of action to mitigate these
factors, the going concern assumption does not seem appropriate.
Therefore, the auditor should ask the management for its adequate disclosure in the
financial statement and include the same in his report. However, if the management
fails to make adequate disclosure, the auditor should express Express a qualified
opinion or adverse opinion, as appropriate, in accordance with SA 705 (Revised) .
But, if the result of the appropriate assumption used in the preparation of financial
statements is material and pervasive as to make the financial statements misleading,
the auditor should express an adverse opinion and in the Basis for Qualified
(Adverse) Opinion section of the auditor’s report, state that a material uncertainty
exists that may cast significant doubt on the entity’s ability to continue as a going
concern and that the financial statements do not adequately disclose this matter.
: 264 :
SA 580 WRITTEN REPRESENTATION
A) Introduction
obtain written representations from management and, where appropriate,
2. Audit evidence is all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based. Written representations
are necessary information that the auditor requires in connection with the
audit of the entity’s financial statements. Accordingly, similar to responses
to inquiries, written representations are audit evidence.
3. Although written representations provide necessary audit evidence, they
do not provide sufficient appropriate audit evidence on their own about
any of the matters with which they deal. Furthermore, the fact that
management has provided reliable written representations does not affect
the nature or extent of other audit evidence that the auditor obtains about
the fulfilment of management’s responsibilities, or about specific
assertions.
B) Effective date
or after 1st April, 2009.
C) Objectives
(a) To obtain written representations from management and, where
appropriate, those charged with governance that they believe that they
have fulfilled their responsibility for the preparation of the financial
statements and for the completeness of the information provided to the
auditor;
(b) To support other audit evidence relevant to the financial statements or
specific assertions in the financial statements by means of written
representations, if determined necessary by the auditor or required by
other SAs; and
(c) To respond appropriately to written representations provided by
management and, where appropriate, those charged with governance, or
if management or, where appropriate, those charged with governance do
not provide the written representations requested by the auditor.
D) Definition
Written representations – A written statement by management provided to the
auditor to confirm certain matters or to support other audit evidence. Written
representations in this context do not include financial statements,
the assertions therein, or supporting books and records.
E) Requirements
1. The auditor shall request written representations from management with
appropriate responsibilities for the financial statements and knowledge of
the matters concerned.
2. The auditor shall request management to provide a written representation
that it has fulfilled its responsibility for the preparation of the financial
statements in accordance with the applicable financial reporting
: 265 :
framework, including where relevant their fair presentation, as set out in
the terms of the audit engagement.
3. The auditor shall request management to provide a written representation
that:
(a) It has provided the auditor with all relevant information and access
as agreed in the terms of the audit engagement, and
(b) All transactions have been recorded and are reflected in the financial
statements.
4. Other SAs require the auditor to request written representations. If, in
addition to such required representations, the auditor determines that it is
necessary to obtain one or more written representations to support other
audit evidence relevant to the financial statements or one or more specific
assertions in the financial statements, the auditor shall request such other
written representations
5. The date of the written representations shall be as near as practicable to,
but not after, the date of the auditor’s report on the financial statements.
The written representations shall be for all financial statements and
period(s) referred to in the auditor’s report.
6. The written representations shall be in the form of a representation letter
addressed to the auditor. If law or regulation requires management to
make written public statements about its responsibilities, and the auditor
determines that such statements provide some or all of the
representations mentioned above, the relevant matters covered by such
statements need not be included in the representation letter.
Doubt as to the Reliability of Written Representations
1. If the auditor has concerns about the competence, integrity, ethical values
or diligence of management, or about its commitment to or enforcement of
these, the auditor shall determine the effect that such concerns may have
on the reliability of representations (oral or written) and audit evidence in
general
2. In particular, if written representations are inconsistent with other audit
evidence, the auditor shall perform audit procedures to attempt to resolve
the matter. If the matter remains unresolved, the auditor shall reconsider
the assessment of the competence, integrity, ethical values or diligence of
management
3. If the auditor concludes that the written representations are not reliable,
the auditor shall take appropriate actions, including determining the
possible effect on the opinion in the auditor’s report in accordance with SA
705
Requested Written Representations Not Provided
If management does not provide one or more of the requested written
representations, the auditor shall:
(a) Discuss the matter with management;
(b) Re-evaluate the integrity of management and evaluate the effect that this
may have on the reliability of representations (oral or written) and audit
evidence in general; and
(c) Take appropriate actions, including determining the possible effect on the
opinion in the auditor’s report in accordance with SA 705,
The auditor shall disclaim an opinion on the financial statements in
accordance with SA 705 if:
(a) The auditor concludes that there is sufficient doubt about the integrity of
management such that the written representations are not reliable; or
(b) Management does not provide the written representations.
: 266 :
QUESTION BANK
1. Explain what is meant by “Written Representations” and indicate to what

extent an auditor can place reliance on such representations.
Answer
Written Representation: A written statement by management provided to the
auditor to confirm certain matters or to support other audit evidence. Written
representations in this context do not include financial statements, the assertions
therein, or supporting books and records.
Audit evidence is all the information used by the auditor in arriving at the conclusions
on which the audit opinion is based. Thus written representations are necessary
information that the auditor requires in connection with the audit of the entity’s
financial statements. Accordingly, similar to responses to inquiries, written
representations are audit evidence. Although written representations provide
necessary audit evidence, they do not provide sufficient appropriate audit evidence
on their own about any of the matters with which they deal. Furthermore, the fact that
management has provided reliable written representations does not affect the nature
or extent of other audit evidence that the auditor obtains about the fulfillment of
management’s responsibilities, or about specific assertions.
The auditor shall request management to provide a written representation that it has
fulfilled its responsibility for the preparation of the financial statements in accordance
with the applicable financial reporting framework, including where relevant their fair
presentation, as set out in the terms of the audit engagement. Other SAs require the
auditor to request written representations. If, in addition to such required
representations, the auditor determines that it is necessary to obtain one or more
written representations to support other audit evidence relevant to the financial
statements or one or more specific assertions in the financial statements, the auditor
shall request such other written representations.
Extent of Reliance: SA 580, “Written Representations”, states that If the auditor has
concerns about the competence, integrity, ethical values or diligence of
management, or about its commitment to or enforcement of these, the auditor shall
determine the effect that such concerns may have on the reliability of
representations (oral or written) and audit evidence in general.
In particular, if written representations are inconsistent with other audit evidence, the
auditor shall perform audit procedures to attempt to resolve the matter. If the matter
remains unresolved, the auditor shall reconsider the assessment of the competence,
integrity, ethical values or diligence of management, or of its commitment to or
enforcement of these, and shall determine the effect that this may have on the
reliability of representations (oral or written) and audit evidence in general. If the
auditor concludes that the written representations are not reliable, the auditor shall
take appropriate actions, including determining the possible effect on the opinion in
the auditor’s report.
: 267 :
Q.2. State briefly the basic elements of Management Representation Letter.
Answer
Basic Elements of a Management Representation Letter: As per SA 580 “Written
Representations”, some of the basic elements of a Management Representation
letter are-
(1) It is a written statement by management provided to the auditor to confirm
certain matters or to support other audit evidence.
(2) It does not include financial statements, the assertions therein, or supporting
books and records.
(3) The auditor shall request management to provide a written representation that it
has fulfilled its responsibility for the preparation of the financial statements in
accordance with the applicable financial reporting framework, including where
relevant their fair presentation, as set out in the terms of the audit engagement.
(4) The written representations shall be for all financial statements and period(s)
referred to in the auditor’s report.
Q.3. In the course of audit of ABC Ltd. its management refuses to provide
written representations. As an auditor what is your duty?
Duty of an Auditor if management refuses to provide written
representations: As per SA 580 “Written Representations”, if the management
does not provide one or more of the requested written representations, the
auditor shall:
(i) Discuss the matter with management,
(ii) Re-evaluate the Integrity of the management and evaluate the effect that
this may have on the reliability of representations (oral or written) and
audit evidence in general, and
(iii) Take appropriate actions, including determining the possible effect on the
opinion in the auditor’s report.
The auditor should disclaim an opinion on the financial statements if
management does not provide written representations in accordance with SA
705 “Modifications to the Opinion in the Independent Auditor’s Report”.
Q.4. An auditor of Sagar Ltd. was not able to get the confirmation about the
existence and value of certain machineries. However, the management
gave him a certificate to prove the existence and value of the machinery
as appearing in the books of account. The auditor accepted the same
without any further procedure and signed the audit report. Is he right in
his approach?
Answer
Validity of Written Representation: The physical verification of fixed assets is the
primary responsibility of the management. The auditor, however, is required to
examine the verification programme adopted by the management. He must satisfy
himself about the existence, ownership and valuation of fixed assets. In the case of
Sagar Ltd., the auditor has not been able to verify the existence and value of some
machinery despite the verification procedure followed in routine audit. He accepted
the certificate given to him by the management without making any further enquiry.
: 268 :
As per SA 580 “Written Representations”, when representation relate to matters
which are material to the financial information, then the auditor should seek
corroborative audit evidence from other sources inside or outside the entity.
He should evaluate whether such representations are reasonable and consistent
with other evidences and should consider whether individuals making such
representations can be expected to be well informed on the matter. “Written
Representations” cannot be a substitute for other audit evidence that the auditor
could reasonably expect to be available.
If the auditor is unable to obtain sufficient appropriate audit evidence that he believes
would be available regarding a matter which has or may have a material effect on
the financial information, this will constitute a limitation on the scope of his
examination even if he has obtained a representation from management on the
matter. Therefore, the approach adopted by the auditor is not right.
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SA 600 USING THE WORK OF ANOTHER AUDITOR
A) Introduction
1. The purpose of this Standard on Auditing (SA) is to establish standards to
be applied in situations where an auditor (referred to herein as the
‘principal auditor’), reporting on the financial information of an entity, uses
the work of another auditor (referred to herein as the ‘other auditor’) with
respect to the financial information of one or more components included in
the financial information of the entity.
This Standard also discusses the principal auditor’s responsibility in
relation to his use of the work of the other auditor. In this Standard, the
term 'financial information' encompasses 'financial statements'.
2. This Standard does not deal with those instances where two or more
auditors are appointed as joint auditors2 nor does it deal with the auditor’s
relationship with a predecessor auditor.
B) Effective date
This Standard on Auditing becomes operative for all audits relating to
accounting periods beginning on or after April 1, 2002.
C) Definition
"Principal auditor" means the auditor with responsibility for reporting on the
financial information of an entity when that financial information includes the
financial information of one or more components audited by another auditor.
"Other auditor" means an auditor, other than the principal auditor, with
responsibility for reporting on the financial information of a component which is
included in the financial information audited by the principal auditor.
"Component" means a division, branch, subsidiary, joint venture, associated

enterprises or other entity whose financial information is included in the
financial information audited by the principal auditor.
D) Requirements
1. When the principal auditor concludes that the financial information of a
component is immaterial, the procedures outlined in this Statement do not
apply. When several components, immaterial in themselves, are together
material in relation to the financial information of the entity as a whole, the
procedures outlined in this Statement should be considered.
2. When the principal auditor uses the work of another auditor, the principal
auditor should determine how the work of the other auditor will affect the
audit.
3. The auditor should consider whether the auditor's own participation

