PAPER – 6: AUDITING AND ASSURANCE

QUESTIONS
1. State with reasons (in short) whether the following statements are True or False.
a. There is no difference between the terms “external audit” and “statutory audit”.
b. It is auditor’s responsibility to maintain adequate accounting system incorporating various
internal controls.
c. Fraud is more difficult to detect than error.
d. An unqualified opinion in audit report is a guarantee as to the future viability of the
company.
e. The auditor of a company has a right to carry out surprise checks of transactions beyond the
end of the accounting year for which he is reporting.
f. Since client pays for the audit, the audit working papers belong to the client.
g. Potential for individuals to gain unauthorized access to data or to alter data without visible
evidence is not there in CIS systems.
h. If auditor relies on the work of an expert and expresses an unqualified opinion, he should
refer to the work of the expert in his report.
i. A Government company cannot contribute amounts to a political party or to any person for
political purpose.
j. Evidence obtained by the auditor through judgmental sampling cannot be considered
sufficient appropriate audit evidence.
k. It is auditor’s responsibility to maintain an adequate accounting system incorporating various
internal controls.
l. The risk of not detecting error is more than the risk of not detecting fraud.
m. Basically, an auditor reports on the truth or otherwise of the financial statements; prevention
and detection of frauds and errors are secondary to this.
n. Fraud means misappropriation of goods or cash and artificial manipulation of accounts.
o. In case of audit of partnership or sole proprietorship, the auditor’s duties are defined purely
by the contract between him and the client.
p. The auditor may, in planning the audit work, intentionally see the cut-off level for verifying
individual transactions at a lower level than in intended to be used to evaluate the results of
the audit.
q. If the directors are of the opinion that any fixed asset does not have a realizable value at least
equal to its book value, the fact should be stated in the accounts.
r. Interest accrued but not due on “Investments” is required to be shown under appropriate sub-
heads under the head “Investments”.
s. An auditor holds office till the due date of the next annual general meeting as determined by
Sections 166 and 210 of the Companies Act, 1956.
 t. In extreme cases, such as situations involving multiple uncertainties that are significant to
the financial statements, the auditor should express a disclaimer of opinion.
u. A company may maintain its books of accounts according to either mercantile system of
accounting or cash system of accounting but not mixed system.
v. An employee of the company cannot be appointed as auditor of its branch under section 228.

Answer:
a. False: “External audit” is a wider term than “statutory audit”. It will cover independent audits –
whether voluntary audits/statutory audits.
b. False: As SA 200, it is management’s responsibility and not auditor’s responsibility.
c. True: Fraud is more difficult to detect than error. This is because fraud generally involves
sophisticated and carefully organized schemes to conceal it such as forgery, deliberate failure to
record transactions, intentional misrepresentations to the auditor.
d. False: Auditor’s opinion (even an unqualified one) is not an assurance as to the future viability of the
company as given in SA 200A.
e. True: The auditor is appointed at the Annual General Meeting to hold office until the next Annual
General Meeting. He is not appointed for a particular accounting year. Consequently, he has the right
of examination of the accounts and records of the company at any time during the period covered by
his appointment, in so far as it is necessary for the purposes of his report. He may, therefore, carry
out surprise checks of transactions beyond the end of the accounting year for which he is reporting.
f. False: Working papers are the property of the auditor. The client does not have a right to access the
working papers of the auditor. The auditor may, at his discretion, make portions of or extracts from
his working papers available to the client.
g. False: Potential for individuals to gain unauthorised access to data or to alter data without visible
evidence may be greater in CIS than in manual systems.
h. False: When expressing an unqualified opinion, the auditor should not refer to the work of an expert
in his report. If, as a result of the work of an expert, the auditor decides to express other than an
unqualified opinion, it may in some circumstances benefit the reader of his report if the auditor refers
to or describes the work of the expert. Where, in doing so, the auditor considers it appropriate to
disclose the identity of the expert, he should obtain prior consent of the expert for such disclosure if
such consent has not already been obtained.
i. True: Section 293A of the Companies Act, 1956 prohibits Government company from contributing
amounts to a political party or to any person for a political purpose.
j. False: The rates of depreciation prescribed by Schedule XIV to the Companies Act, 1956 are the
minimum rates to be charged. AS 6 notified under section 211(3C) of the Companies Act, 1956 also
states that rates lower than statutory rates cannot be charged unless permitted by the statute itself.
k. False: As per SA 200, it is management’s responsibility and not auditor’s responsibility.
l. False: Fraud is more difficult to detect than error. This is because fraud generally involves
sophisticated and carefully organized schemes to conceal it such as Forgery, Deliberate failure to
record transaction, International misrepresentations to the auditor.
m. False: The main objects of any audit are: (a) To certify the correctness of the financial position as
shown in the balance sheet and the accompanying revenue statements, (b) detection of errors, (c)
detection of fraud. [STPAM’s case, (2008) 170 Taxman 371 (Bom.); Frankston and Hastings
Corporation v. Cohen (1960) 102 CLR 607].
