Auditing Standards, Statements and Guidance Notes-An Overview – CA Final Audit Question Bank

Auditing Standards, Statements and Guidance Notes-An Overview – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Auditing Standards, Statements and Guidance Notes-An Overview – CA Final Audit Question Bank

SQC 1 “Quality Control for Firms that perform Audits & Reviews of Historical Financial Information and Other Assurance and Related Services Engagements”

Question 1.
BSS & Associates is a partnership firm of Chartered Accountants which was established five years back. The firm was offering only advisory services at the beginning, however, after audit rotation and advent of GST, firm sees lot of potential in these areas also and started looking for opportunities in these areas also. These services being assurance in nature, the firm required some internal restructuring and set up some policies and procedures for compliance year on year.

The firm started getting new clients for these new services and is now looking to obtain such information as it considers necessary in the circumstances before accepting an engagement with a new client, when deciding whether to continue an existing engagement, and when considering acceptance of a new engagement with an existing client. Where issues have been identified, and the firm decides to accept or continue the client relationship or a specific engagement, it has been setting up a process to document how the issues were resolved.

The firm is now looking to work with only select clients which are in line with the policies of the firm. The firm understands that the extent of knowledge it will have regarding the integrity of a client will grow within the context of an ongoing relationship with that client. With regard to the integrity of a client, you are required to give some examples of the matters to be considered by the firm as per the requirements of SQC 1. [RTP-May 19]
Or
MB & Associates is a partnership firm of the Chartered Accountants which was established seven years back. The firm is getting new clients and has also been offered new engagement services with existing clients. The firm is concerned about obtaining such information as it considers necessary in the circumstances before accepting an engagement with a new client and acceptance of a new engagement with an existing client. The firm is looking to work with only select clients to adhere to the Quality Control Standards. Guide MB & Associates about the matters to be considered with regard to the integrity of a client, as per the requirements of SQC 1. [Nov. 19 – New Syllabus (4 Marks)]
Answer:
Considerations as to integrity of clients:
As per SQC-1 “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements” a firm should establish a system of quality control designed to provide it with reasonable assurance that the firm and its personnel comply with professional standards and regulatory and legal requirements, and that reports issued by the firm are appropriate in the circumstances.

Accordingly, the firm should obtain such information as it considers necessary in the circumstances before accepting an engagement with a new client, when deciding whether to continue an existing engagement, and when considering acceptance of a new engagement with an existing client. Where issues have been identified, and the firm decides to accept or continue the client relationship or a specific engagement, it should document how the issues were resolved.

Considerations as to integrity of clients:
With regard to the integrity of a client, matters that the firm considers include, for example:

The identity and business reputation of the client’s principal owners, key management, related parties and those charged with its governance.
The nature of the client’s operations, including its business practices.
Information concerning the attitude of the client’s principal owners, key management and those charged with its governance towards such matters as aggressive interpretation of accounting standards and the internal control environment.
Whether the client is aggressively concerned with maintaining the firm’s fees as low as possible.
Indications of an inappropriate limitation in the scope of work.
Indications that the client might be involved in money laundering or other criminal activities.
The reasons for the proposed appointment of the firm and non-reappointment of the previous firm.

The extent of knowledge a firm will have regarding the integrity of a client will generally grow within the context of an ongoing relationship with that client.

Question 2.
You are an audit senior working for the firm Bohra & Company. You are currently carrying out the audit of Wisdom Ltd., a manufacturer of waste paper bins. You are unhappy with Wisdom Ltd.’s inventory valuation policy and have raised the issue several times with the audit manager. He has dealt with the client for a number of years and does not see what you are making an objection about. He has refused to meet you on site to discuss those issues.

As the audit manager had dealt with Wisdom Ltd. for so many years, the other partners have decided to leave the audit of Wisdom Ltd. in his capable hands. Comment on the situation outlines above.
Answer:
Quality Control Issues in an engagement:
SQC – 1 “Quality Control for Firms that perform Audits and Reviews of Historical Financial Information and Other Assurance and Related Services Engagements” requires a firm to establish the policies & procedures for dealing/resolving differences of opinion with in engagement team.

An engagement partner is usually appointed to each audit engagement undertaken by the firm, to take responsibility for the engagement on behalf of the firm. Assigning the audit to an experienced audit manager is not sufficient.

SA 220 “Quality Control for an Audit of Financial Statement”, requires that the audit engagement partner takes responsibility for settling disputes in accordance with the firm’s policy in respect of resolution of difference of opinion required by SQC 1.

In the present case, partners of the firm have decided to leave the audit in the hands of Audit manager and no engagement partner has been assigned. The lack of an audit engagement partner also means that several of the requirements of SA 220, about ensuring that engagements in relation to independence and directing, supervising and reviewing the audit are not in place.

Further, the audit manager and senior have conflicting views about the valuation of inventory. This does not appear to have been handled well, with the manager refusing to discuss the issue with the senior.

