Audit of Items of Financial Statements – CA Inter Audit Notes

Audit of Items of Financial Statements – CA Inter Auditing Notes is designed strictly as per the latest syllabus and exam pattern.

Audit of Items of Financial Statements – CA Inter Auditing Notes

Question 1.
What are the obvious assertions in the following items appearing in the Financial Statements?
(i) Statement of Profit and Loss
Travelling Expenditure ₹ 50,000
(ii) Balance Sheet
Trade receivable ₹ 2,00,000 [MTP-Oct. 19]
Answer:
Travelling Expenditure:

Expenditure has been incurred for the purpose of travelling.
Travelling has been undertaken during the year under audit.
Total expenditure incurred was ₹ 50,000 during the year.
It is classified as revenue expenditure and charged to Statement of Profit and Loss.

Trade Receivable

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

Question 2.
Give your assertions for the following Items appearing in Balance Sheet of a Limited Company:

	₹	₹
(i) Cash in hand		10,000
(ii) Investments		1,00,000
(iii) Secured Loans		10,00,000
(iv) Machinery:
Opening Cost	13,00,000
Less: depreciation
Current depreciation	1,30,000	11,70,000

Answer:
Cash in hand is an item of current assets and it implies the following:

that the company has ₹ 10,000 in hand in the form of currency notes and coins on the Balance Sheet date.
that the cash is free and available for expenditure to the company.
that the books of account show a cash balance of ₹ 10,000 as on balance sheet date.

(ii) Investments:
Investments is an item appearing in Balance Sheet either as non-current or as current investments and it implies as follows:

that the company has made invested its surplus funds in the investments, i.e. its existence and ownership.
that the investments are non-current or current investments, i.e. its classification and Rate of interest receivable.
that the value of investments as on Balance Sheet date was ₹ 1,00,000, i.e. its valuation.

(iii) Secured Loan
Secured loan is an item appearing in the Balance sheet either as long term borrowing or as short-term borrowings and it implies as follows:

That the company has borrowed, i.e. its existence
That the borrowing is secured one, i.e. its nature,
That the borrowing as on Balance sheet date was ₹ 10,00,000, i.e. its valuation.

(iv) Machinery
Machinery is an item appearing in the balance sheet as fixed asset under the heading Non-current assets and it implies as follows:

That the Company has certain Plant and Machinery as on balance sheet date, i.e. its existence and ownership.
Opening WDV is ₹ 13,00,000 and year end WDV was ₹ 11,70,000 after charging current year depreciation, i.e. its valuation and allocation of current year depreciation.

Question 3.
Companies prepare their financial statements in accordance with the framework of generally acceptedaccou nting principles (Indian GAAP), also commonly referred to as accounting standards (AS). In preparing financial statements, Company’s management makes implicit or explicit claims (i.e. assertions) regarding assets, liabilities, equity, income, expenses and disclosures in accordance with the applicable accounting standards. Explain with example stating the relevant assertions involved in this regard. Also explain financial statement audit. [RTP-May 20]
Answer:
Assertions involved in preparation of financial statements:
Companies prepare their financial statements in accordance with the framework of generally accepted accounting principles (Indian GAAP), also commonly referred to as accounting standards (AS).

In preparing financial statements, Company’s management makes implicit or explicit claims (i.e. assertions) regarding:

Completeness;
Cut-off;
Existence/Occurrence;
Valuation/Measurement;
Rights and Obligations; and
Presentation and Disclosure
of assets, liabilities, equity, income, expenses and disclosures in accordance with the applicable accounting standards.

Example: If balance sheet of an entity shows machinery with carrying amount of ₹ 25 lakh, the auditor shall assume that the management has claimed/asserted that:

The machinery recognized in the balance sheet exists as at the period- end (existence assertion);
Entity owns and controls such machinery (Rights and obligations assertion);
The machinery has been valued accurately in accordance with the valuation principles (Valuation assertion);
All machineries owned and controlled by the entity are included within the carrying amount of Rupee 25 lakh (Completeness assertion).

Financial Statement Audit:
A financial statement audit comprises the examination of an entity’s financial statements and accompanying disclosures by an independent auditor. The result of this examination is a report by the auditor, attesting to the truth and fairness of presentation of the financial statements and related disclosures.

Question 4.
What does the Valuation assertion mean in respect of Assets, liabilities and equity balances? Explain with the help of example in respect of Inventory. [RTP-May 20]
Answer:
Meaning of Valuation Assertion:
Valuation assertion in respect of Assets, liabilities and equity balances means that Assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.

Example of Valuation assertion w.r.t. Inventory:
As per AS-2 “Valuation of Inventories” inventory is to be recognized at the lower of cost and net realizable value. Any costs that could not be reasonably allocated to the cost of production (e.g. general and administrative costs) and any abnormal wastage have been excluded from the cost of inventory. An acceptable valuation basis (e.g. FIFO, Weighted average etc.) has been used to value inventory as at the period-end.

Question 5.
Discuss the following: Securities premium can be utilized only for certain purposes laid down in the Companies Act, 2013. [Nov. 17 (5 Marks)]
Or
ABC Ltd. has issued shares for cash at a premium off 450, that is, at amount in excess of the nominal value of the shares which isf 10 for cash. Section 52 of the Companies Act, 2013 provides that a Company shall transfer the amount received by it as securities premium to securities premium account. Advise the means in which the amount in the account can be applied. [RTP-May 18]
Or
The securities premium account may only be applied by the company towards the issue of unissued shares of the company to the members of the company as fully paid bonus shares, Comment. [May 19 (3 Marks)]
Answer:
Issue of Shares at Premium:
Where a company has issued shares at a premium, whether for cash or otherwise, company shall transfer the amount received by it to securities premium account and state the means in which the amount in the account can be applied.

As per Sec. 52 of Companies Act, 2013 the securities premium account may be applied by the company for the following purposes:
(a) issue of unissued shares of the company to the members of the company as fully paid bonus shares;
(b) writing off the preliminary expenses of the company;
(c) writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company;
(d) providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company; or
(e) for the purchase of its own shares or other securities under section 68.
Auditor needs to verify whether the premium received on shares, if any, has been transferred to a “securities premium account” and whether the application of any amount out of the said “securities premium account” is only for the purposes mentioned above.

Question 6.
Discuss the following: Shares issued at a discount. [Nov. 12 (5 Marks)]
Or
Briefly discuss the provisions of the Companies Act, 2013 with regard to issue of shares at a discount.
Or
Any share issued by a company at a discounted price shall be void. Explain stating also the audit procedure in this regard. [MTP-March 19]
Or
Validity and consequence of issue of shares at discount, check with respect to the jjrovisions of the Companies Act, 2013. [Nov. 19 (4 Marks)]
Answer:
Shares issued at a discount:

Sec. 53 of the Companies Act, 2013 provides that a company cannot issue shares at discount. As per Sec. 53, a company shall not issue shares at a discount, except in the case of an issue of sweat equity shares given u/s 54 of the Companies Act, 2013.
Any share issued by a company at a discounted price shall be void.
Where any company fails to comply with the provisions of this section, such company and every officer who is in default shall be liable to a penalty which may extend to an amount equal to the amount raised through the issue of shares at a discount or ₹ 5 lakh, whichever is less, and the company shall also be liable to refund all monies received with interest at the rate of 12% p.a. from the date of issue of such shares to the persons to whom such shares have been issued.
Auditor needs to verify that the company has not issued any of its shares at a discount. For this purpose, he may read the minutes of meeting of its directors and shareholders authorizing issue of share capital and the issue price.

Question 7.
Write short note on: Verification of issue of Sweat Equity shares. [Nov. 13 (4 Marks)]
Or
What audit points are to be borne in mind in case of issue of “Sweat Equity shares” by a limited company? [Nov. 16 (6 Marks), MTP-Oct. 19]
Answer:
Verification of Sweat Equity Shares:
The auditor may see that the Sweat Equity Shares issued by the company are of a class of shares already issued and following conditions of Section 54 of Companies Act, 2013 are fulfilled:
(a) the issue is authorised by a special resolution passed by the company;
(b) the resolution specifies the number of shares, the current market price, consideration, if any, and the class or classes of directors or employees to whom such equity shares are to be issued;
(c) where the equity shares of the company are listed on a recognised stock exchange, the sweat equity shares are issued in accordance with the regulations made by the SEBI in this behalf and if they are not so listed, the sweat equity shares are issued in accordance with such rules as may be prescribed.