n. True: From the auditor’s point of view, fraud means misappropriation of goods or cash and artificial
manipulation of accounts. (SA 240)
o. True: No basic legal requirement for audit. So, auditor’s duties and rights are a matter of contract.
p. True: This may be done to cover a large number of items and thereby reduce the likelihood of
undiscovered frauds, errors. It would provide the auditor with the margin of safety when evaluating
the effect of misstatements discovered during the audit.
q. False: This requirement of Part I Schedule VI to the Companies Act, 1956 applies to Current Assets,
Loans and Advances and not to Fixed Assets.
r. False: Interest accrued on “Investments” (whether due or not) should be shown under the head
“current Assets, Loans and Advances” under the sub-head “Current Assets” as the very first item
“Interest accrued on investments”.
s. False: He (auditor) holds office until the conclusion of the next AGM Section 224(1).
t. False: As per SA 700, the auditor should consider expressing a disclaimer of opinion (and if he
believes it is necessary in circumstances, he should express a disclaimer of opinion).
u. False: A company may maintain its books of account according to the double entry system of
accounting [Section 209(3)].
v. True: An employee of the company cannot be appointed as auditor of its branch under Section 228.

Q. 2: State with reasons (in short) whether the following statements are true or False.
(a) Auditor’s primary responsibility is to detect errors and frauds.
(b) The decision in the London and General Bank case spelled out the auditor’s duties towards
prevention and detection of fraud and error in specific terms.
(c) Financial auditor is not concerned with propriety of business transactions.
(d) Test checks may be applied to all transactions.
(e) In case of limited companies, the statutory auditor shall comment whether the internal audit
system commensurate with the size and nature of business.
(f) The auditor examines debit notes to vouch sales return.
(g) Inventory turnover ratio is calculated by the auditor to obtain evidence concerning
management’s assertion about valuation of inventory.
(h) The first auditors of a public limited company appointed by the board of directors hold office
till the conclusion of its statutory meeting.
(i) If an auditor lacks independence, he may issue an adverse report.
(j) The CAG conduct audit of Government companies.
(k) Statutory audit means an audit where duties, rights etc. of the auditor are laid down by law.
(l) Auditor should not disclose to his client anything that comes to his notice during audit.
(m) There is no difference between “fraudulent financial reporting” and “window dressing”.
 (n) If company’s cash is used personally by the cashier and is made up on demand by the
managements, it can be said that the financial statements are misstated.
(o) Loss of major markets means that going concern assumption is lost.
(p) As soon as audit report is signed and issued, auditor should destroy audit working papers.
(q) There is a inverse relationship between detection risk and combined level of inherent and
control risk.
(r) SA 402 deals with responsibility of the auditor of the service organisation.
(s) Vouching is mere comparison of the entries in the books of account with evidence supporting
the entries.
(t) Change of method of depreciation is entirely at the discretion of the management of the
company.
Answer:
(a) False: Auditor’s primary responsibility, as per AAS-2 (SA 200 A) , is to express an opinion on
financial statements.
(b) True: Lord Justice Lindley observed in this case, - “An auditor has nothing to do with prudence or
imprudence of making loans without security. It is nothing to him whether the business of the
company is being conducted prudently or imprudently, profitably or unprofitably, it is nothing to
him whether dividends are properly or improperly declared provided he discharges his own duty to
the shareholders. His business is to ascertain and state the true financial position of the company at
the time of audit and his duty is confined to that.”
(c) False: The financial auditor, as per AAS-2 (SA 200 A), is not generally, concerned with propriety
of business conduct. However, the Companies Act, 1956 has provided for propriety audit relating
to some specific transactions in case of limited companies.
(d) False: Some transactions like opening and closing entries, depreciation entries and non-recurring
or exceptional transactions should not be subject to test check. Cash book and pass book should be
thoroughly checked.
(e) False: Clause 4(vii) of CARO, 2003 requires the auditor to comment whether the company has an
internal audit system commensurate with the size and nature of business. This clause is
compulsorily applicable to listed companies. However, in case of unlisted companies the clause is
applicable only if its:
(a) paid-up capital and reserves of the company are more than rupees fifty lakh as at the
commencement of the financial year; or
(b) average annual turnover exceeds five crores for a period of three consecutive financial year
preceding the financial year under audit.
(f) False: The auditor should examine purchase return book with reference to copies of debit notes
issued to suppliers and outward return notes to vouch purchase return.
(g) True: Calculation of inventory turnover ratio and their comparison with those of previous years’
ratio will provide an evidence on correct valuation of slow-moving, defective and obsolete items
included in inventories.
(h) True: Section 224(5) has laid down the tenure of first auditors until the conclusion of the first
annual general meeting. The first general meeting of a public limited company is referred to as
statutory meeting as per the provisions of section 165(1).
(i) False: An auditor who lacks independence must issue a disclaimer of opinion audit report.