Conclusion: Failure to resolve the difference of opinion is a breach of the firm’s policy under SQC 1.
It indicates that the firm does not have a suitable policy concerning such disputes required by SQC1.

Question 3.
Discuss with reference to SAs: The auditor is responsible for maintaining an attitudepf professional skepticism throughout the audit. Do you agree with the statement?
Answer:
Professional Skepticism:
(a) SA 200 “Overall Objectives of the Independent Auditor and Conduct of Audit in accordance with SAs” requires that the auditor shall plan and perform an audit with professional skepticism.

(b) Meaning of Professional Skepticism: An attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.

Overlooking unusual circumstances.
Over generalising when drawing conclusions from audit observations.
Using inappropriate assumptions in determining N, T, E of audit procedures & evaluating the results thereof.

(d) Professional skepticism includes being alter to:

Contradictory audit evidence.
Questions on reliability of documents.
Conditions indicating possible frauds.
Circumstances suggesting need for audit procedures in addition to those suggested in SAs.

Question 4.
“An Opinion expressed by the auditor is neither an assurance as to the future viability of the enterprise nor the efficiency or effectiveness with which management has conducted the affairs of the enterprise.”
Answer:
Auditor’s responsibility to express an opinion:

SA 200 “Overall Objectives of the Independent Auditor and Conduct of Audit in accordance with SAs” stats that in conducting an audit of financial statements, the auditor is required to express an opinion that whether the F.S. are prepared, in all material respects, in accordance with an applicable FRF.
The opinion expressed by the auditor is common to all audits of financial statements.
For this purpose of expressing opinion he is required to obtain reasonable assurance about whether the F.S. as a whole are free from material misstatement, whether due to fraud or error.
The term reasonable assurance has been defined as higher level of assurance but not absolute.
The auditor’s opinion, therefore, does not assure, the future viability of the entity nor the efficiency or effectiveness with which management has conducted the affairs of the entity.

SA 210 “Agreeing the Terms of Audit Engagement”

Question 5.
Mr. Ram Kapoor, Chartered Accountant, has been appointed as the statutory auditor by XYZ Private Limited for the audit of their financial statements for the year 2020-21. The company has mentioned | in the audit terms that they will not be able to provide internal audit reports to Mr. Rani during the course of audit. Further, company also imposed some limitation on scope of Mr. Ram.

What are the preconditions Mr. Ram should ensure before accepting/refusing the proposal? Also advise, whether Mr. Ram should accept the proposed audit engagement? [RTP-Nov. 19]
Answer:
Preconditions for an audit engagement:
SA 210 “Agreeing the Terms of Engagement” deals with the auditor’s responsibilities in agreeing the terms of the audit engagement with management. Before accepting/refusing an audit engagement, to>establish whether the preconditions for an audit are present, the auditor shall:

(a) Determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable; and

(b) Obtain the agreement of management that it acknowledges and understands its responsibilities for followings:

the preparation of the F.S. in accordance with the applicable FRF,
exercising necessary internal control to enable the preparation of F.S. that are free from material misstatement, whether due to fraud or error.
to provide the auditor with:
(a) Access to all relevant information such as records, documentation and other matters;
(b) Additional information that the auditor may request from management for the purpose of the audit; and
(c) Unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.

Question 6.
AKJ Ltd. is a small-sized 30 years old company having business of manufacturing of pipes. Company has a plant based out of Dchradun and have their corporate office in Delhi. Recently the company appointed new firm of Chartered Accountants as their statutory auditors.

The statutory auditors want to enter into an engagement letter with the company in respect of their services but the management has contended that since the statutory audit is mandated by law, engagement letter may not be required. Auditors did not agree to this and have shared a format of engagement letter with the management for their reference before getting that signed. In this respect management would like to understand that as per SA 210 (auditing standard referred to by the auditors), if the agreed terms of the engagement shall be recorded in an engagement letter or other suitable form of written agreement, what should be included in terms of agreed audit engagement letter? [MTP-April 19]
Answer:
Agreement on Audit Engagement Terms:
SA 210 “Agreeing the Terms of Audit Engagement” deals with the auditor’s responsibilities in agreeing the terms of the audit engagement with management and, where appropriate, those charged with governance. Accordingly,
(1) The auditor shall agree the terms of the audit engagement with management or TCWG, as appropriate.

(2) The agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable form of written agreement and shall include:
(a) The objective and scope of the audit of the F.S.;
(b) The responsibilities of the auditor;
(c) The responsibilities of management;
(d) Identification of the applicable FRF for the preparation of the F.S.; and
(e) Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content.

(3) If law or regulation prescribes in sufficient detail the terms of the audit engagement referred above, the auditor need not record them in a written agreement, except for the fact that such law or regulation applies and that management acknowledges and understands its responsibilities.

