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CA – Final Advanced Auditing & Professional Ethics

Workbook

Final Advanced Auditing & Professional Ethics Workbook Advanced Auditing and Professional Ethics (CA – Final)

Advanced Auditing and Professional Ethics (CA – Final)

Advanced Auditing and Professional Ethics (CA – Final) Compiled by: Pankaj Garg Complied by: Pankaj Garg

Compiled by: Pankaj Garg

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CA – Final Advanced Auditing & Professional Ethics

Must Read - Preface to Workbook

This workbook contains topics which are not covered in main notes but important to study as questions on these

concepts are regularly asked in the exams. Such Topics are Guidance Notes, Accounting Standards,

Companies (AS) Rules, 2006, Schedule VI etc.

As these topics, in itself are very much detailed and the part of IPCC – Account / Final – Financial Reporting, only the portion that is relevant for Auditing paper is covered here. Most of the practical illustrations covered in these notes are taken from “Chartered Accountant” Journal, RTP, Suggested answers, Practice Manuals and Compiler.

On analysis of past year question papers, it can be concluded that around one question covering 16-20 marks is

from the areas mentioned above and generally that question is compulsory one. I hope that readers will be satisfied with the contents of these notes. Still, there always remains scope for improvement. I will be grateful to the readers for their valuable feedback for improvement of these notes. Wishing every success to the readers.

CA. Pankaj Garg e-mail: ca.gargpankaj@sify.com

the readers. CA. Pankaj Garg e-mail: ca.gargpankaj@sify.com Best of Luck……………. Schedule of Upcoming Batches
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CA – Final Advanced Auditing & Professional Ethics CONTENTS S. No. Name of Topic Page
CA – Final Advanced Auditing & Professional Ethics
CONTENTS
S. No.
Name of Topic
Page No.
No. of
Illustrations/Questions
Preface
02
Contents
03
1 Guidance Notes
04
– 07
7
2 Questions on Standards on Auditing
08
– 13
36
3 AS and Companies (AS) Rules
14
– 30
40
4 Company Audit and Schedule VI
31
– 35
13
5 Additional Illustrations / Questions
 Professional Ethics
36
– 36
3
 Bank audit
37
– 38
3
 Tax Audit
39
– 40
4
 Misc.
41
- 42
4
Total Illustrations/Questions
110

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CA – Final Advanced Auditing & Professional Ethics

GUIDANCE NOTES

Statements  Issued with a view to securing compliance by members on matters which in
Statements
 Issued with a view to securing compliance by members on matters which in the opinion of the
council of the institute are critical for the proper discharge of their functions.
 Compliance is Mandatory in Nature
Examples
 Statement on Reporting u/s 227(1A) of the Companies Act, 1956
 Statement on the CARO, 2003.
 Framework for the Preparation and Presentation of Financial Statements.
Duties of
members
 to examine whether ‘Statements’ relating to accounting matters are complied with
in the presentation of F.S.
 In the event of any deviation from such ‘Statements’, to make adequate disclosures
in their audit reports so that the users of F.S. may be aware of such deviations
 to ensure that the ‘Statements’ relating to auditing matters, are followed in the audit
of financial information covered by their audit reports.
 If, for any reason, a member, has not been able to perform an audit in accordance
with such ‘Statements his report should draw attention to the material departures
there from.
Guidance
Notes
Designed to provide guidance to members on matters which may arise in the course of their
professional work and on which they may desire assistance.
Compliance is recommendatory in nature
Example
Accounting
Guidance Note on Accounting Treatment for Excise Duty.
Guidance Note on Accounting for Depreciation in Companies.
Guidance Note on Accounting Treatment for CENVAT.
Guidance Note on Accounting for Corporate Dividend Tax
Auditing
Guidance Note on Independence of Auditors.
Guidance Note on Audit of Fixed Assets.
Guidance Note on Audit u/s 44AB of the Income -tax Act.
Guidance Note on Audit of Abridged Financial Statements.
Duties of
Accounting
member
Examine whether the recommendations in a guidance note relating
to an accounting matter have been followed or not.
If the same have not been followed, consider whether keeping in
view the circumstances of the case, a disclosure in his report is
necessary.
Auditing
Follow recommendations in a guidance note except where he is
satisfied that in the circumstances of the case, it may not be
necessary to do so.
Expected Question
Q. No. 1: The Institute has, from time to time, issued ‘Statements’ and ‘Guidance Notes’ on a number of matters.
Discuss the level of authority attached to these documents and the degree of compliance required in respect
thereof.

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CA – Final Advanced Auditing & Professional Ethics

GUIDANCE NOTES – Accounting and Auditing – Practical Illustrations

Treatment of Q. No. 1 Reserve created on Revaluation As a statutory auditor of a
Treatment of
Q.
No. 1
Reserve
created on
Revaluation
As a statutory auditor of a Public Limited Company, how would you deal with the
following situation: As at the beginning of the year, the company has a capital of
`.2.50 crores, free reserves of ` 0.50 crores and Revaluation Reserve of ` 4.50 crores.
In the relevant year under audit the company has incurred a loss of ` 4 crores. The
of Fixed
company proposes to adjust the loss with the Revaluation Reserve.
Assets
Answer: Adjustment of Loss against Revaluation Reserve:
Relevant Provisions: Guidance Note on “Treatment of Reserve created on Revaluation
of Fixed Assets” states that where the value of fixed assets is written up in the books of
account of a company, the corresponding credit appearing as revaluation reserve does
not represent a realised gain and is, therefore, not available for distribution as dividend.
Therefore any accumulated losses / depreciation (including arrears) should not be
adjusted against revaluation reserve since this would amount to setting off actual losses
against unrealized gains.
Conclusion: The auditor should explain to the management that accumulated losses
cannot be adjusted against the revaluation reserve created on revaluation of the fixed
assets. In case the company in question does so, the balance sheet of the company will
not reflect a true and fair view of the state of affairs of the company, keeping in view
the magnitude of the amounts involved, i.e., accumulated losses amount to ` 4 crores
and share capital and reserves amount to `3 crores (excluding revaluation reserve).
If the management does not agree with the opinion of the auditor, the auditor may even
issue an adverse report.
Guidance
Q.
No. 2
Note on
provision for
liability for
As a Statutory auditor, how would you deal with following: While finalizing its
accounts, a company does not provide for Income-tax payable under the provisions of
the Income-tax Act, 1961. A note is however given that since adequate tax has been
deducted at source, no additional tax is payable. [Nov. 08 – Old (5 Marks)]
taxation
Answer: No provisions for Income Tax Payable:
Guidance Note on provision for liability for taxation, provides that the provision for
anticipated tax liability in respect of profits of the company has to be made while
finalizing its accounts.
According to it, non-provision for taxation would amount to contravention of the
provisions of Sec. 209 and 211 of the Companies Act i.e. maintenance of proper
books of account and disclosures of true and fair view of the state of affairs of the
company.
Conclusion: Auditor is required to quality his report and such qualification should
bring out in what manner the accounts do not disclose "True and Fair “view of the state
of affairs of the Company and its Profit or loss. However, the qualification should also
mention clearly that TDS is in excess of the estimated tax liability for the year.
Terms used
Q.
No. 3
Comment on the following: S Ltd. issued Bonds to the tune of `100 lacs and provided
in F.S.
security to the tune of `80 lacs for the same. It insists that it will disclose the Bonds as
“Secured” in the Balance Sheet of the Company.
[May 10 – New (5 Marks)]
Answer:
Prima facie, the Bonds issued to the tune of `100 lacs are provided with security to
the tune of `80 lacs i.e. neither fully secured nor unsecured.
Guidance Note on the “Terms used in Financial Statements” issued by ICAI,
states “Secured Loans” as loan secured wholly or partly against an asset.
Conclusion: Bonds should be classified under ‘Secured Loans’ for the purpose of
disclosure in the Balance Sheet. However the nature of security should be clearly
specified.

Complied by: Pankaj Garg (CA, CS, CWA(I) – All India Topper, Gold Medalist)

Upcoming Batches: F2F@ SmartteachCA (IMA – ITO, Delhi) w.e.f. 30 May (MWF, 5.30 p.m.- 08.30 p.m.); Satellite@ETENCA w.e.f. 28 May (SS, 2 p.m – 5 p.m.)

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CA – Final Advanced Auditing & Professional Ethics

Accounting Q. No. 4 As a Statutory Auditor, how would you deal with the following:
Accounting
Q.
No. 4
As a Statutory Auditor, how would you deal with the following: For the year ended
for Credit
available in
respect of
MAT under
the IT Act
31st March, 2011, a company has paid Minimum Alternative tax under section 115 JB
of
the Income Tax Act, 1961. The company wants to disclose the same as an ‘Asset’
since the company is eligible to claim credit for the same. [Nov. 09 – New (5 Marks)]
Answer: Disclosure of MAT paid as an Asset:
 As per Guidance Note on “Accounting for Credit available in respect of MAT
1961
under the IT Act 1961”, although MAT credit is not a deferred tax asset under AS
22 , yet it give rise to expected future economic benefit in the form of adjustment of
future income tax liability arising within the specified period.
 The Framework for the Preparation and Presentation of Financial Statements,
issued by the ICAI, defines the term ‘asset’ as follows: “An asset is a resource
controlled by the enterprise as a result of past events from which future economic
benefits are expected to flow to the enterprise.”
 MAT paid in a year in respect of which the credit is allowed during the specified
period under the Income Tax Act is a resource controlled by the company as a
result of past event, namely the payment of MAT.
MAT credit has expected future economic benefits in the form of its adjustment
against the discharge of the normal tax liability if the same arises during the
specified period. Accordingly, MAT credit is an asset.
Conclusion: If the auditor is satisfied that the probability of the company to claim the
said credit is high, it could recognize the same as an asset. In Balance sheet it should be
shown under the head “Loans & Advances” as “MAT credit entitlement”.
Revised
Q.
No. 5
Accounts of
Companies
Before
Comment on the following: The statutory audit of Fortune Limited for the year ended
on 31.03.2009 was completed and auditor also submitted his report with the audited
Financial Statements to the management of the company. Thereafter, the management
of the company approached the auditor to revise certain items in the Financial
Circulation
Statements.
[Nov. 09 – New (5 Marks)]
to
Or
Shareholders
A
of
company wants to amend its accounts after the completion of the audit and adoption
the Accounts by the Board, but before circulation to the shareholders. It requires its
statutory auditor to report on the amended accounts. State the steps the statutory audit
should adopt in such a situation.
Answer: Revision of F.S.:
As per the Guidance Note on Revised Accounts of Companies Before Circulation to
Shareholders, Mngt. can revise its accounts after adoption on which report has been
issued by the Auditors, but before circulation to the shareholders.
In the instant case, the statutory auditor should ascertain whether the original audit
report along with audited accounts has been circulated to the share-holders.
If
not, he can issue a revised report on the amended F.S. subject to following:
(i)
(ii)
Revised accounts must be re-approved by the Board of Directors of the company.
Ask the company to return all the original copies of the earlier audit report along
with the audited accounts.
(iii)
The fact of revision of F.S. with reasons should be incorporated in the Directors’
Report. If it is neither included nor found adequately disclosed in the Director’s
Report, auditor should include the fact with figures and reasons in his revised
audit report to the shareholders.
(iv)
Mention specifically that it is a revised audit report.

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CA – Final Advanced Auditing & Professional Ethics

Audit of Q. No. 6 Payment of Dividend State your views as an auditor on
Audit of
Q.
No. 6
Payment of
Dividend
State your views as an auditor on the following: During the year under audit Z Ltd.
credited to the P & L Account, the entire profit of `20 lakhs on the sale of land not
required for its use. You are informed that the directors would like to propose dividend
out of the above profit.
Answer: Payment of dividend out of Capital profits:
Profit of Rs. 20 lakhs on the sale of land is a capital profit. It represents the excess of
sale value over the original cost of the asset, i.e capital profits.
As per Guidance Note on “ Audit of payment of Dividend” the capital profits can be
distributed by a company only if all the following conditions are fulfilled:
1. The articles of association should permit distribution of capital profits.
2. The capital profit which is sought to be distributed should have actually been
realised.
3. The capital profit should remain after a proper valuation has been fairly taken of
the whole of the assets and liabilities.
Conclusion: The profit arise on sale of land is realized in cash and hence subject to
satisfaction of other conditions can be distributed as dividend. distributable.
Accounting
Q.
No. 7
for
Derivatives
As an auditor, how would you deal with the following: XY Ltd. had entered into
derivative transactions in foreign currency which were based on probable export
orders. As at the year end on 31st March, 2011, the mark-to-market (MTM) loss on the
said derivatives was `250 lakhs. The company contends that since the MTM loss is
notional and likely to be recouped in the next year, the same need not be provided for.
[Nov. 09 – Old (5 Marks)]
Answer: Derivative transactions (MTM) Loss:
As per ICAI announcement on “Accounting for Derivatives” the entity is required to
provide for losses in respect of all outstanding derivative contracts at the balance sheet
date by marking them to market, keeping in view the principle of prudence as
enunciated in AS 1 “Disclosure of Accounting Policies”.
Conclusion: In the given case, XY Ltd. should provide for mark to-market (MTM)
losses amounting `250 Lakhs. Auditors, should consider for making appropriate
disclosures in their reports if the aforesaid accounting treatment and disclosures are not
made by the company.