Question 8.
How would you vouch/verify the following: Reduction of Share Capital? [May 10 (5 Marks)]
Or
What are the duties of an auditor in case of reduction of capital? [Nov. 11 (8 Marks)]
Or
BNP Ltd. has reduced its Share Capital to a greater extent in the year for which you are conducting the audit. State how will you proceed for verifying the reduction of Capital. [MTP-Oct. 20]
Answer:
Reduction of Share Capital:
The duties of the auditor in this regard are following:

Verifying that the special resolution has been passed for reduction of capital in the meeting of the shareholder.
Check that the Articles of Association authorizes the reduction of capital.
Examine the order of the Tribunal confirming the reduction and ensure that a copy of the order and the minutes have been registered and filed with the ROC.
Inspecting the ROC Certificate as regards reduction of capital.
Vouching the journal entries recorded to reduce the capital and to write down the assets by reference to the resolution of shareholders and other documentary evidence.
Ensure that the requirements of Schedule III w.r.t. reduced capital have been complied with.
Confirming that the revaluation of assets have been properly disclosed in the Balance Sheet.
Verifying the adjustment made in the members’ accounts in the Register of Members and confirming that either the paid up amount shown on the old share certificates have been altered or new certificates have been issued in lieu of the old, and the old ones have been cancelled.
Confirming that the words “and reduced”, if required by the order of the Tribunal, have been added to the name of the company in the Balance Sheet.
Verifying that the MOA of the company has been suitably altered.

Question 9.
Distinguish Between: Reserves and Provisions. [May 07, May 12 (5 Marks), March 19]
Answer:
Reserves and Provisions:

Reserves	Provisions
(a) It is an appropriation of profit	(a) It is a charge against Profit.
(b) They are not intended to meet any liability, contingency or diminution in the value of assets, though may be made for some specific purposes, like redemption of debentures.	(b) They are made to provide for depreciation, renewal or a known liability or a disputed claim.
(c) Reserves cannot be created unless there is a profit except a few like revaluation reserve.	(c) They must be created whether or not there is profit.
(d) Reserves are generally optional except few ones like creation of CRR, DRR, etc.	(d) Provisions are not optional and have to be made as per generally accepted accounting principles.

Question 10.
Reserves are amounts appropriated out of profits whereas on the contrary, provisions are amounts charged against revenue. Discuss explaining the difference between the two and also explain clearly revenue reserve and capital reserve. [RTP-May 19]
Answer:
Reserves and Provisions:

Reserves	Provisions
(a) It is an appropriation of profit	(a) It is a charge against Profit.
(b) They are not intended to meet any liability, contingency or diminution in the value of assets, though may be made for some specific purposes, like redemption of debentures.	(b) They are made to provide for depreciation, renewal or a known liability or a disputed claim.
(c) Reserves cannot be created unless there is a profit except a few like revaluation reserve.	(c) They must be created whether or not there is profit.
(d) Reserves are generally optional except few ones like creation of CRR, DRR, etc.	(d) Provisions are not optional and have to be made as per generally accepted accounting principles.

Revenue reserve and Capital Reserve:
(a) Revenue Reserve: Revenue reserves represent profits that are available for distribution to shareholders held for the time being or any one or more purpose, e.g., to supplement divisible profits in lean years, to finance an extension of business, to augment the working capital of the business or to generally strengthen the company’s financial position.

(b) Capital Reserve: Capital reserve represents surplus or profit earned in respect of certain types of transactions (like sale of fixed assets at a price in excess of cost, realisation of profits on issue of forfeited shares, etc.) which are not regarded by the directors as free for distribution as a dividend.

Capital Reserves does not include any amount regarded as free for distribution through the Statement of Profit and Loss.

Capital reserves includes share premium, capital redemption reserve, development rebate reserve and profit on reissue of forfeited shares.

Question 11.
Explain the disclosure requirements of 1ND AS compliant Schedule III to Companies Act, 2013 for each component of “Other Equity”. [Nov. 19 (3 Marks)]
Answer:
Disclosure requirement for individual components of other equity:
For each component of other equity, whether the company has disclosed the following (to the extent applicable):

Balance at the beginning of the reporting period
Changes in accounting policy or prior period error
Restated balance at the beginning of the reporting period
Total Comprehensive Income for the year
Dividends
Transfer to retained earnings
Any other change (to be specified]
Balance at the end of reporting period

Question 12.
How will you vouch/verify: Borrowings from banks?
Or
On going through the financial statements of PQR Ltd., its auditors Kamal Gagan and Associates observed that company has taken Loans from banks and financial institutions. Further, the audit team discusses the following about Liabilities:

“Liabilities are the financial obligations of an enterprise other than owners’ funds. Liabilities include loans/borrowings, trade payables and other current liabilities, deferred payment credits and provisions.

Verification of liabilities is as important as that of assets, for, if any liability is omitted (or understated) or over stated, the Balance Sheet would not show a true and fair view of the state of affairs of the company.”
Advise stating clearly the audit procedures generally required to be undertaken for verification of existertice of Borrowings. [MTP-March 18]
Answer:
Verification of Borrowings from Banks:

Ensure that the loans obtained are within the borrowing powers of the entity.
Examine the relevant records to judge the validity and accuracy of the loans.
Examine the important terms in the loan agreements and the documents, if any, evidencing charge in respect of such loans and advances.
Where the entity has accepted deposits, the auditor should examine whether the directives issued by the RBI or other appropriate authority are complied with.
Obtain a certificate from the bank showing the balance in the accounts as at the end of the year.
Certificate may also be obtained from the bank showing particulars of securities deposited with the bank as security for the loans or of the charge created on an asset and confirm that the same has been correctly disclosed and duly registered with ROC and recorded in the Register of charges.
Reconcile the balances in the overdraft or loan account with that shown in the bank statements.
Verify that the loan or draft has been raised by appropriate authority. In the case of a company, only the BOD is authorised to raise a loan or borrow from a bank.
Confirm, in the case of a company, that the conditions prescribed in Sec. 180 of the Companies Act, 2013 as regards the maximum amount of loan that the company can raise has not been contravened.
Ascertain the purpose for which loan has been raised and the manner in which it has been utilised and ensure that this has not prejudicially affected the entity.

Question 13.
“Until the invoice is paid, the invoice amount is recorded on the organization’s balance sheet as accounts receivable, if balances are not recoverable, then these amounts will need to be written off as an expense in the income statement/profit and loss account.”
It is important to carry out compliance procedures in the sales audit as part of the debtors’ audit procedure.
Verify to ensure that the system for receivables has the necessary features. [MTP-March 18]
Answer:
Verification of Systems for receivables:
In relation to credit sales, it becomes imperative to carry out compliance procedures so as to ensure that the system for receivables has the following features:

Only bona fide sales lead to receivables.
Sales are made only to approved customers.
All such sales are duly recorded in the books.
Once recorded, the debts can only be eliminated by receipt of cash or on the approval by a responsible official.
Debts are collected promptly.
Balances are regularly reviewed and aged, a proper system of follow up exists and if necessary adequate provision for bad debt exists.
Clear segregation of duties relating to identification of debt, receipt of income, reconciliations and write off of debts.

Question 14.
Give your comments and observations on the following: Balance confirmations from trade receivables/trade payables can only be obtained for balances standing in their accounts at the year-end.
Answer:
Balance Confirmations from trade receivables/trade payables:

Guidance Note on “Audit of Debtors, Loans and Advances” recommends that the trade receivables may be requested to confirm the balance either:
- As at the date of the balance sheet; or
- As at any other selected date which is reasonably close to the date of the balance sheet.
The date should be settled by the auditor in consultation with the entity.
Where the auditor decides to confirm the trade receivables at a date other than the balance sheet date, he should examine the movements in trade receivable balances which occur between the confirmation date and the balance sheet date and obtain sufficient evidence to satisfy himself that trade receivable balances stated in the balance sheet are not materially misstated.
Therefore, it is not necessary that balances oftrade receivables/trade payables should necessarily be verified at the end of the year only.

Question 15.
Describe “Analytical Review Procedures” in Audit. Briefly discuss analytical procedures for verification of debtors. |y, [May 14 (8 Marks)]
Answer:
Analytical Review Procedures:
SA 520 “Analytical Procedures” deals with the auditor’s use of analytical procedures as substantive procedures. Analytical Procedures may be defined as evaluation of financial information through analysis of relationships among both financial and non-financial data. It also encompasses such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

The analytical procedures may be used by auditor to assist the auditor in planning the nature, timing and extent of audit procedures. It may also be used as a substantive procedure when their use can be more effective or efficient than tests of details in reducing detection risk for specific F.S. assertions.

Analytical procedures for verification of debtors:
Auditor may also perform below mentioned analytical review procedures as a means of obtaining audit evidence regarding the various assertions relating to trade receivables, loans and advances:

comparison of closing balances of trade receivables, loans and advances with the corresponding figures for the previous year;
comparison of the relationship between current year debtor balances and the currentyear sales with the corresponding figures for the previous year;
comparison of actual closing balances of trade receivables, loans and advances with the corresponding budgeted figures, if available;
comparison of current year’s aging schedule with the corresponding figures for the previous year;
comparison of significant ratios relating to trade receivables, loans and advances with the similar ratios for other firms in the same industry, if available;
comparison of significant ratios relating to trade receivables, loans and advances with the industry norms, if available.