Question 7.
Comment on the following: “It is not mandatory to send a new engagement letter in recurring audit, but sometimes it becomes mandatory to send new letter.” Explain those situations where new engagement letter is to be sent.
Or
R & Co., a firm of Chartered Accountants have not revised the terms of engagements and obtained confirmation from the clients, for last 5 years despite changes in business and professional development. Please elucidate the circumstances that may warrant the revision in terms of engagement. [May 13 (4 Marks)]
Answer:
Situations in which new engagement letter is required in case of recurring audit:
SA 210 “Agreeing the Terms of Engagement” deals with the auditor’s responsibilities in agreeing the terms of the audit engagement with management. As per SA 210,in case of recurring audits, the auditor shall assess whether circumstances require revision in terms of the audit engagement and whether there is a need to remind the entity of the existing terms of the audit engagement.

The auditor may decide not to send a new audit engagement letter or other written agreement each period. However, the following factors may make it appropriate to revise the terms of the audit engagement or to remind the entity of existing terms:

Any indication that the entity misunderstands the objective and scope of the audit.
Any revised or special terms of the audit engagement.
A recent change of senior management.
A significant change in ownership.
A significant change in nature or size of the entity’s business.
A change in legal or regulatory requirements.
A change in the financial reporting framework adopted in the preparation of the F.S.
A change in other reporting requirements.

“ICAI Examiner Comments” s
Many candidates failed to mention most of the circumstances that may warrant the revision in terms of engagement. Some candidates answered the areas to be changed in the engagement letter.

Question 8.
X, a Chartered Accountant was engaged by PQR & Co. Ltd. for auditing their accounts. He sent his letter of engagement to the Board of Directors, which was accepted by the Company. In the course of audit of the company, the auditor was unable to obtain appropriate sufficient audit evidence regarding receivables. The client requested for a change in the terms of engagement. Offer your comments in this regard.
Answer:
Acceptance of changes in Terms of Engagement:
SA 210 “Agreeing the Terms of Engagement” deals with the auditor’s responsibilities in agreeing the terms of the audit engagement with management. As per SA 210, if prior to completing the audit engagement, the auditor is requested to change the audit engagement to an engagement that conveys a lower level of assurance, the auditor shall determine whether there is reasonable justification for doing so.

The auditor shall not agree to a change in the terms of the audit engagement where there is no reasonable justification for doing so.

If the terms of the audit engagement are changed, the auditor and management shall agree on and record the new terms of the engagement in an engagement letter or other suitable form of written agreement.

If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by management to continue the original audit engagement, the auditor shall:

Withdraw from the audit engagement where possible under applicable law or regulation; and
Determine whether there is any obligation, either contractual or otherwise, to report the circumstances to other parties, such as TCWG, owners or regulators.

Question 9.
MEA Limited is a listed company having its operation across India. MEA Limited appointed Mr. X, Mr. Y and Mr. Z, as its joint auditors for the year 2020-21. After making sure that all of them are qualified to be appointed as statutory auditor, MEA Limited issued engagement letter to all of them. But Mr. X was not clear on some points, so he requested MEA Limited to slightly change the terms of his engagement. This change will not impact the ultimate opinion on the financial statement. The engagement letter contains the details on objective and scope of audit, responsibilities of auditor and identification of framework applicable. It also contains the reference to expected form and content of report from all three joint auditors. In your opinion what was the discrepancy in the Audit engagement letter issued by MEA Limited? [RTP-Nov. 20]
Answer:
Agreement on Audit Engagement Terms:
As per SA 210, “Agreeing the Terms of Audit Engagements”, the auditor shallagree the terms of the audit engagement with management or TCWG, as appropriate.

The agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable form of written agreement and shall include:
(a) The objective and scope of the audit of the F.S.;
(b) The responsibilities of the auditor;
(c) The responsibilities of management;
(d) Identification of the applicable FRF for the preparation of the F.S.; and
(e) Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content.

In the present case, MEA Limited appointed Mr. X, Mr. Y and Mr. Z, as its joint auditors for the year 2020-21 and issued engagement letter to all of them. The engagement letter contains the details on objective and scope of audit, responsibilities of auditor, identification of framework applicable and reference to expected form and content of report from all three joint auditors.

Conclusion: Engagement letter issued by MEALtd.does not specify the responsibilities of management, whereas as per SA 210, it should also specify responsibilities of management.