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CA – Final Advanced Auditing & Professional Ethics

STANDARDS ON AUDITING AND RELATED SERVICES

SA 210 Q. No. 1 What is an audit engagement letter? What are the principal
SA 210
Q.
No. 1
What is an audit engagement letter? What are the principal contents of audit engagement
letters?
SA 230
Q.
No. 2
As an auditor, how would you deal with the following: The statutory auditor of the Holding
Company demands for the working papers of the auditors of the subsidiary company, of
which you are the auditor.
[Nov. 09 – Old (4 Marks)]
Answer: Demand of working papers:
 As per SA 230, “Audit Documentation” working papers are the property of the auditor.
The auditor may, at his discretion, make portion of or extracts of his working papers
available to his client.
 SA 600 “Using the Work of Another Auditors” also states that an auditor should respect
the confidentiality of information acquired during the course of his audit work and
should not disclose such information unless there is a legal or professional duty to
disclose.
As per ICAI Guidelines, statutory auditor of an enterprise do not have right of access to
the audit working papers of the branch auditor. An auditor can rely on the work of
another auditor, without having any right of access to the audit working papers of other
auditor.
Conclusion: Statutory auditor of Holding company can not have access to audit working
papers of the subsidiary company’s auditor. He can however, ask the auditor to answer
certain questions about the manner in which the audit is conducted and certain other
clarifications regarding audit.
SA 240
Q.
No. 3
As a Statutory Auditor, how would you deal with the following cases: In the books of
accounts of M/s OPQ Ltd. huge differences are noticed between the control accounts and
subsidiary records. The Chief Accountant informs that this is common due to huge volume
of business done by the company during the year.
Answer: Difference between Control Accounts and Subsidiary Records:
The huge differences found between control accounts and subsidiary records in the
books of M/s OPQ Ltd. indicate that there may be material misstatements requiring
detailed examination by the auditor to ascertain the cause.
The contention of Chief Accountant cannot be accepted simply because the company
has done huge volume of business. Such a phenomenon indicates that recording of
transactions is not being done properly or the accounting system fails to capture all
transactions in time.
Having regard to all these circumstances, it appears from the facts of the case that these
differences indicate the possibility of some kind of material misstatements.
According to SA 240 “The Auditors responsibilities relating to Fraud in an audit of
F.S.”, when the auditor comes across such circumstances indicating the possible
misstatements resulting from entity’s procedure, the auditor shall evaluate whether such
a misstatement is indicative of fraud.
In this case, the circumstances indicate the possibility of material misstatements (that
might be due to fraud) and accordingly, the auditor must investigate further to consider
effect on F.S.
Q. No. 4
Explain briefly duties and responsibilities of an auditor in case of material misstatement
resulting from Management Fraud.
[Nov. 09 – New (6 Marks)]

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CA – Final Advanced Auditing & Professional Ethics

SA - 240 Q. No. 5 Comment on the following: While conducting statutory Audit of
SA - 240
Q.
No. 5
Comment on the following: While conducting statutory Audit of ABC Ltd., you come
across IOUs amounting to Rs. 2 crores as against a cash balance shown in books of `2.10
crores. You also observe that despite similar high balances throughout the year, small
amounts of `50,000 are withdrawn from the bank to meet day-to-day expenses.
[May 09 – New (5 Marks)]
Answer:
According to SA 240 “The Auditors responsibilities relating to Fraud in an audit of
F.S.”,
when
the
auditor
comes
across
such
circumstances
indicating
the
possible
misstatements resulting from entity’s procedure, the auditor shall evaluate whether such a
misstatement is indicative of fraud.
In this case, the circumstances indicate the possibility of fraud and accordingly, the auditor
must investigate further to consider effect on F.S.
The Guidance Note on Audit of Cash and Bank balances also mentions that if the entity is
maintaining an unduly large balance of cash, auditor should carry out surprise verification
of cash more frequently to ascertain whether it agrees. If cash in hand is not in agreement
with the book balance, he should seek explanations and if the same are not satisfactory, he
should state this fact appropriately in his Audit Report.
SA 250
Q.
No. 6
State briefly the Communication/Reporting requirements as per SA 250 on Non-
Compliance in an audit of F.S.:
(i)
To the management
(ii)
To the users of the auditor's report on the financial statements.
(iii)
To the regulatory and enforcement authorities.
[May 09 – Old (8 Marks)]
SA 315
Q.
No. 7
What are the points to be considered while evaluating the “Knowledge of the Business” in
the conduct of an audit?
[May 09 – New (8 Marks)]
SA 500
Q.
No. 8
Write short note on: Assessing the reliability of Audit Evidence. [May 09 – Old (4 Marks)]
Q.
No. 9
As a Statutory Auditor, how would you deal with the following case: M/s LNK’s group
gratuity scheme’s valuation by actuary shows wide variation compared to the previous
year’s figures.
Answer: Using the work of Management Expert as an audit evidence:
SA 500 (Revised), “Audit Evidence” states that the auditor has to evaluate the work of
management expert, say, actuary, before adopting the same.
This becomes more crucial since M/s LNK’s group gratuity scheme’s valuation by
actuary shows wide variation compared to previous year figures. There is no doubt that
appropriateness, reasonableness of assumptions and methods used are the
responsibility of the expert, but the auditor has to determine whether they are
reasonable based on the auditor’s knowledge of the client’s business and result of his
audit procedures.
In the present case, the auditor must verify the reasonableness of assumptions made
and methods adopted by the actuary in the evaluation particularly with reference to
factors such as rate of return on investments, retirement age, number and salary of
employees, etc.
Accordingly, the auditor has to satisfy himself whether valuation done by the actuary
can be adopted, otherwise he may report on his findings for wide variation.
Q.
No. 10
Comment on the following: Z Ltd. had appointed an outside expert to assess accrued
gratuity liability of the company. Based on the said report, the company provides Rs. 80
lakhs as gratuity in the financial statements. [May 09 – New (4 Marks)]
SA 505
Q.
No. 11
Write short note on: Situations where external confirmations can be used.
Q.
No. 12
As a Statutory Auditor, how would you deal with the following: The accountant of C Ltd.
has requested you, not to send balance confirmations to a particular group of debtors since
the said balances are under dispute and the matter is pending in the Court.

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SA 510 Q. No. 14 Comment on the following: You have been appointed as the
SA 510
Q.
No. 14
Comment on the following: You have been appointed as the auditor of Good Health Ltd.
for 2010-11 which was audited by CA Trustworthy in 2009-10. As the Auditor of the
company state the steps you would take to ensure that the Closing Balances of 2009-10
have been brought to account in 2010-11 as Opening Balances and the Opening Balances
do not contain misstatements. [Nov. 08 – New (5 Marks)]
Q.
No. 15
What are the procedures to be followed by a Statutory Auditor in the audit of opening
balances if the financial statements for the preceding year were audited by another auditor?
[Nov. 09 – Old (8 Marks)]
SA 520
Q.
No. 16
As an auditor to what extent you can rely on Analytical Procedures.
SA 530
Q.
No. 17
“An auditor while analyzing the errors in a sample need not consider the qualitative aspects
of errors detected.” Comment.
SA 550
Q.
No. 18
As a Statutory Auditor, how do you verify the existence of Related Parties and disclosure
of Related Party Transactions?
[Nov. 09 – Old (8 Marks)]
Answer: Verification of Existence of related parties and disclosures:
 SA 550 (Revised) “Related Parties” requires that 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.
 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:
(a)
(b)
(c)
Bank, legal and third party confirmations obtained during the audit;
Minutes of meetings of shareholders and of TCWG; and
Such other records or documents as the auditor considers necessary.
Records or Documents that auditor may inspect:
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 TCWG.
Records of the entity’s investments and those of its pension plans.
Contracts and agreements with key management or TCWG.
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 (Prospectus).
Examinations
of
arrangements
that
may
indicate
the
existence
of
related
party
relationships or transactions:
 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.

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CA – Final Advanced Auditing & Professional Ethics

SA 560 Q. No. 19 Briefly explain: Audit procedures on subsequent events. [Nov. 09 –
SA 560
Q.
No. 19
Briefly explain: Audit procedures on subsequent events.
[Nov. 09 – New (4 Marks)]
Q.
No. 20
Comment on the following: A Co. Ltd. has not included in the Balance Sheet as on 31-03-
2011 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 30-04-2011. The auditor wants to sign the said
Balance Sheet and give the audit report on 31-05-2011. The auditor came to know the
result of the negotiations on 15-05-2011. [Nov. 10 – New (5 Marks)]
Answer: Treatment of subsequent Events:
 SA 560 “Subsequent Events” requires that in respect of events occurring between the
date of F.S. and date of the AR, the auditor shall perform audit procedures to obtain
sufficient & appropriate audit evidence to ensure that events which require adjustments
or disclosure in the F.S. have been identified.
 If auditor identifies events that require adjustment or disclosure in the F.S., the auditor
should determined whether each such event is appropriately reflected in the F.S.
The auditor shall request the management to provide a “Written Representation” that all
events occurring subsequent to the date of the F.S. and requires adjustment or disclosure
have been adjusted or disclosed.
Conclusion: The facts of the case indicates the event as of adjusting nature as per AS – 4
“Contingencies and Events Occurring after the Balance Sheet date” and requires
adjustment in assets and liabilities, which has not been made by the management. Auditor
should request mngt. to adjust the sum of `1.50 crores by making provision for expenses. If
the mngt. does not accept the request the auditor should qualify the AR.
SA 570
Q.
No. 21
What are the Financial indications to be considered by an auditor for evolution of the going
Concern assumption?
[Nov. 08 – Old (4 Marks)]
Q.
No. 22
Comment on the following: A Company's net worth is eroded and creditors 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. [May 09 – New (4 Marks)]
Answer: Appropriateness of 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”.
SA 580
Q.
No. 23
What is meant by “Written Representations” and indicate to what extent an auditor can
place reliance on such representations.
Q.
No. 24
An auditor of Mohan 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 Management 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 Mohan 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.

Complied by: Pankaj Garg (CA, CS, CWA(I) – All India Topper, Gold Medalist)

Upcoming Batches: F2F@ SmartteachCA (IMA – ITO, Delhi) w.e.f. 30 May (MWF, 5.30 p.m.- 08.30 p.m.); Satellite@ETENCA w.e.f. 28 May (SS, 2 p.m – 5 p.m.)

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CA – Final Advanced Auditing & Professional Ethics

SA – 580  As per SA 580 “Written Representation” the representations received from management
SA – 580
 As per SA 580 “Written Representation” the representations received from management
are recognised as audit evidence, but they do not constitutes Sufficient and
appropriateness.
 Auditor is required to seek corroborative audit evidence from other sources inside or
outside the entity, to evaluate whether such representations are reasonable and
consistent with other evidences.
 Representation received from Management 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.
Conclusion: The approach adopted by the auditor is not right.
SA 600
Q.
No. 25
“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.
SA 610
Q.
No. 26
Enumerate, in brief, the important aspects to be evaluated by the external auditor in
determining the efficiency and extent of reliance to be placed on the work and function of
an Internal Auditor.
Q.
No. 27
You are appointed as statutory auditor of X Ltd. X Ltd. has an internal audit system and
reports for the same are given to you. Mention the factors you will consider to ensure that
the said system of internal audit of X Ltd. is commensurate with the size of the company
and nature of its business. [May 09 – New (8 Marks)]
SA 620
Q.
No. 28
Briefly explain how an auditor can use the work of an expert.
SA 710
Q.
No. 29
Write short note on: Auditor’s responsibilities regarding comparatives.
Q.
No. 30
The audit report of P Ltd. for the year 2009-10 contained a qualification regarding non
provision of doubtful debts. As the statutory auditor of the company for the year 2010-11,
how would you report, if:
(i)
(ii)
The company does not make provision for doubtful debts in 2010-11?
The company makes adequate provision for doubtful debts in 2010-11?
[June 09 – New (8 Marks)]
Answer:
As per SA 710, when the Audit Report on the prior period intended a qualified opinion and
the said matter is:
(i)
(ii)
Unresolved and results in an modification of the AR regarding current year’s figures,
his report should be modified regarding corresponding figures.
Resolved and properly dealt with in the F.S., the current report need not refer to such
modification.
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.
If however, the provision is made, the auditor need not refer to the earlier years
modification.
SRE
Q.
No. 31
The directors of C Ltd. are concerned about the reliability and usefulness of the monthly
2400
financial management information that they receive. As a result, the company’s auditors
have been engaged to review the system and the information it generates, and to report their
conclusions. What an ordinary procedure includes for the review of financial statements?