Question 16.
Explain disclosure requirements of debtors in financial statements. [Nov. 11 (5 Marks)]
Or
Discuss the following: Disclosure requirements relating to trade receivables under Schedule III to the Companies Act, 2013. [Nov. 14 (5 Marks)]
Answer:
Disclosure requirements relating to Trade receivable under Schedule III:
(i) Aggregate amount of Trade Receivables outstanding for a period exceeding six months from the date they are due for payment should be separately stated.
(ii) Trade receivables shall be sub-classified as:

Secured, considered good;
Unsecured, considered good;
Doubtful.

(iii) Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately.
(iv) Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member should be separately stated.

Question 17.
What procedures an auditor should adopt to test the authenticity of cash at bank? [Nov. 11 (5 Marks)]
Or
How will you verify the following: Bank Balances?
Answer:
Verification of Bank Balances:
1. The auditor should advise the entity to send a letter to all its bankers to, directly confirm the balances to the auditor.

2. The auditor should examine the bank reconciliation statement prepared as on the last day of the year to identify cheques issued by the entity but not presented for payment, and cheques deposited but not credited in the bank account and their tracing in subsequent period.

3. The auditor should pay special attention to those items in the reconciliation statements which are outstanding for an unduly long period.

4. Where a large number of cheques has been issued/deposited in the last few days of the year, and a sizeable proportion of such cheques has subsequently remained unpaid/uncleared, this may indicate an intention of understating creditors/debtors or understating/overstating bank balances. In such a case, it may be appropriate for the auditor to obtain confirmations from the parties concerned, especially in respect of cheques involving large amounts. The auditor should also examine whether a reversal of the relevant entries would be appropriate under the circumstances.

5. In respect of fixed deposits, the relevant receipts/certificates, duly supported by bank advices, should be examined.

6. Remittances shown as being in transit should be examined with reference to their credit in the bank in the subsequent period.

7. Where material amounts are held in bank accounts which are blocked, e.g., in foreign banks with exchange control restrictions or any banks which are under moratorium or liquidation, the auditor should examine whether the relevant facts have been suitably disclosed in the financial statements.

8. Where the auditor finds that the number of bank accounts maintained by the entity is disproportionately large in relation to its size, the auditor should exercise greater care in satisfying himself about the genuineness of banking transactions and balances.

Question 18.
Mention disclosure requirements of Bank Balances in the financial statements of a company.
Answer:
Disclosure Requirements of Bank balances:
1. Cash and Cash Equivalents shall be classified as:

Balances with Bank
Cheques, Drafts on hand
Cash on hand
Others (specifying nature)

2. The following shall be shown separately:

Earmarked balances with bank.
Balances with bank held as margin money or security against borrowing, guarantees and other commitments.
Repatriation restrictions, if any, in respect of cash and bank balances.
Bank deposits with more than 12 months maturity.

Question 19.
“No entry is passed for cheques received by the auditee on the last day of the year and not yet deposited with the bank”. Give your comments and observations.
Answer:
Cheques received on the last day of Accounting Year:
Many a times, cheques are received from the customers on the last day of the accounting year and there are chances that these cheques could not be deposited in the bank on the same day.

Though in general, it is expected that all cheques should be deposited in the bank daily, but there may be a possibility that such cheques which are received particularly during the late hours could not be deposited in the bank.

In such cases, it becomes important that such cheques should be properly accounted for to avoid any frauds and that the financial statements reflect a true and fair view. For this purpose, an effective internal control system needs to be ensured.

It should be ensured that a list of such cheques is prepared in duplicate and a copy of the same has been sent to person controlling the trade receivables’ ledger and a second copy is handed over to cashier along with the cheques received. The person who is controlling the trade receivables’ ledger should ensure that proper accounting entries have been passed by crediting respective trade receivables’ accounts.

The balance of cheques-in-hand should also be disclosed along with the cash and bank balances in the financial statements.

Question 20.
State any six important points to be examined by you, as an auditor, in verifying the correctness of bank balance of an Educational Institution which deposits all its collection/receipt in separate collection account of a bank.
Answer:
Verification of Bank Balance of an Educational Institution:
For verifying the balances lying with bank in collection account, the auditor should adopt following procedure:

Compare the counterfoils of pay-in-slips with the entries in the ledger account.
Compare the entries in the ledger account with the pass book or bank statement.
Review the bank reconciliation statement for its correctness.
Scrutiny the subsequent period bank statement to ensure that items of reconciliation are subsequently cleared.
Check the casting, carry forwards and balancing of ledger account.
Obtain the balance confirmation certificate from the Bank.

Question 21.
Comment on “The cash-book showed a huge cash balance on hand consistently throughout the year”.
Answer:
Maintenance of Huge Cash Balance:
“Guidance Note on Audit of Cash and Bank Balances” recommends that if, during the course of the audit, it comes to the attention of the auditor that the entity is consistently maintaining an unduly large balance of cash in hand, he may perform the following procedures:
He should carry out surprise verification of cash more frequently.
1. If the cash in hand is not in agreement with the balance as shown in the books, he should seek explanations from a senior official of the entity.

2. In case any material difference is not satisfactorily explained, the auditor should state this fact appropriately in his audit report.

3. He should satisfy himself regarding the necessity for such large balances having regard to the normal working requirements of the entity.

4. The entity may also be advised to deposit the whole or the major part of the cash balance in the bank at reasonable intervals.

Question 22.
M, Statutory Auditor of ABC Ltd. wants to verify cash on hand as on 31st March, 2018. The Management informs Mr. M that it is not possible to cooperate, as cashier has been hospitalised. Advise Mr. M. on how to deal with the situation.
Answer:
Limitation on Scope of Auditor:
1. As per “Guidance Note on Audit of Cash and Bank balances” the auditor should carry out physical verification of cash at the date of the balance sheet. However, if this is not feasible, physical verification may be carried out, on a surprise basis, at any time shortly before or after the date of the balance sheet. In the latter case, the auditor should examine whether the cash balance shown in the financial statements reconciles with the results of the physical verification after taking into account the cash receipts and cash payments between the date of the physical verification and the date of the balance sheet.

2. In the present case, management refuses for physical verification as cashier has been hospitalised. This refusal amounts to limitation on scope of auditor, which warrant the auditor to express disclaimer of opinion or qualified opinion in his audit report depending upon the circumstances.

Conclusion: Non-cooperation of ABC Limited will amount to limitation on scope of auditors and auditor may modify the report based on the circumstances.

Question 23.
A significant and important audit activity is to contact banks/financial institutions directly and ask them to confirm the amounts held in current accounts, deposit accounts, EEFC account, cash credit accounts, etc. as at the end of the reporting period under audit. Explain the audit procedure in this context. [RTP-Nov. 20]
Answer:
Audit procedure for Direct Confirmation Procedure:
(a) Auditor is required to confirm all year end account balance maintained with the bank.

(b) In case of any discrepancies, client should be asked to investigate and reconcile the discrepancies, including seeking written explanations/clarifications from the banks/financial institutions on any unresolved queries.

(c) Auditor should emphasize for confirmation of 100% of bank account balances. In remote situations were no reply is received, the auditor should perform additional testing regarding the balances. This testing could include:

Agreeing the balance to bank statement received by the Company or internet/online login to account in auditor’s personal presence;
Prepare a final summary of the results of the circularization and draw the final conclusion.

Question 24.
Comment on the “Responsibility for properly determining the quantity and value of inventories rests with the management of the entity”.
Answer:
Responsibility for determination of quantity and value of inventories:
Guidance Note on Audit of inventories specifies the following:

The responsibility for properly determining the quantity and value of inventories rests with the management of the entity.
The management satisfies this responsibility by carrying out appropriate procedures which will normally include verification of all items of inventory at least once in every financial year.
This responsibility is not reduced even where the auditor attends any physical count of inventories in order to obtain audit evidence.
In any auditing situation, the auditor employs appropriate procedures to obtain reasonable assurance to corroborate the management’s assertions regarding the following:
1. Existence: that all recorded inventories exist as at the year-end.
2. Ownership: that all inventories owned by the entity are recorded and that all recorded inventories are owned by the entity.
3. Valuation: that the stated basis of valuation of inventories is appropriate and properly applied, and that the condition of inventories is recognised in their valuation.

Question 25.
How will you vouch/Verify the following: Work in Progress? [May 13 (4 Marks)]
Answer:
Verification of Capital Work in Progress:
Auditor is required to carefully assess the stage of completion of the W1P for assessing the appropriateness of its valuation. For this purpose, the auditor may perform the following:

examine the production/costing records (e.g., cost sheets),
hold discussions with the personnel concerned, and
obtain expert opinion, where necessary.