is sufficient to be able to act as the principal auditor. For this purpose
the auditor would consider:
(a) the materiality of the portion of the financial information which the
principal auditor audits;
(b) the principal auditor's degree of knowledge regarding the business of
the components;
(c) the risk of material misstatements in the financial information of the
components audited by the other auditor; and
(d) the performance of additional procedures as set out in this SA
regarding the components audited by other auditor resulting in the
principal auditor having significant participation in such audit.
: 270 :
4. When using the work of another auditor, the principal auditor should
ordinarily perform the following procedures:
(a) advise the other auditor of the use that is to be made of the other
auditor's work and report and make sufficient arrangements for
coordination of their efforts at the planning stage of the audit.
(b) inform the other auditor of matters such as areas requiring special
consideration, procedures for the identification of inter-component
transactions that may require disclosure and the time-table for
completion of audit
(c) advise the other auditor of the significant accounting, auditing and
reporting requirements and obtain representation as to compliance
with them.
(d) discuss with the other auditor the audit procedures applied or review
a written summary of the other auditor’s procedures and findings
which may be in the form of a completed questionnaire or check-list
(e) consider the significant findings of the other auditor.
(f) discuss with the other auditor and the management of the
component, the audit findings or other matters affecting the financial
information of the components
5. Reporting Considerations
(a) When the principal auditor concludes, based on his procedures,
that the work of the other auditor cannot be used and the
principal auditor has not been able to perform sufficient additional
procedures regarding the financial information of the component
audited by the other auditor, the principal auditor should express a
qualified opinion or disclaimer of opinion because there is a limitation
on the scope of audit.
(b) In all circumstances, if the other auditor issues, or intends to issue, a
modified auditor's report, the principal auditor should consider
whether the subject of the modification is of such nature and
significance, in relation to the financial information of the entity on
which the principal auditor is reporting that it requires a modification
of the principal auditor's report.
(c) When the principal auditor has to base his opinion on the financial
information of the entity as a whole relying upon the statements and
reports of the other auditors, his report should state clearly the
division of responsibility for the financial information of the entity by
indicating the extent to which the financial information of components
audited by the other auditors have been included in the financial
information of the entity, e.g., the number of
divisions/branches/subsidiaries or other components audited by
other auditors.
6. The principal auditor should document in his working papers the
components whose financial information was audited by other auditors;
their significance to the financial information of the entity as a whole; the
names of the other auditors; and any conclusions reached that individual
components are not material. The principal auditor should also document
the procedures performed and the conclusions reached
7. Principal auditor can visit the component and review the financial
information, however, he cannot establish his right over the working
papers of other auditor because working papers are property of auditor.
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QUESTION BANK
Q1. “There should be sufficient liaison between a principal auditor and other
auditors”. Discuss the above statement and state in this context the
reporting considerations, when the auditor uses the work performed by
other auditor.
Answer
SA 600 on “Using the Work of Another Auditor” lays down the procedure to be
applied in situations where a principal auditor reporting on the financial statement of
the entity uses the work of another independent auditor. SA 600 contemplates
coordination between auditors and requires that there should be sufficient liaison
between the principal auditor and the other auditor. For this purpose, the principal
auditor may find it necessary to issue written communication(s) to the other auditor.
The other auditor, knowing the context in which his work is to be used by the
principal auditor, should co-ordinate with the principal auditor. For example, by
bringing to the principal auditor’s immediate attention any significant findings
requiring to be dealt with at entity level, adhering to the time-table for audit of the
component, etc. He should ensure compliance with the relevant statutory
requirements. Similarly, the principal auditor should advise the other auditor of any
matters that come to his attention that he thinks may have an important bearing on
the other auditor’s work.
When considered necessary by him, the principal auditor may require the other
auditor to answer a detailed questionnaire regarding matters on which the principal
auditor requires information for discharging his duties. The other auditor should
respond to such questionnaire on a timely basis.
When the principal auditor concludes, based on his procedures, that the work of the
other auditor cannot be used and the principal auditor has not been able to perform
sufficient additional procedures regarding the financial information of the component
audited by the other auditor, the principal auditor should express a qualified opinion
or disclaimer of opinion because there is a limitation on the scope of audit.
In all circumstances, if the other auditor issues, or intends to issue, a modified
auditor's report, the principal auditor should consider whether the subject of the
modification is of such nature and significance, in relation to the financial information
of the entity on which the principal auditor is reporting that it requires a modification
of the principal auditor's report.
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SA 610 USING THE WORK OF INTERNAL AUDITOR
A) Introduction
1. This Standard on Auditing (SA) deals with the external auditor’s
responsibilities if using the work of internal auditors. This includes
(a) using the work of the internal audit function in obtaining audit
evidence and
(b) using internal auditors to provide direct assistance under the
direction, supervision and review of the external auditor
2. This SA does not apply if the entity does not have an internal audit
function.
3. If the entity has an internal audit function, the requirements in this SA
relating to using the work of that function do not apply if:
(a) The responsibilities and activities of the function are not relevant to
the audit; or
(b) Based on the auditor’s preliminary understanding of the function
obtained as a result of procedures performed under SA 315, the
external auditor does not expect to use the work of the function in
obtaining audit evidence.
4. Furthermore, the requirements in this SA relating to direct assistance do
not apply if the external auditor does not plan to use internal auditors to
provide direct assistance.
5. The external auditor has sole responsibility for the audit opinion
expressed, and that responsibility is not reduced by the external auditor’s
use of the work of the internal audit function or internal auditors to provide
direct assistance on the engagement. Although they may perform audit
procedures similar to those performed by the external auditor, neither the
internal audit function nor the internal auditors are independent of the
entity as is required of the external auditor in an audit of financial
statements in accordance with SA 200
B) Effective date
or after 01st April, 2016.
C) Objectives
The objectives of the external auditor, where the entity has an internal audit
function and the external auditor expects to use the work of the function to
modify the nature or timing, or reduce the extent, of audit procedures to be
performed directly by the external auditor, or to use internal auditors to provide
direct assistance, are:
(a) To determine whether the work of the internal audit function or direct
assistance from internal auditors can be used, and if so, in which areas
and to what extent; and having made that determination:
(b) If using the work of the internal audit function, to determine whether that
work is adequate for purposes of the audit; and
(c) If using internal auditors to provide direct assistance, to appropriately
direct, supervise and review their work.
D) Definition
Internal audit function – A function of an entity that performs assurance and
consulting activities designed to evaluate and improve the effectiveness of the
entity’s governance, risk management and internal control processes.
Direct assistance – The use of internal auditors to perform audit procedures
under the direction, supervision and review of the external auditor
: 273 :
E) Requirements
Evaluating Internal Audit Function
1. The external auditor shall determine whether the work of the internal audit
function can be used for purposes of the audit by evaluating the following:
(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
(c) Whether the internal audit function applies a systematic and
disciplined approach, including quality control
2. 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
Determining the Nature and Extent of Work of the Internal Audit Function
that Can Be Used
1. The external auditor shall consider the nature and scope of the work that
has been performed, or is planned to be performed, by the internal audit
function and its relevance to the external auditor’s overall audit strategy
and audit plan
2. The external auditor shall make all significant judgments in the audit
engagement and, to prevent undue use of the work of the internal audit
function, shall plan to use less of the work of the function and perform
more of the work directly
3. The external auditor shall also evaluate whether, in aggregate, using the
work of the internal audit function to the extent planned would still result in
the external auditor being sufficiently involved in the audit, given the
external auditor’s sole responsibility for the audit opinion expressed.
Using the Work of Internal Audit Function
1. If the external auditor plans to use the work of the internal audit function,
the external auditor shall discuss the planned use of its work with the
function as a basis for coordinating their respective activities.
2. The external auditor shall read the reports of the internal audit function
relating to the work of the function that the external auditor plans to use
3. The nature and extent of the external auditor’s audit procedures shall be
responsive to the external auditor’s evaluation of:
(a) The amount of judgment involved;
(b) The assessed risk of material misstatement;
(c) The extent to which the internal audit function’s organizational
status and relevant policies and procedures support the objectivity of
the internal auditors; and
(d) The level of competence of the function
Determining Whether, in Which Areas, and to What Extent Internal
Auditors Can Be Used to Provide Direct Assistance
1. The external auditor may be prohibited by law or regulation from obtaining
direct assistance from internal auditors.
2. If using internal auditors to provide direct assistance is not
prohibited by law or regulation, and the external auditor plans to use
internal auditors to provide direct assistance on the audit, the external
auditor shall evaluate the existence and significance of threats to
: 274 :
objectivity and the level of competence of the internal auditors who will be
providing such assistance.
3. The external auditor shall not use an internal auditor to provide direct
assistance if:
(a) There are significant threats to the objectivity of the internal auditor;
or
(b) The internal auditor lacks sufficient competence to perform the
proposed work
4. Prior to using internal auditors to provide direct assistance for purposes
of the audit, the external auditor shall:
(a) Obtain written agreement from an authorized representative of the
entity that the internal auditors will be allowed to follow the external
auditor’s instructions, and that the entity will not intervene in the work
the internal auditor performs for the external auditor; and
(b) Obtain written agreement from the internal auditors that they will
keep confidential specific matters as instructed by the external
auditor and inform the external auditor of any threat to their
objectivity.
5. The external auditor shall direct, supervise and review the work
performed by internal auditors on the engagement in accordance with
SA 220. In so doing:
(a) The nature, timing and extent of direction, supervision, and review
shall recognize that the internal auditors are not independent of the
entity; and
(b) The review procedures shall include the external auditor checking
back to the underlying audit evidence for some of the work
performed by the internal auditors.
The direction, supervision and review by the external auditor of the work
performed by the internal auditors shall be sufficient in order for the
external auditor to be satisfied that the internal auditors have obtained
sufficient appropriate audit evidence to support the conclusions based on
that work.
6. If the external auditor uses internal auditors to provide direct assistance
on the audit, the external auditor shall include in the audit
documentation:
(a) The evaluation of the existence and significance of threats to the
objectivity of the internal auditors, and the level of competence of the
internal auditors used to provide direct assistance;
(b) The basis for the decision regarding the nature and extent of the
work performed by the internal auditors;
(c) Who reviewed the work performed and the date and extent of that
review in accordance with SA 230;
(d) The written agreements obtained from an authorized representative
of the entity and the internal auditors; and
(e) The working papers prepared by the internal auditors who provided
direct assistance on the audit engagement
: 275 :
QUESTION BANK
1. 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?
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.
: 276 :
SA 620 USING THE WORK OF AUDITOR’S EXPERT
A) Introduction
1. This Standard on Auditing (SA) deals with the auditor’s responsibilities
regarding the use of an individual or organisation’s work in a field of
expertise other than accounting or auditing, when that work is used to
assist the auditor in obtaining sufficient appropriate audit evidence.
2. This SA does not deal with:
(a) Situations where the engagement team includes a member with
expertise in specialised area of accounting or auditing, which is dealt
with in SA 220;
or
(b) The auditor’s use of the work of an individual or organisation
possessing expertise in a field other than accounting or auditing,
whose work in that field is used by the entity to assist the entity
(i.e.management’s expert) in preparing the financial statements(a
management’s expert), which is dealt with in SA 500.
B) Effective date
C) Objectives
(a) To determine whether to use the work of an auditor’s expert; and
(b) If using the work of an auditor’s expert, to determine whether that work is
adequate for the auditor’s purposes.
D) Definition
below:
(a) Auditor’s expert – An individual or organisation possessing expertise in a
field other than accounting or auditing, whose work in that field is used by
the auditor to assist the auditor in obtaining sufficient appropriate audit
evidence. An auditor’s expert may be either an auditor’s internal expert
(who is a partner or staff, including temporary staff, of the auditor’s firm or
a network firm), or an auditor’s external expert.
(b) Expertise – Skills, knowledge and experience in a particular field.
(c) Management’s expert – An individual or organisation possessing
expertise in a field other than accounting or auditing, whose work in that
field is used by the entity to assist the entity in preparing the financial
statements.
E) Requirements
1. If expertise in a field other than accounting or auditing is necessary to
obtain sufficient appropriate audit evidence, the auditor shall determine
whether to use the work of an auditor’s expert.
Expertise in a field other than accounting or auditing may include
expertise in relation to such matters as:
· The valuation of complex financial instruments, land and buildings,
plant and machinery, jewelry, works of art, antiques, intangible
assets, assets acquired and liabilities assumed in business
combinations and assets that
· may have been impaired.
: 277 :
· The actuarial calculation of liabilities associated with insurance
contracts or employee benefit plans.
· The estimation of oil and gas reserves.
· The valuation of environmental liabilities, and site clean-up costs.
· The interpretation of contracts, laws and regulations.
· The analysis of complex or unusual tax compliance issues.
2. The nature, timing and extent of the auditor’s procedures will vary
depending on the circumstances. In determining the nature, timing and
extent of those procedures, the auditor shall consider matters including:
(a) The nature of the matter to which that expert’s work relates;
(b) The risks of material misstatement in the matter to which that
expert’s work relates;
(c) The significance of that expert’s work in the context of the audit;
(d) The auditor’s knowledge of and experience with previous work
performed by that expert; and
(e) Whether that expert is subject to the auditor’s firm’s quality control
policies and procedures
(f) whether the auditor’s expert has the necessary competence,
capabilities and objectivity for the auditor’s purposes
3. The auditor shall agree, in writing when appropriate, on the following
matters with the auditor’s expert:
(a) The nature, scope and objectives of that expert’s work;
(b) The respective roles and responsibilities of the auditor and that
expert;
(c) The nature, timing and extent of communication between the auditor
and that expert, including the form of any report to be provided by
that expert; and
(d) The need for the auditor’s expert to observe confidentiality
requirements.
4. The auditor shall evaluate the adequacy of the auditor’s expert’s work
for the auditor’s purposes, including:
(a) The relevance and reasonableness of that expert’s findings or
conclusions, and their consistency with other audit evidence;
(b) If that expert’s work involves use of significant assumptions and
methods, the relevance and reasonableness of those assumptions
and methods in the circumstances
(c) If that expert’s work involves the use of source data that is significant
to that expert’s work, the relevance, completeness, and accuracy of
that source data.
5. Reference to the Auditor’s Expert in the Auditor’s Report:
(a) The auditor shall not refer to the work of an auditor’s expert in an
auditor’s report containing an unmodified opinion unless required by
law or regulation to do so. If such reference is required by law or
regulation, the auditor shall indicate in the auditor’s report that the
reference does not reduce the auditor’s responsibility for the audit
opinion.
(b) If the auditor makes reference to the work of an auditor’s expert in
the auditor’s report because such reference is relevant to an
understanding of a modification to the auditor’s opinion, the auditor
shall indicate in the auditor’s report that such reference does not
reduce the auditor’s responsibility for that opinion.
: 278 :
QUESTION BANK
1. While doing audit, Ram, the Auditor requires reports from experts for the
purpose of Audit evidence. What types of reports/opinions he can obtain
and to what extent he can rely upon the same?
Answer
Using the Work of an Auditor’s Expert: As per SA 620, “Using the Work of an
Auditor’s Expert”, during the audit, the auditor may seek to obtain, in conjunction with
the client or independently, audit evidence in the form of reports, opinions, valuations
and statements of an expert.
While doing audit, Ram, the auditor can obtain the following types of reports,
or options or statements of an expert for the purpose of audit evidence:
(i) The valuation of complex financial instruments, land and buildings, plant and
machinery, jewelry, works of art, antiques, intangible assets, assets acquired
and liabilities assumed in business combinations and assets that may have
been impaired.
(ii) The actuarial calculation of liabilities associated with insurance contracts or
employee benefit plans.
(iii) The estimation of oil and gas reserves.
(iv) The valuation of environmental liabilities, and site clean-up costs.
(v) The interpretation of contracts, laws and regulations.
(vi) The analysis of complex or unusual tax compliance issues.
When the auditor intends to use the work of an expert, he shall evaluate the
adequacy of the auditor’s expert’s work, including the relevance and reasonableness
of that expert’s findings or conclusions, and their consistency with other audit
evidence; if that expert’s work involves use of significant assumptions and methods,
the relevance and reasonableness of those assumptions and methods in the
circumstances; and if that expert’s work involves the use of source data that is
significant to his work, the relevance, completeness, and accuracy of that source
data.
If the auditor determines that the work of the auditor’s expert is not adequate for the
auditor’s purposes, he shall agree with that expert on the nature and extent of further
work to be performed by that expert; or perform further audit procedures appropriate
to the circumstances.
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SA 700 FORMING AN OPINION
A) Introduction
1. This Standard on Auditing (SA) deals with the auditor‟s responsibility to
form an opinion on the financial statements. It also deals with the form
and content of the auditor‟s report issued as a result of an audit of
financial statements
2. SA 701 deals with the auditor‟s responsibility to communicate key audit
matters in the auditor‟s report.
3. SA 705 (Revised) and SA 706 (Revised) deal with how the form and
content of the auditor‟s report are affected when the auditor expresses a
modified opinion or includes an Emphasis of Matter paragraph or an Other
Matter paragraph in the auditor‟s report respectively.
4. This SA applies to an audit of a complete set of general purpose financial
statements and is written in that context.
5. SA 800 deals with special considerations when financial statements are
prepared in accordance with a special purpose framework. SA 805 deals
with special considerations relevant to an audit of a single financial
statement or of a specific element, account or item of a financial
statement. This SA also applies to audits for which SA 800 or SA 805
apply
6. The requirements of this SA are aimed at addressing an appropriate
balance between the need for consistency and comparability in auditor
reporting globally and the need to increase the value of auditor reporting
by making the information provided in the auditor‟s report more relevant
to users. This SA promotes consistency in the auditor‟s report, but
recognizes the need for flexibility to accommodate particular
circumstances of individual jurisdictions.
B) Effective date
or after April 1, 2017
{The Council of ICAI at its 364th meeting held in March 2017 (in partial
modification of decision taken by it at its 350th meeting held in February 2016),
has decided that the effective date/applicability of four Standards viz. SA 700
(Revised), SA 705 (Revised), SA 706 (Revised) and SA 701 be deferred by one
year and consequently the said Standards shall now be effective/applicable
for audits of financial statements for periods beginning on or after April 1,
2018 (instead of audits of financial statements for periods beginning on or after
April 1, 2017 as was earlier decided}
C) Objectives
(a) To form an opinion on the financial statements based on an evaluation of
the conclusions drawn from the audit evidence obtained; and
(b) To express clearly that opinion through a written report.
D) Definition
below:
(a) General purpose financial statements – Financial statements prepared
in accordance with a general purpose framework.
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(b) General purpose framework – A financial reporting framework designed
to meet the common financial information needs of a wide range of users.
The financial reporting framework may be a fair presentation framework or
a compliance framework.
The term “fair presentation framework” is used to refer to a financial
reporting framework that requires compliance with the requirements of the
framework and:
(i) Acknowledges explicitly or implicitly that, to achieve fair presentation of
the financial statements, it may be necessary for management to provide
disclosures beyond those specifically required by the framework; or
(ii) Acknowledges explicitly that it may be necessary for management to
depart from a requirement of the framework to achieve fair presentation of
the financial statements. Such departures are expected to be necessary
only in extremely rare circumstances.
The term “compliance framework” is used to refer to a financial reporting
framework that requires compliance with the requirements of the framework,
but does not contain the acknowledgements in (i) or (ii) above.
E) Requirements
1. The auditor shall form an opinion on whether the financial statements are
prepared, in all material respects, in accordance with the applicable
financial reporting framework.
2. In order to form that opinion, the auditor shall conclude as to whether the
auditor has obtained reasonable assurance about whether the financial
statements as a whole are free from material misstatement, whether due
to fraud or error. That conclusion shall take into account:
(a) The auditor‟s conclusion, in accordance with SA 330, whether
sufficient appropriate audit evidence has been obtained.
(b) The auditor‟s conclusion, in accordance with SA 450, whether
uncorrected misstatements are material, individually or in aggregate.
3. The auditor shall evaluate whether the financial statements are prepared,
in all material respects, in accordance with the requirements of the
applicable financial reporting framework. This evaluation shall include
consideration of the qualitative aspects of the entity‟s accounting
practices, including indicators of possible bias in management‟s
judgments.
4. In particular, the auditor shall evaluate whether, in view of the
requirements of the applicable financial reporting framework:
(a) The financial statements adequately disclose the significant
accounting policies selected and applied;
(b) The accounting policies selected and applied are consistent with the
applicable financial reporting framework and are appropriate;
(c) The accounting estimates made by management are reasonable;
(d) The information presented in the financial statements is relevant,
reliable, comparable, and understandable;
(e) The financial statements provide adequate disclosures to enable the
intended users to understand the effect of material transactions and
events on the information conveyed in the financial statements; and
(f) The terminology used in the financial statements, including the title
of each financial statement, is appropriate.
5. If the auditor:
(a) concludes that, based on the audit evidence obtained, the financial
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(b) is unable to obtain sufficient appropriate audit evidence to conclude
that the financial statements as a whole are free from material
misstatement, the auditor shall modify the opinion in the auditor‟s
report in accordance with SA 705
6. Elements of Audit Report
1 Title: The auditor’s report shall have a title that clearly indicates that
it is the report of an independent auditor. For example, “Independent
Auditor’s Report,” distinguishes the independent auditor’s report from
reports issued by others.
2. Addressee: The auditor’s report shall be addressed, as appropriate,
based on the circumstances of the engagement. Law, regulation or
the terms of the engagement may specify to whom the auditor’s
report is to be addressed. The auditor’s report is normally addressed
to those for whom the report is prepared, often either to the
shareholders or to those charged with governance of the entity
whose financial statements are being audited.
3. Auditor’s Opinion: The first section of the auditor’s report shall
include the auditor’s opinion, and shall have the heading “Opinion.”
The Opinion section of the auditor’s report shall also:
(a) Identify the entity whose financial statements have been
audited;
(b) State that the financial statements have been audited;
(c) Identify the title of each statement comprising the financial
statements;
(d) Refer to the notes, including the summary of significant
accounting policies; and
(e) Specify the date of, or period covered by, each financial
statement comprising the financial statements.
4. Basis for Opinion:
The auditor’s report shall include a section, directly following the
Opinion section, with the heading “Basis for Opinion”, that:
(a) States that the audit was conducted in accordance with
Standards on Auditing;
(b) Refers to the section of the auditor’s report that describes the
auditor’s responsibilities under the SAs;
(c) Includes a statement that the auditor is independent of the
entity in accordance with the relevant ethical requirements
relating to the audit and has fulfilled the auditor’s other ethical
responsibilities in accordance with these requirements.
(d) States whether the auditor believes that the audit evidence the
auditor has obtained is sufficient and appropriate to provide a
basis for the auditor’s opinion.
5. Going Concern: Where applicable, the auditor shall report in
accordance with SA 570 (Revised).
6. Key Audit Matters: For audits of complete sets of general purpose
financial statements of listed entities, the auditor shall communicate
key audit matters in the auditor’s report in accordance with SA 701.
When the auditor is otherwise required by law or regulation or
decides to communicate key audit matters in the auditor’s report, the
auditor shall do so in accordance with SA 701.
Law or regulation may require communication of key audit matters
for audits of entities other than listed entities.
The auditor may also decide to communicate key audit matters for
other entities, including those that may be of significant public
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interest, for example because they have a large number and wide
range of stakeholders and considering the nature and size of the
business.
7. Responsibilities for the Financial Statements: The auditor’s
report shall include a section with a heading “Responsibilities of
Management for the Financial Statements.”
SA 200 explains the premise, relating to the responsibilities of
management and, where appropriate, those charged with
governance, on which an audit in accordance with SAs is conducted.
Management and, where appropriate, those charged with
governance accept responsibility for the preparation of the financial
statements. Management also accepts responsibility for such
internal control as it determines is necessary to enable the
preparation of financial statements that are free from material
misstatement, whether due to fraud or error. The description of
management’s responsibilities in the auditor’s report includes
reference to both responsibilities as it helps to explain to users the
premise on which an audit is conducted.
8. Auditor’s Responsibilities for the Audit of the Financial
Statements:
This section of the auditor’s report shall:
(a) State that the objectives of the auditor are to:
(i) Obtain reasonable assurance about whether the
financial statements as a whole are free from material
misstatement, whether due to fraud or error; and
(ii) Issue an auditor’s report that includes the auditor’s
opinion.
(b) State that reasonable assurance is a high level of assurance,
but is not a guarantee that an audit conducted in accordance
with SAs will always detect a material misstatement when it
exists; and
(c) State that misstatements can arise from fraud or error, and
either:
(i) Describe that they are considered material if, individually
or in the aggregate, they could reasonably be expected to
influence the economic decisions of users taken on the
basis of these financial statements; or
(ii) Provide a definition or description of materiality in
accordance with the applicable financial reporting
framework.
9. Other Reporting Responsibilities: If the auditor addresses other
reporting responsibilities in the auditor’s report on the financial
statements that are in addition to the auditor’s responsibilities under
the SAs, these other reporting responsibilities shall be addressed in
a separate section in the auditor’s report with a heading titled-
“Report on Other Legal and Regulatory Requirements” or
otherwise as appropriate to the content of the section, unless these
other reporting responsibilities address the same topics as those
presented under the reporting responsibilities required by the SAs in
which case the other reporting responsibilities may be presented in
the same section as the related report elements required by the SAs.
10. Signature of the Auditor: The auditor’s report shall be signed. The
report is signed by the auditor (i.e. the engagement partner) in his
personal name. Where the firm is appointed as the auditor, the
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report is signed in the personal name of the auditor and in the name
of the audit firm.
The partner/proprietor signing the audit report also needs to mention
the membership number assigned by the Institute of Chartered
Accountants of India. They also include the registration number of
the firm, wherever applicable, as allotted by ICAI, in the audit reports
signed by them.
11. Auditor’s Address: The auditor’s report shall name specific
location, which is ordinarily the city where the audit report is signed.
12. Date of the Auditor’s Report: The auditor’s report shall be dated no
earlier than the date on which the auditor has obtained sufficient
appropriate audit evidence on which to base the auditor’s opinion.
7. An auditor may be required to conduct an audit in accordance with, in
addition to the Standards on Auditing issued by ICAI, the International
Standards on Auditing or auditing standards of any other jurisdiction. If
this is the case, the auditor‟s report may refer to Standards on Auditing in
addition to the International Standards on Auditing or auditing standards
of such other jurisdiction, but the auditor shall do so only if:
(a) There is no conflict between the requirements in the ISAs or such
auditing standards of other jurisdiction and those in SAs that would
lead the auditor (i) to form a different opinion, or (ii) not to include an
Emphasis of Matter paragraph or Other Matter paragraph that, in the
particular circumstances, is required by SAs; and
(b) The auditor‟s report includes, at a minimum, each of the elements
above when the auditor uses the layout or wording specified by the
Standards on Auditing.
QUESTION BANK (AFTER SA 706)
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SA 701 COMMUNICATING KEY AUDIT MATTERS IN AUDIT REPORT
A) Introduction
communicate key audit matters in the auditor’s report. It is intended to
address both the auditor’s judgment as to what to communicate in the
auditor’s report and the form and content of such communication.
2. The purpose of communicating key audit matters is to enhance the
communicative value of the auditor’s report by providing greater
transparency about the audit that was performed.
3. Communicating key audit matters provides additional information to
intended users of the financial statements (“intended users”) to assist
them in understanding those matters that, in the auditor’s professional
judgment, were of most significance in the audit of the financial
statements of the current period.
4. Communicating key audit matters in the auditor’s report is in the context of
the auditor having formed an opinion on the financial statements as a
whole. Communicating key audit matters in the auditor’s report is not:
(a) A substitute for disclosures in the financial statements that the
applicable financial reporting framework requires management to
make, or that are otherwise necessary to achieve fair presentation;
(b) A substitute for the auditor expressing a modified opinion when
required by the circumstances of a specific audit engagement in
accordance with SA 705 (Revised);1
(c) A substitute for reporting in accordance with SA 570 (Revised)2
when a material uncertainty exists relating to events or conditions
that may cast significant doubt on an entity’s ability to continue as a
going concern; or
(d) A separate opinion on individual matters.
5. SA 705 (Revised) prohibits the auditor from communicating key audit
matters when the auditor disclaims an opinion on the financial statements,
unless such reporting is required by law or regulation.
B) Effective date
Same as per SA 700
C) Objectives
The objectives of the auditor are to determine key audit matters and, having
formed an opinion on the financial statements, communicate those matters by
describing them in the auditor’s report.
D) Definition
Key audit matters— Those matters that, in the auditor’s professional
judgment, were of most significance in the audit of the financial statements of
the current period. Key audit matters are selected from matters communicated
with those charged with governance.
E) Requirements
1. The auditor shall determine, from the matters communicated with those
charged with governance, those matters that required significant auditor
attention in performing the audit. In making this determination, the auditor
shall take into account the following:
(a) Areas of higher assessed risk of material misstatement, or significant
risks identified in accordance with SA 315
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(b) Significant auditor judgments relating to areas in the financial
statements that involved significant management judgment, including
accounting estimates that have been identified as having high
estimation uncertainty.
(c) The effect on the audit of significant events or transactions that
occurred during the period.
2. The auditor shall determine which of the matters determined in
accordance with above paragraph were of most significance in the audit of
the financial statements of the current period and therefore are the key
audit matters.
3. The auditor shall describe each key audit matter, using an appropriate
subheading, in a separate section of the auditor’s report under the
heading “Key Audit Matters”.
The introductory language in this section of the auditor’s report shall
state that:
(a) Key audit matters are those matters that, in the auditor’s professional
judgment, were of most significance in the audit of the financial
statements [of the current period]; and
(b) These matters were addressed in the context of the audit of the
financial statements as a whole, and in forming the auditor’s opinion
thereon, and the auditor does not provide a separate opinion on
these matters.
4. The auditor shall describe each key audit matter in the auditor’s report
unless:
(a) Law or regulation precludes public disclosure about the matter; or
(b) In extremely rare circumstances, the auditor determines that the
matter should not be communicated in the auditor’s report because
the adverse consequences of doing so would reasonably be
expected to outweigh the public interest
5. If the auditor determines, depending on the facts and circumstances of the
entity and the audit, that there are no key audit matters to communicate or
that the key audit matters have been addressed by other paragraphs, the
auditor shall include a statement to this effect in a separate section of the
auditor’s report under the heading “Key Audit Matters”.
6. The auditor shall communicate with those charged with governance:
(a) Those matters the auditor has determined to be the key audit
matters; or
(b) If applicable, depending on the facts and circumstances of the entity
and the audit, the auditor’s determination that there are no key audit
matters to communicate in the auditor’s report
QUESTION BANK
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SA 705 MODIFICATIONS TO THE OPINION
A) Introduction
This Standard on Auditing (SA) deals with the auditor’s responsibility to issue
an appropriate report in circumstances when, in forming an opinion in
accordance with SA 700 (Revised), the auditor concludes that a modification to
the auditor’s opinion on the financial statements is necessary
B) Effective date
SAME AS PER SA 700
C) Objectives
The objective of the auditor is to express clearly an appropriately modified
opinion on the financial statements that is necessary when:
(a) The auditor concludes, based on the audit evidence obtained, that
the financial statements as a whole are not free from material
misstatement; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence
to conclude that the financial statements as a whole are free from material
misstatement
D) Definition
(a) Pervasive – A term used, in the context of misstatements, to describe the
effects on the financial statements of misstatements or the possible
effects on the financial statements of misstatements, if any, that are
undetected due to an inability to obtain sufficient appropriate audit
evidence. Pervasive effects on the financial statements are those that, in
the auditor’s judgment:
(i) Are not confined to specific elements, accounts or items of the
financial statements;
(ii) If so confined, represent or could represent a substantial proportion
of the financial statements; or
(iii) In relation to disclosures, are fundamental to users’ understanding of
(b) Modified opinion – A qualified opinion, an adverse opinion or a