SA 220 “Quality Control for an Audit of Financial Statements’’

Question 10.
During the audit of FMP Ltd., a listed company, Engagement Partner (EP) completed his reviews and also ensured compliance with independence requirements that apply to the audit engagement. The engagement files were also reviewed by the Engagement Quality Control Reviewer (EQCR) except the independence assessment documentation. Engagement Partner was of the view that matters related to independence assessment are the responsibility of the Engagement Partner and not Engagement Quality Control Reviewer. Engagement Quality Control Reviewer objected to this and refused to sign off the documentation. Please advise as per SA 220. [RTP-May 19, MTP-Oct. 19]
Answer:
Responsibilities of EP and EQCR in relation to assessment of independence:
As per SA 220 “Quality control for an Audit of Financial Statements” the engagement partner shall form a conclusion on compliance with independence requirements that apply to the audit engagement. In doing so, the engagement partner shall:
(a) Obtain relevant information from the firm and, where applicable, network firms, to identify and evaluate circumstances and relationships that create threats to independence;
(b) Evaluate information on identified breaches, if any, of the firm’s independence policies and procedures to determine whether they create a threat to independence for the audit engagement; and
(c) Take appropriate action to eliminate such threats or reduce them to an acceptable level by applying safeguards, or, if considered appropriate, to withdraw from the audit engagement, where withdrawal is permitted by law or regulation. The engagement partner shall promptly report to the firm any inability to resolve the matter for appropriate action.

For audits of financial statements of listed entities, the engagement quality control reviewer, on performing an engagement quality control review, shall also consider among other things, the engagement team’s evaluation of the firm’s independence in relation to the audit engagement.

Conclusion: View of EP that matters related to independence assessment are the responsibility of the EP and not EQCR is not correct. The independence assessment documentation should also be given to EQCR for his review.

Question 11.
M/s Sureshchandra & Co. has been appointed as an auditor of SC Ltd. for the financial year 2019-20. CA. Suresh, one of the partners of M/s Sureshchandra & Co., completed entire routine audit work by 29th May, 2020. Unfortunately, on the very next morning, while roving towards office of SC Ltd. to sign final audit report, he met with a road accident and died. CA. Chandra, another partner of M/s Sureshchandra & Co., therefore, signed the accounts of SC Ltd., without reviewing the work performed by CA. Suresh.

State with reasons whether CA. Chandra is right in expressing an opinion on financial statements the audit of which is performed by another auditor. [MTP-April 18]
Answer:
Review of Work performed by others:
As per SA 220, “Quality Control for an Audit of Financial Statements”, the engagement partner shall take responsibility for reviews being performed in accordance with the firm’s review policies and procedures. Review procedures consists of the considerations, whether,

the work has been performed in accordance with professional standards and regulatory and legal requirements;
Significant matters have been raised for further consideration;
appropriate consultations have taken place and the resulting conclusions have been documented and implemented;
the work performed supports the conclusions reached and is appropriately documented;
the evidence obtained is sufficient and appropriate to support the auditor’s report; and
the objectives of the engagement procedures have been achieved.

When the auditor delegates work to assistants or uses work performed by other auditors/ experts he will continue to be responsible for forming and expressing his opinion on the financial statements. However, he will be entitled to rely on the work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied.

The auditor should carefully direct, supervise and review work delegated to assistants. He should obtain reasonable assurance that work performed by other auditors/experts and assistants is adequate for his purpose. ”

In the instant case, Mr. Suresh, a partner of the firm had completed routine audit work and died
before signing audit report. Mr. Chandra another partner of the firm has signed the accounts of SC Ltd., relying on the work performed by Mr. Suresh. ‘

Conclusion: CA. Chandra is allowed to sign the audit-report, though, will be responsible for expressing the opinion. He may rely on the work performed by CA. Suresh provided he further exercises adequate skill and due care and review the work performed by him.

Question 12.
Mention any four information which assists the auditor in accepting and continuing of relationship with the client as per SA 220.
Answer:
Information assisting auditor in accepting and continuing of relationship with the client:
As per SA 220 “Quality Control for an Audit of F.S.” the information which assists the auditor in accepting and continuing of relationship with the client may include the following:

The Integrity of the principal owners, key management and TCWG of the entity;
Competency of engagement team to perform the audit engagement and availability of necessary capabilities, including time and resources;
Compliance with relevant ethical requirements by firm and the engagement team; and
Significant matters that have arisen during the current or previous audit engagement, and their implications for continuing the relationship.

Question 13.
OP & Associates are the statutory auditors of BB Ltd. BB Ltd is a listed company and started its operations 5 years back. The field work during the audit of the financial statements of the company for the year ended March 31, 2020 got completed on July 1, 2020. The auditor’s report was dated July 12, 2020. During the documentation review of the engagement, it was observed that the engagement quality control review was completed on July 15, 2010. Engagement partner had completed his reviews in entirety by July 10, 2020. Comment. JMTP-Oct. 18, March 19]
Answer:
Review by Engagement Partner:
As per SA 220, “Quality Control for an Audit of Financial Statements”, the engagement partner shall take responsibility for reviews being performed in accordance with the firm’s review policies and procedures. For audits of financial statements of listed entities, the engagement partner shall:
(a) Determine that an engagement quality control reviewer has been appointed;
(b) Discuss significant matters arising during the audit engagement, including those identified during the engagement quality control review, with the engagement quality control reviewer; and
(c) Not date the auditor’s report until the completion of the engagement quality control review.

Further, SA 700, “Forming an Opinion and Reporting on Financial Statements”, requires the auditor’s report to be dated not earlier than the date on which the auditor has obtained sufficient appropriate evidence on which to base the auditor’s opinion on the financial statements.