If physical verification of WIP is impracticable, the auditor should lay greater emphasis on ascertaining whether the system, from which the WIP is ascertained, is reliable.

Cost sheets of WIP should be verified as follows:
(a) Ascertain that the cost sheets are duly attested by the works manager.
(b) Test the correctness of the cost as disclosed by the cost records by verification of quantities and cost of materials, wages and other charges included in the cost sheets by reference to the records maintained in respect thereof.
(c) Compare the unit cost or job cost as shown by the cost sheet with the estimated cost.
(d) Ensure that the allocation of overhead expenses had been made on a rational basis.
(e) Compare the cost sheet in detail with that of the previous year. If they vary materially, investigate the cause thereof.
(f) Ensure that the Work-in-Progress as at Balance Sheet date has been appropriately disclosed in Balance Sheet as per the requirements of Schedule III.

Question 26.
Write short notes on: Physical attendance by auditor during inventory taking. [May 09 (5 Marks)]
Or
Briefly mention the matters that a re relevant in planning attendance at physical inventory counting. [Nov. 18 (5 Marks)]
Answer:
Physical attendance by auditor during inventory taking:
(a) The physical verification of stock is the responsibility of the management. The auditor may find it appropriate to attend the stock taking, if the inventory value is material in his opinion.

(b) The extent of participation in inventory taking depends upon the internal control system prevailing, results of examination of inventory records and analytical review procedures.

(d) He test checks few items by himself for their existence and quantum. He selects to test high value items importantly.

(e) The physical conditions of stock – like its age, deterioration, obsolescence etc., are looked into by auditor.

(f) The auditor reviews stores records and notes down major discrepancies for reconciling them in a subsequent date.

(g) The cut off arrangement is also looked into ensure that the entity accounts for stock for which liability had been booked and excludes stick which had been sold.

Question 27.
Write the audit procedures to be performed as an auditor for valuation (assertion) of following: Finished goods and goods for resale. [Nov. 18 (5 Marks), MTP-May 20]
Answer:
Audit procedures to be performed for valuation of Finished Goods and Goods for Resale:
1. CO Ensure that the valuation of inventories is in accordance with the AS 2, “Valuation of Inventories”, being lower of cost or Net Realisable Value.

2. Examine the evidence supporting the assessment of Net Realisable Value. In this regard, the auditor should particularly examine whether appropriate allowance has been made for defective, damaged and obsolete and slow-moving inventories in determining the NRV.

3. Inquire about the elements of costand ensure that the overheads included have been determined based on normal costs and appear reasonable.

4. Request the client to provide inventory ageing split between less than 30 days, 30-60 days old, 60- 90 days old, 90-180 days old, 180- 365 days old and more than 365 days old, for the purpose of follow up for items that are obsolete, damaged, slow moving and ascertain the possible realizable value of such items.

5. Compare recorded costs with replacement costs.

6. Calculate inventory turnover ratio. Obsolete inventory may be revealed if ratio is significantly lower.

Question 28.
State the different types of Analytical Review carried out in verification of inventories. [May 06 (6 Marks)]
Or
State the analytical review procedures normally carried out in the audit of inventories. [May 17 (6 Marks)]
Answer:
Analytical Review carried out in verification of Inventories:
While carrying out audit of inventories, auditor may also apply following analytical review procedures so as to obtain audit evidence regarding the various assertions:

Reconciliation of quantities of opening stocks, purchases, production, sales and closing stocks;
Comparison of closing stock quantities and amounts with those of the previous year;
Comparison of the relationship of current year stock quantities and amounts with the current year sales and purchases, with the corresponding figures for the previous year;
Comparison of the composition of the closing stock (e.g., raw materials as a percentage of total stocks, WIP as a percentage of total stocks) with the corresponding figures for the previous year;
Comparison of current year gross profit ratio with the gross profit ratio for the previous year;
comparison of actual stock, purchase and sales figures with the corresponding budgeted figures, if available;
comparison of yield with the corresponding figure for the previous year;
comparison of significant ratios relating to inventories with the similar ratios for other firms in the same industry, if available;
comparison of significant ratios relating to inventories with the industry norms, if available.

Question 29.
How will you vouch or verify: Goods sent on consignment.
Answer:
Verification of Goods sent on Consignment:
(a) Vouch the Proforma invoice sent with goods to ascertain the quantity and value of goods sent.
(b) Freight evidences given by the transporter like Challan, Bill, Receipt for freight charged.
(c) Insurance charge to be verified from cover note and premium paid receipt issued by Insurance Company.
(d) Account sale sent by consignee, referring to sale price of the goods sold, expenses incurred by him and stock remained unsold.
(e) Obtain confirmation from consignee for the goods held on consignment on balance sheet date.
(f) Unsold goods should have been taken in the closing stock valued properly inclusive of expenses (Proportionate) incurred by consignee.
(g) Journal entries relating to such transaction be verified from the books of the Company.

Question 30.
Indicate Expenses which are essentially of a revenue nature, if incurred for creating an asset, are also regarded as expenditure of capital nature. [May 14 (4 Marks)]
Or
Expenses which are essentially of a revenue nature if incurred for creating an asset or adding to its value of achieving higher productivity are regarded as exposes of a capital nature. Describe any five such expenses. [May 18 (5 Marks)]
Answer:
Expenses of Revenue Nature regarded as Capital Expenditure:

Material and wages when expended on the construction of a building or erection of machinery.
Legal expenses incurred in connection with the purchase of land or building.
Freight when incurred in respect of purchase of plant and machinery.
Major repairs of a fixed asset that increases its productivity.
Wages paid on installation costs incurred in Plant & Machinery.
Interest paid for the qualifying period as per AS-16 i.e. before the asset is constructed.

Question 31.
The auditor A of ABC & Co.- firm of auditors is conducting the audit of XYZ Ltd. and while performing testing of additions wanted to verify that all PPE (Property Plant and Equipment) purchase invoices are in the name of the entity he is auditing. For all additions to land, building in particular, the auditor desires to have concrete evidence about ownership. The auditor is worried about whether the entity has valid legal ownership rights over the PPE claimed to be held by the entity and recorded in the financial statements. Advise the auditor. [RTP-May 18, Nov. 19; MTP-Oct. 19]
Answer:
Verification of Addition to Property, Plant & Equipment:
Acquisition of new property, plant & equipment and improvements to the existing ones should be verified with reference to supporting documents such as orders, invoices, receiving reports and title deeds and applicable customs or excise documents. Due care needs to be taken when the purchase is from a related party. The auditor may employ procedures such as possible comparative prices prevalent in a ready market, evaluation, justification and approvals for the purchase.

Verification of Ownership of Property, Plant & Equipment:
The ownership of assets, like land and buildings, may be verified by examining the title deeds. In case the title deeds are held by other persons, such as solicitors or bankers, confirmation should be, at least where significant, obtained directly by the auditors through a request signed by the client.

Question 32.
Explain with examples the audit procedure to establish the existence of intangible fixed assets as at the period-end. [RTP-Nov. 18, MTP-April 19, RTP-Nov. 19]
Answer:
Audit procedure to establish the existence of intangible fixed assets as at the period-end:
An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
Auditor should check the following points:
1. Auditor should ensure that intangible asset should be recognised only if
(a) it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
(b) the cost of the asset can be measured reliably.

2. Ensure that at initial stages, intangible asset should be measured at cost. After initial recognition an intangible asset should be carried at its cost less any accumulated amortisation and any impairment losses.

3. For verifying the existence of software, the auditor should verify whether such software is in active use by the entity and for the purpose, the auditor should verify the sale of related services / goods during the period under audit, in which such software has been used.

4. For verifying the existence of design/drawings, the auditor should verify the production data to establish if such products for which the design/drawings were purchased, are being produced and sold by the entity.

5. In case any intangible asset is not in active use, deletion should have been recorded in the books of account post approvals by the entity’s management and amortization charge should have ceased to be charged beyond the date of deletion.

Question 33.
How will you verify the following:
(a) Intangible Assets [Nov. 15 (4 Marks)]
(b) Goodwill [May 05 (4 Marks)]
(c) Patents [Nov. 04 (4 Marks)]
(d) Trade Marks and Copyrights [May 17 (4 Marks), RTP-Nov. 20]
Answer:
Verification procedure:
(a) Intangible Assets:
An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. Auditor should check the following points:
1. Auditor should ensure that intangible asset should be recognised only if
(a) it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
(b) the cost of the asset can be measured reliably.

3. Ensure that if an item covered does not meet the definition of an intangible asset, expenditure to acquire it or generate it internally is recognised as an expense when it is incurred.