(j) False: The Chartered Accountant(s) appointed by the CAG as statutory auditor conducts the audit
of government companies. The CAG has a right to conduct supplementary audit.
(k) True: It means audit required by law. In such cases, law lays down the rights duties of auditors.
(l) False: Confidentiality in SA 200 means not to disclose information acquired in course of work to a
third party without client’s consent unless there is a legal/professional duty to disclose.
(m) False: “Fraudulent financial reporting” is wider term than “window dressing”. Fraudulent financial
reporting covers both accounts made to show better position than actual (window dressing) and
accounts being made to show worse position than actual.
(n) True: The amount detected and recorded may only be “tip of the ice-berg”. It may suggest serious
weaknesses in internal controls. Knowledge of what the employee did ought to have a direct
bearing on the nature and details of checks to be applied in relation to matters dealt with by the
employee.
(o) False: The loss of major markets is only an indication that going concern assumption may not be
appropriate. It is not a conclusive evidence that going concern assumption is not be appropriate.
There may be mitigating factors such as a compensating new major market.
(p) False: According to Expert Advisory Committee’s view, auditor should normally maintain working
papers for 10 years.
(q) True: There is inverse relationship between detection risk and combined level of inherent and control
risk. When inherent and control risk are high, the auditor accepts a low level of detection to reduce
overall audit risk. (SA 315 “Identifying and Assessing the Risk of Material Misstatement through
Understanding the Entity and its Environment” and SA 330 “The Auditor’s Responses to Assessed
Risks”
(r) False: SA 402 “Audit Considerations Relating to Entities Using Service Organizations” deals with
responsibility of auditor whose client uses a service organization. In other words, it deals with
responsibility of auditor of the client of the service organization.
(s) False: Vouching is not mere comparison of the entries with the supporting documents. It is a critical
examination of the supporting documents to understand the substance or essence of the transaction
and to ensure that the transactions is accounted for as per its substance.
(t) False: Method of depreciation can be charged only if such change is required by statute/ Accounting
Standards or such change would result in more appropriate presentation of entity’s financial
statements.

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 Illustrative Questions
Q. No. 1: Comment: The management requested your audit firm not to comment on valuation of inventory
and reliability of certain debtors, as they had been covered in Director’s Report.
Answer: (a) Legal requirements – Sections 217, 222 and 227
As per section 217 board’s report is ‘attached to’ a balance sheet. Sections 227(2) and (3)
requires auditors only to report on the documents ‘annexed to’ financial statements.
But section 222 has provided that any information, which is required to be given in accounts
or in a statement annexed to accounts, may be given in the board’s report instead of in the
accounts. In such circumstances, the board’s report shall be annexed to accounts (‘not
attached to’). The auditor should in this case, report on the matters reported upon by the
directors.
(b) In the present situation as per the requirements of section 222 the auditor has a duty to report
on the Board’s report. Therefore, he should not accept their contention and verify the debtors
and inventory by adopting appropriate audit procedures.
Q. No. 2: As an Auditor, comment on the following situation/statement: JKT Ltd. having Rs. 40 lacs paid up
capital, Rs. 9.50 lacs reserves and turnover of last three consecutive financial years, immediately
preceding the financial year under audit, being Rs. 4.90 crores, Rs. 4.50 crores and Rs. 6 crores,
but does not have any internal audit system. In view of the management, internal audit system is
not mandatory.
Answer: Internal Audit System and CARO, 2003: As per Para 4(vii) of CARO, 2003, statutory auditor
is required to comment on whether the auditee company has an internal audit system
commensurate with its size and nature of its business. The clause has a mandatory application in
respect of listed companies. For other companies, it is applicable if either of the following
conditions is satisfied:
a. The company has a paid-up capital and reserves exceeding Rs.50 lakhs at the
commencement of the financial year, or
b. The company has an average annual turnover of Rs.5 crores or more for a period of 3 years
preceding the current financial year. In the instant case, the second condition has been
fulfilled by JKT Ltd. Hence, the auditor will have to mention in his report the fact of not
having such internal audit in his report by the Company.
Q. No. 3: State with reasons your views on the following: Ram and Hanuman Associates, Chartered
Accountants in practice have been appointed as Statutory Auditor of Krishna Ltd. for the
accounting year 2002-2003. Mr. Hanuman holds 100 equity shares of Shiva Ltd., a subsidiary
company of Krishna Ltd.
Answer: Auditor holding securities of a company : As per sub-section (3)(e) of Section 226, a person
holding any security of the company after a period of one year from the date of commencement of
the Companies (Amendment) Act, 2000 w.e.f. December 13, 2001 is not qualified for
appointment as auditor of that company. For the purpose of this section, “security” means an
instrument which carries voting rights.