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SRS Q. No. 32 What is engagement to perform agreed upon procedures. What are the
SRS
Q.
No. 32
What is engagement to perform agreed upon procedures. What are the general principles
4400
governing an agreed upon procedures engagement.
SRS
Q.
No. 33
You have been asked by a company to compile financial statements for the purpose of
4410
obtaining loan from a Bank. Draft a report to be given to the Management for the same.
[Nov. 08 – Old (8 Marks)]
Q.
No. 34
Draft an illustrative engagement letter for an engagement to compile financial statements of
DEF Ltd.
[Nov. 09 – Old (8 Marks)]
Q.
No. 35
While compiling the financial statements of a concern, you observed that the input
information supplied by the concern is incomplete, incorrect and few of the Accounting
Standards have not been followed. Describe, in brief, the procedure you will follow in the
above.
Answer: Compilation of Financial Information:
1. As per SA 4410 “Engagements to Compile Financial Information”, an accountant
would normally have to rely upon the management for information to compile the F. S.
in a compilation engagement.
2. If in the course of compilation of financial statements, it is observed that the
information supplied by the entity is incorrect, incomplete or otherwise unsatisfactory,
the accountant should perform following procedures:
Make any enquiries of management to assess the reliability and completeness of
the information provided;
Assess internal controls prevailing in the entity; and
Verify any matters or explanations.
3.
The accountant may also request the management to provide additional information.
This may be asked in the form of management representation letter.
4.
If the management refuses to provide additional information, the accountant should
withdraw from the engagement, informing the entity of the reasons for such
withdrawal.
5.
If one or more ASs are not complied with, the same should be brought to the notice of
the management and if the same is not rectified by the management, the accountant
should include the same in notes to the accounts and the compilation report to the
management.
Q.
No. 36
Comment on the following: You are appointed to compile financial statements of Y & Co.
for tax purposes. During the course of work, you learn that the inventory is grossly
understated. On pointing the same, the partners of Y & Co. tell you that since you are not
conducting an audit, the said figures duly certified by the firm should be accepted.
[May 09 – New (5 Marks)]
Answer:
As per SRS 4410 “Engagement to Compile Financial Information “if an accountant
becomes aware of material misstatements, the accountant should persuade the management
to carry out necessary amendments in the F.S. or other compiled financial information. If
such amendments are not made and the F.S. are still considered to be misleading the
accountant should withdraw from the engagement.

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ACCOUNTING STANDARDS

Applicability of AS  The Preface to the Statements of AS clarifies that the ASs
Applicability
of AS
 The Preface to the Statements of AS clarifies that the ASs are issued "for use in the presentation of
G.P.F.S. issued to the public by such commercial, industrial or business enterprises, as may be
specified by the Institute from time to time and subject to the attest function of its members.
 The term 'G.P.F.S. includes balance sheet, statement of profit and loss and other statements and
explanatory notes which form part thereof, issued for use of shareholders/ members, creditors,
employees and public at large".
 As far as companies, whether limited or unlimited incorporated under the Companies Act, 1956
are concerned, all such companies are expected to adhere to specified AS in terms of section
211(3A) of the said Act.
 The compliance with AS has to be examined by the auditors while auditing general purpose F. S.
which are statutorily required to be audited under any law. Thus, compliance with AS is required
to be examined by an auditor in an audit of F. S. of individuals and non-corporate enterprises (for
example: Partnership firms, Societies, trusts, HUF, AOP) only where the F.S. are statutorily
required to be audited under any law.
 The AS are also applicable to commercial, industrial or business activities of even charitable or
religious organisations. Accounting Standards do not apply to those organisations whose entire
activities are not of commercial, industrial or business nature, e.g., an organisation collecting
donations to finance education of poor children. However, even if a very small proportion of the
activities of an entity is commercial, industrial or business in nature, the accounting standards will
apply to all its activities.
Q.
No. 1
Comment: The AS issued by the ICAI need to be followed only by limited companies
and not by partnership firms or proprietorships.
Q.
No. 2
As an auditor, how would you deal with the following: In the audit of an organization
whose objects are charitable or religious, the organization holds that the Accounting
Standards are not applicable to it since only a very small proportion of its activities are
business in nature.
[May 09 – Old (5 Marks)]
Companies
Small and
(i)
(AS) Rules
Medium
Whose equity or debt securities are not listed or are not in the process of listing on
any stock exchange, whether in India or outside India;
2006
Size
(ii)
Company
(iii)
(iv)
(v)
Which is not a bank, financial institution or an insurance company;
Whose turnover (excluding other income) does not exceed `50 Cr. in the
immediately preceding accounting year,
Which does not have borrowings (including public deposits) in excess of `10 Cr.
at any time during the immediately preceding accounting year; and
which is not a holding or subsidiary company of a company which is not a small
and medium-sized company.
Explanation: For this purpose, a company shall qualify as a Small and Medium Sized
Company, if the conditions mentioned therein are satisfied as at the end of the relevant
accounting period.
Q.
No. 3
Comment whether the following Companies can be classified as a Small and Medium
Sized Company (SMC) as per the Companies (Accounting standards) Rules, 2006:
(i)
A Pvt. Ltd., a subsidiary of a multinational company listed on London Stock
Exchange. It has a turnover of `12 crores and borrowings of `5 crores.
(ii)
B Pvt. Ltd. has a turnover of `45 crores, other income of `7 crores and bank
borrowings of Rs.9 crores.
(iii)
C Ltd. has appointed Merchant bankers to prepare a Red-herring prospectus for
the purpose of filing the same with SEBI. [Nov. 08 – Old (12 Marks)]

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Companies Answer: Determination of Small and medium Sized Company: (AS) Rules (i) Since A Pvt.
Companies
Answer: Determination of Small and medium Sized Company:
(AS) Rules
(i)
Since A Pvt. Ltd. is a subsidiary of MNC which is listed, on London Stock
2006
Exchange (and is therefore not a SMC), A Pvt. Ltd. cannot be a SMC. The
turnover and borrowings are not relevant in this case.
(ii)
Since B Pvt. Ltd. has a turnover of `45 corers and borrowing of `9 corers, it will
be classified as SMC.
Note: Other incomes are not considered
(iii)
Since C Pvt. Ltd. has appointed merchant bankers to prepare a Red Herring
Prospectus for the purpose of filling the same with SEBI, it is in the process of
listing on a Stock Exchange, therefore C Ltd. cannot be classified as a SMC.
Q.
No. 4
As a Statutory auditor, how would you deal with following: A company which satisfies
the conditions of a Small and Medium sized Company (SMC) as per Companies (AS)
Rules, 2006 has represented that it does not require to give disclosures required by AS-3
“Cash Flow Statements” and AS-18 “Related Party Disclosures” in its F.S.
[Nov. 08 – Old (4 marks)]
Answer: Compliance of AS-3 and AS-18 by SMC:
As per the Companies (AS) Rules, 2006, Compliance of Certain ASs is not mandatory,
but optional.
AS-3, as per the above Rules is not mandatory for SMC. However, AS-18 is required to
be complied with mandatorily.
Conclusion: T company, even if it is a SMC, will have to give disclosures for:
(i)
(ii)
related party relationships, and
transactions between a reporting enterprise and its related parties.
Q.
No. 5
Comment: The management tells you that there is no need for them to follow AS
specified by the ICAI as these are for the auditor to follow.
Answer: Observance of AS:
In terms of Companies (AS) Rules, 2006 prescribed by the C.G. u/s 211(3)(c) of the
Companies Act, 1956, it is mandatory for a Company to follow all the prescribed
AS while preparing and presenting its F.S.
If a Company does not follow AS, the auditor is required to give a qualification in
his report in terms of section 227(3) of the Companies Act, 1956.
Infact directors of the companies are also required to give a written statement as
part of Director Responsibility Statement u/s 217 of the Companies Act that all the
AS prescribed has been followed and there are no discrepancies.
Conclusion: The contention of the company is not correct.
Q.
No. 6
LMN Pvt. Ltd. is a dealer in government securities. The turnover on account of sale of
securities for the year ended 31 st March, 2011 is `85 crores whereas the net profit is
`0.10 Cr. While finalizing the accounts the company did not prepare the Cash Flow
Statement.
[May 10 – Old (5 Marks)]
Answer: Exemption for applicability of AS – 3, preparing Cash Flow Statement is
available only to Small and Medium Size Companies) preparation of Cash
Flow Statement, as per AS – 3 is now made mandatory in respect of the
following enterprises:
(i)
Enterprises whose equity of debt securities are listed on a recognized
Stock Exchange in India and Enterprises that are in the process of issuing
equity or debt securities that will be listed on a recognized Stock
Exchange in India.
(ii)
All other Commercial, industrial and business reporting enterprises,
whose turnover for the accounting period exceeds Rs. 50 crores.

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In the instant case, LMN Pvt. Ltd. did not prepare the Cash Flow Statement, even
In the instant case, LMN Pvt. Ltd. did not prepare the Cash Flow Statement,
even its turn over exceeded Rs. 50 crores. It is not considered as a small and
medium size company as per Companies (AS) Rules, 2006 (AS-3) as
discussed earlier, hereinabove.
Therefore, if LMN Pvt. Ltd. does not prepare cash flow statement it is a
violation of AS-3 and section 211(3C) of the Companies Act, 1956.
The auditor will have to accordingly qualify his report that 211(3C) is not
complied with, the profit & loss account would give a ‘True & Fair View’.
AS-2
Q.
No. 7
A
company was engaged in the business of buying IMFL (Indian Made Foreign Liquor)
and beer and selling same through retail vending shops and bars run by it. The company
sold beer to some of the customers who consumed them in bars run by it and left the
bottles behind. (Technically, these bottles were the property of the customers.) These
bottles were later on disposed off by the company. Answer the followings:
1. Are these bottles left behind by the customers “assets” of the company?
2. Are they “inventories”?
3. If they are “inventories”, how they should be valued?
4. Can the “bottles” be valued at net realisable value and treated as “income”?
Answer:
1. An asset is a resource controlled (not necessarily “owned”) by an enterprise as a
result of past events from which future economic benefits to the enterprise are
expected. In assessing whether an item meets the above definition of “assets”, the
consideration should be given to economic reality and substance and not merely
legal form. Accordingly, the bottles can be considered as “assets” of the company.
2. The stock of empty bottles is “inventory” as the company holds them for sale in the
ordinary course of its business of running the bars.
3. These bottles should be valued at the lower of cost and NRV. However, the cost of
purchase and selling price of beer / IMFL are both inclusive of cost of bottles as beer
/ IMFL cannot be sold without bottles – the primary packing. Practically, the empty
bottles do not appear to cost anything to the company (i.e. zero cost), if that be the
case, the bottles should be reflected at nominal value of Re.1.
4. It would not be correct to value the bottles at NRV with credit being given to
“income” as the bottles have not been sold at the balance sheet date.
Q.
No. 8
As an auditor state your views on the following: Included under Current Assets of XYZ
Ltd. is inventory aggregating to `20 crores. A part of the said inventory manufactured
for export had to be sold earlier at a discounted price offshore due to moisture content
present at the time of delivery. A part of similar inventory is included in `20 crores.
Answer: Valuation of Damaged Inventory:
Auditor is required to examine what part of the inventory is included in the
inventory valued at `20 crores.
He will also have to satisfy himself that whether such part left with the company
has also been damaged on account of moisture content.
If required, the auditor may obtain a certificate from an expert about the condition
of the inventory.
Thereafter, it should be verified whether the principle of valuation enunciated in AS
2 “Valuation of Inventories” have been followed. The standard requires that the
inventories should be valued at the lower of cost or NRV.
Conclusion: In the present case the auditor shall satisfy himself whether the balance
inventory lying with the company is carrying the same quality issue. If yes, than value
of
inventory will be revised based on its NRV(if lower than cost).

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Q. No. 9 The management tells you that WIP is not valued since it is
Q.
No. 9
The management tells you that WIP is not valued since it is difficult to know the same
in view of multiple processes involved and in any case opening and closing WIP would
be more or less the same.
Answer: Valuation of WIP: As per AS-2, “Valuation of inventories” inventories
includes any item held in the process of production. This is known as WIP.
Company is required to find out the stage of completion of products and value of the
same. In certain cases, due to nature of the product and the manufacturing process
involved, physical verification of WIP may be impracticable. But in such cases, the
advice of an expert can be taken. The value of such WIP is normally done by taking the
basic raw material cost and adding thereto the proportionate factory overhead cost
incurred up to the stage of completion.
Valuation of WIP is important due to following:
WIP is an item of Manufacturing, Trading & Profit & Loss A/c and also forming
part of current assets, is relevant and can not be ignored. Omitting WIP will result
in under or over statement of profit and current assets.
Part II of Schedule VI to the Companies Act also prescribes that the figures of
opening and closing balances of stock and WIP be disclosed in the profit & loss
account. Part I of the same schedule requires that the mode of valuation of stock be
shown in the Balance Sheet.
Conclusion: The argument of the management that the opening and closing WIP would
be more or less the same is not justified because the cost incurred for raw materials and
overheads would be different and would give different value of opening and closing
WIP. Taking into consideration all the above aspects, management is wrong and if WIP
is not valued or taken into consideration, auditor should qualify his report.
AS - 4
Q.
No. 10
During the course of audit of D Co. Ltd. you as an auditor have observed that Inter
corporate deposit of ` 50 lakhs has been over due. The D Co. Ltd. has disclosed this in
the notes to accounts note No. 15 in schedule no. 21 stating that ` 50 lakhs is over due
from XYZ Co. Ltd. and the said company is in the process of liquidation. The
management is taking steps to appoint the liquidator.’ [Nov. 10 – New (5 Marks)]
Answer:
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.
In the instant case, it appears from the note no 15 that the overdue of outstanding inter
corporate deposit may not be realisable in full. The company is in the process of
liquidation, makes it clear that on the balance sheet date, the amount of deposit is not
safe and is not likely to be realised.
Conclusion: As per AS 4 provision for the loss was required in the accounts.
Accordingly, auditor should qualify the Audit Report.
Q.
No. 11
State your views as an auditor on the following: V Ltd. had announced a voluntary
retirement plan for its employees on January 1, 2010. The scheme is scheduled to close
on June 30, 2010. The scheme envisaged an initial lump sum payment of maximum of
Rs. 2 lakhs and monthly payments over the balance period of service of employees
coming under the plan. 200 employees opted for the scheme as on March 31, 2010. The
total lump sum payment for these employees would be Rs. 250 lakhs and the aggregate
of future payments to them would amount to Rs.1,500 lakhs. However, no payment had
been made to the employees under the scheme up to March 31, 2010. Nor the company
made any provision in its accounts towards any liability under the scheme.