In the present case, OP & Associates are the statutory auditors of a listed company which started its operations 5 years back. The field work during the audit of the financial statements of the company for the year ended March 31,2020 got completed on July 1,2 02 0. The auditor’s report was dated July 12, 2020. During the documentation review of the engagement, it was observed that the engagement quality control review was completed on July 15, 2020.

Conclusion: Signing of auditor’s report i.e. on July 12, 2020 which is before the completion of review engagement quality control review i.e. July 15, 2020, is not in order.

SA 230 “Audit Documentation”

Question 14.
Mr. A, a practicing Chartered Accountant, has been appointed as an auditor of True Pvt. Ltd. What factors would influence the amount of working papers required to be maintained for the purpose of his audit? [Nov. 15 (5 Marks), RTP-May 20]
Answer:
Factors affecting Form, Content and Extent of Audit Documentation:
SA 230 “Audit Documentation” deals with the auditor’s responsibility to prepare audit documentation for an audit of financial statements. Accordingly, the various factors that may affect form, content and extent of audit documentation are following

The size and complexity of the entity.
The nature of the audit procedures to be performed.
The identified risks of material misstatement.
The significance of the audit evidence obtained.
The nature and extent of exceptions identified.
The need to document a conclusion or the basis for a conclusion not readily determinable from the documentation of the work performed or audit evidence obtained.
The audit methodology and tools used.
Timely preparation of audit documentation.

“ICAI Examiner Comments” ‘
Many examinees did not discuss the factors influencing the amount of audit working papers and the answers were general in nature explaining the type of working papers. Also some examinees wrote about the importance of working papers. A few examinees described the need of the working papers which was not required. Some examinees also discussed about current audit file and permanent audit file.

Question 15.
Discuss the Auditor’s responsibilities to provide access to his audit working papers to Regulators and the third parties. [Nov. 14 (3 Marks)]
Answer:
Access to Working papers to Regulators and Third Parties:
Clause (1) of Part I of Second Schedule to the Chartered Accountants Act, 1949 states that a CA in practice shall be deemed to be guilty of professional misconduct if he discloses information acquired in the course of his professional engagement to any person other than his client, without the consent of his client or otherwise than as required by law for the time being in force.

SA200 on “Overall Objectives of the Independent Auditor and the conduct of an audit in accordance with Standards on Auditing” also reiterates that, “the auditor should respect the confidentiality of the information obtained and should not disclose any such information to any third party without specific authority or unless there is a legal or professional duty to disclose”. If there is a request to provide access by the regulator based on the legal requirement, the same has to be complied with after informing the client about the same.

SQC-1, “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements”, provides that, unless otherwise specified by law or regulation, audit documentation is the property of the auditor. He may at his discretion, make portions of, or extracts from, audit documentation available to clients, provided such disclosure does not undermine the validity of the work performed, or, in the case of assurance engagements, the independence of the auditor or of his personnel.

As per SA 230, Audit documentation serves a number of additional purposes, including the enabling the conduct of external inspections in accordance with applicable legal, regulatory or other requirements.

Conclusion: It is auditor’s responsibility to provide access to his audit working papers to Regulators when required by law whereas auditor is under no obligation to provide access to working papers to third parties.

Question 16.
As an auditor, how would you deal with the following: The statutory auditor of the Holding Company demands for the working papers of the auditors of the subsidiary company, of which you are the auditor.
Answer:
Access to working papers:

As per SA 230, “Audit Documentation” working papers are the property of the auditor. The auditor may, at his discretion, make portion of or extracts of his working papers available to his client.
SA 600 “Using the Work of Another Auditors” also states that an auditor should respect the confidentiality of information acquired during the course of his audit work and should not disclose such information unless there is a legal or professional duty to disclose.
As per ICAI Guidelines, statutory auditor of an enterprise does not have right of access to the audit working papers of the branch auditor. An auditor can rely on the work of another auditor, without having any right of access to the audit working papers of other auditor.

Conclusion: Statutory auditor of Holding company cannot have access to audit working papers of the subsidiary company’s auditor. He can however, ask the auditor to answer certain questions about the manner in which the audit is conducted and certain other clarifications regarding audit.

Question 17.
B is the Principal Auditor of ABC Co. Ltd., with 8 branches audited by 8 Branch Auditors. B wanted to ensure that the works of Branch Auditors were adequate for the purpose of his audit. Hence, he insisted on Branch Auditors to get familiar with a check list he prepared for branches and, besides, required them to share the working papers complied by them for his review and return. Is principal auditor within his right in asking for such sharing of working papers? [May 18 – New Syllabus (5 Marks)]
Answer:
Principal Auditor’s right to review the working papers of branch auditors:
SA 600 “Using the Work of Another Auditor” guides principal auditor regarding the procedures to be performed when he is using the work of another auditor. As per SA 600, when principal auditor plans to use the work of branch auditor, he should consider the professional competence of the other auditor in the context of specific assignment if the other auditor is not a member of the ICAI. He 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.