 It is further laid down in sub-section (4) of Section 226 that a person is not eligible for
appointment as auditor of any company, if he is disqualified from acting as auditor of that
company’s subsidiary or holding company or of any other subsidiary of the same holding
company. Sub-section (5) of Section 226 provides that if an auditor, after his appointment,
becomes subject to any of the disqualification specified in sub-sections (3) and (4), he shall be
deemed to have automatically vacated his office.
A firm would also be disqualified to be appointed as an auditor even when one partner is
disqualified under clause (e) of sub-section (3) of Section 226. In the present case, Mr. Hanuman,
Chartered Accountant, a partner of M/s Ram and Hanuman Associates, holds 100 equity shares of
Shiva Ltd. which is a subsidiary of
Krishna Ltd. As such, the firm, M/s Ram and Hanuman Associates would be disqualified to be
appointed as statutory auditor of Krishna Ltd., which is the holding company of Shiva Ltd., even
when one partner is disqualified under this clause.
Q. No. 4: State with reasons your views on the following: Mr. Ramadas, a fellow member of the Institute of
Chartered Accountants of India, working as Manager of Sivram & Co., a Chartered Accountant
firm, signed the audit report of Om Ltd. on behalf of Sivram & Co.
Answer: Signature on Audit Report: Section 229 of the Companies Act, 1956 requires that only a person
appointed as the auditor of the company or where a firm is so appointed, a partner in the firm
practising in India, may sign the auditor’s report or sign or authenticate any other document of the
company required by law to be signed or authenticated by the auditor. Therefore, Mr. Ramdas, a
fellow member of the Institute and a manager of M/s Sivram & Co., Chartered Accountants,
cannot sign on behalf of the firm in view of the specific requirements of the Companies Act,
1956. If any auditor’s report or any document of the company is signed or authenticated otherwise
than in conformity with the requirements of Section 229, the auditor concerned and the person, if
any, other than the auditor who signs the report or signs or authenticates the document shall, if the
default is willful, be punishable with a fine.
Q. No. 5: The management of Anita Limited suggested for quick completion of the statutory audit that it
would give its representation about the receivables in terms of their recoverability. The
management also acknowledged to the auditors that the management would give their
representation after scrutinizing all accounts diligently and they own responsibility for any errors
in these respects. It wanted auditors to complete the audit checking all other important areas
except receivables. The auditor certified the account clearly indicating in his report the fact of
reliance he placed on representation of the management.
Answer: The management of Anita Limited wants the auditor to carry out audit on all areas, except on area
of receivables. There cannot be any restriction on scope of audit in case of statutory audit.
The management representation, according to SA 580, cannot substitute other audit evidence that
the auditor could reasonably expect to be available to the auditor. The audit evidence for checking
receivables – say, invoices, debt acknowledgement documents, receipts, statement of accounts,
confirmations etc., are available evidences which auditor is duty bound to verify.
Just because management had owned responsibility for the correctness of its evaluation of
receivables, the auditor cannot shirk his responsibility. This is negligence on his part if he relies on
the management representation without assessing the corroborative available evidences.
Q. No. 6: Give your comment on “The Central Government has appointed Mr. Sushil, a retired Finance
Director of a reputed company, a non-practising member of ICAI, as a special auditor of MM Ltd.,
on the ground that the company was not being managed on sound business principles. Mr. Ajay,
MD of MM Ltd. feels, that the appointment of Mr. Sushil is not valid as he does not hold a
certificate of practice”.
Answer: Appointment of Special Auditor: Section 233A of the Companies Act, 1956, under the
circumstances as specified in the section, empowers the Central Government that it may issue
directions to the effect that a special audit of the company’s accounts for the specified period shall
be conducted.
Amongst others, one of the circumstances specified is in case a company is not being managed in
accordance with some business principles or prudent commercial practices. Further the said section
also provides that for the purpose, it may appoint a chartered accountant, whether or not the
chartered accountant is in practice, or the company’s auditor itself to conduct such special audit.
Therefore, the appointment of Mr. Sushil, a non-practising member of Institute of Chartered
Accountants of India is within the provisions of law and, accordingly, the contention of Mr. Ajay
M.D. is not correct.

Q. No. 7: As a company auditor how would you react to the following situation: Rs. 5 lakhs paid by a
pharma company to the legal advisor defending the patent of a product treated as capital
expenditure.
Answer: Expenditure made by a pharma company to the legal advisor Expenses of Rs. 5 lakhs made by a
pharma company to the legal advisor are legal expenses. Such expenses are incurred for defending
the patent of a product of the pharma company is a revenue expenditure relating to the asset
because it neither enhance the capacity of the asset nor any endurable benefit is obtained in future
in addition to what is available at present. The legal fees paid is normally an expenditure in the
revenue nature irrespective of the amount unless it is incurred for bringing any new assets in
existence. Therefore, it is not correct to treat the expenditure as capital expenditure. It would result
in the overstatement of assets value and profit and calls for qualification in the audit report.

Q. No. 8: Comment on the “Responsibility for properly determining the quantity and value of inventories
rests with the management of the entity”.