4. In some cases, an asset may incorporate both intangible and tangible elements that are, in practice, inseparable. Ensure that in determining whether such an asset should be treated under AS 10, “Property, Plant and Equipments”, or as an intangible asset under AS 26, “Intangible Assets” appropriate judgment has been taken to assess as to which element is predominant.

5. Auditor should also ensure that proper disclosure is made in the financial statements about the carrying amount, amortisation methods, useful lives, etc. in compliance of AS 26 and Schedule III to the Companies Act, 2013.

(b) Goodwill:

Ensure that goodwill has been recognized in the books in compliance of AS 26. As per AS – 2 6, “Intangible Assets”, internally generated goodwill is not to be recognised as an asset, as it is not an identifiable resource controlled by the enterprise that can be measured reliably at cost.
Examine the vendors’ agreement to ascertain the amount of goodwill.
Ensure that whenever business is acquired at a price, payable in cash or otherwise, which is in excess of the value of net assets taken over, such excess amount is the goodwill.
Ensure that only the amount paid to the vendors not represented by tangible or intangible assets, the value of which can be measured reliably has been debited to goodwill account.
Ensure goodwill has not recognised in the books by revaluation of assets or writing back the amount of goodwill earlier written off.
Ensure that the goodwill not yet written off has been properly disclosed under the head “Non-Current Assets” as per Schedule III requirements.
Ensure amortisation of goodwill over a reasonable period as a matter of financial prudence.

Obtain a list of patents owned by the client as on the balance sheet date and verify ownership of a patent by inspection of the certificate issued in respect of grant of the patent.
Examine the agreement if it has been so as to find out the total cost.
In case of outright purchase of patent rights, the purchase consideration, legal fees and registration charges should be included in cost. When they are developed within the organisation, all costs incurred on their development including legal and registration expenses for registration of the patent should constitute the cost.
Check that the patent rights are alive and legally enforceable.
Check that renewal fees have been paid on due dates and being charged to revenue. The last renewal receipt should be examined to ascertain that the patent has not lapsed.
Ascertain that the rate at which the value of each patent is being written off is adequate since the amount paid in respect of each patent should be amortised over its life or a lesser period if its commercial life is shorter; its value would be completely written off by the time it would cease to have a commercial value.
Ascertain that only the actual cost incurred in the process has been capitalised.

(d) Trade Marks and Copyrights:

Obtain duly signed schedule of Trade Marks and Copyrights and confirm that all of them are shown in the Balance Sheet.
Examine the written agreement in case of assignment of Copyrights or transfer of trade marks.
Ensure that trademarks and copyrights have been duly registered under respective laws.
Verify existence of copyright by reference to contract between the author & the entity and note down the terms of payment of royalty.
See that the value has been determined properly and the costs incurred for the purpose of obtaining the trademarks and copyrights have been capitalised.
Ascertain that the legal life of the trademarks and copyrights have not expired.
Ensure that amount paid for both the intangible assets is properly amortised having regard to appropriate legal and commercial considerations, as per the provisions of AS 26 on Intangible Assets.

Question 34.
You are an auditor of PQR Ltd. which has spent ₹ 10 lakhs on Research activities of the product during period under audit. Board of Directors want to recognize it as an internally generated intangible asset. Advise and discuss the conditions necessary to be fulfilled to recognize the intangible assets in the financial statements. [May 19 (4 Marks), MTP-Oct. 20]
Answer:
Conditions to be fulfilled to recognise the intangible assets in the financial statements:
As per AS 26 “Intangible Assets”, an intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.

Intangible asset should be recognised only if
(a) it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and
(b) the cost of the asset can be measured reliably.

An enterprise should assess the probability of future economic benefits using reasonable and supportable assumptions that represent best estimate of the set of economic conditions that will exist over the useful life of the asset.

Para 41 of AS 26 states that no intangible asset arising from research (or from the research phase of an internal project) should be recognised. Expenditure on research (or on the research phase of an internal project) should be recognised as an expense when it is incurred. As 26 takes the view that, in the research phase of a project, an enterprise cannot demonstrate that an intangible asset exists from which future economic benefits are probable. Therefore, this expenditure is recognised as an expense when it is incurred.

Question 35.
How will you vouch/verify the following: Leasehold Rights. [RTP-Nov. 20]
Answer:
Verification of Leasehold Rights:
1. Inspect the lease or assignment thereof to ascertain the amount of premium, if any, for securing the lease, and its terms and conditions; and that the lease has been duly registered. A lease exceeding one year is not valid unless it has been granted by a registered instrument.

2. Ascertain that all the conditions, the failure to comply with which might result in the forfeiture or cancellation of the lease, e.g., payment of ground rent on the due dates, insurance of property, its maintenance in a satisfactory state of repairs, etc. prescribed by the lease, are being duly complied with.

3. Examine the counterpart of the tenants’ agreements, if part of the leasehold property has been sublet.

4. Make certain that due provisions for any claim that might arise under the dilapidation clause on the expiry of the lease has been made, and, if no such provision has been made, draw the client’s attention to the matter.

5. Ensure that the outlay as well as any legal expenses incurred to acquire the leases which are shown as an asset in the Balance Sheet is being written off at a rate which could completely wipe off the asset over the unexpired term of the lease.

Question 36.
Verification of liabilities is as important as that of assets, considering if any liability is omitted (or understated] or overstated, the Balance Sheet would not show a true and fair view of the state of affairs of the entity. Explain stating also criteria for a liability to be classified as current liability. [RTP-Nov, 18, MTP-April 19]
Answer:
Criteria for classifying a liability as a Current Liability:
A liability shall be classified as current when it satisfies any of the following criteria:
(a) it is expected to be settled in the company’s normal operating cycle;
(b) it is held primarily for the purpose of being traded;
(c) it is due to be settled within twelve months after the reporting date; or
(d) the company does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date. Terms of a liability that could at the option of the counter party, result in its settlement by the issue of equity instruments do not affect its classification.
All other liabilities shall be classified as non-current.

Question 37.
Liabilities include trade payables and other current liabilities, deferred payment credits and provisions. Verification of liabilities is as important as that of assets, considering if any liability is omitted (or understated] or overstated, the Balance Sheet would not show a true and fair view of the state of affairs of the entity.
Advise stating clearly the audit procedure to establish the existence of trade payables and other current liabilities as at the period-end. [MTP-Aug. 18]
Answer:
Audit procedure to establish the existence of trade payables and other current liabilities as at the period-end:
Verification of trade payables and other current liabilities may be carried out by employing the following procedures:
(a) examination of records;
(b) direct confirmation procedure;
(c) analytical review procedures,
The NTE of substantive procedures to be performed is, however, a matter of professional judgment of the auditor which is based, inter alia, on the auditor’s evaluation of the effectiveness of the related
internal controls.

(A) Examination of Records:

The auditor should check the adequacy of cut-off procedures adopted by the entity in relation to transactions affecting the trade payable accounts.
The auditor should examine the correspondence and other relevant documentary evidence to satisfy himself about the validity, accuracy and completeness of trade payables/acceptances.
In case there are any unusual payments around the year-end, the auditor should examine them thoroughly,
The auditor should review subsequent transactions to identify/confirm material liabilities outstanding at the balance sheet date.

(B) Direct confirmation procedure:
1. The verification of balances by direct communication with trade payables is theoretically the best method of ascertaining whether the balances are genuine, accurately stated and undisputed, particularly where the internal control system is weak.

2. The auditor employs direct confirmation procedure with the consent of the entity under audit. There may be situations where the management of the entity requests the auditor not to seek confirmation from certain trade payables. In such cases, the auditor should consider whether there are valid grounds for such a request. Before accepting a refusal as justified, the auditor should examine any available evidence to support the management’s explanations, e.g., correspondence between the entity and the trade payables.

3. While determining the information to be obtained, the form of confirmation, as well as the extent and timing of application of the confirmation procedure, the auditor should consider all relevant factors such as the effectiveness of internal control, the apparent possibility of disputes, inaccuracies or irregularities in the accounts, the probability that requests will receive consideration, and the materiality of the amounts involved.

4. The trade payables may be requested to confirm the balances either
(a) as at the date of the balance sheet, or
(b) as at any other selected date which is reasonably close to the date of the balance sheet.

5. The form of requesting confirmation from the trade payables may be either
(a) the ‘positive’ form of request, wherein the creditor is requested to respond whether or not he is in agreement with the balance shown, or (b) the ‘negative’ form of request, wherein the creditor is requested to respond only if he disagrees with the balance shown.