disclaimer of opinion on the financial statements.
E) Requirements
The auditor shall modify the opinion in the auditor’s report when:
(a) The auditor concludes that, based on the audit evidence obtained, the
financial statements as a whole are not free from material misstatement;
or
(b) The auditor is unable to obtain sufficient appropriate audit evidence to
conclude that the financial statements as a whole are free from material
misstatement.
There are three types of modified opinions, namely-
1. A qualified opinion
2. An adverse opinion
3. A disclaimer of opinion
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Qualified Opinion
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence,
concludes that misstatements, individually or in the aggregate, are
material, but not pervasive, to the financial statements; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence on
which to base the opinion, but the auditor concludes that the possible
effects on the financial statements of undetected misstatements, if any,
could be material but not pervasive.
Adverse Opinion
The auditor shall express an adverse opinion when the auditor, having obtained
sufficient appropriate audit evidence, concludes that misstatements, individually
or in the aggregate, are both material and pervasive to the financial statements.
Disclaimer of Opinion The auditor shall disclaim an opinion when the auditor
is unable to obtain sufficient appropriate audit evidence on which to base the
opinion, and the auditor concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be both material and
pervasive.
The auditor shall disclaim an opinion when, in extremely rare circumstances
involving multiple uncertainties.
When the auditor modifies the opinion on the financial statements, the auditor
shall, in addition to the specific elements required by SA 700 (Revised):
(a) Amend the heading “Basis for Opinion” required by para of SA 700
(Revised) to “Basis for Qualified Opinion,” “Basis for Adverse Opinion,” or
“Basis for Disclaimer of Opinion,” as appropriate; and
(b) Within this section, include a description of the matter giving rise to the
modification.
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SA 706 EMPHASIS OF MATTER AND OTHER MATTER
PARAGRAPH
A) Introduction
This Standard on Auditing (SA) deals with additional communication in the
auditor’s report when the auditor considers it necessary to:
(a) Draw users’ attention to a matter or matters presented or disclosed in the
financial statements that are of such importance that they are fundamental
to users’ understanding of the financial statements; or
(b) Draw users’ attention to any matter or matters other than those presented
or disclosed in the financial statements that are relevant to users’
understanding of the audit, the auditor’s responsibilities or the auditor’s
report
B) Effective date
SAME AS PER SA 700
C) Objectives
The objective of the auditor, having formed an opinion on the financial
statements, is to draw users’ attention, when in the auditor’s judgment it is
necessary to do so, by way of clear additional communication in the auditor’s
report, to:
(a) A matter, although appropriately presented or disclosed in the financial
statements, that is of such importance that it is fundamental to users’
understanding of the financial statements; or
(b) As appropriate, any other matter that is relevant to users’ understanding
of the audit, the auditor’s responsibilities or the auditor’s report
D) Definition
(a) Emphasis of Matter paragraph – A paragraph included in the auditor’s
report that refers to a matter appropriately presented or disclosed in the
financial statements that, in the auditor’s judgment, is of such importance
that it is fundamental to users’ understanding of the financial statements.
(b) Other Matter paragraph – A paragraph included in the auditor’s report
that refers to a matter other than those presented or disclosed in the
financial statements that, in the auditor’s judgment, is relevant to users’
understanding of the audit, the auditor’s responsibilities or the auditor’s
report.
E) Requirements
Emphasis of Matter Paragraphs in the Auditor’s Report
1. If the auditor considers it necessary to draw users’ attention to a matter
presented or disclosed in the financial statements that, in the auditor’s
judgment, is of such importance that it is fundamental to users’
understanding of the financial statements, the auditor shall include an
Emphasis of Matter paragraph in the auditor’s report provided:
(a) The auditor would not be required to modify the opinion in
accordance with SA 705 as a result of the matter; and
(b) When SA 701 applies, the matter has not been determined to be a
key audit matter to be communicated in the auditor’s report.
2. When the auditor includes an Emphasis of Matter paragraph in the
auditor’s report, the auditor shall:
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(a) Include the paragraph within a separate section of the auditor’s report with
an appropriate heading that includes the term “Emphasis of Matter”;
(b) Include in the paragraph a clear reference to the matter being emphasized
and to where relevant disclosures that fully describe the matter can be
found in the financial statements. The paragraph shall refer only to
information presented or disclosed in the financial statements; and
(c) Indicate that the auditor’s opinion is not modified in respect of the matter
emphasized.
3. Emphasis of Matter paragraphs in the auditor’s report in certain
circumstances. These circumstances include:
• When a financial reporting framework prescribed by law or regulation
would be unacceptable but for the fact that it is prescribed by law or
regulation.
• To alert users that the financial statements are prepared in accordance
with a special purpose framework.
• When facts become known to the auditor after the date of the auditor’s
report and the auditor provides a new or amended auditor’s report (i.e.,
subsequent events).
Other Matter Paragraphs in the Auditor’s Report

1. If the auditor considers it necessary to communicate a matter other than those
that are presented or disclosed in the financial statements that, in the auditor’s
judgment, is relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report, the auditor shall include an Other Matter
paragraph in the auditor’s report, provided:
(a) This is not prohibited by law or regulation; and
(b) When SA 701 applies, the matter has not been determined to be a key
audit matter to be communicated in the auditor’s report.
2. When the auditor includes an Other Matter paragraph in the auditor’s report,
the auditor shall include the paragraph within a separate section with the
heading “Other Matter,” or other appropriate heading.
3. Examples of using other matter paragraph
- In the rare circumstance where the auditor is unable to withdraw from an
engagement even though the possible effect of an inability to obtain
sufficient appropriate audit evidence due to a limitation on the scope of
the audit imposed by management is pervasive, the auditor may consider
it necessary to include an Other Matter paragraph in the auditor’s report to
explain why it is not possible for the auditor to withdraw from the
engagement.
- Law, regulation or generally accepted practice may require or permit the
auditor to elaborate on matters that provide further explanation of the
auditor’s responsibilities in the audit of the financial statements or of the
auditor’s report thereon.
- the auditor may include an Other Matter paragraph in the auditor’s report,
referring to the fact that another set of financial statements has been
prepared by the same entity in accordance with another general purpose
framework and that the auditor has issued a report on those financial
statements.
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QUESTION BANK OF SA 700 705 706
1. Under the applicable Standards on Auditing, in what circumstances does

the report of the statutory auditor require modifications? What are the
types of modifications possible to the said report?
Answer
Modifications in Audit Report: As per SA 705, “Modifications to the Opinion in the
Independent Auditor’s Report”, the auditor shall modify the opinion in the auditor’s
report when:
(a) The auditor concludes that, based on the audit evidence obtained, the financial
that the financial statements as a whole are free from material misstatement.
If financial statements prepared in accordance with the requirements of a fair

presentation framework do not achieve fair presentation, the auditor shall discuss the
matter with management and, depending on the requirements of the applicable
financial reporting framework and how the matter is resolved, shall determine
whether it is necessary to modify the opinion in the auditor’s report in accordance
with SA 705.
Types of Modification to the Auditor’s Opinion: As per SA 705, “Modifications
to the Opinion in the Independent Auditor’s Report”, modified opinion may be
defined as a qualified opinion, an adverse opinion or a disclaimer of opinion.
Types of modifications possible to the said report are below-mentioned:
(i) Qualified Opinion: The auditor shall express a qualified opinion when the
auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are material, but not pervasive,
to the financial statements; or the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, but the auditor
concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be material but not pervasive.
(ii) Adverse Opinion: The auditor shall express an adverse opinion adverse
opinion when the auditor, having obtained sufficient appropriate audit evidence,
concludes that misstatements, individually or in the aggregate, are both
material and pervasive to the financial statements.
(iii) Disclaimer of Opinion: The auditor shall disclaim an opinion when the auditor
is unable to obtain sufficient appropriate audit evidence on which to base the
opinion, and the auditor concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be both material and
pervasive.
The auditor shall disclaim an opinion when, in extremely rare circumstances
involving multiple uncertainties, the auditor concludes that, notwithstanding having
obtained sufficient appropriate audit evidence regarding each of the individual
uncertainties, it is not possible to form an opinion on the financial statements due to
the potential interaction of the uncertainties and their possible cumulative effect on
: 291 :
Q.2. XYZ Pvt. Ltd. has submitted the financial statements for the year ended
31-3-16 for audit. The audit assistant observes and brings to your notice
that the company's records show following dues:
Income Tax relating to Assessment Year 2012-13 ` 125 lacs - Appeal is
pending before Hon'ble ITAT since 30-9-14.
Customs duty ` 85 lakhs - Demand notice received on 15-9-15 but no
action has been taken to pay or appeal.
As an auditor, how would you bring this fact to the members?
Non-Compliance of Laws and Regulations: 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. Owing
to the inherent limitations of an audit, there is an unavoidable risk that some
material misstatements in the financial statements may not be detected, even
though the audit is properly planned and performed in accordance with the
SAs.
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
Further, the auditor is required to report on certain matters specified in Para 3
of CARO, 2016 under section 143 of the Companies Act, 2013.
One of such matter is non-payment of dues to Government, on account of any
dispute. As per clause (vii)(b) of Para 3 of CARO, 2016, in case dues of income
tax or sales tax or service tax or duty of customs or duty of excise or value
added tax have not been deposited on account of any dispute, then the
amounts involved and the forum where dispute is pending shall be mentioned.
In the present case, there is Income Tax demand of ` 125 Lacs and the
company has gone for an appeal, it needs considerations as to whether the
entire demand is disputed, because it is difficult to presume that the demand by
Income Tax authority is without any basis. Therefore, as per AS 29 “Provisions,
Contingent Liabilities and Contingent Assets”, partly to the extent the company
considers that the demand is based on some logical basis, that amount may be
provided for and the remaining may be disclosed as the contingent liability.
Further, it should be brought to notice of the members by reporting.
Additionally, the demand notice has been received for Customs duty of ` 85
lakhs and is outstanding on the closure of financial year, for which no action
has been taken by the management. Therefore, it should also be brought to
notice of the members by reporting.
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Q.3. What are the features of a qualified Audit Report?
The Features of a Qualified Report are-
(i) Clarity: The Auditor must express the nature of qualification, in a clear
and unambiguous manner.
(ii) Explanation: Where the Auditor answers any of the statutory affirmations
in the negative or with a qualification, his report shall state the reasons for
such answer.
(iii) Placement: All qualifications should be contained in the Auditor’s Report.
When there are notes which are subject matter of a qualification, the
same should preferably be annexed to the Auditors’ Report. However, a
reference to the notes to Accounts in the Auditors’ Report does not
automatically become a qualification.
(iv) Except for: A quantified opinion should be expressed as “except for” for
the effects of the matter to which qualification related. It would not be
appropriate to use phrases such as “with the foregoing explanation” or
“subject to” in the opinion paragraph as these are not sufficiently clear or
forceful.
(v) Quantification: It is also necessary that the auditor should quantify,
wherever possible, the effect of individual as well as the total effect of all
qualifications on statement of profit and loss and/or state of affairs these
qualifications on the financial statements in a clear and unambiguous
manner. In circumstances where it is not possible to quantify the effect of
the qualifications accurately the auditor may do so on the estimates made
by the management after carrying out such audit tests as are possible and
clearly indicate that the figures given are based on the estimates of the
management.
(vi) Nature of qualification: Vague statements the effect of which on
accounts cannot be ascertained like ‘the trade receivables balances are
subject to confirmation’, ‘no provision for taxation has been made in view
of the loss during the year’ etc., should be avoided.
(vii) Violation of law: Where the company has committed an irregularity
resulting in a breach of law, the Auditor should bring the same to the
notice of the shareholders by properly qualifying his report.
(viii) Notes – Report Relationship – Where notes of a qualificatory nature
appear in the accounts, the Auditors should state all qualifications
independently in their report so that the user can assess the significance
of these qualifications.
(ix) Draft Report: The auditor may discuss matters of qualification with the
management or those charged with governance of the company to
acquire their views. It is not necessary that the Auditor should accept the
management’s view and modify his opinion. But it would enable the
Auditor to accurately draft the qualifications in his Final Report.
Q.4. Write a short note on Certificate for Special Purpose vs. Audit Report.
Certificate for Special Purpose vs. Audit Report: A certificate is a written
confirmation of the accuracy of the facts stated therein and does not involve
any estimate or opinion.
The term ‘certificate’ is, therefore, used where the auditor verifies the accuracy
of facts.
An auditor may thus, certify the circulation figures of a newspaper or the value
of imports or exports of a company.
: 293 :
An auditor’s certificate represents that he has verified certain figures and is in a
position to vouch safe their accuracy as per his examination of documents and
books of account.
A report, on the other hand, is a formal statement usually made after an
enquiry, examination or review of specified matters under report and includes
the reporting auditor’s opinion thereon. Thus, when a reporting auditor
issues a certificate, he is responsible for the factual accuracy of what is
stated therein. On the other hand, when a reporting auditor gives a report, he
is responsible for ensuring that the report is based on factual data, that his
opinion is in due accordance with facts, and that it is arrived at by the
application of due care and skill.
The ‘report’ involves expression of opinion which may differ from one
professional to another.
There is no question of exactitude in case of a report since the information
contained therein is based on estimates and involves judgement element.
Q5. Compare and explain the following:

(i) Reporting to Shareholders vs. Reporting to those Charged with
Governance
(ii) Audit Qualification vs. Emphasis of Matter
: 294 :
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SA 710 COMPARATIVE FINANCIAL INFORMATION- CORRESPONDING
FIGURES AND COMPARATIVE FINANCIAL STATEMENTS
A) Introduction
1. This Standard on Auditing (SA) deals with the auditor’s responsibilities
regarding comparative information in an audit of financial statements.
When the financial statements of the prior period have been audited by a
predecessor auditor or were not audited, the requirements and guidance
in SA 510 regarding opening balances also apply.
2. The nature of the comparative information that is presented in an entity’s
financial statements depends on the requirements of the applicable
financial reporting framework. There are two different broad approaches
to the auditor’s reporting responsibilities in respect of such comparative
information: corresponding figures and comparative financial statements.
The approach to be adopted is often specified by law or regulation but
may also be specified in the terms of engagement.
3. The essential audit reporting differences between the approaches are:
(a) For corresponding figures, the auditor’s opinion on the financial
statements refers to the current period only; whereas
(b) For comparative financial statements, the auditor’s opinion refers to each
period for which financial statements are presented.
This SA addresses separately the auditor’s reporting requirements for each
approach.
B) Effective date
C) Objectives
(a) To obtain sufficient appropriate audit evidence about whether the
comparative information included in the financial statements has been
presented, in all material respects, in accordance with the requirements
for comparative information in the applicable financial reporting
framework; and
(b) To report in accordance with the auditor’s reporting responsibilities.
D) Definition
(a) Comparative information – The amounts and disclosures included in the
financial statements in respect of one or more prior periods in accordance
with the applicable financial reporting framework.
(b) Corresponding figures – Comparative information where amounts and
other disclosures for the prior period are included as an integral part of the
current period financial statements, and are intended to be read only in
relation to the amounts and other disclosures relating to the current period
(referred to as “current period figures”). The level of detail presented in the
corresponding amounts and disclosures is dictated primarily by its
relevance to the current period figures.
(c) Comparative financial statements – Comparative information where
amounts and other disclosures for the prior period are included for
comparison with the financial statements of the current period but, if
audited, are referred to in the auditor’s opinion. The level of information
included in those comparative financial statements is comparable with that
of the financial statements of the current period.
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For purposes of this SA, references to “prior period” should be read as “prior
periods” when the comparative information includes amounts and disclosures
for more than one period.
E) Requirements
Audit Procedures
1. The auditor shall determine whether the financial statements include the
comparative information required by the applicable financial reporting
framework and whether such information is appropriately classified. For
this purpose, the auditor shall evaluate whether:
(a) The comparative information agrees with the amounts and other
disclosures presented in the prior period; and
(b) The accounting policies reflected in the comparative information are
consistent with those applied in the current period
2. If the auditor becomes aware of a possible material misstatement in the
comparative information while performing the current period audit, the
auditor shall perform such additional audit procedures as are necessary in
the circumstances to obtain sufficient appropriate audit evidence to
determine whether a material misstatement exists.
3. If the auditor had audited the prior period’s financial statements, the
auditor shall also follow the relevant requirements of SA 560
4. As required by SA 580, the auditor shall request written representations
for all periods referred to in the auditor’s opinion. The auditor shall also
obtain a specific written representation regarding any prior period item
that is separately disclosed in the current year’s statement of profit and
loss
Audit Reporting
Corresponding Figures
When corresponding figures are presented, the auditor’s opinion shall not refer to the
corresponding figures except in the circumstances described below:
1. If the auditor’s report on the prior period, as previously issued, included a
qualified opinion, a disclaimer of opinion, or an adverse opinion and the matter
which gave rise to the modification is unresolved, the auditor shall modify the
auditor’s opinion on the current period’s financial statements. In the Basis for
Modification paragraph in the auditor’s report, the auditor shall either:
(a) Refer to both the current period’s figures and the corresponding figures in
the description of the matter giving rise to the modification when the
effects or possible effects of the matter on the current period’s figures are
material; or
(b) In other cases, explain that the audit opinion has been modified because
of the effects or possible effects of the unresolved matter on the
comparability of the current period’s figures and the corresponding
figures.
2. If the auditor obtains audit evidence that a material misstatement exists in the
prior period financial statements on which an unmodified opinion has been
previously issued, the auditor shall verify whether the misstatement has been
dealt with as required under the applicable financial reporting framework and, if
that is not the case, the auditor shall express a qualified opinion or an adverse
opinion in the auditor’s report on the current period financial statements
3. If the financial statements of the prior period were audited by a predecessor
auditor and the auditor is permitted by law or regulation to refer to the
predecessor auditor’s report on the corresponding figures and decides to do so,
the auditor shall state in an Other Matter paragraph in the auditor’s report:
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(a) That the financial statements of the prior period were audited by the
predecessor auditor;
(b) The type of opinion expressed by the predecessor auditor and, if the
opinion was modified, the reasons therefore; and
(c) The date of that report.
4. If the prior period financial statements were not audited, the auditor shall state
in an Other Matter paragraph in the auditor’s report that the corresponding
figures are unaudited. Such a statement does not, however, relieve the auditor
of the requirement to obtain sufficient appropriate audit evidence that the
opening balances do not contain misstatements that materially affect the
current period’s financial statements.
Comparative Financial Statements