Answer: The Guidance Note on Audit of Inventories specifies that the responsibility for properly
determining the quantity and value of inventories rests with of the management of the entity.
Therefore, it is the responsibility of the management the entity to ensure that the inventories
included in the financial information are physically in existence and represent all owned by the
entity. The management can satisfy this responsibility by carrying out appropriate procedures
such as verification of all items of inventory at least once in every financial year. The auditor is
expected to examine the adequacy of the methods and procedures of physical verification
followed by the entity. He is also required to determine whether the procedures for identifying
 defective, damaged, obsolete, excess and slow-moving items are well-designed and operate
properly.
This responsibility of the management is not reduced even where the auditor attends any physical
count of inventories in order to obtain audit evidence. The entities usually maintain detailed stock
records in the form of Stores/Stock ledgers showing in respect of each major item the receipts,
issues and balances. The extent of examination of these records by an auditor with reference to
the relevant basic documents (e.g., goods received notes, inspection reports, material issue notes,
bin cards, etc.) depends upon the facts and circumstances of each case. In valuation aspects,
compliance with AS 2 should also be ensured.

Q. No. 9: As an auditor, what would you do in the following situations: One customer from whom Rs. 4
lakhs are recoverable for credit sales gives a motor car in full settlement of the dues. The directors
estimate that the market value of the motor car transferred is Rs. 4.20 lakhs. As on the date of the
balance sheet the car has not been registered in the name of the auditee.
Answer: As per AS 10 “Accounting for Fixed Assets” when a fixed asset acquired in exchange for another
asset:
(i) Its cost is (usually) determined by reference to the fair market value of the consideration
given.
(ii) It may be appropriate to consider also the fair market value of the asset acquired if this is
more evident.
An alternative accounting treatment which is used is that when assets exchange is similar to
record the assets acquired at net book value of the asset given up. In each case, an adjustment is
made for any balancing receipt or payment of cash or other consideration. In the given case, the
company has acquired a motor car by exchange of an amount due from him.
Determination of ownership
(i) Proof of payment of consideration by the customer
(ii) Possession of assets by him is sufficient to determine ownership of the car.
Registration is only a permission given to the vehicle under the Motor Vehicles Act to ply on the
road and it does not determine the ownership.
Valuation of car
(i) It will be valued at 4,00,000 because the value of asset given up is more clearly evident than
the fair market value of the asset acquired.
(ii) Hence, it should be valued at Rs.4,00,000 and the asset account should be debited at
Rs.4,00,000 and the customer account credited at Rs.4,00,000.
(iii) In case, the directors revalue the asset at Rs.4,20,000 then the excess of Rs.20,000 shall be
treated as Revaluation revenue.
Q. No. 10: Reena Ltd received Rs. 50 lakhs as grant from the State Government towards the part cost of a
specific machinery. The company credited the above sum of Rs. 50 lakhs as income in its profit
and loss account for the year. What are your views on the accounting treatment of the above
receipt of Rs. 50 lakhs?
Answer: AS 12 “Accounting for government grants” regards two methods of presentation of grants related to
specific fixed assets in financial statements as acceptable alternatives:
(i) Under first alternative, the grant is shown in the Balance Sheet as a deduction from the gross
value of machinery. The grant is recognized in P& L A/c over the useful life of a depreciable
asset by way of a reduced depreciation charges.
(ii) Under second alternative, it can be treated as deferred income which should be recognized in P
& L A/c over useful life of asset in proportion in which depreciation on machinery will be
charged. The deferred income pending its apportionment to P & L A/c should be disclosed in
Balance Sheet with a suitable description e.g. Deferred Government Grants.
In the given case, Reena Ltd. received Rs.50 lakhs as grant towards part cost of specific
machinery. The company has credited the said sum as income in its Profit and Loss account which
is incorrect. As the treatment is not in accordance with Accounting Standard so company is
advised to rectify as per provision given above.

Q. No. 11: You are the auditor of a manufacturing company, whose year ends on 31st March. An event
occurred after the year ended, but before you complete the audit. The audit report issued by you is
dated 20th July, 2009. The sales ledger balance at 31st March, 2009 was Rs.90,000. By 20th July
2009 Rs. 55,000 only had been received against this amount as full and final payment.
Answer: Consideration of subsequent events
SA 560 requires that the auditors should consider the effect of subsequent events on the financial
statements and the auditor’s report. Depending on the nature of subsequent event, i.e. adjusting
event or non-adjusting event, the auditor has to examine the impact on financial statements. AS 4
“Contingencies and Events Occurring After the Balance Sheet Date” also classifies an adjusting
event which provides further evidence of conditions that existed at the balance sheet date after
balance sheet date, the effect of such events have to be seen by the auditor on figures contained in
the financial statements. The facts indicated in the question clearly reveal that subsequent
realisation has been good. Such consideration helps the auditor in assuring the existence of debtors
as also the realisability aspect. The auditor’s duties in respect of debtors remaining uncollected at
the time of giving audit report involves examination of actual past experience of collections from
debtors. Further, the auditor has to see that how much provision was assessed in respect of bad and
doubtful debts having regard to recovery position, due date, legal cases, cheques dishonoured, etc.,
as on March 31, 2009. Accordingly, the auditor would have now to see that in respect of
outstanding amount of Rs.35,000, whether the amount of provision needs any revision.