(C) Analytical review procedures:
In addition to the audit procedures discussed above, the following analytical review procedures may often be helpful as a means of obtaining audit evidence regarding the various assertions:
(a) comparison of closing balances of trade payables with the corresponding figures for the previous year;
(b) comparison of the relationship between current year trade payable balances and the current year purchases with the corresponding figures for the previous year;
(c) comparison of actual closing balances of trade payables, etc., with the corresponding budgeted figures, if available;
(d) comparison of current year’s aging schedule of trade payables with the corresponding figures for the previous year;
(e) comparison of significant ratios relating to trade payables with the similar ratios for other firms in the same industry, if available;
(f) comparison of significant ratios relating to trade payables with the industry norms, if available.

Question 38.
How will you vouch/verify: Trade Creditors? [Nov. 07 (5 Marks)]
Answer:
Verification of Trade Creditors:
(a) Check the adequacy of cut off procedure to ensure that transaction of next period are not accounted and all transactions of year end are accounted.
(b) Check posting in the bought ledger from books of prime entry.
(c) Compare the balances in the schedule of creditors with balances in bought ledger.
(cf) Compare the balances with the confirmation or statement of account received from trade creditors.
(e) Pay special attention to long outstanding items and enquire about the reason thereof.
(f) Verify subsequent payments and reversal entries in the bought ledger of year end entries.
(g) See that trade creditors are classified and shown in the balance sheet as per requirement of Schedule III of the Companies Act, 2013.

Question 39.
Describe the criteria for classification of assert as current asset.
Answer:
Classification of Assets:
An asset shall be classified as current when it satisfies any of the following criteria:
(a) it is expected to be realized in, or is intended for sale or consumption in, the company’s normal operating cycle;
(b) it is held primarily for the purpose of being traded;
(c) it is expected to be realized within twelve months after the reporting date; or
(d) it is cash or cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting date.
All other assets shall be classified as non-current.

Question 40.
Write the audit procedures to be performed as an auditor for valuation (assertion) of: Loans and Advances and other current assets. [Nov. 18 (5 Marks), MTP-May 20]
Answer:
Audit procedures to be performed for valuation of Loans and Advances and other current assets:
1. Examine the provision made for doubtful accounts. For this purpose, auditor need to review the process followed by the entity to derive an allowance for doubtful accounts. Compare the process used in the last year and determine the appropriateness of method used.

2. Obtain the ageing report of loans and advances, split between not currently due, 30 days old, 30-60 days old, 60-180 days old, 180-365 days old and more than 365 days old.

3. Obtain list of loans and advances under dispute and compare with previous year.

4. Identify loans and advances that appear doubtful and check the respective provisions made. In case provisions are not been made, inquire the reasons from management

5. Examine bad loans/advances write-offs. Prepare schedule of movements on Bad loans/advances – Provision Accounts and loans/advances written off.

6. Examine whether the write-offs or other reductions in the recoverable balances have been approved by appropriate authority.

7. Examine whether the restatement of foreign currency loans and advances/other current assets has been done properly.

Question 41.
Write a short note on: Contingent Liability.
Answer:
Contingent Liability:
As per AS 29 “Provisions, Contingent Liabilities and Contingent Assets” a contingent liability is:

(a) 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
(b) a present obligation that arises from past events but is not recognised 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.

Recognition Principle of Contingent Liabilities

An enterprise should not recognise a contingent liability.
A contingent liability is disclosed, unless the possibility of an outflow of resources embodying economic benefits is remote.
Contingent liabilities are assessed continually to determine whether an outflow of resources embodying economic benefits has become probable. If it becomes probable that an outflow of future economic benefits will be required for an item previously dealt with as a contingent liability, a provision is recognised in the financial statements of the period in which the change in probability occurs.

Question 42.
How will you vouch/verify: Contingent Liabilities [May 07, May 17 (4 Marks}]
Answer:
Verification of Contingent Liabilities:

Review minutes of the meetings of the Board of Directors or other similar bodies.
Review contracts, agreements and arrangements.
Review list of pending law suits and obtain a certificate and opinion of the lawyer dealing with the cases.
Review of records relating to contingent liabilities maintained by the company.
Review of terms and condition of grants and subsidy availed.
Obtain representation from the management that all known contingent liabilities have been included in the accounts and disclosed properly.
Ensure that proper disclosure is made of all the contingent liabilities as per the requirements of AS-29 and Schedule III to the Companies Act, 2013.

Question 43.
How will you vouch/verify the following?
(a) Consignment Sales
(b) Goods sent out on sale or return basis. [Nov. 09 (5 Marks)]
Or
Discuss the audit procedures generally required to be undertaken by the auditor while auditing Goods sent out on Sale or Return Basis. [Nov. 20 (3 Marks)]
Answer:
Vouching of Consignment Sales:
1. Verify the terms of agreement between the consignor and the consignee to ascertain the terms and conditions regarding commission and other expenses.

2. Ensure that the goods consigned are not treated as ordinary sales.

3. Ensure that the gross sale proceeds as mentioned in the account Sales has been credited to the Consignment Account and debited to the consignee’s account.

4. Ascertain that credit has been taken only for the profit on the goods sold through the consignee before the year end. No profit should be taken for the profit on goods remaining in the hands of the consignee.

5. Ensure that the stock lying with the consignee at the end should be taken in the balance sheet at cost on a consistent basis and credited to the Consignment A/c to arrive at the result of the consignment transactions.

6. Obtain confirmation of the balance in the account of the consignee from the consignee.

7. In case, goods are consigned at invoice price, auditor should ensure that the necessary-adjustments to remove the loading have been made.

8. Examine the adjustments made at the year-end in respect of the goods not yet sold, commission and the expense incurred by consignee.

Vouching of Goods sent on sale or return basis:
1. Check maintenance of separate memoranda records of goods sent out on sale or return. Only after approval from customer, personal account of customer is debited and the sales account is credited.

2. Ensure that the price of such goods is unloaded from the sales account and the debtor’s record before the approval from customer.

3. In respect of the goods for which approval period has expired, ensure that either goods have been received back or customer’s account have been debited.

4. In respect of the goods for which approval period has not expired till the close of the year and lying with the party, ensure that cost of such goods has been included in the closing stock.

Question 44.
As statutory auditor of the company, list out audit procedures required to be undertaken for the following:
(i) Interest income from fixed deposits.
(ii) Dividend income.
(iii) Gain/(Loss) on sale of investment in Mutual funds.
Also indicate disclosure requirements of above as per Companies Act, 2013. [May 18 (4+2+2+2 Marks)]
Or
ABC Limited appointed XYZ & Company, Chartered Accountants, as a Statutory Auditor of the Company for the year 2019-20. CA. X, partner of XYZ & Company, was looking after the audit of other income of the company which consists of interest income on fixed deposits. As a Statutory Auditor how would CA. X verify interest income on fixed deposits for the year 2019-20? [Nov. 20 (4 Marks)]
Answer:
Audit procedure for financial items:
(i) Interest income from fixed deposits:
(a) Obtain a list of all fixed deposits exist at the beginning of the year and newly made during the audit, along with the applicable interest rate and the number of days for which the deposit was made.

(b) Verify the arithmetical accuracy of the interest calculation by multiplying the deposit amount with the applicable rate and number of days during the period under audit.

(c) For deposits outstanding as at the year end, obtain direct confirmation from the respective bank/financial institution.

(d) Obtain a confirmation of interest income from the bank and verify that the interest income as per bank reconciles to the calculation shared by the entity.

(e) Obtain a copy of Form 26AS (TDS) and reconcile the interest reflected therein to the calculation shared by client.

(ii) Dividend Income:
Verify that the dividend is recognised in the statement of profit and loss only when the entity’s right to receive payment of the dividend is established, provided it is probable that the economic benefits associated with the dividend will flow to the entity and the amount of the dividend can be measured reliably.

(iii) Gain/(Loss) on sale of investment in Mutual funds:
(a) Verify that Gain/(loss) on sale of investment in mutual funds is recognised as other income only on transfer of title from the entity and is determined as the difference between the redemption price and carrying value of the investments.

(b) For this purpose, obtain the mutual fund statement and trace the gain/loss as recorded in the books of account to the gain/loss as reflected in the statement.

Disclosure Requirements of Schedule III:
1. Classification of Other Income into:

Interest Income (except for a finance company)
Dividend Income
Net gain/loss on sale of Investments
Other Non-Operating Income (net of expenses directly attributable)

2. Dividend from foreign company
3. Adjustments to the carrying amount of investments
4. Net gain from foreign currency transactions and translations other than those considered as
Finance Costs.
5. Any item of revenue which exceed 1% of revenue from operations or X 1 lakh, whichever is higher

Question 45.
Discuss the special precautions in verification of purchase invoice.
Answer:
Special Precautions in verification of purchase Invoice:
1. Adjustment of Invoice Amount: In case, the total amount of the invoice has been adjusted in separate accounts, the entire amount so adjusted should be added together to confirm that there has not been error under adjustment.

2. Duplicate copy of Invoice: Ensure that if the payment is adjusted on the basis of duplicate invoice, the original invoice also needs to be marked as paid at the same time.