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AS - 4 Answer: Event occurring after the B/S Date: Relevant Provision: As per AS-
AS - 4
Answer: Event occurring after the B/S Date:
Relevant Provision: As per AS- 4 on 'Contingencies and Events Occurring After the
Balance Sheet Date', assets and liabilities should be adjusted for events occurring after
the balance sheet date that provide additional evidence to assist the estimation of
amounts relating to conditions existing at the balance sheet date or that indicate that the
fundamental accounting assumption of going concern is not appropriate.
Facts of the case: A condition existed on the balance sheet date (31st March, 2010)
regarding the liability towards the Voluntary Retirement Plan since the management
started the scheme in the month of January, 2010 and 200 employees opted for the
scheme as on March 31, 2010.
Conclusion: Since it was probable that future events will confirm that a liability has
been incurred on the balance sheet date and that the amount could be estimated on
reasonable basis, a provision for payments under the scheme would be required to be
made for an appropriate amount for the aforesaid number of employees.
Q. No. 12
Arya Ltd. was under audit for the year ended 31.03.2010. An appeal filed by Arya Ltd.
against the demand of Excise Duty of `26 crores was pending before the Supreme
Court for which neither provision was made nor was disclosed in the notes to the
financial statements. On 12th July, 2010, the auditor came to know through paper
reports that the point involved in the appeal of Arya Ltd. was adjudicated by the
Supreme Court in the case of some other assessee, which is in favour of the department
of Excise Duty. The auditor insisted that provisions be made of `26 crores in the
financial statements. The Management was of the view that since its own case is still
pending, no provision is called for. It was also of the view that the event does not have
any effect on the financial position of the company on the date of the Balance Sheet. Is
the view of the Management tenable?
Answer: Subsequent Events:
Relevant Provisions:
As per AS- 4 on 'Contingencies and Events Occurring After the Balance Sheet
Date', assets and liabilities should be adjusted for events occurring after the balance
sheet date that provide additional evidence to assist the estimation of amounts
relating to conditions existing at the balance sheet date or that indicate that the
fundamental accounting assumption of going concern is not appropriate.
SA 560 on “Subsequent Events” lays down that the “auditor should consider the
effect of subsequent events on the F.S. and on the auditor’s report”.
Explanation:
The issue involved in the appeal of Arya Ltd. was similar to the point in case of
some other company and since the appeal of that company was decided against that
company and in favour of the Excise Department, it is necessary for Arya Ltd. to
make a provision of Rs. 26 crores.
Conclusion: The view of the management that its own appeal is undecided or that it has
no effect on the financial position as on 31.03.2006 is not at all tenable. Since the
financial position is materially affected, the auditor should express a qualified opinion
or an adverse opinion as may be appropriate.
AS - 5
Q. No. 13
As a statutory auditor, how would you deal when PQ Ltd., as part of overall cost cutting
measure announced voluntary retirement scheme (VRS) to its employees, to reduce the
employee strength. During the first half year ended 30.9.2010 the company paid a
compensation of `72 lakhs to those who availed the scheme. The Chief Accountant has
reflected this payment as part of regular salaries and wages paid by the company. Is this
correct?

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AS - 5

Answer: Treatment of Ordinary activity with large amount:

As per AS 5, “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies” the payment made to its employees on account of VRS as an overall cost cutting measure is an ordinary activity.

AS 5 requires that when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.

Though this is not an extraordinary item, but the nature and amount of this expenses is such that its separate disclosure is required to allow the users to understand the financial position and performance of the company. Conclusion: Compensation of `72 Lakhs paid towards VRS availed by employees should be shown separately in the profit and loss account of PQ Ltd.

separately in the profit and loss account of PQ Ltd.  Q. No. 14 State your

Q. No. 14

State your views as an auditor on the following: Y Ltd. provided `25 lakhs for inventory obsolescence in 2009-2010. In the subsequent years, it was determined that 50% of such stock was usable. The company wants to adjust the same through prior period adjustment account as the provision was made in the earlier year.

Answer: Prior Period Adjustment:

As per AS 5 on "Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies", prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the F.S. of one or more prior periods.

   Q. No. 15 Answer: Applicability of AS-7:
Q. No. 15
Answer: Applicability of AS-7:

The write-back of provision made in respect of inventories in the earlier year does not constitute prior period adjustment since it neither constitutes error nor omission.

An estimate may have to be revised if changes occur regarding the circumstances on which the estimate was based, or as a result of new information, more experience or subsequent developments.

The revision of the estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary item or a prior period item. Conclusion: Revision of the estimate does not bring the resulting amount of `12.5 lakhs within the definition either of a prior period item or of an extraordinary item. The amount, however, involved is material and requires separate disclosure to understand the financial position and performance of an enterprise. Accordingly, adjustment in the value of the inventory through prior period item would not be proper.

Comment: B Co. Ltd. is engaged in the business of developing mass scale housing projects including development of small commercial complexes. The flats/commercial spaces are booked by the public and are allotted by way of allotments letter to each allottee. Major construction activities pertaining to buildings are undertaken of flats/commercial spaces is given to allottees by executing legal document. The CEO of the B Co. says that AS 7 is not applicable to the company. [Nov. 09 – New (5 Marks)]

AS - 7

AS 7 (Revised) “Accounting for Construction contracts” states that, "This Statement should be applied in accounting for construction contracts in the F.S. of contractors. The revised AS 7 is silent about its applicability to construction activities undertaken by enterprises on their own account and not as contractors.

The matter was considered by Expert Advisory committee of the Institute and they are of the view that the revised AS 7 is not applicable to such enterprises.

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Conclusion: The activity of developing housing projects on its own account can be considered as
Conclusion: The activity of developing housing projects on its own account can be
considered as a commercial venture by the company in the nature of production activity
and, therefore, should be construed as such. Accordingly, the flats/commercial spaces
should be identified as inventories in accordance with AS 2 and revenue should be
recognition in accordance with AS 9.
AS - 9
Q.
No. 16
A
Ltd. prepared an invoice for an export consignment on FOB basis on 30 th March,
2010. The goods were dispatched from the factory on 30 th March, 2010 and the Bill of
Lading was made on 3 rd April, 2010. A Ltd. had booked the invoice in the Sales
Register for March, 2010.
[May 10 – Old (5 Marks)]
Answer: Revenue recognition in case of export sale:
As per AS-9 ‘Revenue Recognition’ revenue involving sale of goods is to be
recognized on transfer of significant risk and reward of ownership to the buyer.
In
the instant case, A Ltd. has invoiced the goods and they have left the factory on 30 th
March, 2011. However the same is for export and the bill of landing is dated 3 rd April
2011.
Conclusion: The sale should be therefore, recognized in April 2011. The auditor will
therefore have to qualify his report stating that revenues are overstated to that extent.
Q.
No. 17
State your views as an auditor on the following: T Ltd. purchased goods on credit for
`5 crores for export from ABC Ltd. Upon the export order being cancelled, T Ltd.
decided to sell the same in the domestic market at a discounted price. Accordingly ABC
Ltd was requested to offer a price discount of 25%. ABC Ltd. wants to adjust the sales
figure to the extent of discount requested by T Ltd.
Answer: Treatment of discount subsequent to sale:
ABC Ltd. had sold goods on credit worth `5 crores to T Ltd. and, therefore, the sale
was complete in all respects. T Ltd' s decision to sell the same in the domestic
market at a discount does not affect the amount booked under sales by ABC Ltd.
The price discount of 25% offered by ABC Ltd. at the request of T Ltd. was not in
the nature of discount given during the ordinary course of trade.
As far as ABC Ltd. is concerned, there appears to be an uncertainty relating to
collectability, which has arisen subsequent to the time of sale.
Therefore, it would be appropriate to make a separate provision to reflect the
uncertainty relating to collectability rather than to adjust the amount of revenue
originally recorded.
Conclusion: Discount should be charged to the P & L A/c separately and not shown as
deduction from the sales figure.
Q. No. 18
Comment: LM Ltd. has 2 divisions L and M. The finished products of division L are
transferred to division M where further processing is carried out before sale to
customers. To achieve transparency and accountability between the divisions, division
L
raises an invoice on division M at cost plus normal margins. At the year end the
unrealized profits on inter-division stocks are eliminated. However, the transfers are
recorded at the invoice value as sales and purchases in the respective divisions for the
purpose of preparing the Profit and Loss Account. Suitable disclosures, for this are
given in then ‘Notes to Accounts’.

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AS - 9

Answer: Revenue recognition in case of inter division transfers:

The recognition of inter-divisional transfers as sales is an inappropriate accounting treatment and is inconsistent with AS 9.

In case of inter-divisional transfers, risks and rewards remain within the enterprise and also there is no consideration from the point of view of the enterprise as a whole. Thus, the recognition criteria for revenue recognition has not been fulfilled

in respect of inter-divisional transfers. Conclusion: In the instant case, LM Ltd cannot recognise inter-division transfers from

L to M as sales and the same will have to be eliminated during finalisation. If not so

done, the statutory auditor will have to qualify his report.

Q. No. 19

As an auditor, state your view on the following: (a) M Ltd. manufactures machinery used in Steel Plants. It quotes prices in various tenders issued by Steel Plants. As per terms of contract, full price of machinery is not released by the steel plants, but 10% thereof is retained and paid after one year if there is satisfactory performance of the machinery supplied. The company accounts for only 90% of the invoice value as sales income and the balance amount in the year of receipt to the extent of actual receipts only.

the year of receipt to the extent of actual receipts only. Answer : Recognition of Revenue

Answer: Recognition of Revenue:

AS 9 on ‘Revenue Recognition’, states that revenue from sale of goods should be recognised as and when sale is made if following conditions are satisfied:

and when sale is made if following conditions are satisfied:     In Q.
    In Q. No. 20
In
Q. No. 20

Property in the goods has been transferred for a price

all significant risks and rewards of ownership have been transferred, and

seller retains no effective control of the goods associated with ownership and

no significant uncertainty exists regarding the amount of consideration. the present case, the goods, as well as the risks and rewards of ownership have been

transferred to the steel plants. The invoice raised by M Ltd. is for the full price, but

10% less is received as the same is kept as ‘Retention Money’. Conclusion: Under the circumstances, revenue is required to be recognised at the full invoice price. Depending on the past experience of recovering the balance 10% from the steel plants, M Ltd. can, make a provision for sales income which is not likely to realise. In the absence of the above, the auditor will have to qualify his report.

Comment: In the notes to accounts of C Co. Ltd. as on 31-03-2011 Note no. 11 states

that ‘Certain machinery items are lying at customs warehouses and company has paid ` 900 lakhs up to 30-06-2010 as detention charges, out of which a sum of `580 lakhs is written back during the year 2010-11 based on settlement with the concerned authorities in respect of a major spares of machinery. For the remaining machinery item negotiations are pending and a provision of `44 lakhs is made. As such total amount of `364 lakhs paid/provided on account of detention charges have been capitalized and included in the fixed assets/capital work in progress. The management is of the view that these expenses are directly attributable to the acquisition of the related Fixed

Asset.’

[Nov. 10 – New (5 Marks)]

AS - 10

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AS - 10

Answer: Capitalisation of Detention Charges:

As per AS – 10 “Accounting for Fixed Assets” the cost of an item of fixed assets comprises its purchase price, including import duties and other non-refundable taxes or

levies and any directly attributable cost of bringing the asset to its working condition for its intended use; any trade discounts and rebates are deducted in arriving at the purchase price. Examples of directly attributable costs are:

1. site preparation ;

2. initial delivery and handling costs ;

3. installation cost, such as special foundations for plant ; and

4. professional fees, for example fees of architects and engineers.

Conclusion: Detention charges, being in the nature of penalty levied by Customs for

not removing the articles within specified period from custom port can not be considered as directly attributable cost. Treatment done by the company is incorrect. The auditor should qualify the report appropriately mentioning the effect on Balance sheet and Profit and Loss Account.

the effect on Balance sheet and Profit and Loss Account. Q. No. 21 Limited includes in

Q. No. 21

Limited includes in the Schedule of Inventory, those items of Fixed Assets which

have not been in active use and held for disposal, as inventory item. [May 10 – New (5 Marks)]

F

Answer: Treatment of assets held for Disposal

  Q. No. 22 Answer: Valuation of Fixed Assets: Relevant provisions: 
Q. No. 22
Answer: Valuation of Fixed Assets:
Relevant provisions:

AS-10 “Accounting for Fixed Assets” requires that the items of fixed assets that have been retired from active use and are held for disposal be stated at the lower of their net book value and NRV and are shown separately in the financial statements.