As per SA 230 “Audit Documentation” and SQC 1 “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements”, unless otherwise specified by law or regulation, audit documentation is the property of the auditor. The Principal auditors of an enterprise do not have right of access to the audit working papers of the branch auditors.

In the present case, Mr. B requires the branch auditors to share their working papers with him for the purpose of review.

Conclusion: considering the requirements of SA 600, SA 230 and SQC 1, principal auditor is not right in asking for sharing of working papers.

SA 244 “The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements”

Question 18.
In the course of audit, A Ltd. you suspect the management has indulged in fraudulent financial reporting? State the possible source of such fraudulent financial reporting. [May 12 (6 Marks)]
Answer:
Possible Sources of Fraudulent Financial Reporting: ’
SA 240, “The Auditor’s responsibilities relating to Fraud in an Audit of Financial Statements”, deals with auditor’s responsibilities in relation to fraud while performing the audit. Auditor is primarily concerned with those frauds that causes material misstatement in financial statements.

Possible sources of fraudulent financial reporting as stated in SA 240 are:

Recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.
Inappropriately adjusting assumptions and changing judgments used to estimate account balances.
Omitting, advancing or delaying recognition in the financial statements of events and transactions that have occurred during the reporting period.
Concealing, or not disclosing, facts that could affect the amounts recorded in the financial statements.
Engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity.
Altering records and terms related to significant and unusual transactions.

“ICAI Examiner Comments”
While some have a good grip over the topic, few have no idea on the practical aspects of possible sources of fraudulent financial reporting.

Question 19.
You are appointed as an auditor of Global Ltd. Explain the risk factors relating to misstatements arising from misappropriation of assets. [Nov. 15 (4 Marks)]
Answer:
Risk Factors relating to misstatements arising from misappropriation of Assets:
SA 240, “The Auditor’s responsibilities relating to Fraud in an Audit of Financial Statements”, deals with auditor’s responsibilities in relation to fraud while performing the audit.

Accordingly, various risk factors that relate to misstatements arising from misappropriation of assets are classified according to the below mentioned conditions generally present when fraud exists:
1. Incentive or pressure to commit fraud: It may exist when management is under pressure, from sources outside or inside the entity, to achieve an expected (and perhaps unrealistic) earnings target or financial outcome.

2. A perceived opportunity to do so: It may exist when an individual believes internal control can be overridden, for example, because the individual is in a position of trust or has knowledge of specific weaknesses in internal control.

3. Rationalization of the Act: Individuals may be able to rationalize committing a fraudulent act. Some individuals possess an attitude, character or set of ethical values that allowthem knowingly and intentionally to commit a dishonest act. However, even otherwise honest individuals can commit fraud in an environment that imposes sufficient pressure on them.

“ICAI Examiner Comments”
The conditions generally present when fraud exists namely incentives/preSsureS, opportunities, and attitudes/rationalization are not focused by majority of examinees. Examinees wrote Irrelevant answers. Many examinees explained the effect of misappropriation of assets instead of risk factors relating to misstatements arising from misappropriation of assets.

Question 20.
Explain briefly dudes and responsibilities of an auditor in case of material misstatements resulting from management fraud. . [Nov. 09, May 17(6 Marks)]
Or
Cloud Ltd. appointed an auditor for the financial year 2020-21. While going through the audit procedure, the auditor observed that the management has entered into certain transactions which are irregular in nature and the management is personally benefited from such transactions. Explain briefly the duties and responsibilities of an auditor in case of material misstatement resulting from Management Fraud.
Or
Fraud can be committed by management overriding controls using such techniques as engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity. In view of the above-mentioned circumstances of management fraud, explain briefly duties and responsibilities of an auditor in case of material misstatement resulting from such Management Fraud. _
Answer:
Auditor’s duties in case of material misstatement resulting from management fraud:
(a) SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” requires that the auditor is responsible for obtaining reasonable assurance that the F.S. taken as a whole are free from material misstatement, whether caused by fraud or error.

(b) Management is in a unique position to perpetrate fraud because of management’s ability to manipulate accounting records and prepare fraudulent financial statements by overriding controls.

(c) When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of professional skepticism throughout the audit.

(d) The auditor should recognize the possibility that a material misstatement due to fraud could exist, notwithstanding his past experience of the honesty and integrity of the entity’s management and those charged with governance.

(e) If conditions cause the auditor to believe that a document may not be authentic or that terms in a document have been modified, the auditor shall investigate further.

(f) Where responses to inquiries of management or TCWG are inconsistent, the auditor shall investigate the inconsistencies.

(g) Section 143(12) of Companies Act 2013 requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. For this purpose, Rule 13 of CAAR, 2014 prescribes the amount of ₹ 1 Cr. or more.