1. When comparative financial statements are presented, the auditor’s opinion
shall refer to each period for which financial statements are presented and on
which an audit opinion is expressed.
2. When reporting on prior period financial statements in connection with the
current period’s audit, if the auditor’s opinion on such prior period financial
statements differs from the opinion the auditor previously expressed, the
auditor shall disclose the substantive reasons for the different opinion in an
Other Matter paragraph in accordance with SA 706.
3. If the financial statements of the prior period were audited by a predecessor
auditor, in addition to expressing an opinion on the current period’s financial
statements, the auditor shall state in an Other Matter paragraph:
(a) That the financial statements of the prior period were audited by a
predecessor auditor;
(b) The type of opinion expressed by the predecessor auditor and, if the
opinion was modified, the reasons therefor; and
(c) The date of that report,
4. If the prior period financial statements were not audited, the auditor shall state
in an Other Matter paragraph that the comparative financial statements are
unaudited. Such a statement does not, however, relieve the auditor of the
requirement to obtain sufficient appropriate audit evidence that the opening
balances do not contain misstatements that materially affect the current
period’s financial statements
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QUESTION BANK
1. Write a short note on Corresponding figures.
Answer
Corresponding Figures: As per SA 710 “Comparative Information—Corresponding
Figures and Comparative Financial Statements”, “corresponding figures” is a
comparative information where amounts and other disclosures for the preceding
period are included as part of the current period financial statements, and are
intended to be read in relation to the amounts and other disclosures relating to the
current period. These corresponding figures are not presented as complete financial
statements capable of standing alone, but are an integral part of the current period
financial statements intended to be read only in relationship to the current period
figures.
2. What are the auditor’s responsibilities in respect of corresponding

figures?
Auditor’s responsibilities in respect of corresponding figures: As per SA
710 “Comparative Information—Corresponding Figures and Comparative
Financial Statements”, in respect of corresponding figures, the auditor shall
determine whether the financial statements include the comparative information
required by the applicable financial reporting framework and whether such
information is appropriately classified. For this purpose, the auditor shall
evaluate whether:
(a) The comparative information agrees with the amounts and other
disclosures presented in the prior period; and
(b) The accounting policies reflected in the comparative information are
consistent with those applied in the current period or, if there have been
changes in accounting policies, whether those changes have been
properly accounted for and adequately presented and disclosed.
If the auditor becomes aware of a possible material misstatement in the
comparative information while performing the current period audit, the auditor
shall perform such additional audit procedures as are necessary in the
circumstances to obtain sufficient appropriate audit evidence to determine
whether a material misstatement exists. If the auditor had audited the prior
period’s financial statements, the auditor shall also follow the relevant
requirements of SA 560 “Subsequent Events”.
As required by SA 580, “Written Representations”, the auditor shall request
written representations for all periods referred to in the auditor’s opinion. The
auditor shall also obtain a specific written representation regarding any prior
period item that is separately disclosed in the current year’s statement of profit
and loss.
3. The audit report of P Ltd. for the year 2014-15 contained a qualification
regarding non-provision of doubtful debts. As the statutory auditor of the
company for the year 2015-16, how would you report, if:
(i) The company does not make provision for doubtful debts in 2015-
16?
(ii) The company makes adequate provision for doubtful debts in 2015-
16?
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Answer
Auditor’s responsibilities in cases where audit report for an earlier year is
qualified is given in SA 710 “Comparative Information – Corresponding Figures and
Comparative Financial Statements”. As per SA 710, When the auditor’s report on the
prior period, as previously issued, included a qualified opinion, a disclaimer of
opinion, or an adverse opinion and the matter which gave rise to the modified
opinion is resolved and properly accounted for or disclosed in the financial
statements in accordance with the applicable financial reporting framework, the
auditor’s opinion on the current period need not refer to the previous modification.
SA 710 further states that if the auditor’s report on the prior period, as previously
issued, included a qualified opinion and the matter which gave rise to the
modification is unresolved, the auditor shall modify the auditor’s opinion on the
current period’s financial statements. In the Basis for Modification paragraph in the
auditor’s report, the auditor shall either:
(i) Refer to both the current period’s figures and the corresponding figures in the
description of the matter giving rise to the modification when the effects or
possible effects of the matter on the current period’s figures are material; or
(ii) In other cases, explain that the audit opinion has been modified because of the
effects or possible effects of the unresolved matter on the comparability of the
current period’s figures and the corresponding figures.
In the instant Case, if P Ltd. does not make provision for doubtful debts the auditor
will have to modify his report for both current and previous year’s figures as
mentioned above. If however, the provision is made, the auditor need not refer to the
earlier year’s modification.
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SA 720 AUDITOR’S RESPONSIBILITIES IN RELATION TO OTHER
INFORMATION IN A DOCUMENT CONTAINING AUDITED
FINANCIAL STATEMENTS
A) Introduction
1. This Standard on Auditing (SA) deals with the auditor’s responsibility in
relation to other information in documents containing audited financial
statements and the auditor’s report thereon. In the absence of any
separate requirement in the particular circumstances of the engagement,
the auditor’s opinion does not cover other information and the auditor has
no specific responsibility for determining whether or not other information
is properly stated. However, the auditor reads the other information
because the credibility of the audited financial statements may be
undermined by material inconsistencies between the audited financial
statements and other information
2. In this SA “documents containing audited financial statements” refers to
annual reports (or similar documents), that are issued to owners (or
similar stakeholders), containing audited financial statements and the
auditor’s report thereon.
3. For purposes of the SAs, other information does not encompass, for
example:
· A press release or a transmittal memorandum, such as a covering
letter, accompanying the document containing audited financial
statements and the auditor’s report thereon.
· Information contained in analyst briefings.
· Information contained on the entity’s web site
4. Other information may comprise, for example:
· A report by management or those charged with governance on
operations.
· Financial summaries or highlights.
· Planned capital expenditures.
· Financial ratios.
· Selected quarterly data..
B) Effective date
C) Objectives
The objective of the auditor is to respond appropriately when documents
containing audited financial statements and the auditor’s report thereon include
other information that could undermine the credibility of those financial
statements and the auditor’s report
D) Definition
(a) Other information – Financial and non-financial information (other than
the financial statements and the auditor’s report thereon) which is
included, either by law, regulation or custom, in a document containing
audited financial statements and the auditor’s report thereon.
(b) Inconsistency – Other information that contradicts information contained
in the audited financial statements. A material inconsistency may raise
doubt about the audit conclusions drawn from audit evidence previously
obtained and, possibly, about the basis for the auditor’s opinion on the
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(c) Misstatement of fact – Other information that is unrelated to matters
appearing in the audited financial statements that is incorrectly stated or
presented. A material misstatement of fact may undermine the credibility
of the document containing audited financial statements.
E) Requirements
1. The auditor shall read the other information to identify material
inconsistencies, if any, with the audited financial statements.
2. The auditor shall make appropriate arrangements with management or
those charged with governance to obtain the other information prior to the
date of the auditor’s report. If it is not possible to obtain all the other
information prior to the date of the auditor’s report, the auditor shall read
such other information as soon as practicable.
3. If, on reading the other information, the auditor identifies a material
inconsistency, the auditor shall determine whether the audited financial
statements or the other information needs to be revised.
Material Inconsistencies Identified in Other Information Obtained Prior to
the Date of the Auditor’s Report
1. When revision of the audited financial statements is necessary and
management refuses to make the revision, the auditor shall modify the
opinion in accordance with SA 705
2. When revision of the other information is necessary and management
refuses to make the revision, the auditor shall communicate this matter to
those charged with governance; and
Include in the auditor’s report an Other Matter(s) paragraph describing the
material inconsistency in accordance with SA 706.
Material Inconsistencies Identified in Other Information Obtained
Subsequent to the Date of the Auditor’s Report
1. When revision of the audited financial statements is necessary, the
auditor shall follow the relevant requirements in SA 560.
2. When revision of the other information is necessary and management
agrees to make the revision, the auditor shall carry out the procedures
necessary under the circumstances.
3. When revision of the other information is necessary, but management
refuses to make the revision, the auditor shall notify those charged with
governance of the auditor’s concern regarding the other information and
take any further appropriate action.
Material Misstatements of Fact
1. If, on reading the other information for the purpose of identifying material
inconsistencies, the auditor becomes aware of an apparent material
misstatement of fact, the auditor shall discuss the matter with
management
2. When, following such discussions, the auditor still considers that there is
an apparent material misstatement of fact, the auditor shall request
management to consult with a qualified third party, such as the entity’s
legal counsel, and the auditor shall consider the advice received.
3. When the auditor concludes that there is a material misstatement of fact in
the other information which management refuses to correct, the auditor
shall notify those charged with governance of the auditor’s concern
regarding the other information and take any further appropriate action.
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QUESTION BANK FOR PRACTICE:
Q.1.’ ‘After the statutory audit has been completed a fraud has been detected at the
office of the auditee.’ What is your defence as an auditor?
Chapter/Concept reference- 5, SA 240
Detection of Fraud after Completion of Statutory Audit:
As per SA 240, the primary responsibility for the prevention and detection of fraud rests
with both those charged with governance of the entity and management.
An auditor conducting an audit in accordance with SAs is responsible for obtaining
Owing to the inherent limitations of an audit, there is an unavoidable risk that some
material misstatements of the financial statements will not be detected, even though the
audit is properly planned and performed in accordance with the SAs.
The risk of not detecting a material misstatement resulting from fraud is higher than the
risk of not detecting one resulting from error.
The question of whether the auditor has adhered to the basic principles governing an
audit (such as performance of the audit work with requisite skills and competence,
documentation of important matters, details of the audit plan and reliance placed on
internal controls, nature and extent of compliance and substantive tests carried out,
etc.) is determined by the adequacy of the procedures undertaken in the circumstances
and the suitability of the auditor’s report based on the results of these procedures.
The liability of the auditor for failure to detect fraud exists only when such failure is
clearly due to not exercising reasonable care and skill. Thus, in the instant case after
the completion of the statutory audit, if a fraud has been detected, the same by itself
cannot mean that the auditor did not perform his duty properly.
If the auditor can prove with the help of his papers (documentation) that he has followed
adequate procedures necessary for the proper conduct of an audit, he cannot be held
responsible for the same. If however, the same cannot be proved, he would be held
responsible.
Q.2. ‘Doing a statutory audit is full of risk’. Narrate the factors which cause the risk
Chapter reference- Standards, SA 200
Factors Causing Risk Under Statutory Audit:
As Per SA 200 “Overall Objectives of the Independent Auditor and the conduct of an
audit in accordance with standards on auditing”, the purpose of an audit is to enhance
the degree of confidence of intended users in the financial statements. This is achieved
by the expression of an opinion by the auditor on whether the financial statements are
prepared, in all material respects, in accordance with an applicable financial reporting
framework. In the case of most general purpose frameworks, that opinion is on whether
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the financial statements are presented fairly, in all material respects, or give a true and
fair view in accordance with the framework.
Factors which may cause such risk in conducting an audit are discussed below-
(i) Exercising judgement on the part of the auditor: The auditor’s work involves
exercise of judgement, for example, in deciding the extent of audit procedures and
in assessing the reasonableness of the judgements and estimates made by
management in preparing the financial statements.
(ii) Nature of audit evidence: Much of the evidence available to the auditor can
enable him to draw only reasonable conclusions therefrom. The auditor normally
relies upon persuasive evidence rather than conclusive evidence. Even in
circumstances where conclusive evidence is available, the cost of obtaining such
an evidence may far exceed the benefits.
(iii) Inherent limitations of internal control: Internal control can provide only
reasonable, but not absolute, assurance on account of several inherent limitations
such as potential for human error, possibility of circumstances of control through
collusion, etc.
On account of above, it is quite clear that an audit suffers from control risk on
account of inherent limitations of internal control and detection risk on account of
test nature of audit and judgement and estimates involved in formulating
accounting policies.
Q.3. Mention briefly the conditions or events, which increase the risk of fraud or error
leading to material misstatement in Financial Statements.
Chapter Reference- 5, SA 240
Conditions Which Increases the Risk of Fraud or Error: In planning and performing
an examination, the auditor should take into consideration the risk of material
misstatements of the financial information caused by fraud or error. Weaknesses in the
design of the internal control system and non-compliance with identified control
procedures amongst other conditions or events which increase the risk of fraud or error
are-
(i) Weaknesses in the design of internal control system and non-compliance with the
laid down control procedures, e.g., a single person is responsible for the receipt of
all dak and marking it to the relevant sections or two persons are responsible for
receipt of dak but the same is not followed in actual practice, etc.
(ii) Doubts about the integrity or competence of the management, e.g., domination by
one person, high turnover rate of employees, frequent change of legal counsels or
auditors, significant and prolonged understaffing of the accounts department, etc.
(iii) Unusual pressures within the entity, for example, industry is doing well but the
company is not performing accordingly, heavy dependence on a single line of
product, inadequate working capital, entity needs raising share prices to support
the market price in the wake of public offer, etc.
(iv) Unusual transactions such as transactions with related parties, excessive payment
for certain services to lawyers, etc.
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(v) Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate
documentation, significant differences between the figures as per the accounting
records and confirmation received from third parties, etc.
Q.4. “The auditors should consider the effect of subsequent events on the financial
statement and on auditor’s report” according to SA 560 – Comment.
Chapter reference- 3, SA 560.
Effect of Subsequent Events: SA 560 “Subsequent Events”, establishes standards on
the auditor’s responsibility regarding subsequent events.
According to it, ‘subsequent events’ refer to those events which occur between the date
of financial statements and the date of the auditor’s report, and facts that become
known to the auditor after the date of the auditor’s report. It lays down the standard that
the auditor should consider the effect of subsequent events on the financial statements
and on the auditor’s report.
The auditor should obtain sufficient appropriate evidence that all events upto the date of
the auditor’s report requiring adjustment or disclosure have been identified and to
identify such events. The auditor should-
(i) obtain an understanding of any procedures management has established to
ensure that subsequent events are identified.
(ii) inquire of management and, where appropriate, those charged with governance as
to whether any subsequent events have occurred which might affect the financial
statements.
Examples of inquiries of management on specific matters are:
Whether new commitments, borrowings or guarantees have been entered
into.
 Whether sales or acquisitions of assets have occurred or are planned.
 Whether there have been increases in capital or issuance of debt
instruments, such as the issue of new shares or debentures, or an
agreement to merge or liquidate has been made or is planned.
 Whether there have been any developments regarding contingencies.
 Whether there have been any developments regarding risk areas and
contingencies.
 Whether any unusual accounting adjustments have been made or are
contemplated.
 Whether any events have occurred or are likely to occur which will bring into
question the appropriateness of accounting policies used in the financial
statements as would be the case, for example, if such events call into
question the validity of the going concern assumption.
Whether any events have occurred that are relevant to the measurement of
estimates or provisions made in the financial statements.
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Whether any events have occurred that are relevant to the recoverability of
assets.
(iii) Read minutes, if any, of the meetings, of the entity’s owners, management and
those charged with governance, that have been held after the date of the financial
statements and inquiring about matters discussed at any such meetings for which
minutes are not yet available.
(iv) Read the entity’s latest subsequent interim financial statements, if any.
(v) Read the entity’s latest available budgets, cash flow forecasts and other related
management reports for periods after the date of the financial statements.
(vi) Inquire, or extend previous oral or written inquiries, of the entity’s legal counsel
concerning litigation and claims.
(vii) Consider whether written representations covering particular subsequent events
may be necessary to support other audit evidence and thereby obtain sufficient
appropriate audit evidence.
When the auditor identifies events that require adjustment of, or disclosure in, the
financial statements, the auditor shall determine whether each such event is
appropriately reflected in those financial statements. If such events have not been
considered by the management and which in the opinion of the auditor are material, the
auditor shall modify his report accordingly
Q.5. Auditors of M/s Fortune India (P) Ltd. were changed for the accounting year 2015-
16. The closing inventory of the company as on 31.3.2015 amounting to ` 100 lacs
continued as it is and became closing inventory as on 31.3.2016. The auditors of
the company propose to exclude from their audit programme the audit of closing
inventory of ` 100 lacs on the understanding that it pertains to the preceding
year which was audited by another auditor.
Verification of Inventory: As per SA 510 “Initial Audit Engagements – Opening
Balances”, in conducting an initial audit engagement, the objective of the auditor with
respect to opening balances is to obtain sufficient appropriate audit evidence about
whether-
(i) Opening balances contain misstatements that materially affect the current period’s
(ii) Appropriate accounting policies reflected in the opening balances have been
When the financial statements for the preceding period were audited by predecessor
auditor, the current auditor may be able to obtain sufficient appropriate audit evidence
regarding opening balances by perusing the copies of the audited financial statements
including the other relevant documents relating to the prior period financial statements
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such as supporting schedules to the audited financial statements. Ordinarily, the current
auditor can place reliance on the closing balances contained in the financial statements
for the preceding period, except when during the performance of audit procedures for
the current period the possibility of misstatements in opening balances is indicated.
General principles governing verification of assets require that the auditor should
confirm that assets have been correctly valued as on the Balance Sheet date. The
contention of the management that the inventory has not undergone any change cannot
be accepted, it forms part of normal duties of auditor to ensure that the figures on which
he is expressing opinion are correct and properly valued. Moreover, it is also quite likely
that the inventory lying as it is might have deteriorated and the same need to be
examined.
The auditor is advised not to exclude the audit of closing inventory from his audit
programme
Q.6. What are the obvious assertions in the following items appearing in the Financial
Statements?
(i) Statement of Profit and Loss
Travelling Expenditure ` 50,000
(ii) Balance Sheet
Trade receivable ` 2,00,000
Chapter Reference- 3, Assertion Concept
Ans. (i) Travelling Expenditure ` 50,000
Expenditure has been actually incurred for the purpose of travelling.
Travelling has been undertaken during the year under consideration.
Total amount of expenditure incurred is ` 50,000 during the year.
It has been treated as revenue expenditure and charged to Statement of
Profit and Loss.
(ii) Trade receivable ` 2,00,000

 These include all sales transaction occurred during the year.
 These have been recorded properly and occurred during the year.
 These constitute assets of the entity.
 These have been shown at proper value, i.e. after showing the deduction on
account of provision for bad and doubtful debts.
Q.7. General Purpose Financial Statements

Chapter Reference- Accounting Basics
General Purpose Financial Statements: As defined in SA 700 “Forming an Opinion
and Reporting on Financial Statements”, general purpose financial statements are
financial statements prepared in accordance with a general purpose framework.
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A financial reporting framework designed to meet the common financial information
needs of a wide range of users is called General purpose framework.
The term “General Purpose Financial Statements” normally includes a Balance Sheet, a
statement of profit and loss (also known as ‘income statement’), a cash flow statement
and those notes and other statements and explanatory material that are an integral part
of the financial statements. They may also include supplementary schedules and
information based on or derived from, and expected to be read with, such statements.
Many users, however, have to rely on the financial statements as their major source of
financial information and such financial statements should, therefore, be prepared and
presented with their needs in view. Accounting Standards are applicable to all General
Purpose Financial Statements.
Q.8. Going Concern Concept.

AS 1, “Disclosure of Accounting Policies”, lays down that the “Going Concern”, is one of
the fundamental accounting assumption underlying financial statements. This Going
Concern concept envisages that the entity will continue for the foreseeable future.
Accounts are prepared on this concept unless there are indication that going concern
concept is not holding good for a particular entity. On account of this basic concept of
going concern, assets and liabilities are recorded on the basis that the entity will be able
to realise its assets and discharge its liabilities in the normal course of business. If this
assumption is unjustified, the entity may not be able to realise its assets at the recorded
amounts and there may be changes in the amounts and maturity dates of liabilities. AS
1, “Disclosure of Accounting Policies”, also requires that no specific disclosure is
required in case the same has been followed in the preparation of financial statements.
In case this assumption is not followed, the fact should be disclosed.
SA 570 “Going Concern”, establishes standards on the auditor’s responsibilities in the
audit of financial statements regarding the management’s use of the going concern
assumption in the preparation and presentation of the financial statements.
Q.9.State the matters which the statutory Auditor should look into before framing an
opinion on accounts on finalisation of audit of accounts. Discuss overall audit
approach.
Chapter Reference- General Conceptual Question
Answer
Formation of Opinion on Accounts: The principal aspect to be covered in an audit to form
an opinion, an auditor has to look into following matters-
(i) An examination of the system of accounting and internal control to ascertain whether it
is appropriate for the business and helps in properly recording all transactions. This is
followed by such tests and enquiries as are considered necessary to ascertain whether
the system is in actual operation. These steps are necessary to form an opinion as to
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whether reliance can be placed on the records as a basis for the preparation of final
statements of account.
(ii) Reviewing the system and procedures to find out whether they are adequate and
comprehensive and incidentally whether material inadequacies and weaknesses exist to
allow frauds and errors going unnoticed.
(iii) Checking of the arithmetical accuracy of the books of account by the verification of
postings, balances, etc.
(iv) Verification of the authenticity and validity of transaction entered into by making an
examination of the entries in the books of accounts with the relevant supporting
documents.
(v) Ascertaining that a proper distinction has been made between items of capital and of
revenue nature and that the amounts of various items of income and expenditure
adjusted in the accounts corresponding to the accounting period.
(vi) Comparison of the Balance Sheet and profit and loss account or other statements with
the underlying record in order to see that they are in accordance therewith.
(vii) Verification of the title, existence and value of the assets appearing in the Balance
Sheet.
(viii) Verification of the liabilities stated in the Balance Sheet.
(ix) Checking the result shown by the profit and loss and to see whether the results shown
are true and fair.
(x) Where audit is of a corporate body, confirming that the statutory requirements have
been complied with.
(xi) Reporting to the appropriate person/body whether the statements of account examined
do reveal a true and fair view of the state of affairs and of the profit and loss of the
organisation.
It will thus be realised that the duties of auditor are not limited to the verification of the
arithmetical accuracy of the books of account kept by his client; he must also satisfy
himself that entries in the books are true and contain a complete record of all the
transactions of the business and these are recorded in such a manner that their real
nature is revealed.
Q.10. Audit versus Investigation.