As per AS-2 “Valuation of Inventories”, “inventories” are assets “held for sale in the ordinary course of business, in the process of production for such sale; or in the form of materials or supplies to be consumed in the production process or in the rendering of service”. Conclusion: Inclusion of fixed assets, not in active use and held for disposal, as inventory item in the schedule of inventory is not in line with the requirements of AS- 10 and AS-2. Such fixed assets should be stated at lower of net book value and NRV and are shown separately in F.S.

Comment: An old car of a company having a nominal book value has found a buyer, who is willing to pay `1 lakh for it. The company proposes not to sell the car, but to neglect its valuation in its accounts at `1 lakh. Should the auditor permit the company

to do so?

The old car formed part of the fixed assets of the company and ordinarily the same should be valued at actual cost less depreciation written off. The market price of any of such assets is not relevant for balance sheet valuation of a going concern.

There is no prohibition in law for revaluation of fixed assets. But when all other assets are presumably shown at historical cost, revaluation only of one motorcar seems illogical and has the effect of distorting the overall view of the accounts.

AS- 10, “Accounting for Fixed Assets” also clarifies, when a fixed asset is revalued in F.S., an entire class of assets should be revalued, or the selection of assets for revaluation should be made on a systematic basis and the basis should be disclosed.

Complied by: Pankaj Garg (CA, CS, CWA(I) – All India Topper, Gold Medalist)

Upcoming Batches: F2F@ SmartteachCA (IMA – ITO, Delhi) w.e.f. 30 May (MWF, 5.30 p.m.- 08.30 p.m.); Satellite@ETENCA w.e.f. 28 May (SS, 2 p.m – 5 p.m.)

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AS - 10

Facts of the case:

In the present case, there is no proper appraisal and a revaluation based on one stray bid is not proper to establish a proper replacement value of an item of asset.

The willingness of a buyer to pay the particular price is not logical basis to work out the value of the asset. The company though proposes not to sell the car at Rs. One lakh yet it has decided to neglect its value in the accounts. Conclusion: In view of the fact that the company has been taking proper step, the auditor should permit the company to neglect the valuation of car in the accounts because it is in accordance with the relevant requirements of the AS.

Q. No. 23

As a statutory auditor of a Public Limited Company, how would you deal with the following: The company has sold some old machinery for Rs. one crore. The details of the cost of such machinery are not available since the entire records relating to fixed assets have been destroyed in an earthquake.

Answer: Profit/Loss on Sale of Machinery:

As per AS 10 "Accounting for Fixed Assets", gains or losses arising on disposal are generally recognised in the profit and loss statement.

are generally recognised in the profit and loss statement.  In the instant case, since the

In the instant case, since the entire records of fixed assets have been destroyed, the WDV of the machinery sold should be determined by company on some estimated and reasonable basis.

Such calculation may be done by obtaining old copies of annual reports, annual accounts filed with ROC, IT Returns etc. A note to that effect would also have to be given by the management in the accounts.

    Q. No. 24  
Q. No. 24

Under this situation, the auditor will have to see whether the estimate of cost and WDV arrived at in the above manner by the company is reasonable and whether the profit/loss is determined accordingly.

If the auditor is of the opinion that the said estimates are satisfactory based on available records and the note given by management explains the said fact, he may not qualify his report.

If he is not so satisfied, he would have to give disclaimer in the audit report that in the absence of proper records, the said profit/loss has been arrived on an estimated basis and in that view he has been unable to form an opinion.

As far as the report under the CARO, 2003 order is concerned, the auditor would have to point out that proper records of fixed assets showing full particulars as required by that clause are not available.

As a statutory auditor of a Public Limited Company, how would you deal with the following situation: As at the beginning of the year, the company has a capital of `2.50 crores, free reserves of `0.50 crore and Revaluation Reserve of `4.50 crores. In the relevant year under audit the company has incurred a loss of `4 crores. The company proposes to adjust the loss with the Revaluation Reserve.

Answer: Adjustment of Losses against Revaluation Reserve:

Accumulated losses cannot be adjusted against the revaluation reserve created on revaluation of the fixed assets.

In case the company in question does so, the balance sheet of the company will not reflect a true and fair view of the state of affairs of the company keeping in view the magnitude of the amounts involved, i.e., accumulated losses amount to Rs.4 crores and share capital and reserves amount to Rs.3 crores (excluding revaluation reserve).

If the management does not agree with the opinion of the auditor, the auditor may even issue an adverse report.

Complied by: Pankaj Garg (CA, CS, CWA(I) – All India Topper, Gold Medalist)

Upcoming Batches: F2F@ SmartteachCA (IMA – ITO, Delhi) w.e.f. 30 May (MWF, 5.30 p.m.- 08.30 p.m.); Satellite@ETENCA w.e.f. 28 May (SS, 2 p.m – 5 p.m.)

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AS - 12 Q. No. 25 As a Statutory auditor, how would you deal with
AS - 12
Q.
No. 25
As a Statutory auditor, how would you deal with following: A company receives a
grant from the State Govt. as compensation for loss of stocks due to unseasonal floods.
Entire grant received is credited to “Capital Reserve”. [Nov. 08 – Old (5 Marks)]
Answer: Accounting of Government Grants:
As per AS-12 “Accounting for Government Grants” grants related to revenue
should be recognized on a systematic basis in the profit and loss Account over, the
periods necessary to match them with the related costs which they are intended to
compensate.
Such Grants should either be shown separately under 'Other Income’ in the profit &
loss account or should be deducted in reporting the related expenses or losses, if
such Grant is received in the same year in which loss is sustained.
Conclusion: Accounting Treatment is wrong. In no case, it can be credited to
'CAPITAL RESERVE'. The Auditor should give qualified report.
Q.
No. 26
Comment on the following: XYZ Limited received a grant of Rs. 25 lakhs under the
Government's Subsidy Scheme, for acquiring an imported machinery for setting up
new plant. The entire grant received is credited to Profit and Loss Account.
[Nov. 09 – New (5 Marks)]
Answer: Treatment of Capital Grant:
As per AS 12, “Accounting for Government Grants” grants received for acquisition of
specific fixed asset maybe treated in following ways:
(a)
(b)
Deduction from the gross value of the asset; or
Treating it as deferred income which should be recognised in the P & L account
on a systematic and rational basis over the useful life of the asset.
By crediting the entire amount of grant to P & L account, the company has treated it as
a revenue income which is not in accordance with the requirements of the AS 12.
Conclusion: Auditor needs to qualify the report stating the fact that the income has
been overstated to the extent of the amount of grant net of proportionate credit that
would have been worked out.
AS - 13
Q.
No. 27
As a statutory auditor of a Public Limited Company, how would you deal with the
following situation: The company had subscribed to shares of associate companies
amounting to ` 5 crores. These associate companies have incurred substantial losses
and have been referred to BIFR for being declared as sick companies. The company
does not want to make any provision for the fall in the value of the investments.
Answer: Valuation of Investments:
Relevant Provision:
AS 13 on "Accounting for Investments" requires that long-term investments should
be carried in the F.S. at cost. However, provision for diminution shall be made to
recognise a decline, other than temporary, in the value of the investments, such
reduction being determined and made for each investment individually".
Facts of the case:
In the present case, the investments made in associate companies can be classified
as long term investments.
These associate companies have incurred substantial losses and have been referred
to BIFR for being declared as sick companies. The net worth of these companies
would have been wiped out resulting in a fall in the value of the investments.
Conclusion: Such fall in value of investments cannot be merely temporary as the
companies could take a long time to turn around and again have a positive net worth.
The auditor would therefore have to qualify his report by saying that no provision for
diminution for fall in the value of investments as required by AS 13 has been made and
to that extent the profits and reserves have been overstated.

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AS - 16 Q. No. 28 As a statutory auditor for the year ended 31st
AS - 16
Q.
No. 28
As a statutory auditor for the year ended 31st March 2011, how would you deal with
the Following: X Ltd., has borrowed ` 25 crores from financial institutions during the
financial year 2010-11. These borrowings are used to invest in shares of Y Ltd., a
subsidiary company which is implementing a new project estimated to cost ` 50 crores.
As on 31st March 2011, since the said project was not yet complete, the directors of X
Ltd. resolved to capitalize the interest on the borrowings amounting to ` 3 crores and
add it to the cost of investments.
Answer: Capitalisation of Interest on Borrowings in respect of Investments
Relevant Provisions:
 AS-16 “Borrowing Costs” does not consider investment in shares as qualifying
assets that can enable a company to add the borrowing costs to investments.
 In the instant case, X Ltd. has used borrowed funds for making investment in shares
of a subsidiary company. For acquiring shares of a subsidiary company, apart from
any fees, duties etc., there are no cost incurred for investing in shares.
Any borrowing costs incurred cannot be treated as part of cost of investments and
cannot be added to the cost of investments.
Conclusion: The statutory auditor is required to qualify his report by stating that the
borrowing costs have been wrongly added to the cost of investments. It is required to
Charge the borrowing cost to the profit and loss account.
The effect of the same on the Profit for the year would also have to be mentioned in the
audit report.
Q.
No. 29
As a Statutory Auditor, how would you deal with: ABC Ltd. commenced construction
of a flyover in Mumbai in January, 2010 under BOLT scheme. The same was
completed in February, 2011. Due to seasonal heavy rains in July, 2010 in the area, the
work on the flyover had to be suspended for 1 month. The company accordingly
suspended borrowing costs of `12.50 lakhs for that month from capitalisation.
Answer: Capitalization of borrowing costs:
As per AS 16, “Borrowing Costs”, capitalization of borrowing costs should be
suspended in respect of periods in which active development is interrupted, except
for the situation when temporary delay is necessary as a part of the process or
substantial technical and administrative work is being carried out.
Thus, the test as to whether or not to capitalize the borrowing costs depends
primarily upon the nature of interruption of activities during “extended periods”.
In the instant case, it has been mentioned that the construction activity was
interrupted due to seasonal rain and hence being regular feature.
Conclusion: Borrowing cost of `12.50 lakhs incurred by ABC Ltd. should be
capitalized. Suspension of capitalization by the company is not a correct treatment and
statutory auditor should report accordingly.
AS - 17
Q.
No. 30
Following is the data regarding six segments of Z Ltd.:
(` in ‘000s)
Particulars
Segment Revenue (Rs.)
Segment Result (Rs.)
Segment Assets (Rs.)
A
B
C
D
E
F
150
310
40
30
40
30
25
(95)
5
5
(5)
15
20
40
15
10
10
5
The Finance Director is of the view that it is sufficient that segments A and B alone be
reported. Advise

Complied by: Pankaj Garg (CA, CS, CWA(I) – All India Topper, Gold Medalist)

Upcoming Batches: F2F@ SmartteachCA (IMA – ITO, Delhi) w.e.f. 30 May (MWF, 5.30 p.m.- 08.30 p.m.); Satellite@ETENCA w.e.f. 28 May (SS, 2 p.m – 5 p.m.)

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Answer: Identification of Reportable Segments:

As per AS 17 on ‘Segment Reporting’, “a business segment or geographical segment should be identified as a reportable segment if:

(i)

its revenue from sales to external customers and inter segment transfer is 10% or more of the total revenue, external and internal of all segments, or

(ii)

its segment result, whether profit or loss, is 10% or more of:

a. the combined result of all segments in profit; or

b. the combined result of all segments in loss,

whichever is greater in absolute amount; or

(iii)

its segment assets are 10% or more of the total assets of all segments.

AS 17 also requires that if total external revenues attributable to reporting segments constitute less than 75% of the total enterprise revenue, additional segments should be identified even if they do not meet 10% criteria. Conclusion: On the basis of the above the following conclusions emerge:

On the basis of the above the following conclusions emerge:  Segmental Revenue – A and

Segmental Revenue – A and B will be reportable segments since both these segments 10% or more of total revenue i.e., `6,00,000.

Segmental Results – A, B & F will be reportable segments since the result of these segments is 10% or more than (`1,00,000) the combined results of segments in loss.

Segment assets – A,B,C, D and E will be the reportable segments since there are 10% or more if total segmental assets i.e. `1,00,000. Hence all the segments have to be reported.

` 1,00,000. Hence all the segments have to be reported.  AS - 18 Q. No.

AS - 18

Q. No. 31

firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ

Ltd. during the year ended on 31.03.07. The total job work charges paid by XYZ Ltd. during the year are over Rs. 50 lakhs. The father is a Managing Director of XYZ Ltd. having substantial holding. The Managing Director told the auditor that since he is not involved in the activities of the firm and since the amount paid to it is insignificant; there is no need to disclose the transaction. He further contended that such a payment made in the last year was not disclosed. Is Managing Director right in his approach?