Q. No. 12: You are appointed as an auditor of PQR Ltd. What will be your opinion in the following
circumstances?
(i) You are not able to obtain sufficient appropriate audit evidence concerning opening
balances.
(ii) If the opening balances contain misstatements which materially affect the financial
statements for the current period.
Answer:
 (i) If, after performing procedures, the auditor is unable to obtain sufficient appropriate
audit evidence concerning opening balances, the auditor should, as appropriate,
express:
a. a qualified opinion, or
b. a disclaimer of opinion.
The auditor may also express an opinion which is qualified or disclaimed regarding the profit or loss
and unqualified regarding state of affairs, as appropriate.
(ii) If the opening balances contain misstatements which materially affect the financial
statements for the current period and the effect of the same is not properly accounted for and
adequately disclosed, the auditor should express a qualified opinion or an adverse
opinion, as appropriate.
Q. No. 13: Gupta & associates, a firm of chartered accountants has been appointed as an auditor of ABC Ltd.
situated in Delhi. Kumar associates, a firm of other chartered accountants has been appointed for
auditing a division of the same company situated at Nagpur. What procedures should Gupta &
associates follow while using the work of Kumar Associates with respect to the financial information
of Nagpur division included in the financial information of ABC Ltd.
Answer: Using the work of another auditor (SA 600): SA 600 is applicable in the situation where an auditor
(principal auditor) reporting on the financial information of the entity, uses the work of another
auditor (other auditor) with respect to the financial information of one or more components
included in the financial information of the entity. The term ‘financial information’ encompasses
‘financial statements. "Component" means a division, branch, subsidiary, joint venture, associated
enterprises or other entity whose financial information is included in the financial information
audited by the principal auditor.
Generally when another auditor has been appointed for the component, the principal auditor would
be entitled to rely upon the work of such auditor unless there are circumstances to indicate that he
should not rely. In the given case for using the work of Kumar & Associates (other auditor) with
respect to the financial information of Nagpur division included in the financial information of
ABC Ltd.,Gupta & Associates(principal auditor) should follow the following procedure :
(1) The principal auditor should perform procedures to obtain sufficient appropriate audit
evidence, that the work of the other auditor is adequate for the principal auditor's purposes,
in the context of the specific assignment.
(2) The principal auditor might discuss with the other auditor the audit procedures applied or
review a written summary of the other auditor’s procedures and findings which may be in
the form of a completed questionnaire or check-list. The principal auditor may also wish to
visit the other auditor. The nature, timing and extent of procedures will depend on the
circumstances of the engagement and the principal auditor's knowledge of the professional
competence of the other auditor. This knowledge may have been enhanced from the review
of the previous audit work of the other auditor.
(3) The principal auditor should consider the significant findings of the other auditor.
(4) The principal auditor may consider it appropriate to discuss with the other auditor and the
management of the component, the audit findings or other matters affecting the financial
 information of the components. He may also decide that supplemental tests of the records or
the financial statements of the component are necessary. Such tests may, depending upon the
circumstances, be performed by the principal auditor or the other auditor.
(5) The principal auditor should document in his working papers the components whose
financial information was audited by other auditors; their significance to the financial
information of the entity as a whole; the names of the other auditors; and any conclusions
reached that individual components are not material. The principal auditor should also
document the procedures performed and the conclusions reached. For example, the auditor
would document the results of discussions with the other auditor and review of the written
summary of the other auditor's procedures.
Q. No. 14: Comment on the following case: Lehar Ltd. installed a new water treatment plant at its factory on
1.10.2007. The company estimated that the new plant will become obsolete after 4 years only and
hence charged depreciation at a rate higher than that envisaged in Schedule XIV to the Companies
Act. During the year 2007-08, the company therefore had written off 1/4th of the cost.
Answer: As per AS-6 on Depreciation Accounting, assessment of depreciation and the amount to be
charged in respect thereof in an accounting year/period are usually based on the following three
factors:-
(i) Historical Cost.
(ii) Expected useful life of the asset.
(iii) Estimated residual value of the asset.
If the management’s estimate of the useful life of an asset in shorter than that envisaged under the
relevant statute (Companies Act) the depreciation is appropriately computed by applying a higher
rate. The depreciation rate provided in Schedule XIV is the minimum rate and a company can
charge higher than those prescribed. Hence, in the instance case decision of Lehar Ltd., to write off
the cost of water treatment plant over four years is absolutely correct and as per AS-6.
However, the company has wrongly charged full year’s depreciation during 2007-08 instead of
half year’s depreciation as per requirement of Schedule XIV. The auditor should highlight this to
the company and ask to rectify the same.