(h) Para 3(xi] of CARO, 2020 also requires the company auditor to report whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.

“ICAI Examiner Comments”
Most of the candidates could not write title duties and responsibilities of an auditor in case of material misstatements resulting from management fraud correctly.

Question 21.
You notice a misstatement resulting from fraud or suspected fraud duringthe audit and conclude that it is not possible to continue the performance of audit, As a Statutory Auditor, how would you deal?
Answer:
Auditor’s unable to complete the engagement:
SA 240, “The Auditor’s responsibilities relating to Fraud in an Audit of Financial Statements”, deals with auditor’s responsibilities in relation to fraud while performing the audit. Accordingly, if the auditor conclude that it is not possible to continue performing the audit as a result of misstatement resulting from fraud or suspected fraud, the auditor should:
(a) Consider the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities;

(b) Consider the possibility of withdrawing from the engagement; and

Discuss with the appropriate level of management and TCWG, the auditor’s withdrawal from the engagement and the reasons for the withdrawal; and
Determine whether there is a professional or legal requirement to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities, the auditor’s withdrawal from the engagement and the reasons for the withdrawal.

Further, as per section 140(2] of the Companies Act, 2013, the auditor who has resigned from the company shall file within a period of 30 days from the date of resignation, a statement in the Form ADT-3 with the company and the Registrar.

Section 143(12] of Companies Act, 2013, requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. For this purpose, Rule 13 prescribes the amount of ₹ 1 Cr. or more.

Question 22.
The Managing Director of the Company has committed a “Teeming and Lading” Fraud. The amount involved has been however subsequently after the year end deposited in the company. As a Statutory Auditor, how would you deal?
Answer:
Fraud Committed by Managing Director:
SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” requires that the auditor is responsible for obtaining reasonable assurance that the F.S. taken as a whole are free from material misstatement, whether caused by fraud or error.

Management is in a unique position to perpetrate fraud because of management’s ability to manipulate accounting records and prepare fraudulent financial statements by overriding controls.

In the instant case, Managing Director of the company has committed a “Teeming and Lading” fraud. The fact that the amount involved has been subsequently deposited after the year end is not important because the auditor is required to perform his responsibilities as laid down in SA 240 as stated below:
(a) Consider the impact of fraud on financial statements and its disclosure in the audit report.
(b) Communicate the matter to the Chairman and Board of Directors.
(c) Consider the reliability of audit evidence previously obtained as the fraud has been conducted at a higher level of management which raises a genuine doubt about representations of management.

Section 143 (12] of Companies Act, 2013 requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. For this purpose, Rule 13 prescribes the amount of ₹ 1 Cr. or more.

Para 3(xi) of CARO, 2020 also requires the company auditor to report whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.

Question 23.
As a Statutory Auditor, how would you deal with the following cases: In the books of account of M/s OPQ Ltd. huge differences are noticed between the control accounts and subsidiary records. The Chief Accountant informs that this is common due to huge volume of business done by the company during the year.
Answer:
Difference between Control Accounts and Subsidiary Records:
The huge differences found between control accounts and subsidiary records in the books of M/s OPQ Ltd. indicate that there may be material misstatements requiring detailed examination by the auditor to ascertain the cause.

The contention of Chief Accountant cannot be accepted simply because the company has done huge volume of business. Such a phenomenon indicates that recording of transactions is not being done properly or the accounting system fails to capture all transactions in time.

Having regard to all these circumstances, it appears from the facts of the case that these differences indicate the possibility of some kind of material misstatements.

According to SA 240 “The Auditors responsibilities relating to Fraud in an audit of F.S.”, when the auditor comes across such circumstances indicating the possible misstatements resulting from entity’s procedure, the auditor shall evaluate whether such a misstatement is indicative of fraud.

In this case, the circumstances indicate the possibility of material misstatements (that might be due to fraud) and accordingly, the auditor must investigate further to consider effect on F.S.

Section 143(12) of Companies Act, 2013 requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as maybe prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. For this purpose, Rule 13 prescribes the amount of ₹ 1 Cr. or more.

Question 24.
While conducting statutory Audit of ABC Ltd., you come across IOUs amounting to ₹ 2 crores as against a cash balance shown in books of ₹ 2.10 crores. You also observe that despite similar high balances throughout the year, small amounts of ₹ 50,000 are withdrawn from the bank to meet day-to-day expenses. [May 09 (5 Marks)]
Answer:
Auditor’s duties in case of suspected fraud:
SA 240 “Auditor’s Responsibilities relating to fraud in an audit of financial statements” requires that the auditor is responsible for obtaining reasonable assurance that the F.S. taken as a whole are free from material misstatement, whether caused by fraud or error.

When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of professional skepticism throughout the audit.

The auditor should recognize the possibility that a material misstatement due to fraud could exist.

When the auditor comes across such circumstances indicating the possible misstatements resulting from entity’s procedure, the auditor shall evaluate whether such a misstatement is indicative of fraud.