Chapter Reference- General Conceptual Question
Ans: Audit is generally objected to find out whether the accounts show true & fair view. It is a
critical examination of books of accounts.
Investigation on the other hand is critical examination of the accounts with a special
purpose. For example if fraud is suspected and an accountant is called upon to check
the accounts to whether fraud really exists and if so, the amount involved, the character
of the enquiry changes into investigation. Investigation may be undertaken in numerous
areas of accounts, e.g., the extent of waste and loss, profitability, cost of production etc.
It extends scope beyond books of accounts.
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For auditing on the other hand, the general objective is to find out whether the accounts
show a true and fair view. The auditor seeks to report what he finds in the normal
course of examination of the accounts adopting generally followed techniques unless
circumstances call for a special probe. Fraud, error, irregularity, whatever comes to the
auditor’s notice in the usual course of checking, are all looked into in depth and
sometimes investigation results from the prima facie findings of the auditor.
Q.11. Discuss with reference to SAs:

(a) The auditor shall communicate all significant findings with those charged
with Governance.
(b) Factors affecting form, contents and extent of audit.
(c) While planning the audit of S Ltd. you want to apply sampling techniques.
What are the risk factors you should keep in mind?
(d) What are the auditor’s responsibilities in respect of corresponding figures?
Chapter Reference- Standards, SA 260,230,530,710
Answer:
(a) Communication of Findings with Those Charged with Governance: As per
SA-260 “Communication with Those Charged with Governance”, the auditor shall
communicate the following significant findings from the audit, with those charged
with governance-
(i) The auditor’s views about significant qualitative aspects of the entity’s
accounting practices, including accounting policies, accounting estimates and
financial statement disclosures. When applicable, the auditor shall explain to
those charged with governance why the auditor considers a significant
accounting practice, that is acceptable under the applicable financial
reporting framework, not to be most appropriate to the particular
circumstances of the entity;
(ii) Significant difficulties, if any, encountered during the audit;
(iii) Unless all of those charged with governance are involved in managing the
entity:
(1) Significant matters, if any, arising from the audit that were discussed, or
subject to correspondence with management; and
(2) Written representations the auditor is requesting; and
(iv) Other matters, if any, arising from the audit that, in the auditor’s professional
judgment, are significant to the oversight of the financial reporting process.
(b) Factors Affecting Form, Contents and Extent of audit documentation: As per
SA-230 on “Audit Documentation”, the form, content and extent of audit
documentation depend on the following factors-
(i) The size and complexity of the entity.
(ii) The nature of the audit procedures to be performed.
(iii) The identified risks of material misstatement.
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(iv) The significance of the audit evidence obtained.
(v) The nature and extent of exceptions identified.
(vi) The need to document a conclusion or the basis for a conclusion not readily
determinable from the documentation of the work performed or audit
evidence obtained.
(vii) The audit methodology and tools used.
(c) Risk Factors while applying Sampling Techniques: As per SA 530 “Audit
Sampling”, sampling risk is the risk that the auditor’s conclusion based on a
sample may be different from the conclusion if the entire population were
subjected to the same audit procedure. Sampling risk can lead to two types of
erroneous conclusions-
(i) In the case of a test of controls, that controls are more effective than they
actually are, or in the case of tests of details, that a material misstatement
does not exists when in fact it does. The auditor is primarily concerned with
this type of erroneous conclusion because it affects audit effectiveness and is
more likely to lead to an inappropriate audit opinion.
(ii) In the case of test of controls, the controls are less effective than they
actually are, or in the case of tests of details, that a material misstatements
exists when in fact it does not. This type of erroneous conclusion affects audit
efficiency as it would usually lead to additional work to establish that initial
conclusions were incorrect.
(d) Auditor’s Responsibilities in Respect of Corresponding Figures: As per SA
710 “Comparative Information—Corresponding Figures and Comparative Financial
Statements”, in respect of corresponding figures, the auditor shall determine
whether the financial statements include the comparative information required by
the applicable financial reporting framework and whether such information is
appropriately classified. For this purpose, the auditor shall evaluate whether-
(i) The comparative information agrees with the amounts and other disclosures
presented in the prior period; and
(ii) The accounting policies reflected in the comparative information are
consistent with those applied in the current period or, if there have been
changes in accounting policies, whether those changes have been properly
accounted for and adequately presented and disclosed.
If the auditor becomes aware of a possible material misstatement in the
comparative information while performing the current period audit, the auditor shall
perform such additional audit procedures as are necessary in the circumstances to
obtain sufficient appropriate audit evidence to determine whether a material
misstatement exists. If the auditor had audited the prior period’s financial
statements, the auditor shall also follow the relevant requirements of SA 560
“Subsequent Events”.
As required by SA 580, “Written Representations”, the auditor shall request written
representations for all periods referred to in the auditor’s opinion. The auditor shall
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also obtain a specific written representation regarding any prior period item that is
separately disclosed in the current year’s Statement of Profit and Loss.
Q.12.Identification of significant related party transaction outside business

Identification of Significant Related Party Transaction Outside Business:
As per SA 550 on “Related Parties”, for identified significant related party transactions
outside the entity’s normal course of business, the auditor shall:
(i) Inspect the underlying contracts or agreements, if any, and evaluate whether:
(1) The business rationale (or lack thereof) of the transactions suggests that they
may have been entered into to engage in fraudulent financial reporting or to
conceal misappropriation of assets;
(2) The terms of the transactions are consistent with management’s
explanations; and
(3) The transactions have been appropriately accounted for and disclosed in
accordance with the applicable financial reporting framework; and
(ii) Obtain audit evidence that the transactions have been appropriately authorized
and approved.
Q.13.Self-revealing errors and four illustrations thereof.
Self-revealing Errors: These are such errors the existence of which becomes apparent
in the process of compilation of accounts
Examples:
- Omission to post a part of a journal entry to the ledger.
- Wrong totaling of the Purchase Register.
- A failure to record in the cash book amounts paid into or withdrawn from the bank.
- A mistake in recording amount received from X in the account of Y.
Q.14.With reference of SA 250, give some examples or matters indicating to the

auditor about non compliance of laws & regulations by management
Chapter Reference- SA 250
Answer
Non-compliance of Laws and Regulations by Management: As per SA 250 on
“Consideration of Laws and Regulation in an Audit of Financial Statements”, the
following are examples or matters indicating to the auditor about non-compliance with
laws and regulations by management-
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(i) Investigations by regulatory organisations and government departments or
payment of fines or penalties.
(ii) Payments for unspecified services or loans to consultants, related parties,
employees or government employees.
(iii) 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.
(iv) Purchasing at prices significantly above or below market price.
(v) Unusual payments in cash, purchases in the form of cashiers’ cheques payable to
bearer or transfers to numbered bank accounts.
(vi) Unusual payments towards legal and retainership fees.
(vii) Unusual transactions with companies registered in tax havens.
(viii) Payments for goods or services made other than to the country from which the
goods or services originated.
(ix) Payments without proper exchange control documentation.
(x) Existence of an information system which fails, whether by design or by accident,
to provide an adequate audit trail or sufficient evidence.
(xi) Unauthorised transactions or improperly recorded transactions.
Q.15. Inquiry from Management is helpful for Auditor to evaluate subsequent events.
Discuss specific enquiries in reference of SA 560, which might have effect on the
Chapter Reference-3, SA 560
Inquiring from Management to Evaluate Subsequent Event: As per SA 560
“Subsequent Events”, in inquiring of management and, where appropriate, those
charged with governance, as to whether any subsequent events have occurred that
might affect the financial statements, the auditor may inquire as to the current status of
items that were accounted for on the basis of preliminary or inconclusive data and may
make specific inquiries about the following matters-
(i) Whether new commitments, borrowings or guarantees have been entered into.
(ii) Whether sales or acquisitions of assets have occurred or are planned.
(iii) Whether there have been increases in capital or issuance of debt instruments,
such as the issue of new shares or debentures, or an agreement to merge or
liquidate has been made or is planned.
(iv) Whether any assets have been appropriated by government or destroyed, for
example, by fire or flood.
(v) Whether there have been any developments regarding contingencies.
(vi) Whether any unusual accounting adjustments have been made or are
contemplated.
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Q.16.What do you mean by "Written Representations"? As an auditor, how you will
deal if management does not provide requested written representations?
Written Representations: As per SA 580, “Written Representation” is a written
statement by management provided to the auditor to confirm certain matters or to
support other audit evidence. These representations are an important source of audit
evidence. If management modifies or does not provide the requested written
representations, it may alert the auditor to the possibility that one or more significant
issues may exist. Further, a request for written, rather than oral, representations in
many cases may prompt management to consider such matters more rigorously,
thereby enhancing the quality of the representations.
Requested Written Representations not provided by Management: If management does
not provide one or more of the requested written representations, the auditor shall-
(i) discuss the matter with management;
(ii) re-evaluate the integrity of management and evaluate the effect that this may have
on the reliability of representations (oral or written) and audit evidence in general;
and
(iii) take appropriate actions, including determining the possible effect on the opinion
in the auditor’s report.
The auditor shall disclaim an opinion on the financial statements if management does
not provide the written representations.
Q.17. The auditor is responsible for maintaining an attitude of professional skepticism

throughout the audit. Do you agree with the statement?
Professional Skepticism:
As per SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an
Audit in Accordance with Standards on Auditing”, professional skepticism is an attitude
that includes a questioning mind, being alert to conditions which may indicate possible
misstatement due to error or fraud, and a critical assessment of audit evidence.
Therefore, professional skepticism is necessary to the critical assessment of audit
evidence. This includes questioning contradictory audit evidence and the reliability of
documents and responses to inquiries and other information obtained from
management and those charged with governance. It also includes consideration of the
sufficiency and appropriateness of audit evidence obtained in the light of the
circumstances, for example in the case where fraud risk factors exist and a single
document, of a nature that is susceptible to fraud, is the sole supporting evidence for a
material financial statement amount.
Maintaining professional skepticism throughout the audit is necessary if the auditor is,
for example, to reduce the risks of overlooking unusual circumstances, over
generalising when drawing conclusions from audit observations or using inappropriate
assumptions in determining the nature, timing, and extent of the audit procedures and
evaluating the results thereof.
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Further, while obtaining reasonable assurance, the auditor is responsible for
maintaining professional skepticism throughout the audit, considering the potential for
management override of controls and recognizing the fact that audit procedures that are
effective for detecting error may not be effective in detecting fraud. This requirement is
also designed to assist the auditor in identifying and assessing the risks of material
misstatement due to fraud and in designing procedures to detect such misstatement
Therefore, we do agree with the statement.
Q.18.Mention any four information which assists the auditor in accepting and
continuing of relationship with the client as per SA 220.
Information which assist the Auditor in accepting and continuing of relationship with
Client: As per SA 220, “Quality Control for an Audit of Financial Statements” the auditor
should obtain information considered necessary in the circumstances before accepting
an engagement with a new client, when deciding whether to continue an existing
engagement and when considering acceptance of a new engagement with an existing
client. The following information would assist the auditor in accepting and
continuing of relationship with the client:
(i) The integrity of the principal owners, key management and those charged with
governance of the entity;
(ii) Whether the engagement team is competent to perform the audit engagement
and has the necessary capabilities, including time and resources;
(iii) Whether the firm and the engagement team can comply with relevant ethical
requirements; and
(iv) Significant matters that have arisen during the current or previous audit
engagement, and their implications for continuing the relationship.
Q.19.State the significant difficulties encountered during audit with reference to SA-
260 (communication with those charged with governance).
Significant Difficulties Encountered During the Audit: As per SA 260 “Communication
with Those Charged with Governance”, significant difficulties encountered during the
audit may include such matters as:
♦ Significant delays in management providing required information.
♦ An unnecessarily brief time within which to complete the audit.
♦ The unavailability of expected information. Extensive unexpected effort required to
obtain sufficient appropriate audit evidence.
♦ Restrictions imposed on the auditor by management.
♦ Management’s unwillingness to make or extend its assessment of the entity’s
ability to continue as a going concern when requested.
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Q.20.Write a short note on Fundamental Accounting Assumptions.
Chapter reference- Accounting Basics
In this context, AS 1 states that certain fundamental accounting assumptions underlie
the preparation and presentation of financial statements. They are usually not
specifically stated because their acceptance and use are assumed. Disclosure is
necessary if they are not followed. The following have been generally accepted as
fundamental accounting assumptions-
(i) Going Concern: The enterprise is normally viewed as a going concern, that is, as
continuing in operation for the foreseeable future. It is assumed that the enterprise
has neither the intention nor the necessity of liquidation or of curtailing materially
the scale of the operations.
(ii) Consistency:It is assumed that accounting policies are consistent from one
period to another.
(iii) Accrual: Revenues and costs are accrued, that is, recognised as they are earned
or incurred (and not as money is received or paid) and recorded in the financial
statements of the periods to which they relate.
Thus, if the fundamental accounting assumptions, viz., Going Concern,
Consistency and Accrual are followed in financial statements, specific disclosure is
not required. However, if a fundamental accounting assumption is not followed, the
fact should be disclosed.
Q.21. Explain the test of controls and substantive procedures as audit procedure of
obtaining sufficient appropriate audit evidence for forming an audit opinion.
Chapter Reference- 3, Audit procedures
Answer
Collection of Evidences to Form Audit Opinion: Auditor should obtain sufficient and
appropriate audit evidences and test them before framing an opinion about the assertions the
financial statements reveal. For this, the auditor checks evidences through (a) Test of
Controls and (b) SubstantiveProcedure.
According to SA 330 “The Auditor’s Responses to Assessed Risks”, ‘test of controls’means
an audit procedure designed to evaluate the operating effectiveness of controls in preventing,
or detecting and correcting, material misstatements at the assertion level.
The auditor shall design and perform tests of controls to obtain sufficient appropriate audit
evidence as to the operating effectiveness of relevant controls when:
(a) The auditor’s assessment of risks of material misstatement at the assertion level
includes an expectation that the controls are operating effectively (i.e., the auditor
intends to rely on the operating effectiveness of controls in determining the nature,
timing and extent of substantive procedures); or
(b) Substantive procedures alone cannot provide sufficient appropriate audit evidence at
the assertion level.
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SA 330 further explains the ‘substantive procedure’ as an audit procedure designed to
detect material misstatements at the assertion level. Substantive procedures comprise:
(i) Tests of details (of classes of transactions, account balances, and disclosures),
and
(ii) Substantive analytical procedures.
Irrespective of the assessed risks of material misstatement, the auditor shall design and
perform substantive procedures for each material class of transactions, account
balance, and disclosure.
The auditor shall consider whether external confirmation procedures are to be
performed as substantive audit procedures.
Q22. The auditor of a limited company has given a clean report on the financial
statement on the basis of xerox copies of the books of accounts, vouchers and
other records which were taken away by the Income Tax Department in search
under section 132 of the I.T. Act, 1961. Comment.
Chapter Reference- 3, SA 500 Audit Evidence
Answer
Reliability of Audit Evidence: As per SA 500 on “Audit Evidence”, the reliability of
information to be used as audit evidence, and therefore of the audit evidence itself, is
influenced by its source and its nature, and the circumstances under which it is
obtained, including the controls over its preparation and maintenance where
relevant.While recognising that exceptions may exist, the following generalisations
about the reliability of audit evidence may be useful:
(i) The reliability of audit evidence is increased when it is obtained from independent
sources outside the entity.
(ii) The reliability of audit evidence that is generated internally is increased when the
related controls, including those over its preparation and maintenance, imposed by
the entity are effective.
(iii) Audit evidence obtained directly by the auditor (for example, observation of the
application of a control) is more reliable than audit evidence obtained indirectly or
by inference (for example, inquiry about the application of a control).
Applying the above, the degree of reliance which can be placed by the auditor on the
documentary audit evidence available in the present case will be considerably
increased if the xerox copies of account books and vouchers are certified to be true
copies by the Income Tax Department. If the tax authorities refuse to certify the same,
the auditor should get the certificate to this effect from the management of the company.
The auditor should use procedure like confirmation of balances from third parties,
inspection of tangible assets, etc. and obtain evidence which corroborates the
documentary evidence available. In any case, the auditor has to satisfy himself that he
has obtained sufficient and appropriate audit evidence to support the figures contained
in the financial statements and formulate his opinion accordingly. Under such
circumstances, the auditor should have appropriately modified his report and bring this
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fact to the attention of shareholders. In case he was satisfied, a simple paragraph of
information was enough but in case the auditor failed to establish the reliability of
evidence available, he would be required to a disclaimer of opinion.
Q.23. “In cases where audit sample selection has been done on a random basis, no
statistical process for selection of samples needs to be followed”. Comment.
Selection of Audit Sample: 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 characteristics of
the items selected in order to form or assist in forming a conclusion concerning the
population.
The audit sample collection on a random basis ensures that all items in the population
have an equal chance of selection, for example, by use of random number tables. This
method is considered appropriate, provided the population to be sampled consists of
reasonably similar units and fall within a reasonable range.
Thus, strictly speaking, in case of selection of an audit sample on the basis of random
tables there is no need to follow any other statistical process for selection of sample.
In fact, selection of an audit sample on random basis is the pre-requisite for application
of statistical techniques. However, certain methods such as Haphazard Sampling and
Block Sampling may result in selection of a sample which is not free from bias.
Therefore, whenever audit sample selection has been done on a random basis i.e.
selection of a representative sample, no statistical process for selection of sample
needs to be followed.
Q.24. Medical Council of India organised a three-day International Conference of

Doctors in Delhi. You are asked to audit the accounts of the conference. Draft the
audit programme for audit of receipt of participation fees from delegates to the
conference. Mention any six points, peculiar to the situation, which you will like
to include in your audit programme.
Chapter Reference- No Specific Chapter, General Conceptual Test
Audit of Receipts of Participation Fees: The organization of three-day International
Conference of Doctors in Delhi by Medical Council of India is a one-time event.
Normally, in view of mega-size of the event, a special cell is made in the organization to
handle the entire event. Since few people would be handling the event, the internal
controls may not be that strong and, thus, more emphasis is required to be given on
substantive procedure. Audit of receipt of participation fees should be under the
following areas-
(I) Internal Control System
(i) Examine the organization structure of special cell created for the International
Conference, if any, and division of responsibilities amongst persons and
control/custody over receipt books.
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(ii) Verify the internal control system for restricting the participation of
unregistered delegates.
(II) Rate of Participation Fees
(i) Verify with reference to resolution passed by the Organizing
Committee/Medical Council of India.
(ii) Also verify the rate from the literature/registration form circulated for
promotion of conference.
(III) Receipts of Participation Fees
(i) Verify counter foil of the receipts issued for individual registration.
(ii) Ensure that receipts are issued for all the registration received in cash.
(iii) Trace the receipts in Bank Statement or Cash Book – as the case may be.
(iv) Verify Bank Reconciliation Statement and list out dishonoured cheques.
(v) Verify subsequent recovery in respect of dishonoured cheques.
(IV) Overall Checking
(i) Verify the total receipts of participation fees shown in the financial statements with
reference to total number of receipts issued to participants.
(ii) Cross check the total number of delegates with reference to the following:
(a) Kits distributed to participants.
(b) Bill of caterer for providing meals during conference.
(c) Capacity of the Hall.
(d) Participation Certificate if any issued.
(V) Foreign Delegates: In case of foreign delegates – if registration fees are higher –
ensure that they are registered at higher fees.
(VI) Special Issues
(i) Take out list of absentees and in case of nil absentees, probe the issue
further.
(ii) If certain participants are exempted from payment of fees – obtain the list
along with proper authorization in this regard.
Q.25.What precautions should be taken by an auditor while applying test check

techniques?
Precautions While Applying Test Check Techniques: While adopting test check
technique, an auditor should take following precautions-
(i) The transactions of the concern should be classified under appropriate heads and
may be stratified in case of wide variations between the transactions of the same
kind.
(ii) Authorisations, documentations, recording of the transactions should be studied
right from the beginning to end.
(iii) Evaluating the system of internal control for its efficiency, soundness and
capability to produce reliable accounting and financial data.
(iv) Preparation of test check plan with clear audit objective understood by the audit
staff.
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(v) Un-biased selection of the transactions with reference to the random number
tables or other statistical methods.
(vi) Identification of the areas where test check may not be done.
(vii) Based on degree of reliance and the confidence level required in the audit, the
number of transactions to be selected for each test plan should be pre-determined.
(viii) Setting up criteria to judge what constitute material or immaterial errors. Further
investigation of only material errors be carried out and all immaterial errors may be
avoided.
Q.26. Explain the Relationship between materiality and audit risk.