Q. No. 15: Comment – One customer from whom Rs.5 lakhs are recoverable for credit sales gives a motor
car in full settlement of dues. The directors estimate that the market value for the motor car
transferred is Rs.5.25 lakhs. As on the date of the balance sheet the car has not been registered in
the name of auditee.
Answer: According to AS – 10, Accounting for Fixed Assets, when fixed asset is acquired in exchange or in
part exchange for another asset, the cost of asset acquired should be recorded either at fair market
value or at the net book value of the asset given up. In the present case the latter is more evident
(Rs.5 lakhs given up) than the fair value of motor care (Rs.5.25 lakhs estimated by the directors).
Hence, the Customer’s account should be credited with Rs. 5 lakhs and the motor car recorded at
the same account.
AS – 1, Disclosure of Accounting Policies, the accounting treatment and presentation in the
financial statements of transactions and events should be governed by their substance and not
merely by legal form. The motor car has not been registered in the name of the company on the
date of the balance sheet in the present case. Taking accounting principle of substance over form
into consideration as laid down by AS – 1 the auditor should ensure that the car’s acquisition is
recorded in the present year though the car is not registered in the name of the auditee.
Q. No. 16: State briefly the duty of the auditor with regard to each of the following:
(a) A sum of Rs.10,00,000 is received from an Insurance Company in respect of a claim for loss
of goods in transit costing Rs.8,00,000. The amount is credited to purchases account.
(b) A loss of Rs.2,00,000 on account of embezzlement of cash was suffered by the company and it
was debited to salary account.
Answer:
(a) Claim received from insurance company
(i) According to AS-5, “Net Profit or Loss for the Period, Prior Period Items andChanges in
Accounting Polices” requires that all items of income and expenses which are
recognized in a period should be included in the determination of net profit or loss for
the period.
(ii) The loss of goods in transit costing Rs.8,00,000 should be therefore, charged to profit
and loss account of present financial year and insurance claim of Rs.10,00,000 should be
credited to profit and loss account under an appropriate head. It should not have been
credited to purchases account. If done so, the purchases would be overstated.
Insurance claim (excess) is profit from ordinary activities. AS-5 states 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 entity for the
period, the nature and amount of such items should be disclosed separately. Thus, a separate
disclosure of insurance claim received is necessary as per the requirements of AS-5, and it
should not be credited to purchases account.
(b) Embezzlement of cash
(i) AS-5, Net Profit or Loss for the Period, Prior Period items and changes in Accounting
Policies “requires that (income and) expenses within (Profit of) 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.”
(ii) Embezzlement of cash of Rs.2,00,000 is an ordinary business loss which as per the
requirements of AS-5 should be disclosed separately in the profit and loss account. It
should not be merged with salary.
Q. No. 17: State your opinion/comment on the following : An auditor purchased goods worth Rs.1,500 on
credit from a company being audited by him. The Company allowed him one month’s credit,
which is normally allowed to all known customers.
Answer:
(i) According to section 226(2)(d) of the Companies Act, 1956 if a person is indebted to the company
for an amount exceeding one thousand rupees, he is disqualified from being appointed as the auditor.
(ii) According to Guidance Note on Independence of Auditors, even if a person is allowed normal period
of credit as allowed to other customers and the amount exceed Rs. 1,000, he cannot be appointed as
an auditor.
(iii) Taking into consideration, the view expressed in the Guidance Note, the auditor who has purchased
goods worth Rs.1,500 on one month credit has been disqualified for being auditor, even if he has
been allowed normal period of credit, his office stands vacated automatically.
Q. No. 18: Give your comments on the following : PQR and Co., a firm of chartered accountants has three
partners, P, Q and R; P is also in whole time employment elsewhere. The firm is already holding
audit of 40 companies including audit of one foreign company. The firm is offered the audit of Z
Ltd. and its 20 branches.
Answer: According to Section 224(1B) of the Companies Act, 1956, and notification issued by the ICAI :
(a) In case of partnership firms of auditor, the ceiling on audit is twenty companies per partner of
the firm.
(b) Any partner who is in full-time employment elsewhere is not to be taken into account while
computing the ceiling on number of companies that the firm can audit.
(c) Audit of head office and branches would be taken as one audit.
(d) Audit of foreign companies would be excluded from specified number of audits under this
section.
In the given case,
(a) The firm can taken maximum of forty audits (20 × 2) + (10 × 0). There are three partners – P,
Q and R. Since P is in full-time employment, the firm cannot undertake any audit on his
behalf.
(b) The firm is holding 39 audits at present since foreign company is not counted towards
specified number under Section 224(1B). It can take one more audit.
(c) The firm can, therefore, accept audit of Z Ltd. and its 20 branches. Such an audit would be
counted as one assignment.