A

  Q. No. 32 Y of
Q. No. 32
Y
of

Answer: Related party Disclosures:

AS 18 “Related Party Disclosures” requires disclosure of related party relationship and transactions between a reporting enterprise and its related parties.

In the instant case, the managing director of XYZ Ltd. is a partner in the firm with his son, which has been paid Rs. 2 lakhs as job work charges. The managing director constitutes a substantial holding in the firm. And hence the transaction is covered by AS 18. Conclusion: The approach of the managing director is not tenable under the law and accordingly all disclosure requirements have to be complied. Accordingly, the approach followed by the Managing Director is not right. Under the circumstances, the auditor shall have to modify his report.

Ltd. wishes to obtain a machine tool costing `20 lakhs by way of lease. Effective life

the machine tool is 12 years but the company requires it only for the first five years.

It enters into an agreement with R Ltd. for a lease rental of `2 lakhs p.a.

The Finance Director of Y Ltd. is not sure about the treatment of these lease rentals and hence requests your assistance in proper disclosure of the same. For calculation purposes, the implicit rate of interest may be taken at 15%. Discount factors: 0.87, 0.76, 0.66, 0.57 and 0.50.

AS - 19

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Answer: Accounting Treatment of Lease Rental: The fair value of asset is `20 lacs and
Answer: Accounting Treatment of Lease Rental:
The fair value of asset is `20 lacs and the present value of lease rentals is `6.72 lacs. The machine is
required for 5 years only which is less than 50% of the economic life.
As per AS 19, having regard to substance of the transaction, the lease will be classified as an
operating lease. As per AS 19, the following may be disclosed:
Future minimum lease payments – Not later than 1 year
`2 lacs
Future minimum lease payments – Later than 1 year and not later than 5 years
`4.98 lacs
AS – 20
Q.
No. 33
As a statutory auditor for the year ended 31st March 2011, how would you deal with the
following: As on 31/3/2010, the equity share capital of X Ltd. is `10 crores divided into
shares of `10 each. During the financial year 20010-11, it has issued bonus shares in the
ratio of 1:1. The net profit after tax for the years 2009-10 and 2010-11 is ` 8.50
crores and ` 11.50 crores respectively. The EPS disclosed in the accounts for two years
is
` 8.50 and ` 5.75 respectively.
Answer: Disclosure of Earnings Per Share:
Relevant Provision:
 As per AS 20, in the case of a bonus issue, the number of equity shares outstanding
before the event of a bonus issue have to be adjusted for the proportionate change in
the number of equity shares outstanding as if the event had occurred at the beginning
of the earliest period reported.
 In view of the above, the EPS for both the years will have to be calculated taking the
equity share capital after the bonus issue as the denominator.
If the same is done the EPS for 31/3/2010 will be ` 4.25 and that for 31/3/2010 will
be ` 5.75. Since the above figures of EPS have not been disclosed, the company has
not complied with the provisions of the AS 20.
Conclusion: As EPS reported is not in compliance with AS 20, auditor is required to
qualify his report in terms of Sec. 227(3)(d) of the Companies Act, 1956.
Q.
No. 34
T
Pvt. Ltd. is an unlisted closely held company with turnover less than `50 crores. While
finalizing the accounts, Mr. M the Director (finance) disputed the applicability of AS 20
to
the company.
Answer: Applicability of AS - 20:
AS 20 “Earning Per Share”, is mandatory in respect of enterprises whose equity shares
or potential equity shares are listed on a recognised stock exchange in India. However,
every company is required under Part IV, Schedule VI to the Companies Act 1956, to
disclose EPS.
Accordingly, every company, which is required to give information under Part IV of
Schedule VI to the Companies Act, 1956, should calculate and disclose EPS in
accordance with AS 20, whether or not its equity shares or potential equity shares are
listed on a recognised stock exchange in India.
Conclusion: The contention of Director (Finance) is incorrect. The auditor will have to
ensure that EPS is disclosed as per AS 20 or else the auditor should appropriately modify
the audit report.
AS -22
Q.
No. 35
As a statutory auditor for the year ended 31st March 2011, how would you deal with the
following: X Ltd., a listed company, was incurring heavy losses since the last several
years and the industry in which it was functioning was not expected to perform
better in the next few years. While finalising the accounts for the year ended 31 st March
2010, the CFO of the company decided to create a Deferred Tax Asset for the tax benefits
that would arise in future years from the earlier years losses that had remained
unabsorbed in Income tax.

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AS -22

Or Do you approve of the following: Shakti Pan Masala (P) Ltd. was incurring heavy
Or
Do you approve of the following: Shakti Pan Masala (P) Ltd. was incurring heavy
losses in the last several years since it could not withstand the competition in the
market. The State in which the company had its registered office and also its major
sales had moved a bill in the State Assembly to ban manufacture and sale of all kinds
of Pan Masalas in the State. While finalizing the accounts for the year ended 31-03-
2011, the CFO of the company created a Deferred Tax Asset for the tax benefits that
would arise in future years from the earlier years losses that had remained unabsorbed
in Income Tax.
Answer: Recognition of Deferred Tax Assets:
Relevant Provision:
 AS 22 on “Accounting for Taxes on Income”, requires that deferred tax should be
recognised for all timing differences, subject to the considerations of prudence in
respect of deferred tax assets.
 The standard further states that where an enterprise has unabsorbed depreciation or
carry forward of losses under the tax laws, deferred tax assets should be recognised
only to the extent that there is virtual certainty supported by convincing evidence
that sufficient future taxable income will be available against which such deferred
tax assets can be realised.
This implies that there is a reasonable certainty that the carry forward losses would
be recouped in the future years.
Facts of the case:
In the instant case, looking to the fact that the industry in which the company was
functioning was not expected to perform well in the next few years, getting virtual
certainty and convincing evidence for the same would be almost impossible.
Hence, in the absence of virtual certainty for offset of the losses in future years,
creating a deferred tax asset would not be possible for the company.
Conclusion: The statutory auditor would therefore have to qualify his report by stating
that deferred tax assets have been created though there is no virtual certainty for
getting the said benefit in income tax.
He would also have to mention the amount by which the loss for the year has been
understated and the amount by which the reserves are overstated.
Q. No. 36
Comment: T Ltd. an Indian company, subject to Income tax Act, 1961, discloses
advance Income-tax paid (Current tax asset) and provision for Income-tax (Current tax
liability), separately in Balance Sheet for the year ended 31.3.2011, i.e., it does not
offset the amount.
[May 10 – New (5 Marks)]
Answer:
As per AS 22 – Accounting for Taxes in Income, an enterprise should offset assets
and liabilities representing current tax if the enterprise:
(i)
(ii)
has a legally enforceable right to set off the recognized amounts and
intends to settle the asset and liability on a net basis.
An enterprise will normally have a legally enforceable right to set off an asset and
liability representing current tax when they relate to income taxes levied under the
same governing taxation laws and the taxation laws permit the enterprise to make or
receive a single net payment.
Conclusion: T Ltd. is entitled to set off the advance tax against provision for tax, and
can show only the net amount in the balance sheet.

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AS - 25 Q. No. 37 As a Statutory auditor, how would you deal with
AS - 25
Q.
No. 37
As a Statutory auditor, how would you deal with following: A company which has
presented its quarterly results for a limited review report, has represented that
expenditure incurred on heavy repairs carried in that quarter are being spread over the
entire year, since it would otherwise, distort the quarterly results.
[Nov. 08 – Old (4 marks)]
Answer: Presentation of Quarterly Results (AS-25):
As per AS-25, "Interim Financial Reporting" (which is mandatory for all entities
preparing Interim Financial Report), uniform accounting policies are to be applied in
interim and annual F.S. It further says that uneven costs can also be anticipated or
deferred only if appropriate to do so at the end of the year.
Conclusion: In the instant case, in view of the above, as stated in AS-25, heavy repairs
can not be deferred to other quarters. If so done by the company, the limited review
report will have to contain a qualification for the same.
AS 26
Q.
No. 38
As an auditor, how would you deal with the following: PQR Ltd. had acquired a Brand
from another company for `100 lakhs. PQR Ltd. contends that since the said brand is a
very popular and famous brand, no depreciation or amortisation needs to be provided.
[Nov. 09 – Old (4 Marks)]
Answer: Amortization or Depreciation of Brand:
AS 26 “Intangible Assets” provides that an intangible asset should be measured
initially at cost. After initial recognition, an intangible asset should be carried at
cost less any accumulated amortization and any accumulated impairment losses.
The depreciable amount of an intangible asset should be allocated on a systematic
basis over the best estimate of its useful life. There is a rebuttable presumption that
the useful life of an intangible asset will not exceed ten years from the date when
the asset is available for use.
The auditor should satisfy himself that the value of brand is amortized in
accordance with AS 26, as brand is considered to be an intangible asset.
Conclusion: The contention of PQR Ltd., that Brand is very popular and famous, no
depreciation or amortization needs to be provided, is wrong and hence, the auditor will
have to qualify this matter in his report and quantify the amount of non-amortisation.
AS 29
Q.
No. 39
Comment: There is a sales-tax demand of Rs. 3 crores against X Ltd. relating to prior
years against which the company has gone into an appeal. [May 10 – Old (5 Marks)]
Answer:
As per AS 29 “Provisions, contingent Liabilities and Contingent Assets”, contingent
liability is:
(a)
(b)
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; or
present obligation that arises from past events but is not recognized because:
(i)
it is not probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; or
(ii)
a reliable estimate of the amount of the obligation cannot be made.
Accordingly in this case, when there is sales tax demand of Rs. 3 crores and the
company has gone in an appeal, it needs considerations as to whether the entire
demand is disputed, because it is difficult to presume that the demand by sales tax
authority is without any basis.

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AS -29

Conclusion: Therefore, to the extent the company considered 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. Note: The answer may also covers the requirement of reporting under CARO, Para No. 4(ix)(b)- “In case dues of Income Tax/ Sales Tax/ Service Tax/ Customs Duty/ Wealth Tax/ Excise Duty/ Cess have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned.

Q. No. 40

As on 31-3-2010, there was a claim for damage from one of the customers against the company engaged in selling of accounting software for an alleged failure to provide after sales services in relation to the software purchased from it. Before finalisation of accounts for the year ended 31-3-2010 (the accounts were finalised on 14th June, 2010), the company won the case and had no liability whatsoever in this regard. The company has made a provision for this contingent liability in its accounts for the year ended 31-3-2010, which it says, will be reversed in the next year.

31-3-2010, which it says, will be reversed in the next year. Answer : Accounting treatment of

Answer: Accounting treatment of Contingent Liabilities:

As per AS-29 ‘Provisions, Contingent Liabilities and Contingent Assets’ no provision should be made for a contingent liability. Only disclosures are to be made (in the notes to the account) in respect of contingent liabilities and even such disclosures are not required if the possibility of loss is remote.

Thus, the company’s accounting treatment – making provision for a contingent liability violates (AS) 29.



Impact of post balance sheet development – The company won the case and had no liability. This development has occurred after 31-3-2010 but before the date of finalisation of accounts (i.e. 14-6-2010). It should be taken into account for finalisation of accounts as it pertains to the conditions existing at the balance sheet date. The impact of this development is that even disclosures are not required as it is no longer a continent liability. If this development had not taken place, the company would be required to make disclosures of the contingent liability. Conclusion: Auditor should ask the company to rectify the accounts and reverse the provision made as on 31-3-2010 itself and also ask the company to remove any disclosures regarding this contingent liability in the notes to the accounts. If company does not do so, he should qualify his opinion on the truth and fairness of accounts and also quality his remarks regarding compliance with AS which he is required to make pursuant to Section 227(3)(d) of the Companies Act, 1956.

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Company Audit

Issue of prospectus  Section 62 of the Companies Act, 1956 deals with civil liability
Issue of
prospectus
 Section 62 of the Companies Act, 1956 deals with civil liability for mis-statements in the
prospectus.
 An Action in this case can be brought by a person who has sustained a loss or damage as a result
of subscription to the shares or debentures, on the faith of the prospectus containing an untrue
statement.
The liability would arise if the written consent of the auditor to the issue of the prospectus,
including the report purporting to have been made by him as an “expert” has been obtained.
However, auditor will not liable to third parties if he can prove that:
(a)
The prospectus was issued without his knowledge or consent and that on becoming aware of its
issue, he forthwith gave reasonable public notice that it was issued without his knowledge or
consent. He would withdraw his consent by writing to the company, to the ROC, to the stock
exchange and through suitable press publicity.
(b)
He withdrew his consent in writing before delivery of the prospectus for registration, or
(c)
After the delivery of prospectus for registration but before allotment of shares or debentures, on
becoming aware of the untrue misleading statement, he withdrew his consent in writing and gave
reasonable public notice of his withdrawal and of the reasons thereof, or
(d)
He was competent to make the statement and that he had reasonable grounds to believe up to the
time of allotment of the shares or debentures that the statement was true.
Q.
No. 1
Comment: Auditors liability to third parties in relation to issue of prospectus.
[Nov. 08 – Old (8 Marks)]
Or
Explain the liability of the auditor u/s 62 of the Companies Act, 1956, for making an
untrue statement in the report (as an expert forming a part of the prospectus).
[May 10 – New (5 Marks)]
Payment
controlled
by Co. law
Q.
No. 2
As an Auditor, comment on the following: BOD of PQ Ltd. has given donations of
`50,000 each to a charitable school and a trust for blinds, during the year ended 31-3-
2011. The average net profit of the company during last three financial years amounts
to `12 lacs.
Answer: Donation to Charitable Trust:
 Sec. 293(1)(e) of Companies Act, 1956, provides that the BOD of a Public Ltd. Co.
can not contribute to charitable and other funds (not directly relating to the business
of the company or the welfare of its employees), any amounts the aggregate of
which will, in any FY, exceed `50,000 or 5% of average net profits of the 3
preceding FYs, whichever is greater, (except with the consent of the company).
 In the given case, the donations given by the company are not directly relating to
business of the company or the welfare of its employees, hence in this case, the
BOD can contribute either
(i)
`50,000 or
(ii)
5% of average net profit of least 3 FYs i.e. `60,000 which ever is greater.
Conclusion: BOD has violated Section 293(1)(e) of the Companies Act, and this
matter should be reported in the auditor’s report.