Chapter Reference- Standards, SA 200 and SA 320
Relationship between Materiality and Audit Risk: SA 320 on ‘Materiality in Planning
and Performing an Audit’ requires that the auditor should consider materiality and its
relationship with audit risk when conducting an audit. Materiality depends on the size
and the nature of the items judged in the particular circumstances of its misstatement.
The audit should be planned so that audit risk is kept at an acceptably low level. There
is an inverse relationship between Materiality and the degree of audit risk. Higher the
materiality level the lower the audit risk and vice-versa. After the auditor has assessed
the inherent and control risks, he should consider the level of detection risk that he is
prepared to accept and, based upon his judgment, select appropriate substantive audit
procedures. If the auditor does not perform any substantive procedures, detection risk,
that is, the risk that the auditor will fail to detect a misstatement, will be high.
The auditor’s assessment of audit risk may change during the course of an audit
according to the need and development of the circumstances.
Q.27.Describe set of instructions which an auditor has to give to his client before the
start of actual audit
Following Instructions are given by the Auditor to the Client Before the Start of
Audit:
(i) It is the responsibility of the management to prepare the financial statements, to
select and consistently apply the appropriate accounting policies.
(ii) Management is responsible for the maintenance of adequate accounting records
and internal controls for safeguarding assets of the company.
(iii) Unrestricted access to whatever records, documentation and other information
required in connection with the audit.
(iv) Management’s responsibility for making judgements of estimates that are
reasonable and prudent so as to give a true and fair view of the state of affairs of
the entity.
(v) Management’s responsibility for preparation of the financial statements as a going
concern.
: 320 :
Q.28.Are surprised checks desirable in audit, if so, give important recommendations.
Answer
Need of Surprise Checks: 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.
The following are the important recommendations-
(i) Surprise checks should be considered as a desirable part of each audit.
(ii) The areas over which surprise checks should be employed would depend upon the
circumstances of each audit but should normally include:
(1) Verification of cash and investments.
(2) Test-verification of stores and inventories and the records relating thereto.
(3) Verification of books of prime entry and statutory registers normally required to be
examined for the purposes of audit.
(iii) The frequency of surprise checks may be determined by the auditor in the
circumstances of each audit but should normally be at least once in the course of an
audit.
(iv) The results of the surprise checks should be communicated to the management if they
reveal any weakness in the system of internal control or any fraud or error or deficiency
in the maintenance of records.
(v) The auditor should satisfy himself that adequate action is taken by the management on
the matters communicated by him.
(vi) It is not necessary in all cases for the results of the surprise checks to be included in the
auditors’ report on the accounts. They should, however, be included if in the opinion of
the auditor they are material and affect a true and fair view of the accounts on which he
is reporting.
Q.29.With reference to Standard on Auditing 530, state the requirements relating to

audit sampling, sample design, sample size and selection of items for testing.
Answer
Audit Sampling: As per SA 530 on “Audit Sampling”, the meaning of the term Audit
Sampling is – 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.
The requirements relating to sample design, sample size and selection of items for testing
are explained below-
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Sample design - When designing an audit sample, the auditor shall consider the purpose of
the audit procedure and the characteristics of the population from which the sample will be
drawn.
Sample Size- The auditor shall determine a sample size sufficient to reduce sampling risk to
an acceptably low level.
Selection of Items for Testing- The auditor shall select items for the sample in such a way
that each sampling unit in the population has a chance of selection.
Q.30.Explain the important requirements which should be kept in mind to establish or

evaluate a system of internal control for application process at Service Bureau.
Chapter Reference- 4, Internal Control
Requirements of Internal Control System at a Service Bureau: Various
requirements to establish or evaluate a system of internal control for applications
processed at a service bureau are stated below-
(i) Liaison between bureau and user should be clearly defined. Senior member of the
user’s staff is appointed as liaison officer.
(ii) Need for a system testing including all clerical procedures at the user company.
(iii) Control over physical movement of data and in this respect whether a copy or
microfilm of documents sent to the service bureau is kept.
(iv) Planning procedure so that error is identified by documents provided by the
bureau. The user must ensure that prompt correction and resubmission of
rejection to meet the bureau processing schedule.
(v) Establishing a system in the user company to ensure that all exceptional reports
are received from bureau.
(vi) Establish clerical control to verify the accuracy of computer processing.
(vii) Normally, user has no physical control over the files; therefore, high control over
the maintenance of data on master files should be established.
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Q.31. Statutory Auditor versus Internal Auditor.
Chapter Reference- 4,Internal Audit
Q.32. Write a short note on Letter of Weakness.

Chapter Reference- 4, Internal Control
Letter of Weakness:
(i) The auditor does compliance procedure to ascertain that the internal control
system exist in the entity; it works effectively; it work continuously in the entity
during review period.
(ii) When he comes across any weakness in the control points, he issues letter of
weakness.
(iii) Letter of weakness is a report issued by auditor stating the weakness in internal
control mechanism. It also suggests measures by which the weakness in the
system be corrected and the control system be made better protected.
(iv) Lapses in operation of internal control too are reported in the communication of
weakness.
(v) The communication of weakness is reporting to management of such weakness in
design and operation of internal control as have come to notice of auditor during
his auditing and it should not be taken to be a review and comment on adequacy
of the control mechanism for management purpose.
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THEORETICAL QUESTIONS from INTER CA AUDIT MODULE
Chapter 1- Nature Objective and Scope of Audit
Q1. Explain Clearly Meaning of Auditing. How would you as an auditor perform the
audit
“An audit is independent examination of fi nancial information of any entity, whether
profit oriented or not, and irrespective of its size or legal form, when such an
examination is conducted with a view to expressing an opinion thereon.”
The person conducting this task should take care to ensure that financial
statements would not mislead anybody.
This he can do honestly by satisfying himself that:
(i) the accounts have been drawn up with reference to entries in the books of
account;
(ii) the entries in the books of account are adequately supported by sufficient and
appropriate evidence;
(iii) none of the entries in the books of account has been omitted in the process of
compilation and nothing which is not in the books of account has found place in
the statements;
(iv) the information conveyed by the statements is clear and unambiguous;
(v) the financial statement amounts are properly classified, described and disclosed in
conformity with accounting standards; and
(vi) the statement of accounts present a true and fair picture of the operational results
and of the assets and liabilities.
Q.2. The independent Audit of an entity’s financial statements is a vital service to

investors, trade payables and other participants in economic exchange. Explain
Advantages of Audit
The chief utility of audit lies in reliable financial statements on the basis of which the
state of affairs may be easy to understand. Apart from this obvious utility, there are
other advantages of audit. Some or all of these are of considerable value even to those
enterprises and organisations where audit is not compulsory, these advantages are
given below:
(a) It safeguards the financial interest of persons who are not associated with
the management of the entity, whether they are partners or shareholders, bankers,
FI’s, public at large etc.
(b) It acts as a moral check on the employees from committing defalcations or
embezzlement.
(c) Audited statements of account are helpful in settling liability for taxes,
negotiating loans and for determining the purchase consideration for a business.
(d) These are also useful for settling trade disputes for higher wages or bonus as
well as claims in respect of damage suffered by property, by fire or some other
calamity.
(e) An audit can also help in the detection of wastages and losses to show the
different ways by which these might be checked, especially those that occur due to
the absence or inadequacy of internal checks or internal control measures.
(f) Audit ascertains whether the necessary books of account and allied records
have been properly kept and helps the client in making good deficiencies or
inadequacies in this respect.
(g) As an appraisal function, audit reviews the existence and operations of
various controls in the organisations and reports weaknesses, inadequacies,
etc., in them.
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(h) Audited accounts are of great help in the settlement of accounts at the time of
admission or death of partner.
(i) Government may require audited and certifi ed statement before it gives
assistance or issues a license for a particular trade.
Q3. State the objectives of audit according to SA 200.

As per SA-200 “Overall Objectives of the Independent Auditor”, in conducting an audit
of financial statements, the overall objectives of the auditor are:
(a) To obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement; and
(b) To report on the financial statements, and communicate as required by the SAs, in
accordance with the auditor’s findings.
Q4. The code of ethics for professional accountants, prepared by the International
Federation of Accountants (IFAC) identifies five types of threats.
The Code of Ethics for Professional Accountants, prepared by the International
Federation of Accountants (IFAC) identifies five types of threats. These are:
1. Self-interest threats, which occur when an auditing firm, its partner or associate
could benefit from a financial interest in an audit client. Examples include (i) direct
financial interest or materially significant indirect financial interest in a client, (ii)
loan or guarantee to or from the concerned client, (iii) undue dependence on a
client’s fees and, hence, concerns about losing the engagement, (iv) close
business relationship with an audit client, (v) potential employment with the client,
and (vi) contingent fees for the audit engagement.
2. Self-review threats, which occur when during a review of any judgement or
conclusion reached in a previous audit or non-audit engagement (Non audit
services include any professional services provided to an entity by an auditor,
other than audit or review of the financial statements. These include management
services, internal audit, investment advisory service, design and implementation of
information technology systems etc.), or when a member of the audit team was
previously a director or senior employee of the client. Instances where such
threats come into play are (i) when an auditor having recently been a director or
senior officer of the company, and (ii) when auditors perform services that are
themselves subject matters of audit.
3. Advocacy threats, which occur when the auditor promotes, or is perceived to
promote, a client’s opinion to a point where people may believe that objectivity is
getting compromised, e.g. when an auditor deals with shares or securities of the
audited company, or becomes the client’s advocate in litigation and third party
disputes.
4. Familiarity threats are self-evident, and occur when auditors form relationships
with the client where they end up being too sympathetic to the client’s interests.
This can occur in many ways: (i) close relative of the audit team working in a
senior position in the client company, (ii) former partner of the audit firm being a
director or senior employee of the client, (iii) long association between specific
auditors and their specific client counterparts, and (iv) acceptance of significant
gifts or hospitality from the client company, its directors or employees.
5. Intimidation threats, which occur when auditors are deterred from acting
objectively with an adequate degree of professional skepticism. Basically, these
could happen because of threat of replacement over disagreements with the
application of accounting principles, or pressure to disproportionately reduce work
in response to reduced audit fees.
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Chapter 2- Audit Strategy, Planning and Programming
1. “Once the overall audit strategy has been established, an audit plan can be
developed to address the various matters identified in the overall audit strategy”
Explain.
Once the overall audit strategy has been established, an audit plan can be developed to
address the various matters identified in the overall audit strategy, taking into account
the need to achieve the audit objectives through the efficient use of the auditor’s
resources. The establishment of the overall audit strategy and the detailed audit plan
are not necessarily discrete or sequential processes, but are closely inter-related since
changes in one may result in consequential changes to the other.
The auditor shall establish an overall audit strategy that sets the scope, timing
and direction of the audit, and that guides the development of the audit plan.
The process of establishing the overall audit strategy assists the auditor to determine,
subject to the completion of the auditor’s risk assessment procedures, such matters
as:
1. The resources to deploy for specific audit areas, such as the use of appropriately
experienced team members for high risk areas or the involvement of experts on
complex matters;
2. The amount of resources to allocate to specific audit areas, such as the number of
team members assigned to observe the inventory count at material locations, the
extent of review of other auditors’ work in the case of group audits, or the audit
budget in hours to allocate to high risk areas;
3. When these resources are to be deployed, such as whether at an interim audit
stage or at key cut-off dates; and
4. How such resources are managed, directed and supervised, such as when team
briefing and debriefing meetings are expected to be held, how engagement
partner and manager reviews are expected to take place.
2. “Planning is not a discrete phase of an audit, but rather a continual and iterative
process”. Discuss.
Planning is not a discrete phase of an audit, but rather a continual and iterative process
that often begins shortly after (or in connection with) the completion of the previous
audit and continues until the completion of the current audit engagement. Planning,
however, includes consideration of the timing of certain activities and audit procedures
that need to be completed prior to the performance of further audit procedures. For
example, planning includes the need to consider, prior to the auditor’s identification and
assessment of the risks of material misstatement, such matters as:
1. The analytical procedures to be applied as risk assessment procedures.
2. Obtaining a general understanding of the legal and regulatory framework
applicable to the entity and how the entity is complying with that framework.
3. The determination of materiality.
4. The involvement of experts.
5. The performance of other risk assessment procedures.
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3. “The nature, timing and extent of the direction and supervision of engagement
team members and review of their work vary depending on many factors.”
Explain.
The auditor shall plan the nature, timing and extent of direction and supervision of
engagement team members and the review of their work.
The nature, timing and extent of the direction and supervision of engagement team
members and review of their work vary depending on many factors, including:
2. The area of the audit i.e. the materiality of the information being audited by team
members
3. The assessed risks of material misstatement. Example: An increase in the
assessed risk of material misstatement for a given area of the audit ordinarily
requires a corresponding increase in the extent and timeliness of direction and
supervision of engagement team members, and a more detailed review of their
work.
4. The capabilities and competence of the individual team members performing the
audit work.
4. “The utility of the audit programme can be retained and enhanced only by keeping
the programme and also the client’s operations and internal control under
periodic review so that inadequacies or redundancies of the programme may be
removed” Discuss stating clearly the advantages of an audit programme.
The advantages of an audit programme are:
(a) It provides the assistant carrying out the audit with total and clear set of
instructions of the work generally to be done.
(b) It is essential, particularly for major audits, to provide a total perspective of the
work to be performed.
(c) Selection of assistants for the jobs on the basis of capability becomes easier when
the work is rationally planned, defined and segregated.
(d) Without a written and pre-determined programme, work is necessarily to be
carried out on the basis of some ‘mental’ plan. In such a situation there is always a
danger of ignoring or overlooking certain books and records. Under a properly
framed programme, the danger is significantly less and the audit can proceed
systematically.
(e) The assistants, by putting their signature on programme, accept the responsibility
for the work carried out by them individually and, if necessary, the work done may
be traced back to the assistant.
(f) The principal can control the progress of the various audits in hand by examination
of audit programmes initiated by the assistants deputed to the jobs for completed
work.
(g) It serves as a guide for audits to be carried out in the succeeding year.
(h) A properly drawn up audit programme serves as evidence in the event of any
charge of negligence being brought against the auditor. It may be of considerable
value in establishing that he exercised reasonable skill and care that was expected
of professional auditor.
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The disadvantages are:
(a) The work may become mechanical and particular parts of the programme may be
carried out without any understanding of the object of such parts in the whole audit
scheme.
(b) The programme often tends to become rigid and inflexible following set grooves;
the business may change in its operation of conduct, but the old programme may
still be carried on. Changes in staff or internal control may render precaution
necessary at points different from those originally decided upon.
(c) Inefficient assistants may take shelter behind the programme i.e. defend
deficiencies in their work on the ground that no instruction in the matter is
contained therein.
(d) A hard and fast audit programme may kill the initiative of efficient and enterprising
assistants.
5. “Determining materiality involves the exercise of professional judgment”. Discuss

stating the factors that may affect the identification of an appropriate benchmark.
Also give examples.
Determining materiality involves the exercise of professional judgment. A percentage
is often applied to a chosen benchmark as a starting point in determining materiality
for the financial statements as a whole. Factors that may affect the identification of an
appropriate benchmark include the following:
- The elements of the financial statements e.g. Assets, liabilities, equity, revenue,
expenses;
- Whether there are items on which the attention of the users of the particular
entity’s financial statements tends to be focused e.g. For the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets.
- The nature of the entity, where the entity is at in its life cycle, and the industry and
economic environment in which the entity operates; The entity’s ownership
structure and the way it is financed e.g. If an entity is financed solely by debt rather
than equity, users may put more emphasis on assets, and claims on them, than on
the entity’s earnings);
- The relative volatility of the benchmark.
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Chapter 3 Audit Documentation and Audit Evidence
1 Define audit documentation. Also give some examples.

SA 230 on “Audit Documentation”, audit documentation refers to the record of audit
procedures performed, relevant audit evidence obtained, and conclusions the auditor
reached. (terms such as “working papers” or “work papers” are also sometimes used.)
Audit Documentation include:
Audit programmes.
Analyses.
Issues memoranda.
Summaries of signifi cant matters.
Letters of confi rmation and representation.
Checklists.
Correspondence (including e-mail) concerning signifi cant matters.
The auditor may include copies of the entity’s records (for example, signifi cant and
specific contracts and agreements) as part of audit documentation. Audit documentation
is not a substitute for the entity’s accounting records.
2 “Audit documentation summary may facilitate effective and efficient reviews and
inspections of the audit documentation, particularly for large and complex
audits”. Explain.
The auditor may consider it helpful to prepare and retain as part of the audit
documentation a summary (sometimes known as a completion memorandum) that
describes-
the significant matters identified during the audit and
how they were addressed.
Such a summary may facilitate effective and efficient review and inspection of the audit
documentation, particularly for large and complex audits. Further, the preparation of
such a summary may assist auditor’s consideration of the significant matters. It may
also help the auditor to consider whether there is any individual relevant SA objective
that the auditor cannot achieve that would prevent the auditor from achieving the
overall objectives of the auditor.
3 “Although written representations provide necessary audit evidence yet they do

not provide sufficient appropriate audit evidence on their own about any of the
matters with which they deal”. Discuss.
Audit evidence is all the information used by the auditor in arriving at the conclusions on
which the audit opinion is based. Written representations are necessary information that
the auditor requires in connection with the audit of the entity’s financial statements.
Accordingly, similar to responses to inquiries, written representations are audit
evidence.
Written representations are requested from those responsible for the preparation and
presentation of the financial statements.
Although written representations provide necessary audit evidence, they do not provide
sufficient appropriate audit evidence on their own about any of the matters with which
they deal. Furthermore, the fact that management has provided reliable written
representations does not affect the nature or extent of other audit evidence that the
auditor obtains about the fulfillment of management’s responsibilities, or about specific
assertions.
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4. Discuss the objective of Auditor with respect to Opening balances – in
conducting an initial audit engagement.
In conducting an initial audit engagement, the objective of the auditor with respect
to opening balances is to obtain sufficient appropriate audit evidence about whether:
(a) Opening balances contain misstatements that materially affect the current period’s
(b) Appropriate accounting policies reflected in the opening balances have been
5. Define Risk of material misstatement. Explain its components also.
Risk of material misstatement: may be defined as the risk that the financial
statements are materially misstated prior to audit. This consists of two components
described as follows
(a) Inherent risk—The susceptibility of an assertion to a misstatement that could be
material before consideration of any related controls.
(b) Control risk—The risk that a misstatement that could occur in an assertion that
could be material will not be prevented or detected and corrected on a timely basis
by the entity’s internal control. Less evidence would be required in case assertions
that have a lower risk of material misstatement. But on the other hand if assertions
have a higher risk of material misstatement, more evidence would be required.
6 “When deviations from controls upon which the auditor intends to rely are
detected, the auditor shall make specific inquiries to understand these matters
and their potential consequences” Explain.
When deviations from controls upon which the auditor intends to rely are detected, the
auditor shall make specific inquiries to understand these matters and their potential
consequences, and shall determine whether:
(a) The test of controls that have been performed provide an appropriate basis for
reliance on the controls;
(b) Additional test of controls are necessary; or
(c) The potential risks of misstatement need to be addressed using substantive
procedures.
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Chapter 4- Risk Assessment and Internal Control
1. “The auditor shall obtain an understanding of the major activities that the entity
uses to monitor internal control over financial reporting” Explain
The auditor shall obtain an understanding of the major activities that the entity uses to
monitor internal control over financial reporting.
(i) Monitoring of controls Defined: Monitoring of controls is a process to assess the
effectiveness of internal control performance over time.
(ii) Helps in assessing the effectiveness of controls on a timely basis: It involves
assessing the effectiveness of controls on a timely basis and taking necessary
remedial actions.
(iii) Management accomplishes through ongoing activities, separate evaluations
etc.: Management accomplishes monitoring of controls through ongoing activities,
separate evaluations, or a combination of the two. Ongoing monitoring activities
are often built into the normal recurring activities of an entity and include regular
management and supervisory activities.
(iv) Management’s monitoring activities include: Management’s monitoring
activities may include using information from communications from external parties
such as customer complaints and regulator comments that may indicate problems
or highlight areas in need of improvement.
(v) In case of Small Entities: Management’s monitoring of control is often
accomplished by management’s or the owner-manager’s close involvement in
operations. This involvement often will identify significant variances from
expectations and inaccuracies in financial data leading to remedial action to the
control.
2. “Risk of material misstatement consists of two components” Explain clearly

defining risk of material misstatement. Same as Chapter 3 Q5.
3. “The SAs do not ordinarily refer to inherent risk and control risk separately, but
rather to a combined assessment of the “risks of material misstatement”” Explain
Same as above
4. “The auditor shall obtain an understanding of the control environment” Explain

stating what is included in control environment.
The control environment includes:
(i) the governance and management functions and
(ii) the attitudes, awareness, and actions of those charged with governance and
management .
(iii) the control environment sets the tone of an organization, influencing the control
consciousness of its people.
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Elements of the Control Environment– Elements of the control environment that may
be relevant when obtaining an understanding of the control environment include the
following:
(a) Communication and enforcement of integrity and ethical values–
These are essential elements that influence the effectiveness of the design,
administration and monitoring of controls.
(b) Commitment to competence– Matters such as management’s consideration of
the competence levels for particular jobs and how those levels translate into
requisite skills and knowledge.
(c) Participation by those charged with governance– Attributes of those charged
with governance such as:
Their independence from management.
The extent of their involvement and the information they receive, and the
scrutiny of activities.
The appropriateness of their actions, including the degree to which difficult
questions are raised and pursued with management, and their interaction
with internal and external auditors.
Their experience and stature.
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Chapter 5
1. What do you understand by the term fraud? Provide its meaning as given under
SA 240
Refer Chapter 5 Q1
2. Briefly explain self- revealing errors with some examples