3. Compliance of special conditions: If supplies are received on certain special conditions, verified that these conditions are the same as were agreed to at the time the order was placed, e.g., payment of freight and insurance charges of goods while in transit, etc.

4. Timings of Payment: If the amount of an invoice was payable after the lapse of some time, subsequent to the receipt of goods, it should be ascertained that it has not been paid earlier and the benefit of cash discount, if any, has been obtained.

5. Goods purchased for personal use: Where goods have been purchased for the use of an officer but the invoice is made out in the name of the entity, it should be seen that the cost has been charged to the officer concerned and not to the Purchases Account of entity.

6. Purchases from related parties: If purchases are made from the associated concerns, ensure that such purchases are made only under an appropriate sanction.

7. Inspection before taking delivery: Ensure that the goods were inspected on arrival and the delivery note and the goods inward note should be examined.

8. Goods delivered directly to customer: The auditor should make appropriate inquiries in order to establish that the transaction was appropriately authorised by a responsible official. A copy of the delivery note signed by the account receivable on delivery of the goods should be examined, and it should be ascertained whether the account receivable is a regular purchaser of the company’s goods and not an employee of the company wishing to take advantage of a weakness in the system.

Question 46.
While auditing purchases which types of analytical procedures will be performed by the auditor I to obtain audit evidence as to overall reasonableness of purchase quantity and price. [May 19 (4 Marks)]
Or
Discuss the audit procedure to be considered by an auditor while performing analytical procedure to obtain audit evidence as to overall reasonableness of purchase quantity and price. [Nov. 19 (3 Marks)]
Answer:
Analytical procedures to be performed while auditing purchases:
Analytical procedures to obtain audit evidence as to overall reasonableness of purchase quantity and price include:
1. ConsumptionAnalysis: Auditor should examine consumption of raw material from manufacturing account and compare the same with previous years with closing stock and ask for the reasons from management for any significant variations noticed.

2. Stock Composition Analysis: Auditor should collect reports from management for composition of stock i.e. raw materials as a percentage of total stock and compare the same with previous year and ask for reasons from management for any significant variations noticed.

3. Ratios: Auditor should compare the creditors turnover ratios and stock turnover ratios of the current year with previous years.

4. Quantitative Reconciliation: Auditor should review quantitative reconciliation of closing stocks with opening stock, purchases and consumption.

Question 47.
State the disclosure requirements in respect of Statement of point and loss as per Schedule HI of Companies Act, 2013, in case of Employee benefits expenses. [Nov. 16 (4 Marks)]
Answer:
Disclosure requirements w.r.t. employee benefit expenses as per Schedule III:
Schedule III requires that a Company shall disclose by way of notes additional information regarding the employee benefit expenses as:

salaries and wages,
contribution to provident and other funds,
expense on Employee Stock Option Scheme (ESOP) and Employee Stock Purchase Plan (ESPP),
staff welfare expenses.

Question 48.
While reviewing Employee benefits expenses of a company, how you as an auditor you will evaluate its hiring, appraisal and retirement process? [May 19 (3 Marks)]
Answer:
Evaluation of hiring, appraisal and retirement process:
Tests the controls the company has set around employee benefit payment process to determine how effective and reliable they are. If they are effective, the auditor can minimise the amount of transaction testing he must do.
Common internal controls over the employee benefit payment cycle includes maintaining of attendance records, employee master, authorisation and approval of monthly payroll processing and disbursement, computation of employee deductions like payroll taxes, accrual of other benefits like gratuity, leave encashment, bonus etc.

Select a random sample of transactions and examines the related appointment letters, appraisal letters, attendance records, HR policies, employee master etc.

Perform substantive analytical procedures, which may comprise of evaluation of reasonable of monthly expense, comparison with previous accounting period, any analysis auditor may find relevant and most important of all setting an expectation in relation to the expense incurred during the period under audit and compare that with the client’s business operations and overall trend in the industry.

Question 49.
Define Depreciation and discuss various purposes of providing depreciation. [May 11(8 Marks)]
Or
Write short note on: Purposes of providing depreciation. [Nov. 12, Nov, 14,. May 17 (4 Marks)]
Answer:
Deprecation and purpose of providing depreciation:
AS 10 “Property, Plant and Equipment” defines depreciation as the systematic allocation of the depreciable amount of an asset over its useful life. Depreciable amount is the cost of an asset, or other amount substituted for cost less, its residual value.

Purposes of Providing depreciation:
(a) To provide the funds for the replacement of assets: This is accomplished by retaining the amount of depreciation charged in the profit and loss account in the business.

(b) To determine true cost of manufactured goods: As the value of fixed assets depletes gradually by consumption during the process of production, it is necessary that such consumption of value be charged in the accounts for determination of the true cost of production.

(c) To determine the profit or loss for the year: Depreciation being an expense represented by the loss in value of fixed assets arising on use, it is charged to the profit and loss account for determining the profit or loss during a year

(d) To show a true and fair value of entity’s assets in the balance sheet: since the original costs of fixed assets gradually decreases due to use and other factors, it is improper to continue to carry such assets at original costs. Therefore, the amount of depreciation charged in the profit and loss account representing the loss in value of the assets is deducted from the original cost on a cumulative basis so as to reflect in the balance sheet a true and fair value of the fixed assets.

Question 50.
Mention any five attributes to be considered by an auditor while verifying for depreciation and amortisation expenses. [May 18 (5 Marks)]
Answer:
Attributes to be considered by auditor while verifying depreciation and amortization:
(a) Occurrence: Recorded depreciation and amortisation expenses were actually incurred during the period.

(b) Completeness: Depreciation and amortisation expenses pertaining to the period have been recorded appropriately and there in no understatement/overstatement.

(d) Presentation: Presentation of depreciation and amortization expenses in the financial statements are as per requirements of applicable FRF.

(e) Disclosure: Required disclosures for depreciation and amortisation have been appropriately made.

Question 51.
“While the auditor may choose to analyse the monthly trends for expenses like rent, power and fuel but for other expenses, an auditor generally prefers to verify other attributes.” Mention those attributes. [Nov. 18 (5 Mai ksj|
Answer:
Attributes to be examined while vouching expenses:

Whether the expenditure pertained to current period under audit;
Whether the expenditure qualified as a revenue and not capital expenditure;
Whether the expenditure had a valid supporting like travel tickets, insurance policy, third party invoice etc.;
Whether the expenditure has been classified under the correct expense head;
Whether the expenditure was authorised as per the delegation of authority matrix;
Whether the expenditure v/as in relation to the entity’s business and not a personal expenditure.

Question 52.
Explain the audit procedure to vouch/verify:
(i) Rent expenses
(ii) Power and Fuel expenses [RTP-May 19]
Answer:
Audit Procedure to Vouch Rent Expenses:

Obtain a month wise schedule of rent payment along with the rent agreements.
Examine whether rent expense has been recorded for all 12 months and whether the rent paid is as per the underlying agreement.
Examine whether agreement contains any escalation clause, if yes, verify whether rent has been increased/adjusted during the period only as per escalation clause.
Verify whether the agreement is in the name of the entity.
Verify whether the expense pertains to premises used for running business operations of the entity.

Audit Procedure to Vouch Power and Fuel expenses:

Obtain a month wise expense schedule of payment towards power and fuel along with the power bills.
Examine whether the expenses have been recorded for all 12 months.
Compile a month wise summary of power units consumed and the applicable rate and check the arithmetical accuracy of the bill raised on monthly basis.
Analyse the monthly power units consumed by linking it to units of finished goods produced and investigate reasons for variance in monthly trends.

Objective Type Questions (True/False, Correct/Incorrect)

Question 1.
In vouching payments, the auditor does not merely check proof that money has been paid away.
Answer:
Statement is correct.
The object of vouching is not merely to ascertain that money has been paid away, but also to obtain reasonable assurance with regard to various assertions like authorisation, completeness, cutoff, classification, validity etc.

Question 2.
It is not essential to verify the sale proceeds of scrap which did not have a significant value if the company had a good accounting and costing systems.
Answer:
Statement is incorrect.
Auditor cannot overlook other aspects like existence of internal control, percentage of scrap produced, sale price of scrap etc.

Question 3.
Employee benefits expense represents the amount an entity pays to its employees for their labour/ efforts only.
Answer:
Statement is incorrect.
Employee benefits expense represents the aggregate amount an entity pays to its employees for their labour/efforts, as well as associated expenses such as perquisites/benefits, post- employment benefits like gratuity, superannuation, leave encashment, provident fund contribution etc.