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Branch Q. No. 3 Audit XLW has a branch office in Malaysia. The company has
Branch
Q.
No. 3
Audit
XLW has a branch office in Malaysia. The company has appointed Mr. X, who is
qualified to audit accounts as per Malaysian laws. Mr. Z, the statutory auditor objects
to
the same, contending that he alone can audit the branch office accounts. Discuss.
Can Mr. Z visit the branch?
Answer: Eligibility criteria for appointment as Branch Auditor
As
per Sec. 228 of the Companies Act, 1956, a company can appoint as auditor of a
foreign branch an accountant duly qualified to act as an auditor in accordance with the
laws of the foreign country.
Further, if the accounts of any branch office are audited by a person other than the
company’s auditor, the company’s auditor shall have the following rights:
 to visit the branch office if he considers necessary; and
 access at all times to books and vouchers maintained at the branch office.
Conclusion: Mr. Z contention that he alone can audit the branch office accounts is not
valid, however he has a right to visit the branch office if he so desires.
Q.
No. 4
Mr. P is the statutory auditor of S Ltd. which has a branch in Pune. The company in
general meeting decided to have the accounts of Pune Branch audited by Mr. Q who
was appointed without Mr. P’s knowledge and consent. State your comments on the
above with reasons.
Answer: Appointment of Branch auditor:
As per Sec. 228(3)(a), where a company in general meeting decides to have the
accounts of a branch audited otherwise than by the company’s auditor, the company in
that meeting shall do either of the following two things:
(a)
(b)
appoint an eligible person as branch auditor, or
authorise the BOD to appoint such a person in consultation with the company’s
auditor.
Conclusion: So, it is clear that if the company itself appoints the branch auditor in
general meeting there is no need for consultation with the statutory auditor. The need
for consultation with company’s auditor arises only when the BOD appoint the branch
auditor. Appointment of Mr. Q as branch auditor without P’s consent is Valid.
Q.
No. 5
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 Rs.10 crores for the year 2004-05. Comment.
Answer: Reference of Branch audit exemption in audit Report:
Companies (Branch Audit Exemptions) Rules, 1961 provides for the exemption of a
branch office of a company carrying on manufacturing, processing or trading activity
from the provisions of section 228, if the average quantum of activity of the branch
does not exceed the higher of `2 lakh or 2% of the average of the total turnover
(Including other incomes).
As the turnover of the branch is less than the limit prescribed above, hence audit of
concerned branch is not required. However, as per Rule 7 of above said rules,
auditor is required to refer the exemption in his report.
Conclusion: Auditor fails to comply with the requirements of Rule 7.

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Schedule VI Q. No. 6 Comment on the following: X Ltd., paid `25 lakhs as
Schedule VI
Q.
No. 6
Comment on the following: X Ltd., paid `25 lakhs as advance to Y Ltd. towards the
purchase of a printing machinery on 15.1.11 with delivery instructions to deliver the
same in the last week of June, 11. Further on 2.2.11 X Ltd. purchased two diesel
generator sets from Y Ltd. for `30 lakhs on 90 days Credit term. In the accounts for
2010-11, X Ltd. intends to adjust the advance paid against Credit purchase and show
the net amount of `5 lakhs as due from them. As the statutory auditor, how would you
deal with this?
[Nov. 08 – New (5 Marks)]
Answer: Adjustment of advance paid against the Personal Account:
X Ltd. has paid advance amount to the supplier of machinery to be used in the
project, such advance amount is required to be shown under the head ‘Capital Work
in Progress’, in terms of requirement of Schedule VI to the Companies Act, 1956
and the existing accounting practice.
If the advance is for purchase of other machinery, it should be grouped under a
separate head ‘Advance Payment for Capital Expenditure’ and should be disclosed
as next item to Fixed Assets in the Balance Sheet.
Conclusion: Proposal of X Ltd., to show the net balance in the personal account of Y
Ltd., is not correct. Such proposal will conceal two material items in the B/S – one,
expenditure towards capital asset and the other current liability for purchase of the
generator set.
Auditor should advise X Ltd., to show these two items separately. If X Ltd., does not
accept the advice, the auditor should qualify his report with suitable quantification of
amount involved.
Q.No.7
Comment on the following as auditor: Interest paid or payable to the managing director
or manager has not been shown separately in profit and loss account on the ground that
it is not even 0.1% of total interest paid / payable.
Answer:
Clause 3(v) of Part II of Schedule VI to the Companies Act, 1956 requires that the profit and loss
account shall disclose interest paid or payable to the managing director or manager. In view of this
specific statutory requirement, interest paid or payable to the managing director or manager are
material irrespective of their quantum and should be disclosed separately. If not disclosed, auditor
will have to qualify his audit report.
Audit of
Q.
No. 8
Dividends
State your views as an auditor on the following: During the year under audit, Ram Ltd.
credited to the Profit and Loss Account, the entire profit of ` 20 lakhs on the sale of
land not required for its use. You are informed that the directors would like to propose
dividend out of the above profit.
Answer: Distribution of Capital Profits as Dividend:
Profit of ` 20 lakhs on the sale of land is a capital profit. It represents the excess of sale value over
the original cost of the asset, i.e capital profits. The capital profits can be distributed by a company
only if all the following conditions are fulfilled:
4. The articles of association should permit distribution of capital profits.
5. The capital profit which is sought to be distributed should have actually been realised.
6. The capital profit should remain after a proper valuation has been fairly taken of the whole
of the assets and liabilities.
Conclusion: The profit arise on sale of land is realized in cash and hence subject to satisfaction of
other conditions can be distributed as dividend.

Complied by: Pankaj Garg (CA, CS, CWA(I) – All India Topper, Gold Medalist)

Upcoming Batches: F2F@ SmartteachCA (IMA – ITO, Delhi) w.e.f. 30 May (MWF, 5.30 p.m.- 08.30 p.m.); Satellite@ETENCA w.e.f. 28 May (SS, 2 p.m – 5 p.m.)

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Audit of

Dividends

Q. No. 9

Give your views on the following:

The rates of equity dividend declared and paid by a company are as follows:

2008-2009

15%

2007-2008

12%

2006-2007

12%

The company has earned sufficient profit after tax in 2009-10 and wishes to propose a

dividend on equity shares at 11% of the current profits and transfer to Reserve 20%.

The company has not issued any bonus shares during the last few years. The post-tax profit in 2009-10 is higher than the corresponding profit of each of the previous three years.

Will it make any difference if the company proposed a rate of equity dividend @

(a)

(b)

20%?

Will it make any difference if the amounts of net profits after tax of the company are as follows:

2009-2010

10,00,000

2008-2009

17,00,000

2007-2008

15,00,000

2006-2007

18,00,000

2007-2008 15,00,000 2006-2007 18,00,000 Answer  The proposal is not legally sustainable. Transfer

Answer

The proposal is not legally sustainable. Transfer to reserves at a %age higher than 10% can be made only when the company complies with the requirements laid down by the Companies (Transfer of Profits to Reserve) Rules.

  Q. No. 10
Q. No. 10

Ensure minimum distribution of dividend i.e average rate of dividend for the immediately preceding three years. In the present case the average rate of dividend works out to 13%. The dividend proposed in 2009-10, viz. 11% is less than this rate and, therefore the company cannot transfer higher than 10%.

Further company’s post-tax profit is not less than the average post-tax profit for the last two years and no bonus shares have been issued by the company during 2009-10 or in the preceding three years, therefore transfer higher than 10% will not be allowed. (a) Dividend @20%: As the company ensures minimum distribution of dividend i.e. average rate of last three years, the company’s proposal to transfer to reserves @ 20% would be in order. (b) In this case also, the company can pay dividend @11% without ensuring minimum distribution as the current year profit is less by more than 20% of average profits of last two years. The post-tax profit for the current year is `10,00,000 whereas the average post tax profit, taking 2008-2009 and 2007-2008 figure into account is `16,00,000; the former is less than the latter by about 37.5%.

As an Auditor, comment on the following situation: JKT Ltd. having `40 lacs paid up capital, `9.50 lacs reserves and turnover of last three consecutive financial years immediately preceding the financial year under audit, being `4.90 crores, `4.50 crores and `6 crores, but does not have any internal audit system. In view of the management, internal audit system is not mandatory.

Or Comment: The company has a turnover exceeding `5 crores for a period of three consecutive financial years immediately preceding the financial year concerned, but does not have any internal audit system.

CARO

Answer:

As average annual turnover of preceding three years exceeds `5 Crores, auditor is required to report on non-existence of internal audit system by virtue of requirement of Para 4(vii) of CARO.

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CA – Final Advanced Auditing & Professional Ethics

CARO Q. No. 11 As an auditor, state your view on the following: A Public
CARO
Q.
No. 11
As an auditor, state your view on the following: A Public Company defaulted in the
repayment of deposits together with interest on the due date for more than a year and
the Chief Accountant contends that the auditor need not report on the default
committed by the company.
Answer: Reporting required under Para 4(vi) of CARO and under Sec, 227(3)(f).
Misc.
Q.
No. 12
As a statutory auditor for the year ended 31st March 2010, how would you deal with
the following: P Ltd. has filed a petition in the High Court for adjustment of product
development expenses of `50 crores against the balance in Securities Premium
account. While finalizing the accounts, the directors carried out the said adjustment
since they were certain that the High Court approval would be received. The said
petition has not come up for hearing till the date of signing of the accounts by the
auditor.
Answer: Adjustment of Product Development Expenses against Balance in the
Securities Premium Account:
 Product development expenses are normally classified as revenue expenditure. In
Adjustment of such expenses against Securities Premium Account is violation of
generally accepted accounting principles.
 However, any adjustment that is approved by the High Court will override the
generally acceptable accounting principles.
In the instant case, though the company has filed a petition in the HC for such
adjustment, and though the directors are certain that the HC would approve the
adjustment, the petition has not been finalised till the date of signing of accounts.
Conclusion: The company cannot carry out the said adjustment. The statutory auditor,
therefore, will have to qualify his report by stating that the product development
expenses have been adjusted against the Securities Premium Account rather than
treating them as the revenue expenditure and writing it off to the P & L A/c.
The statutory auditor would also have to mention the amount by which the profit for
the year has been overstated.
Q.
No. 13
Y Ltd. has accumulated losses of `12 crores. The Reserves and Surplus of the said
company also include “Securities Premium Account” of `15 crores. The company
intends to adjust the accumulated losses against the “Securities Premium Account”. Is
the company permitted to do so under the provisions of the Companies Act, 1956?
Answer:
Not permitted by virtue of Sec. 78.

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PROFESSIONAL ETHICS

Q. No. 1 X, a practicing chartered accountant paid 25% of the audit fees received
Q.
No. 1
X, a practicing chartered accountant paid 25% of the audit fees received by him to his employee Y,
who was an M.Com., under the nomenclature of office allowance and such an arrangement continued
for a number of years. Comment.
Answer: Sharing fees with Employees:
As per clause (2) of Part I of the First Schedule to the Chartered Accountants Act, 1949 , a CA in
practice is deemed to be guilty of professional misconduct if he pays or allows or agrees to pay or
allow, directly or indirectly, any share, commission or brokerage in the fees or profits of his
professional business, to any person other than
 a member of the Institute or
 a partner or
 a retired partner or
 the legal representative of a deceased partner,
 or a member of any other professional body or
 with such other persons having such qualification as may be prescribed,
for the purpose of rendering such professional services to time in or outside India.
Conclusion: In the given case in substance the CA has shared his profit and therefore, is guilty of
professional misconduct under the clause. It is not the nomenclature to a transaction that is material
but it is the substance of the transaction, which has to be looked into.
Q.
No. 2
T, a practicing CA uses the designation, ‘Municipal Councillor’ apart from the expression ‘FCA’ on
his visiting card. Comment.
Answer: Using designated other than CA:
As per clause (7) of Part I of the First Schedule to the CA Act, 1949 , a CA in practice is deemed
to be guilty of professional misconduct if he Advertises his professional attainments or services,
or uses any designation or expressions other than the CA on professional documents, visiting
cards, letter heads or sign boards.
However, an recognized degree of university or title indicating membership of ICAI or other
recognized institution may be used.
It also restrains a member from using any designation or expression other than that of a CA in
documents through which the professional attainments of the member would come to the notice of
the public.
Conclusion: A member is not permitted to use the designation such as ‘Member of Parliament’,
Municipal Councillor’ or any other functionary in addition to that of CA. Therefore under this clause
T is guilty of professional misconduct.
Professional
Q. No. 3
Write short note on: Professional Negligence.
[May 09 – Old (4 marks)]
Negligence
Answer: Professional negligence:
Negligence, which is culpable, generally consists of under mentioned three elements:
(a)
Existence of duty or responsibility owed by one party to another to perform some
act with certain degree of care and competence.
(b)
Occurrence of a breach of such duty and
(c)
Loss or detriment, being suffered by the party to whom the duty was owed as a
result of negligence.
In this context, professional negligence would constitute failure to perform duties
according to "accepted professional standards", resulting in some damage to a party to
whom duty is owed.