Self-Revealing Errors: These are such errors the existence of which becomes
apparent in the process of compilation of accounts. A few illustrations of such errors are
given hereunder, showing how they become apparent.
3. There are many ways for cash defalcation, one of which is by suppressing cash
receipts. List out few techniques of how the receipts are suppressed.
Refer Chapter 5 Q3
4. Fraud Risk Factors are the events or conditions that indicate an incentive or
pressure to commit fraud or provide an opportunity to commit fraud. Further the
nature of the industry or the entity’s operations also provides opportunities to
engage in fraudulent financial reporting. List out some of the cases from where
these opportunities may arise.
Refer Chapter 5 Q4
5. You notice a misstatement resulting from fraud or suspected fraud during the
audit and conclude that it is not possible to continue the performance of audit. As
a Statutory Auditor, how would you deal?
Refer Chapter 5 Q8
6. Fraud can be committed by management overriding controls using such

techniques as engaging in complex transactions that are structured to
misrepresent the financial position or financial performance of the entity.
In view of the above-mentioned circumstances of management fraud, explain
briefly duties and responsibilities of an auditor in case of material misstatement
resulting from such Management Fraud.
Refer chapter 5 Q9
7. Intelligent Ltd. entered into an agreement with Mr. Intellectual on 15th March,
2017, whereby it agreed to pay him ` 2 lakhs per month as retainership fee for
consultation in IT department. However, no amount was actually paid and ` 24
lakhs was provided in the Statement of Profit and Loss for the year ending on
March 31st, 2017. Management of the company uttered that need-based
consultation was obtained throughout the year. However, on investigation, no
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documentary or other evidence of receipt of such service was found. As the
auditor of Innocent Ltd., what would be your approach?
Would your approach be different if the amount involved is ` 1 crore or above?
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of
Financial Statements”, fraud can be committed by management overriding controls
using such techniques as recording fictitious journal entries, particularly close to the end
of an accounting period, to manipulate operating results or achieve other objectives.
In the given case, Intelligent Ltd. has entered into an agreement with Mr. Intellectual, at
year-end, for consultation in IT department. It also charged yearly fee of ` 24 lakhs in
the Statement of Profit and Loss, however, no documentary or other evidence of receipt
of such service was found, on investigation. It is clear that company has passed
fictitious journal entries, near year-end, to manipulate the operating results.
Accordingly, the auditor would adopt the approach which will be based on the result of
misstatement on the basis of such fictitious journal entry, i.e. if, as a result of a
misstatement resulting from fraud or suspected fraud, the auditor encounters
exceptional circumstances that bring into question the auditor’s ability to continue
performing the audit, the auditor shall determine the professional and legal
responsibilities applicable in the circumstances, including whether there is a
requirement for the auditor to report to the person or persons who made the audit
appointment or, in some cases, to regulatory authorities; or the auditor may consider for
appropriateness of withdrawal from such engagement, where withdrawal from the
engagement is legally permitted.
In addition, the auditor is required to report according to section 143(12) of the
Companies Act, 2013. As per Section 143(12), if an auditor of a company, in the course
of the performance of his duties as auditor, has reason to believe that an offence
involving fraud
is being or has been committed against the company by officers or employees of the
company, he shall immediately report the matter. If the offence of fraud involved is of `
1crore or above, he shall report the matter to the Central Government.
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Chapter 6
1. Briefly mention three reasons why IT should be considered relevant to an audit of

The auditor should consider relevance of IT in an audit of financial statements for the
following reasons:
(a) Since auditors rely on the reports and information generated by IT systems, there
could be risks in the IT systems that could have an impact on audit.
(b) Standards on auditing SA 315 and SA 330 require auditors to understand, assess
and respond to risks that arise from the use of IT systems.
(c) By relying on automated controls and using data analytics in an audit, it is possible
to increase the effectiveness and efficiency of the audit process.
2. Describe how risks in IT systems, if not mitigated, could have an impact on audit.
When risks in IT systems are not mitigated the audit impact could be as
follows:
(i) The auditor may not be able rely on the reports, data obtained, automated
controls, calculations and accounting procedures in the IT system.
(ii) The auditor has to perform additional audit work by spending more time and
efforts.
(iii) The auditor may have to issue a modified opinion, if necessary.
3. What are the different testing methods used when auditing in an automated
environment. Which is the most effective and efficient method of testing?
When auditing in an automated environment, the following testing methods are used:
(a) Inquiry
(b) Observation
(c) Inspection
(d) Re-performance
A combination of inquiry and inspection is generally the most effective and efficient
testing method. However, determining the most effective and efficient testing method is
a matter of professional judgement and depends on the several factors including risk
assessment, control environment, desired level of evidence required, history of
errors/misstatements, complexity of business, assertions being addressed.
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Chapter 7
1. What is the meaning of Sampling? Also discuss the methods of Sampling.

Explain in the light of SA 530 “Audit Sampling”.
According to SA 530 “Audit sampling”, ‘audit sampling’ refers to 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.
Methods of Sampling:
Refer Q4.
2. With reference to Standard on Auditing 530, state the requirements relating to

audit sampling, sample design, sample size and selection of items for testing.
Refer chapter 7 Q6.
3. While planning the audit of S Ltd. you want to apply sampling techniques. What
are the risk factors you should keep in mind?
Refer Chapter 7 Q7.
4. Write short notes on the following:

(a) Advantages of Statistical sampling in Auditing.
Refer Chapter 7 Q3.
(b) Stratified sampling

Refer Chapter 7 Q4
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Chapter 8
1. Define Analytical Procedures.
Refer Chapter 8 Q1
2. What are the factors that determine the extent of reliance that the auditor places
on results of analytical procedures? Explain with reference to SA-520 on
“Analytical procedures”.
Refer Chapter 8 Q2
3. While carrying out the statutory audit of a large entity, what are the substantive
procedures to be performed to assess the risk of material misstatement?
Substantive Procedures to be performed to assess the risk of material
misstatement: As per SA 330, “The Auditor’s Response to Assessed Risk”,
substantive procedure is an audit procedure designed to detect material misstatements
at the assertion level. They comprise tests of details and substantive analytical
procedures.
Test of Details: The nature of the risk and assertion is relevant to the design of tests of
details. For example, tests of details related to the existence or occurrence assertion
may involve selecting from items contained in a financial statement amount and
obtaining the relevant audit evidence. On the other hand, tests of details related to the
completeness assertion may involve selecting from items that are expected to be
included in the relevant financial statement amount and investigating whether they are
included. In designing tests of details, the extent of testing is ordinarily thought of in
terms of the sample size.
Substantive Analytical Procedures: Substantive analytical procedures are generally
more applicable to large volumes of transactions that tend to be predictable over time.
The application of planned analytical procedures is based on the expectation that
relationships among data exist and continue in the absence of known conditions to the
contrary. However, the suitability of a particular analytical procedure will depend upon
the auditor’s assessment of how effective it will be in detecting a misstatement that,
individually or when aggregated with other misstatements, may cause the financial
statements to be materially misstated.
In some cases, even an unsophisticated predictive model may be effective as an
analytical procedure. For example, where an entity has a known number of employees
at fi xed rates of pay throughout the period, it may be possible for the auditor to use this
data to estimate the total payroll costs for the period with a high degree of accuracy,
thereby providing audit evidence for a significant item in the financial statements and
reducing the need to perform tests of details on the payroll. The use of widely
recognised trade ratios (such as profit margins for different types of retail entities) can
often be used effectively in substantive analytical procedure to provide evidence to
support the reasonableness of recorded amounts.
: 337 :
Chapter 9 (all other questions covered in JKSC Question bank of chapter 9)
1. How will you vouch and/or verify the following:

(a) Goods sent out on Sale or Return Basis.
(b) Borrowing from Banks.
2. How will you vouch/verify the following:

(a) Goods sent on consignment.
(b) Foreign travel expenses.
(c) Receipt of capital subsidy.
(d) Provision for income tax.
3. How will you vouch and/or verify payment of taxes?

4. How would you vouch/verify the following:
(a) Advertisement Expenses.
(b) Sale of Scrap.
: 338 :
Chapter 10 (all questions covered in JKSC textbook)
1. An auditor purchased goods worth ` 501,500 on credit from a company being

audited by him. The company allowed him one month’s credit, which it normally
allowed to all known customers. Comment.
2. (a) Ram and Hanuman Associates, Chartered Accountants in practice have

been appointed as Statutory Auditor of Krishna Ltd. for the accounting year
2015-2016. Mr. Hanuman holds 100 equity shares of Shiva Ltd., a subsidiary
company of Krishna Ltd. Discuss.
(b) Managing Director of PQR Ltd. himself wants to appoint Shri Ganpati, a
practicing Chartered Accountant, as first auditor of the company. Comment
on the proposed action of the Managing Director.
3. Under what circumstances the retiring Auditor cannot be reappointed?
4. Discuss the following:

(a) Ceiling on number of audits in a company to be accepted by an auditor.
(b) Filling of a casual vacancy of auditor in respect of a company audit.
(c) In Joint Audit, “Each Joint Auditor is responsible only for the work allocated
to him”.
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Chapter 11
1. “The auditor shall form an opinion on whether the financial statements are
prepared, in all material respects, in accordance with the applicable financial
reporting framework.” Explain.
In order to form that opinion, the auditor shall conclude as to whether the auditor has
obtained reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error.
That conclusion shall take into account:
(a) whether sufficient appropriate audit evidence has been obtained;
(b) whether uncorrected misstatements are material, individually or in aggregate;
(c) The evaluations.
2. “The auditor shall evaluate whether the financial statements are prepared, in all
material respects, in accordance with the requirements of the applicable financial
reporting framework. This evaluation shall include consideration of the qualitative
aspects of the entity’s accounting practices, including indicators of possible bias
in management’s judgments.” Discuss stating clearly qualitative aspects of the
entity’s accounting practices.
The auditor shall evaluate whether the financial statements are prepared in accordance
with the requirements of the applicable financial reporting framework. This evaluation
shall include consideration of the qualitative aspects of the entity’s accounting practices,
including indicators of possible bias in management’s judgments.
Qualitative Aspects of the Entity’s Accounting Practices:
1. Management makes a number of judgments about the amounts and disclosures in
2. SA 260 (Revised) contains a discussion of the qualitative aspects of accounting
practices.
3. In considering the qualitative aspects of the entity’s accounting practices, the
auditor may become aware of possible bias in management’s judgments. The
auditor may conclude that lack of neutrality together with uncorrected
misstatements causes the financial statements to be materially misstated.
Indicators of a lack of neutrality include the following:
(i) The selective correction of misstatements brought to management’s attention
during the audit.
(ii) Possible management bias in the making of accounting estimates.
4. SA 540 addresses possible management bias in making accounting estimates.
3. Discuss the factors affecting the decision of the auditor regarding which type of
modified opinion is appropriate.
Refer Chapter 11- Q2
4. Discuss the objective of the auditor as per Standard on Auditing (SA) 705
“Modifications to The Opinion in The Independent Auditor’s Report”.
As per Standard on Auditing (SA) 705 “Modifications To The Opinion In The
Independent
Auditor’s Report”, the objective of the auditor is to express clearly an appropriately
modified opinion on the financial statements that is necessary when:
(a) The auditor concludes, based on the audit evidence obtained, that the financial
that the fi nancial statements as a whole are free from material misstatement.
: 340 :
Chapter 12
1. The functioning of banking industry in India is regulated by the Reserve Bank of

the Central Bank of our country. Explain.
The functioning of banking industry in India is regulated by the Reserve Bank of India
(RBI) which acts as the Central Bank of our country. RBI is responsible for development
and supervision of the constituents of the Indian financial system (which comprises
banks and non-banking financial institutions) as well as for determining, in conjunction
with the Central Government, the monetary and credit policies keeping in with the need
of the hour.
Important functions of RBI are issuance of currency; regulation of currency issue; acting
as banker to the central and state governments; and acting as banker to commercial
and other types of banks including term-lending institutions. Besides, RBI has also been
entrusted with the responsibility of regulating the activities of commercial and other
banks. No bank can commence the business of banking or open new branches without
obtaining licence from RBI. The RBI also has the power to inspect any bank.
The provisions of the Reserve Bank of India Act, 1934, also affect the functioning of
banks. The Act gives wide powers to the RBI to give directions to banks which also
have considerable effect on the functioning of banks.
2. “The engagement team should hold discussions to gain better understanding of
the bank and its environment, including internal control, and also to assess the
potential for material misstatements of the financial statements. All these
discussions should be appropriately documented for future reference”. Explain.
3. Write a short note on reversal of income under bank audit.

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Chapter 13
1. You have been appointed as an auditor of an NGO, briefly state the points on
which you would concentrate while planning the audit of such an organisation?
Refer Chapter 13 Q4
2. The general transactions of a hospital include patient treatment, collection of

receipts, donations, capital expenditures. You are required to mention special
points of consideration while auditing such transactions of a hospital?
Refer Chapter 13 Q12
3. Mention the special points to be examined by the auditor in the audit of a

charitable institution running hostel for students pursuing the Chartered
Accountancy Course and which charges only ` 500 per month from a student for
his lodging/boarding.
1. General
(i) Study the constitution under which the charitable institution has been set up whether
under the Society Registration Act, as a trust or as a company limited by guarantee.
Verify whether it is managed as contemplated by the law and rules and regulations
made thereunder.
(ii) Examine the internal control structure particularly with reference to admission to hostel,
expenses incurred on different kinds of activities.
(iii) Verify the broad nature of expenses likely to be incurred with reference to the previous
year’s annual audited accounts.
2. Verification of the receipts
(i) Check the amounts received on account of, monthly rentals, etc., and receipts issued
for the same.
(ii) Ascertain that there is adequate internal control over the issue of official receipts,
custody of unused receipt books, printing of receipt books, etc.
(iii) Cross - tally the rent received along with the number of students (from the student
register) staying in the hostel during the year.
3. Verification of expenses
(i) Check the day-to-day administration expenses incurred along with the necessary
vouchers, supporting for the same like salary registers, repairs register, etc.
(ii) Verify whether the expenses incurred are in conformity with the budgets prepared
internally or fi led with the relevant authorities.
4. Verify investments made from surplus funds as well as existing investments by
physically verifying the same and that they are in the name of the institution and that
there is no charge/pledge against the same.
5. Verify all capital expenditure and expenditure on repairs, etc., incurred with the
vouchers and also whether proper tenders, etc., were invited for the same. See that all
furniture, glass, cutlery, kitchen utensils, liner, etc. are adequately depreciated.
: 342 :
4. Explain in detail the duties of Comptroller and Auditor General of India
Refer Chapter 13
5. An NGO operating in Delhi had collected large scale donations for Tsunami
victims. The donations so collected were sent to different NGOs operating in
Tamil Nadu for relief operations. This NGO operating in Delhi has appointed you
to audit its accounts for the year in which it collected and remitted donations for
Tsunami victims. Draft audit programme for audit of receipts of donations and
remittance of the collected amount to different NGOs. Mention six points each,
peculiar to the situation, which you will like to incorporate in your audit
programme for audit of said receipts and remittances of donations
Receipt of Donations:
(i) Internal Control System: Existence of internal control system particularly with
reference to division of responsibilities in respect of authorised collection of
donations, custody of receipt books and safe custody of money.
(ii) Custody of Receipt Books: Existence of system regarding issue of receipt
books, whether unused receipt books are returned and the same are verified
physically including checking of number of receipt books and sequence of
numbering therein.
(iii) Receipt of Cheques: Receipt Book should have carbon copy for duplicate receipt
and signed by a responsible official. All details relating to date of cheque, bank’s
name, date, amount, etc. should be clearly stated.
(iv) Bank Reconciliation: Reconciliation of bank statements with reference to all cash
deposits not only with reference to date and amount but also with reference to
receipt book.
(v) Cash Receipts: Register of cash donations to be vouched more extensively. If
addresses are available of donors who had given cash, the same may be cross-
checked by asking entity to post thank you letters mentioning amount, date and
receipt number.
(vi) Foreign Contributions, if any, to receive special attention to compliance with
applicable laws and regulations.
Remittance of Donations to Different NGOs:
(i) Mode of Sending Remittance: All remittances are through account payee
cheques. Remittances through Demand Draft would also need to be scrutinised
thoroughly with reference to recipient.
(ii) Confirming Receipt of Remittance: All remittances are supported by receipts
and acknowledgements..
(iii) Identity: Recipient NGO is a genuine entity. Verify address, 80G Registration
Number, etc.
(iv) Direct Confirmation Procedure: Send confirmation letters to entities to whom
donations have been paid.
(v) Donation Utilisation: Utilisation of donations for providing relief to Tsunami
victims and not for any other purpose.
(vi) System of NGOs’ Selection: System for selecting NGO to whom donations have
been sent.
: 343 :
CORRECT OR INCORRECT QUESTIONS WITH REASONS
Q1. State with reasons (in short) whether the following statements are correct or
incorrect:
(i) C & AG orders to conduct test audit of the accounts of a Government company.
(ii) The auditor shall not modify the opinion in the auditor's report.
(iii) The first auditor of a Government company was appointed by the Board in its
meeting after 10 days from the date of registration.
(iv) As per section 138 of the Companies Act, 2013 private companies are not
required to appoint internal auditor.
(v) Written representation by management as to the quality of inventory is substitute
for verification.
(vi) Letter of weakness is issued by the Management.
(vii) Scrutiny of Bank Reconciliation statement is one of the audit techniques.
(viii) The basic objective of audit does not change with reference to nature, size or
form of an entity.
(ix) Director's relative can act as an auditor of the company.
(x) If an LLP (Limited Liability Partnership Firm) is appointed as an auditor of a
company, every partner of a firm shall be authorized to act as an auditor.
Answer
(i) Correct: Comptroller and Auditor- General of India may, in case of a government
company, if he considers necessary, by an order, cause test audit to be conducted
of the accounts of such company.
(ii) Incorrect: The auditor shall modify the opinion in the auditor’s report when the
auditor concludes that, based on the audit evidence obtained, the financial
statements as a whole are not free from material misstatement or the auditor is
unable to obtain sufficient appropriate audit evidence to conclude that the financial
statements as a whole are free from material misstatement.
(iii) Incorrect: According to section 139(7) of the Companies Act, 2013, in the case of a
Government company, the first auditor shall be appointed by the Comptroller and
Auditor-General of India within 60 days from the date of registration of the
company. If CAG fails to make the appointment within 60 days, the Board shall
appoint in next 30 days.
(iv) Incorrect: Section 138 of the Companies Act, 2013 requires every private company
to appoint an internal auditor having turnover of ` 200 crore or more during the
preceding financial year; or outstanding loans or borrowings from banks or public
financial institutions exceeding ` 100 crore or more at any point of time during the
preceding financial year.
(v) Incorrect: Inspecting inventory when attending physical inventory counting assists
the auditor in ascertaining the existence of the inventory (though not necessarily
its ownership) and in identifying its quality for example, obsolete, damaged or
ageing inventory. Written representations cannot be a substitute for other evidence
that the auditor could expect to be reasonably available.
Alternative Reason for incorrect answer may be given as: One of the objectives of
the written representation is to support other audit evidence relevant to the
financial statements or specific assertions in the financial statements by means of
written representation. So it is clear that written representations cannot be a
substitute for other evidence that the auditor could expect to be reasonably
available.
(vi) Incorrect: Letter of weakness is a report issued by auditor stating the weakness in
internal control mechanism. It also suggests measures by which the weakness in
the system to be corrected and the control system be made better protected.
: 344 :
(vii) Correct: For collection and accumulation of audit evidence, certain methods and
means are available and these are known as audit techniques. The scrutiny of
Bank
(viii) Correct: An audit is an independent examination of financial information of any
entity, whether profit oriented or not, and irrespective of its size or legal form, when
such an examination is conducted with a view to expressing an opinion thereon. It
is clear that the basic objective of auditing, i.e., expression of opinion on financial
statements does not change with reference to nature, size or form of an entity.
(ix) Incorrect: As per section 141(3) of the Companies Act, 2013, 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.
(x) Incorrect: As per section 141(2) of the Companies Act, 2013, where a firm
including a limited liability partnership (LLP) is appointed as an auditor of a
company, only the partners who are Chartered Accountants shall be authorised to
act and sign on behalf of the firm.
Q.2. State Whether Correct or incorrect with reasons in short