Question 4.
Dividends are recognised in the statement of profit and loss only when the entity’s right to receive payment of the dividend is established.
Answer:
Statement is incorrect.
Recognition of dividend in the statement of profit and loss is subject to satisfaction of following conditions:
(a) the entity’s right to receive payment of the dividend is established;
(b) it is probable that the economic benefits associated with the dividend will flow to the entity; and
(c) the amount of the dividend can be measured reliably.

Question 5.
“Sweat Equity Shares” means equity shares issued by the company to employees or directors at a premium or for consideration other than cash for providing know-how or making available right in the nature of intellectual property rights or value additions, by whatever name called.
Answer:
Statement is incorrect.
As per section 2(88) of Companies Act, 2013 “Sweat Equity Shares” means equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing know-how or making available right in the nature of intellectual property rights or value additions, by whatever name called.

Question 6.
There is no difference between reserves and provision.
Answer:
Statement is incorrect.

Reserves are amounts appropriated out of profits which are not intended to meet any liability, contingency, commitment or diminution in the value of assets known to exist at the date of the Balance Sheet.
Provisions are amounts charged against revenue to provide for depreciation, renewal or diminution in the value of assets ora known liability the amount of which cannot be determined with substantial accuracy or a claim which is disputed.

Question 7.
Capital reserves represent profits that are available for distribution to shareholders held for the time being or any one or more purpose.
Answer:
Statement is incorrect.
Capital reserve represents surplus or profit earned in respect of certain types of transactions (like sale of fixed assets at a price in excess of cost, realisation of profits on issue of forfeited shares, etc.) which are not regarded by the directors as free for distribution as a dividend.

Profits that are available for distribution to shareholders held for the time being or any one or more purpose are generally classified as Revenue Reserve.

Question 8.
Capital reserve, generally, can be utilised for writing down fictitious assets or losses or (subject to provisions in the Articles) for issuing bonus shares if it is realised.
Answer:
Statement is correct.

Capital reserve represents surplus or profit earned in respect of certain types of transactions (like sale of fixed assets at a price in excess of cost, realisation of profits on issue of forfeited shares, etc.) which are not regarded by the directors as free for distribution as a dividend.
Capital reserve, can be utilised for writing down fictitious assets or losses or for issuing bonus shares if it is realised. But the amount of share premium or capital redemption reserve account can be utilised only for the purpose specified in Sections 52 and 55 respectively of the Companies Act, 2013.

Question 9.
If Company X’s balance sheet shows building with carrying amount of ₹ 100 lakh, the auditor shall assume that the management has only asserted that the building recognized in the balance sheet exists as at the period-end.
Answer:
Statement is incorrect.
Showing building with carrying amount of ₹ 100 lakhs in the balance sheet entitled the auditor to assume that the management has represented that:

The building recognized in the balance sheet exists as at the period-end (existence assertion);
Company X owns and controls such building (Rights and obligations assertion);
The building has been valued at ₹ 100 Lakhs (Valuation assertion);
All buildings owned and controlled by Company X are included within the carrying amount of ₹ 100 lakhs (Completeness assertion).

Question 10.
Authorised capital is the sum stated in the memorandum as the capital of the company with which it is to be registered being the maximum amount which it is authorised to raise by issuing shares, and upon which it pays the stamp duty.
Answer:
Statement is correct.
Section 2(8) of the Companies Act, 2013, defines “Authorised capital” or “Nominal capital” as such capital as is authorised by the memorandum of a company to be the maximum amount of share capital of the company.

Question 11.
The securities premium account may only be applied by the Company towards the issue of unissued shares of the company to the members of the company as fully paid bonus shares.
Answer:
Statement is incorrect.
As per Section 52 of Companies Act, 2013, securities premium account can be utilised for below mentioned purposes:
(a) towards the issue of unissued shares of the company to the members of the company as fully paid bonus shares;
(b) in writing off the preliminary expenses of the Company;
(c) in writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company;
(d) in providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company; or
(e) for the purchase of its own shares or other securities under section 68.

Question 12.
A company can issue its sweat equity shares at discounted price.
Answer:
Statement is correct.
As per Sec. 53 of the Companies Act, 2013, a company shall not issue shares at a discount. However, exception has been given in.the case of an issue of sweat equity shares.

Question 13.
A company shall disclose by way of notes additional information regarding aggregate expenditure and income for an item which exceeds ₹ 1,00,000.
Answer:
Statement is incorrect.
As per Schedule III to the Companies Act, 2013, a company shall disclose by way of notes additional information regarding aggregate expenditure and income for an item which exceeds 1% of the revenue from the operation or ₹ 1,00,000 whichever is higher.

Question 14.
A Special Resolution is required by company to authorize issue of shares at a discount. [Nov. 09 (2 Marks)]
Answer:
Statement is incorrect.
As per Section 53 of Companies Act, 2013, a company cannot issues shares at a discount.

Question 15.
The Statutory Auditor is required to verify inventory physically. [Nov. 14 (2 Marks)]
Answer:
Statement is Incorrect.

Physical verification of inventories is the responsibility of the management of the entity.
However, as per SA 501 “Audit Evidence – Specific Consideration for Selected Items” where the inventories are material and the auditor are placing reliance upon the physical count by the management, the auditor should attend the stocktaking.

Question 16.
Depreciation is charged by the company on purchase of stand-by depreciable assets which are ready to use. [Nov. 17 (2 Marks)]
Answer:
Statement is correct.

As per AS 10 “Property, Plant and Equipment, depreciation of an asset begins when it is available for use, i.e., when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.
Therefore, it is irrelevant, whether the asset is in active use or held in standby mode.

Question 17.
Vouching of payments is merely check proof that money has been paid. [Nov. 17 (2 Marks)]
Answer:
Statement is incorrect.

Vouching is an act of examining vouchers with an objective to establish the authenticity of the transactions recorded in the primary books of account.
Vouching may be classified as substantive audit procedure which aims at verifying the genuineness and validity of a transaction contained in the accounting records. Vouching is used to ensure that various transactions for the period are fairly & truly recorded in the books.

Question 18.
Negative balance of ‘Reserves & Surplus’ is shown on the Assets side of Balance Sheet. [Nov, 17 (2 Marks)]
Answer:
Statement is incorrect.
As per General Instructions for preparation of Balance Sheet as given in Schedule III to Companies Act, 2013, Balance of‘Reserves and Surplus’ should be shown on the liabilities side of Balance Sheet even if it has negative balance.

Question 19.
According to Section 53 of the Companies Act, 2013, a company can issue shares at a discount. [RTP-Nov.19]
Answer:
Statement is incorrect.

As per Sec. 53 of the Companies Act, 2013, a company shall not issue shares at a discount, except in the case of an issue of sweat equity shares given under Section 54 of the Companies Act, 2013.

Question 20.
An intangible asset is an identifiable monetary asset. [RTF-Nov.19]
Answer:
Statements is incorrect.

An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.

Question 21.
Depending on how the business operates, the management may value inventory using weighted average basis. [MTP-May 20]
Answer:
Statement is incorrect.
As per AS 2 “Valuation of Inventories” depending on how the business operates, the management may value inventory using First-in first-out (FIFO) or weighted average basis.

Question 22.
Mr. Z, a team member of auditor of Grateful and Competent Limited was of the opinion that while conducting an audit of a company no distinction is required to be made between revenue expenditure and capital expenditure. [MTP-Oct. 20]
Answer:
Statement is incorrect.
Opinion of Mr. Z is not because one of the important aspects to be followed while conducting audit of a company is that a distinction is required to be made properly between revenue expenditure and capital expenditure.

Question 23.
Tangible assets are depreciated when the asset is actually put to active use. [MTP-Oct. 20]
Answer:
Statement is incorrect.

Depreciation is a fall in value of asset due to obsolescence, usage and effluxion of time.
Therefore, depreciation is charged when the asset is ready for use. Active use of asset is not a mandatory criteria for charge of depreciation.

Question 24.
One of the key principles of accrual basis of accounting requires that an asset’s cost is proportionally expensed based on the period over which the asset is expected to be used. [RTP-Nov. 20]
Answer:
Statement is correct.

One of the key principles of accrual basis of accounting requires that an asset’s cost is proportionally expensed based on the period over which the asset is expected to be used. Both depreciation and amortization are methods that are used to prorate the cost of a specific type of asset over its useful life.
Depreciation represents systematic allocation of the depreciable value of an item of PPE over its useful life while amortisation represents systematic allocation of the depreciable amount of an intangible asset over its useful life.

Question 25.
Dividends are recognized in the statement of profit and loss only when the amount of dividends can be measured reliably. [Nov. 20 (2 Marks)]
Answer:
Statement is correct.
Dividends are recognised in the statement of profit and loss only when:

the entity’s right to receive payment of the dividend is established;
it is probable that the economic benefits associated with the dividend will flow to the entity; and
the amount of the dividend can be measured reliably.

Audit of Items of Financial Statements – CA Inter Auditing Notes

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