Q. No. 19: Akash Ltd. has its registered office at New Delhi. During the current accounting year, it has
shifted its corporate Head Office to Haryana though it has retained the Registered Office at New
Delhi. The Managing Director of the company wants to shift its books of account to Haryana from
New Delhi, as he feels there is no legal bar in doing so.
Ans:
(i) Under section 227 of the Companies Act, 1956, the auditor has to report whether the company under
audit has maintained proper books of account as per requirements of section 209. Further, the books
of account should be kept at the registered office of the company. However, the board of directors
may decide to keep them or a part thereof, at any place in India other than registered office. If such a
resolution is passed, the company must file with the Registrar of Companies the details of such
address.
(ii) In the present case, the managing director of Akash Limited wants to shift the books of account from
registered office at New Delhi to corporate head office at Haryana. This can be done, according to
section 209, by passing a board’s resolution and filing of such address with the Registrar of
Companies.
Q. No. 20: Statements issued by the Institute of Chartered Accountants of India are mandatory in nature
while guidance notes are recommendatory in nature. Comment.
Answer: The Institute has, from time to time, issued ‘Guidance Notes’ and ‘Statements’ on a number of
matters. The ‘Statements’ have been issued with a view to securing compliance by members on
matters which, in the opinion of the Council, are critical for the proper discharge of their functions.
‘Statements’ therefore are mandatory. Accordingly, while discharging their attest function, it will be
the duty of the members of the Institute:
(a) to examine whether ‘Statements’ relating to accounting matters are complied with in the
presentation of financial statements covered by their audit. In the event of any deviation from
the ‘Statements’, it will be their duty to make adequate disclosures in their audit reports so that
the users of financial statements may be aware of such deviations; and
(b) 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 thereform.
‘Guidance Notes’ are primarily 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 in resolving
issues which may pose difficulty. Guidance Notes are recommendatory in nature. A member should
ordinarily follow recommendations in a guidance note relating to an auditing matter except where he
is satisfied that in the circumstances of the case, it may not be necessary to do so. Similarly, while
discharging his attest function, a member should 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, the member should consider whether keeping in view the circumstances of the case, a
disclosure in his report is necessary.
Q. No. 21: What are Auditing and Assurance Standards? What is the procedure for issuing Auditing and
Assurance Standards?
Answer: Auditing and Assurance Standards are Auditing Standards, which prescribe the way the auditing
should be conducted. Auditing and Assurance Standards are the benchmarks by which the quality
of audit performance can be measured and achievement of objective can be documented. AASs
have been 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”
AASs are therefore , Mandatory from the dates specified either in the respective AAS or by
notification issued in this behalf by the Council of ICAI.
Procedure for Issuing the Statements on Standard Auditing Practices : Broadly, the following
procedure is adopted for the formulation of Auditing and Assurance Standards.
(i) The Auditing and Assurance Standards Board (AASB) determines the broad areas in which
the Auditing and Assurance Standards (AASs) need to be formulated and the priority in
regard to the selection therefor.
(ii) In the preparation of AASs, the AASB is assisted by study groups constituted to consider
specific subjects. In the formation of study groups, provision is made for participation of a
cross-section of members of the Institute.
(iii) On the basis of the work of the study groups, an exposure draft of the proposed AAS is
prepared by the Board and issued for comments by members of the Institute.
 (iv) After taking into consideration the comments received, the draft of the proposed AAS is
finalised by the AASB and submitted to the Council of the Institute.
(v) The Council of the Institute will consider the final draft of the proposed AAS, and if
necessary, modify the same in consultation with the AASB. The AAS is issued under the
authority of the Council.
Q. No. 22: During the course of audit, CA Tripathi , the auditor seeks a representation letter from ABC Ltd.
confirming that the company has a satisfactory title to all assets and there are no encumbrances on
the company’s asset. Management of ABC Ltd. refuses to give the representation letter in this
regard. What is the option available for the auditor as per AAS 11.
Answer: As per SA 580 “Written Representation” if management refuses to provide representations on any
matter that the auditor considers necessary, this will constitute a limitation on the scope of his
examination. In such circumstances, the auditor should evaluate any reliance he has placed on other
representations made by management during the course of his examination and consider if the
refusal may have any additional effect on his report.
In case management is not willing to give in writing the representations made by it during the course
of audit, the auditor should himself prepare a letter in writing setting out his understanding of
management’s representations that have been made to him during the course of audit and send it to
management with a request to acknowledge and confirm that his understanding of the representations
is correct. If the management refuses to acknowledge or confirm the letter sent by the auditor, this
will constitute a limitation on the scope of his examination. In such circumstances, the auditor should
evaluate any reliance on those representations and consider if the refusal may have any additional
effect on his report.
Thus CA Tripathi should re-evaluate any reliance that he has placed on other representations made
by the management during the course of audit.and consider if the refusal may have any additional
effect on his report ( i.e. , he should consider whether he should qualify the assertion in the auditor’s
report that he has obtained all information and explanations required by him and whether such a
refusal would also require a qualification of his opinion as to whether the financial statements
present a true and fair view).

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