(a) If financial statements are misstated, and in the auditor’s judgment such
misstatement is material and pervasive, he should issue a qualified opinion.
(b) Under the Companies Act, 2013, the financial statements of a company must be
approved by two directors out of which one shall be the managing director.
(c) A joint auditor is not bound by the views of the majority of the joint auditors
regarding matters to be covered in the auditors report.
(d) The auditor is responsible for the compliance with laws and regulations by the
audit client entity.
(e) The use of computer facilities by a small enterprise may increase the control risk.
(f) “Substantive procedures” may be defined as audit procedures designed to
evaluate the operating effectiveness of controls in preventing, detecting and
correcting material misstatements.
(g) Analytical procedure is a part of routine audit checking.
(h) NGOs registered under the Companies Act, 2013 can maintain their books on
either accrual or cash basis.
(i) Fraud against the company shall be reported by the auditor to the Central
Government within 45 days of his knowledge.
(j) If the Board of Directors fails to appoint the first auditor in case of a company other
than a Government Company, then the Central Government shall appoint the
auditor.
(a) Incorrect: As per SA 705 “Modifications to the Opinion in the Independent
Auditor’s Report”, the auditor shall express an adverse opinion when the auditor,
having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are both material and pervasive to
the financial statements. However, the auditor shall express qualified opinion when
he concludes that misstatement, individually or in aggregate are material but not
pervasive.
(b) Incorrect: As per section 134 of the Companies Act, 2013, the financial
statements shall be approved by the board of directors before they are signed on
behalf of the board at least by the following-
(i) The Chairperson of the company where he is authorised by the Board; or
(ii) By two directors out of which one shall be managing director and
(iii) The Chief Executive Officer, if he is a director in the company,
(iv) The Chief Financial Officer, wherever he is appointed; and
(v) The Company Secretary of the company, wherever he is appointed.
: 345 :
(c) Correct: As per SA 299 “Responsibility of Joint Auditors”, if a joint auditor is not
bound by the views of majority of joint auditors regarding matters to be covered in
the report and should express his opinion in a separate report in case of a
disagreement.
(d) Incorrect: As per SA 250 “Consideration of Laws and Regulations in an Audit of
Financial Statements”, 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.
The auditor is not responsible for preventing non-compliance and cannot be
expected to detect non-compliance with all laws and regulations. However, before
issuing an opinion on financial statements auditor has to determine whether client
has complied with the provisions of applicable laws and regulations.
(e) Correct: Many controls which would be relevant to large entities are not practical
in the small business. For example, in case of small business using computer
facilities, accounting work may not be segregated and be performed by only a few
persons. These persons may have both operating and custodial responsibilities,
and segregation of functions may be missing or severely limited thereby increasing
the control risk.
(f) Incorrect: ‘Substantive procedure’ may be defined as an audit procedure
designed to detect material misstatements at the assertion level whereas ‘tests of
controls’ is an audit procedure designed to evaluate the operating effectiveness of
controls in preventing, or detecting and correcting, material misstatements at the
assertion level.
(g) Incorrect: By routine checking we traditionally think of extensive checking and
vouching of all entries whereas “Analytical procedure” means evaluation of
financial information through analysis of plausible relationships among both
financial and non-financial data. It includes the consideration of comparisons of the
entity’s financial information. Routine checks cannot be depended upon to disclose
all the mistakes or manipulations that may exist in accounts, certain other
procedures also have to be applied.
From the above, it may be concluded that analytical procedure is not a part of
routine audit checking.
(h) Incorrect: NGOs registered under the Companies Act, 2013 must maintain their
books of account under the accrual basis as required by the provisions of section
128 of the said Act. If the accounts are not maintained on accrual basis, it would
amount to non-compliance of the provision of the Companies Act, 2013.
(i) Incorrect: As per section 143(12) of the Companies Act, 2013 read with the
Companies (Audit and Auditors) Rules, 2014, if an offence of fraud, which involves
amount of rupees 1 crore or above, is being or has been committed in the
company by its officers or employees, the auditor shall report the matter to the
Board or the Audit Committee immediately or within 2 days of his knowledge of the
fraud seeking their reply or observations within 45 days and forward the report to
the Central Government within 15 days from the date of receipt of such reply or
observations. However, in case of a fraud, which involves amount of less than
rupees 1 crore, the auditor shall report the matter to the Board or the Audit
Committee.
(j) Incorrect: As per section 139(6) of the Companies Act, 2013, if Board of Directors
fail to appoint the first auditor in case of a company other than a Government
company, it shall inform the members of the company. The members of the
company shall within 90 days at an extraordinary general meeting appoint the
auditor.
: 346 :
Q.3. State whether correct or incorrect with reasons in short
(i) Emphasis of Matter paragraph in the Auditor's Report is a substitute of Disclaimer

of Opinion.
(ii) The primary objective of an audit is to detect fraud and errors in Financial
Statements.
(iii) The Statutory-Auditor is required to verify inventory physically.
(iv) It is the responsibility of the Auditor to ensure that Statement of Profit and Loss
and Balance Sheet of the company shall comply with the Accounting Standards.
(v) An Auditor's external expert is not subjected to quality control policies and
procedures of an audit firm.
(vi) Extracts and copies of important legal documents, agreements and minutes
relevant to the audit is part of current audit file.
(vii) The Auditor shall express an unqualified opinion if the Auditor is unable to obtain
sufficient audit evidence regarding the opening balances.
(viii) The first Auditor is generally appointed by the company at a General Meeting.
(ix) Surprise checks are part of internal check.
(x) An Auditor is bound to provide copies of the working papers to the CEO of the
company.
(i) Incorrect: As per SA 706 “Emphasis of Matter Paragraphs and Other Matter
Paragraphs in the Independent Auditor’s Report”, the inclusion of an Emphasis of
Matter paragraph in the auditor’s report does not affect the auditor’s opinion.
Whereas the auditor shall disclaim an opinion when he is unable to obtain
sufficient appropriate audit evidence on which to base the opinion, and the auditor
concludes that the possible effects on the financial statements of undetected
misstatements could be both material and pervasive.
Therefore, an Emphasis of Matter paragraph is not a substitute for the auditor
expressing
a disclaimer of opinion.
(ii) Incorrect: Detection of fraud and errors in the financial statements is not the
primary objective of audit. The primary objective of an audit is to obtain reasonable
assurance about whether the financial statements are free from material
misstatements thereby enabling the auditor to express an opinion on the financial
statements.
(iii) Incorrect: Physical verification of inventories is the responsibility of the
management of the entity. However, where the inventories are material and the
auditor is placing reliance upon the physical count by the management, the auditor
should attend the stock-taking.
(iv) Incorrect: It is the responsibility of the company to ensure that statement of profit
and loss and balance sheet of the company shall comply with the accounting
standards. However, according to Section 143(3)(e) of the Companies Act, 2013, it
is the duty of the auditor to report that the statement of profit and loss and balance
sheet of the Company are complying with the accounting standards.
(v) Correct: As per SA 620 “Using the Work of an Auditor’s Expert”, an auditor’s
external expert is not a member of the engagement team and is not, therefore,
subject to quality control policies and procedures of the audit firm.
(vi) Incorrect: Extracts and copies of important legal documents, agreements and
minutes relevant to the audit is part of a permanent audit file. Current audit file
: 347 :
contains information, documents, statements etc. relevant for use only for current
period audit assignment.
(vii) Incorrect: As per SA 510 “Initial Audit Engagements—Opening Balances”, if the
auditor is unable to obtain sufficient appropriate audit evidence regarding the
opening balances, the auditor shall express a qualified opinion or a disclaimer of
opinion, as appropriate.
(viii) Incorrect: As per Sec 139 (6) of the Companies Act, 2013, the first auditor(s) of a
company shall be appointed by the Board of Directors within one month of the
date of registration of the company.
(ix) Incorrect: Surprise checks are part of normal audit procedures and the results of
such checks are important to the auditor in deciding the scope of his audit and
submitting his report thereon.
(x) Incorrect: Working papers are the property of the auditor, thus he is not bound to
provide copies of the working papers to anyone unless otherwise specified by law
or regulation. However, the auditor may, at his discretion, make portions of or
extracts from his working papers available to CEO of the Company or any third
party.
Q.4. State with reasons (in short) whether the following statements are correct or
incorrect:
(i) One of the techniques used for gathering evidence is substantial review.
(ii) The method which involves dividing the population into groups of items is knows
as block sampling.
(iii) A flow chart is a graphic presentation of each point of the company’s system of
internal control.
(iv) It is necessary for the auditor to maintain professional skepticism throughout the
audit.
(v) Capital Reserve and Reserve Capital are the same.
(vi) Central Government permission is required when auditors are to be removed
before expiry of their term, but not so when auditors are changed after expiry of
their term.
(vii) It is not necessary to follow standards on auditing as they are meant only for
reference purposes.
(viii) An auditor issues unqualified opinion when he concludes that the financial
statements give true and fair view.
(ix) All intangible assets are not required to be amortized.
(x) Auditor’s right of lien is unconditional.
(i) Correct. For collection and accumulation of audit evidence, certain methods and
means are available and these are known as audit techniques. Some of the
techniques commonly adopted by the auditors are Posting checking, Casting
Checking, Physical Examination and count, Confirmation, Inquiry, Year end
Scrutiny, Re-computation, Tracing in subsequent period, Bank reconciliation.
Substantial review is examination of accounts having large amounts, value and
importance. Substantial review can be used for gathering evidence.
(ii) Incorrect. The method which involves dividing the population into groups of items
is known as cluster sampling whereas block sampling involves the selection of a
defined block of consecutive items.
(iii) Correct. Flow chart is a graphic presentation of each part of the entity’s system of
internal control. It minimizes the amount of narrative explanation and thereby
: 348 :
achieves a presentation not possible in any other form. It gives bird’s eye view of
system for suggestion
(iv) Correct. As per SA 200, “Overall Objectives of the Independent Auditor and the
Conduct of an Audit in Accordance with Standards on Auditing”, professional
skepticism is an attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud, and a critical
assessment of audit evidence. Thus, it is necessary for the auditor to maintain
professional skepticism throughout the audit.
(v) Incorrect. Capital reserve represent surplus profit earned in respect of certain
types of transactions e.g. Profit on sale of fixed assets etc. which is not available
for distribution as dividend. Reserve Capital is that part of Capital which shall not
be called up except when Company is being wound up.
(vi) Correct. Removal of auditor before expiry of his term i.e. before he has submitted
his report is a serious matter and may adversely affect his independence. Hence,
the permission of the Central Government is required when auditors are removed
before expiry of their term and the same is not needed when they are not re-
appointed after expiry of their term.
(vii) Incorrect. While discharging attestation functions, it will be the duty of auditor to
ensure that the standards on auditing are followed in the audit of financial
information covered by their audit reports. If for any reason member has not been
able to perform an audit in accordance with standards, his report should draw
attention to the material departures.
(viii) Correct. An unqualified opinion should be expressed when the auditor concludes
that the financial statements give a true and fair view in accordance with the
financial reporting framework used for the preparation and presentation of the
It indicates, implicitly, that any changes in the accounting principles or in the method of
their application, and the effects thereof, have been properly determined and disclosed
in the financial statements.
(ix) Incorrect. As per AS -26, the depreciable amount of an intangible asset should be
allocated on a systematic basis over the best estimate of its useful life. The useful
life of an intangible asset may be very long but it is always finite.
(x) Incorrect. In terms of the general principles of law, any person having the lawful
possession of somebody else’s property, on which he has worked, may retain the
property for non-payment of his dues on account of the work done on the property.
On this premise, auditor can exercise lien on books and documents placed at his
possession by the client for non-payment of fees for work done on the books and
documents.
incorrect
(a) The scope of work of an internal auditor may extend even beyond the financial
accounting.
(b) An auditor has nothing to do with prudence or profitability of a company.
(c) Evaluating responses to enquiries is an integral part of the inquiry process.
(d) Internal control questionnaires are a good source of identifying weakness in
internal control system.
: 349 :
(e) Cluster sampling is less effective than random sampling.
(f) Errors of duplication affects the Trial Balance.
(g) Substantive procedures do not test the balances of accounts.
(h) The first auditors of a Government company was appointed by the Board of
Directors.
(i) The members of XYZ Ltd. preferred a complaint against the auditor stating that he
has failed to send the auditor’s report to them.
(j) Mr. Pawan, a practising Chartered Accountant, is appointed as “Tax-Consultant” of
ABC Ltd., in which his father Mr. Singh is the Managing Director.
(a) Correct. The scope of work of an internal auditor may extend even beyond
the financial accounting and may include cost investigation, inquiries relating
to losses and wastages, production audit, performance audit, etc.
(b) Incorrect. Companies Act, 2013 requires the company auditor to go beyond
the functions of reporting and express an opinion about the propriety or
prudence of certain transactions. Also, the auditor shall remain alert
throughout the audit for audit evidence of events or conditions that may cast
significant doubt on the entity’s ability to continue as a going concern.
Therefore it would not be correct to say that an auditor has nothing to do with
prudence or profitability of a company because it may impact the going
concern.
(c) Correct. Evaluating responses to inquiries is an integral part of the inquiry
process. Responses to inquiries may provide the auditor with information not
previously possessed or with corroborative audit evidence. Alternatively,
responses might provide information that differs significantly from other
information that the auditor has obtained. In some cases, responses to
inquiries provide a basis for the auditor to modify or perform additional audit
procedures.
(d) Correct. The questionnaire form provides an orderly means of disclosing
control defects. It is the general practice to review the internal control system
annually and record the review in detail. In the questionnaire, generally
questions are so framed that a ‘Yes’ answer denotes satisfactory position
and a ‘No’ answer suggests weakness.
(e) Correct. In cluster sampling population is divided into group called cluster
and a number of cluster is selected on random basis. In case of random
sampling, each item is randomly chosen and so every item has an equal
chance of being selected. Thus, cluster sampling is less effective.
(f) Incorrect. Error of duplication is another type of error of commission which
means recording the same transaction twice. Therefore, this error will not
affect the trial balance.
(g) Incorrect. Substantive procedure is an audit procedure designed to detect
material misstatements at the assertion level. It comprise (i) tests of details
(of classes of transactions, account balances, and disclosures), and (ii)
substantive analytical procedures.
(h) Incorrect. As per section 139(7) of the Companies Act, 2013, in the case of
a Government company, the first auditor shall be appointed by the
Comptroller and Auditor-General of India within 60 days from the date of
registration of the company.
Alternatively, the statement would be correct in case C&AG does not appoint
the first auditor within 60 days, Board of Directors of the company shall
appoint the first auditor within next 30 days.
: 350 :
(i) Incorrect. As per the provisions of the Companies Act, 2013, it is no part of
the auditor’s duty to send a copy of his report to members of the company.
The auditor’s duty concludes once he forwards his report to the company. It
is the responsibility of company to send the report to every member of the
company.
(j) Correct. A Chartered Accountant appointed as an auditor of a company,
should ensure the independence in respect of his appointment. In this case,
Mr. Pawan is a "Tax Consultant" and not a "Statutory Auditor" or "Tax
Auditor" of ABC Ltd., hence he is not subject to the above requirements.
incorrect:
(i) AB & Co. is an audit firm having partners Mr. A and Mr. B. Mr. C, the relative of
Mr. B is holding securities having face value of ` 2,00,000 in XYZ Ltd. AB & Co. is
qualified for being appointed as an auditor of XYZ Ltd.
(ii) Working papers are property of client, as it contains client’s information.
(iii) The auditor of a Ltd. Company wanted to refer to the minute books during audit
but board of directors refused to show the minute books to the auditors.
(iv) The auditor has to report to Central Govt. within 90 days of his knowledge of an
offence involving fraud.
(v) Manner of rotation of auditor will not be applicable to company A, which is having
paid up share capital of ` 15 crores and having public borrowing from nationalized
bank of ` 50 crore because it is a Private Limited Company.
(vi) The auditor should study the Memorandum and Articles of Association to see the
validity of his appointment.
(vii) Teeming and lading is one of the techniques of inflating cash payments.
(viii) Managing director of A Ltd. himself appointed the first auditor of the company.
(ix) A Chartered Accountant holding securities of S Ltd. having face value of ` 950 is
qualified for appointment as an auditor of S Ltd.
(x) Mr. N, a member of the Institute of Chartered Accountants of England and Wales,
is qualified to be appointed as auditor of Indian Companies.
(i) Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to
be appointed as an auditor of a company if his relative is holding any security of or
interest in the company of face value exceeding ` 1 lakh.
Therefore, AB & Co. shall be disqualified for being appointed as an auditor of XYZ Ltd.
as Mr. C, the relative of Mr. B who is a partner in AB & Co., is holding securities in XYZ
Ltd. having face value of ` 2 lakh.
(ii) Incorrect: Working papers are the property of the auditor and he is entitled to retain
them. He may, at his discretion, make portions of or extracts from his working papers
available to clients.
(iii) Incorrect: The provisions of Companies Act, 2013 grant rights to the auditor to access
books of account and vouchers of the company. He is also entitled to require
information and explanations from the company. Therefore, he has a statutory right to
inspect the minute book.
(iv) Incorrect: If an auditor of a company, in the course of the performance of his duties as
auditor, has reason to believe that an offence involving fraud is being or has been
committed against the company by officers or employees of the company, he shall
immediately report the matter to the Central Government within 60 days of his
knowledge and after following the prescribed procedure.
(v) Incorrect: According to section 139 of the Companies Act, 2013, the provisions related
to rotation of auditor are applicable to all private limited companies having paid up share
capital of ` 20 crore or more; and all companies having paid up share capital of below
: 351 :
threshold limit mentioned above, but having public borrowings from financial institutions,
banks or public deposits of ` 50 crore or more.
Although company A is a private limited company yet it is having public borrowings from
nationalized bank of ` 50 crores, therefore it would be governed by provisions of rotation
of auditor.
(vi) Incorrect: The auditor should study the Memorandum of Association to check the
objective of the company to be carried on, amount of authorized share capital etc. and
Articles of Association to check the internal rules, regulations and ensuring the validity
of transactions relating to accounts of the company.
To see the validity of appointment, the auditor should ensure the compliance of the
provisions of section 139, 140 and 141 of the Companies Act, 2013.
Alternative reasoning: The auditor should study the appointment letter & the
prescribed form submitted to the Registrar of the Companies to see the validity of his
appointment.
(vii) Incorrect: Teeming and Lading is one of the techniques of suppressing cash receipts
and not of inflating cash payments. Money received from one customer is
misappropriated and the account is adjusted with the subsequent receipt from another
customer and so on.
(viii) Incorrect: As per section 139(6) of the Companies Act, 2013, the first auditor of a
company, other than a government company, shall be appointed by the Board of
directors within 30 days from the date of registration of the company.
Therefore, the appointment of first auditor made by the managing director of A Ltd. is in
violation of the provisions of the Companies Act, 2013.
(ix) Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to
be appointed as an auditor of a company if he is holding any security of or interest in the
company.
As the chartered accountant is holding securities of S Ltd. having face value of ` 950, he
is not eligible for appointment as an auditor of S Ltd.
(x) Incorrect: A person shall be eligible for appointment as an auditor of a company only if
he is a chartered accountant.
It may be noted that a firm whereof majority of partners practising in India are qualified
for appointment as aforesaid may be appointed by its firm name to be auditor of a
company.
Thus, Mr. N is disqualified to be appointed as an auditor of Indian Companies.
: 352 :

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Ch. No. Chapter QUESTIONS Pg.No.

CHAPTER 1 NATURE SCOPE AND OBJECTIVE OF AUDITING

Sr.No Topics as per Module JKSC Textbook Reference

Q.6. Explain Basic Principles Governing an Audit of Financial Statements.

Q.7. Explain Relationship of auditing with other disciplines

Q.8. Explain Qualities of Auditor

Q.9. Explain Advantages of Audit

Q.10. Independence is a pre-requisite of auditing financial statements. Comment.

CHAPTER 2 AUDIT STRATEGY PLANNING AND PROGRAMMING)

Sr.No Topics as per Module JKSC Textbook

Q.2. Benefits of Planning

Q.3. Short note- Audit Strategy

Q.9. Short note- Documentation of Audit plan

Q.10.What do you understand by audit programme? Mention the advantages and

Q.12.Mention the factors to be considered for identification of an appropriate

CHAPTER 3 AUDIT DOCUMENTATION AND EVIDENCE

Sr.No List of topics as per module JKSC textbook

Audit documentation provides:

Purpose of Audit Documentation

Some examples of circumstances in which it is appropriate to prepare audit

Q.5. Short note- completion memorandum

Q.6. Short note- Ownership and retention of working papers

SA 500- AUDIT EVIDENCE

Appropriateness of Audit Evidence: Appropriateness is the measure of the quality of

Q.8. What are the types of audit Evidence.

Q. 9. Short note- Reliability of Audit Evidence

Q.10.Explain Audit Techniques.

Q.11.Explain the concept of Assertions with examples.

Q.12.Explain Audit Procedures in brief.

SA 505 External Confirmation

Q.14.Short note- External Confirmation Procedure

Q.15.Factors to be considered while designing a confirmation request

Q.16.Mention the steps to be taken if management refuses to allow auditor to send a

SA 580 Written Representations

Q.17.What do you understand by Written Representations? Comment upon its

SA 501- Audit Evidence- Specific Consideration for Selected Items.

(a) Attendance at physical inventory counting, unless impracticable, to:

Attendance at Physical Inventory Counting Involves:

Q.20.Mention the Factors to be considered while planning attendance at Physical

Q.21.Mention the procedures if inventory counting was not possible on the

Q.22.Mention the audit procedures to be performed for verifying completeness of

Q.23.What do you understand by Initial audit Engagement? Mention the audit

SA 550 Related Party

Q.24.Explain Related Party as per SA 550

Q.25.Explain Auditor’s Responsibilities regarding Related Party transactions

SA 560 Subsequent Events

Q.26.What do you understand by Subsequent Events? Mention the audit procedures

SA 570- Going Concern

Q.27.Explain Indicators of Material Uncertainty Regarding Going Concern Assumption

Q.28.Mention the Audit Procedures to be performed if material uncertainty over going

Q.29.Explain the Concept of True and Fair View.

CHAPTER 4 RISK ASSESSMENT AND INTERNAL CONTROL

Sr. List of topics as per module JKSC textbook reference

Q.4. Mention the inherent limitations of internal control system.

Q.6. Explain in brief the components of Internal control system

Q.12. Mention the objectives and scope of internal audit.

Q.13. Short note- Standards on Internal audit issued by the ICAI

Q14.Auditors’ Responsibility for Reporting on Internal Financial Controls over

Auditors are required to express an opinion on the effectiveness of an entity’s internal

CHAPTER 5 AUDITOR’S RESPONSIBLITIES IN RELATION TO