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Bank Audit

Q. No. 1 Mr. X, a practicing CA, has been issued a credit card by
Q. No. 1
Mr. X, a practicing CA, has been issued a credit card by State Bank of India. He used the credit card for
buying clothes for him for Rs. 1200. Is he eligible for appointment as one of the auditors of the Bank?
Answer: Disqualification for appointment as an auditor:
Relevant Provisions:
 Sec. 30 of the Banking Regulation Act, 1949 requires that the Balance Sheet and Profit and Loss
Account of a banking company should be audited by a person duly qualified under any law for the
time being in force to be an auditor of companies.
 According to section 226(3)(d) of the Companies Act, 1956, a person who is indebted to the company
for an amount exceeding `1,000, or who has given any guarantee or provided any security in
connection with the indebtedness of any third person to the company for an amount exceeding `1,000,
can not be appointed as an auditor.
 It is to be noted that the disqualification is not confined to appointment as auditor of the particular
branch to which the debt is owed, but to any branch.
In the context of banks, the expression indebtedness would cover, inter alia, the amounts outstanding
in respect of credit cards issued by a bank.
Conclusion: Thus, where the credit card outstanding exceed the prescribed limit of `1,000, the CA in
whose name the card is issued as well as the firm of which he is a partner would be disqualified for
appointment as auditor of the issuing bank. X is not eligible for appointment as an auditor of the Bank.
Q. No. 2
Your firm has been appointed as Central Statutory Auditors of a Nationalised Bank. The Bank follows
financial year as accounting year. State your views on the following issues which were brought to your
notice by your Audit Manager:
(a)
The bank has recognised on accrual basis income from dividends on securities and Units of Mutual
Funds held by it as at the end of financial year. The dividends on securities and Units of Mutual
Funds were declared after the end of financial year.
(b)
The bank is a consortium member of Cash Credit Facilities of ` 50 crores to X Ltd Bank's own share
is ` 10 crores only. During the last two quarters against a debit of ` 1.75 crores towards interest the
credits in X Ltd's account are to the tune of ` 1.25 crores only. Based on the certificate of lead bank,
the bank has classified the account of X Ltd as performing.
Answer:
(a)
Income Recognition:
Income from dividend on shares of corporate bodies and units of mutual funds should be booked
on cash basis.
In respect of income from government securities and bonds and debentures of corporate bodies,
where interest rates on these instruments are pre-determined, income could be booked on accrual
basis, provided interest is serviced regularly and as such is not in arrears.
Banks may book income from dividend on shares of corporate bodies on accrual basis, provided
dividend on the shares has been declared by the corporate body in its AGM and the owner's right
to receive payment is established. This is also in accordance with AS-9 as well.
In the instant case, the recognition of income by the bank on accrual basis is not in order
(b)
NPA Classification in Consortium advances:
 In consortium advances, each bank may classify the advance given by it according to its own
experience of recovery and other factors.
 Since in the last two quarters, the amount remains outstanding and, thus, interest amount should
be reversed.
 Despite the certificate of lead bank to classify the account as performing, the advance need to be
classified as non-performing asset.

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Q. No. 3 Write a short note on: Corporate Debt Restructuring. Answer: Corporate Debt Restructuring
Q. No. 3
Write a short note on: Corporate Debt Restructuring.
Answer: Corporate Debt Restructuring (CDR)
 CDR system has been evolved for restructuring of the corporate debts of viable entities facing
problems, which are out side the purview of BIFR, DRT and other legal proceedings. All the banks
have been advised by RBI to follow the CDR mechanism which would be a non-statutory voluntary
system based on debtor creditor agreement and inter creditor agreement.
 The mechanism will apply only to the multiple banking account/syndicate/consortium with an
outstanding exposure of `20 crore and above by bank and financial institutions.
 CDR would generally affect the operations both at Branch level as well as the Head Office level,
although, in most of the cases the effects of provisioning as envisaged in the RBI circular due to
sacrifice in the interest would be made at the Head Office level.
 In case of restructuring of the principal amount, auditors should verify that adequate security coverage
of the loan/credit account is available.

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TAX AUDIT

Q. No. 1 A public charitable trust earns ‘income’ of Rs.10 lakhs from Unit Trust
Q.
No. 1
A public charitable trust earns ‘income’ of Rs.10 lakhs from Unit Trust of India, which is not taxable
under Section 10(33) of Income-tax Act, 1961. It spends Rs.7 lakhs on its activities. The entire
expenditure is vouched and is in accordance with the trust objects and is fully allowable as ‘application’.
As Auditor of the Trust, would you require the trust to make any provision for tax in its accounts?
Answer: Tax audit of Public Trusts:
 Section 10(33) of the Income-tax Act, 1961 provides exemption in respect of income received
in respect of units from UTI to all assessees including a public charitable trust. Hence, `10
lakhs received from UTI is not taxable income of the trust. The Income-tax Act, 1961
requires that for claiming full exemption by the trust, it is required to apply at least 85% of
such income during the previous year for charitable or religious purposes.
 As per the facts given, the trust has applied only ` 7 lakhs i.e. 70% of its total income towards
the trust objects and, thus, contravened the requirements of the Act. Yet the trust shall not be
required to pay tax on its income because the income has been received on account of units,
which in any case is fully exempt.
 Accordingly, the trust is not required to make any provisions for tax in the accounts. The fact
that not spending `3 lakhs out of `10 lakhs, though contravening the requirement of spending
at least 85% of "income" would, therefore, not attract tax. Hence, no tax provision is
necessary.
Q.
No. 2
Mr. P carries on the business of dealing and export of diamonds. For the year ended 31st March, 2011,
you as the tax auditor, find that the entire exports are to another firm in U.S.A., which is owned by Mr.
P’s brother.
Answer: Export Payments to a Relative:
Clause 18 of Form 3CD, requires the tax auditor to specify particulars of payments made to
persons specified u/s 40(A)(2)(b) of the Income Tax Act, 1961. Persons specified in the said
section are relatives of an assessee and sister concerns, etc.
In the instant case, however, Mr. P has not made any payments to his brother. On the
contrary, he must have received payments from him against exports made and, thus, this
clause would not be applicable to him.
Mr. P will nonetheless be still as a part of his normal audit planning would be required to
verify whether the exports are genuine, i.e., whether the diamonds have been delivered by
verifying the necessary delivery documents, relevant invoices, etc., the reasonableness of the
price and whether the export realisations have been received.
Q.
No. 3
Mr. X deals in a commodity and purchase and sales of that commodity is ultimately settled otherwise than
by the actual delivery. During the financial year 2010-11 he purchased the commodity worth ` 55 Lacs
and sold the same commodity for ` 64 Lacs and the contract was settled otherwise than by the actual
delivery. X seeks your advice whether he is liable for tax audit u/s 44AB of the Income Tax Act.
Answer: Liability for Tax Audit in case of Speculative Transactions:
Mr. X deals in commodity as a speculator. A speculative transaction means a transaction in
which a contract for the purchase or sale of any commodity, including stocks and shares, is
periodically or ultimately settled otherwise than by the actual delivery.
As such, in such transaction the difference amount is ‘turnover’. In the given case the
difference of ` 64 lacs and ` 55 lakhs i.e, `. 9 Lakhs is the turnover.
In such transactions though the contract notes are issued for full value of the purchases or
sales, but the entries in the books of account are made only for the differences.
Conclusion: Mr. X is not liable for Tax audit under section 44AB of the Income Tax Act, 1961.

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Q. No. 4 A leading jewellery merchant used to value his inventory at cost on
Q. No. 4
A leading jewellery merchant used to value his inventory at cost on LIFO basis. However, for the current
year, in view of requirements of AS-2, he changed over to FIFO method of valuation. The difference in
value of stock amounted to `55 lakhs which is higher than that under the previous method. In such a
situation, what are the reporting responsibilities of a Tax Audit u/s 44AB of Income Tax Act, 1961.
Answer: Reporting Requirement in case of change in valuation of stock:
 Change in the method of valuation of stock is not a change in method of accounting, as it is
only a change in accounting policy. However in the Income Tax Act, 1961 this is considered
under method of accounting. Under the Income-Tax Act, 1961 if the change in method of
valuation is bonafide, and is regularly and consistently adopted in the subsequent years as
well, such change would be permitted to be made for tax purposes.
 In the instant case, the change in the valuation of stock from LIFO basis to FIFO basis is
pursuant to mandatory requirements of the AS-2 ‘Valuation of Inventories’ and therefore
should be viewed as bonafide change.
 This apart, the tax auditor in his report has to specifically refer to the method of valuation of
stock under Clause 12 in Form 3CD.
 Method of valuation of closing stock employed in the previous year.
 Details of deviation, if any, from the method of valuation prescribed u/s 145A and the
effect thereof on profit or loss.

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MISCELLANEOUS

SEBI

Guidelines

Q. No. 1

As the auditor of LMN Ltd. you notice certain differences in the figures between the books of account and offer document. The company explains that it is due to certain

adjustments made as per SEBI (Disclosure and Investor Protection) Guideline, 2000. State such disclosure and adjustments which are to be incorporated in the Financial Statement

of the offer document.

[Nov. 08 – New (8 Marks)]

Answer: SEBI (Disclosure and Investor Protection) Guidelines, 2000 require following disclosure and adjustment in the F.S. to be incorporated in the offer document:

All significant accounting policies and standards followed in the preparation of the F.S. shall be disclosed.

Statement of assets and liabilities and P & L or any other financial information shall be incorporated after making the following adjustments:

(a)

(b)

incorporated after making the following adjustments: (a) (b) (i) (ii) Incorrect accounting policies or failures to

(i)

(ii)

Incorrect accounting policies or failures to make provisions or other adjustments which resulted in audit qualifications. Where there has been change in accounting policy, the profits or losses of the earlier years and of the year in which the change has taken place shall be recomputed to reflect what the profits or losses would have been if a uniform accounting policy was followed in each of these years. Statement of profit or loss shall disclose both the profit and loss before and after considering the profit or loss from extraordinary items. The statement of assets and liabilities shall be prepared after deducting the balance outstanding on revaluation reserve account from both fixed assets and reserve and the net worth arrived at after such deduction.

(iii)

(iv) Q. No. 2 1. 2. 3. 4. More specifically it can show – 
(iv)
Q. No. 2
1.
2.
3.
4.
More specifically it can show –

Flowchart

Explain briefly the Flow Chart technique for evaluation of the Internal Control system. [Nov. 09 – New (4 Marks)]

techniques

for

evaluation of

Answer: Flow-Chart Technique for evaluation of Internal Control:

It is a graphic presentation of internal controls in the organisation and is normally drawn up to show the controls in each section or sub-section.

IC System

It provides the most concise and comprehensive way for reviewing the internal controls and the evaluator’s findings.

A flow chart is a diagram full with lines and symbols and if judicious use of them can be made, it is probably an effective way of presenting the state of internal controls in the client’s organisation.

A properly drawn up flow chart can provide a neat visual picture of the whole activities of the section or department involving flow of documents and activities.

at what point a document is raised internally or received from external sources;

the number of copies in which a document is raised or received;

the intermediate stages set sequentially through which the document and the activity pass;

distribution of the documents to various sections, department or operations;

checking authorisation and matching at relevant stages;

filing of the documents; and

final disposal by sending out or destruction.

P a g e

| 42

CA – Final Advanced Auditing & Professional Ethics

Investigation

Q.

No. 3

A state government has appointed you as an investigator to investigate into the affairs of the sick company. Investigation in such a case involves detailed examination of records for several years, collection of information from different sources and analysis of facts and figures. Briefly discuss the major steps involved in such an investigation.

Audit Q. No. 4 Planning Write short notes on: Usefulness of careful and adequate audit
Audit
Q.
No. 4
Planning
Write short notes on: Usefulness of careful and adequate audit planning.
[May 09 – Old (4 marks)]
Answer: Usefulness of careful and adequate Audit Planning
The auditor should plan his work to enable him to conduct an effective audit in an
efficient and timely manner. Careful and adequate audit planning helps him to:
(i)
Ensure that appropriate attention is devoted to important areas of the audit
(ii)
Ensure that potential problems are promptly identified
(iii)
Ensure that the work is completed expeditiously
(iv)
Utilize the assistants properly and
(v)
Co-ordinate the work done by other auditors and experts