In the present case, the circumstances indicate the possibility of fraud and accordingly, the auditor must investigate further to consider effect on financial statements.

The Guidance Note on Audit of Cash and Bank balances also mentions that if the entity is maintaining an unduly large balance of cash, he should, carry out surprise verification of cash more frequently to ascertain whether it agrees. If cash in hand is not in agreement with the book balance, he should seek explanations and if the same are not satisfactory, he should state this fact appropriately in his Audit Report.

Question 25.
M/s Honest Limited has entered into a transaction on 5th March, 2021, near year-end, whereby it has agreed to pay ₹ 5 lakhs per month to Mr. Y as annual retainer-ship fee for “engineering consultation”. No amount was actually paid, but ₹ 60 lakhs are provided in books of account as on March 31,2021. Your inquiry elicits a response that need-based consultation was obtained round the year, but there is no documentary or other evidence of receipt of the service. As the auditor of | M/s Honest Limited, what would be your approach? [Nov. 13 (5 Marks), RTP – Nov. 18]
Answer:
Auditor’s duties in case of suspected fraud:
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, fraud can be committed by management by various means including therein recording of fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.

In the given case, Honest Ltd. has entered into an agreement with Mr. Y, at year-end, for engineering consultation. It also provides ₹ 60 lakhs in the books of account, however, no documentary or other evidence of receipt of such service is available. It appears that company has passed fictitious journal entries, near year-end, to manipulate the operating results.

SA 240 further provides that if, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:
(1) Determine the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities;

(2) Consider whether it is appropriate to withdraw from the engagement, where withdrawal from the engagement is legally permitted.

Further, Sec. 143(12) of the Companies Act, 2013 read with Rule 13 of Companies (Audit & Auditor’s) Rules, 2016 requires that if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the audit committee within 2 days of his knowledge (as amount involved is less than ₹ 1 Cr.) mentioning the following:

Nature of Fraud with description; .
Approximate amount involved; and
Parties involved etc.

“ICAI Examiner Comments’’
Most of the candidates failed to identify the suspected fraud in the financial statement in j accordance with SA 240 and many related it to wrong accounting and creation of provision as ‘ per AS-29. Also, some candidates confined themselves to the audit procedures to verity/vouch I the transaction and looking for evidence, whereas the question makes it very clear that no evidence is available.

Question 26.
Comment on the following: On 15th March, 2021, the directors of Phony Ltd. instructed their I accountant to enter purchases amounting ₹ 1.02 crores from a company incorporated dated 11th March, 2021. However, no amount was actually paid and ₹ 1.02 crore was provided in the books of account as purchases for the year ending on 31st March, 2021.

On inspection, no documentary or other evidence of such purchases was found. As the auditor of Phony Ltd., what would be your approach regarding reporting of such bogus purchases? [MTP-May 20]
Answer:
Auditor’s duties in case of suspected fraud:
As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, fraud can be committed by management by various means including therein recording of fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.

In the given case, directors of Phony Ltd. instructed their accountant to enter purchases amounting ? 1.02 crores from a company incorporated dated 11th March, 2021. However, no amount was actually paid and 11.02 crore was provided in the books of account as purchases for the year ending on 31st March, 2021. On inspection, no documentary or other evidence of such purchases was found. It appears that company has passed fictitious journal entries, near year-end, to manipulate the operating results.

SA 240 further provides that if, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:
(1) Determine the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons ,who made the audit appointment or, in some cases, to regulatory authorities;

(2) Consider whether it is appropriate to withdraw from the engagement, where withdrawal from the engagement is legally permitted.

Further, Sec. 143(12) of the Companies Act, 2013 read with Rule 13 of Companies (Audit & Auditor’s) Rules, 2016 requires that if an auditor of a company, in the course of the performance of his duties as statutory auditor, has reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of ₹ 1 Cr. or above, is being or has been committed against the company by its officers or employees, the auditor shall report the matter to the CG.

Question 27.
Is it appropriate for the auditor to make inquiries of management regarding management’s own assessment of the risk of fraud and the controls in place to prevent and detect it? Discuss. [Nov. 16 (5 Marks)]
Answer:
Appropriateness of making inquiries of management regarding assessment of fraud:
SA 240 “Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements” requires the auditor to make inquiries of management regarding:
(a) Management’s assessment of risk of material misstatement due to fraud;
(b) Management’s process for identifying & responding to the risks of fraud in the entity, including any specific risks of fraud;
(c) Management”s communication, if any, to TCWG; and
(d) Management’s communication, if any, to employees regarding its views on business practices and ethical behaviour.

Management is responsible for the entity’s internal control and for the preparation of the financial statements. Accordingly, it is appropriate for the auditor to make inquiries of management regarding management’s own assessment oftheriskof fraud and the controls in place to prevent and detect it.

The nature, extent and frequency of management’s assessment of such risk and controls may vary from entity to entity. In some entities, management may make detailed assessments on an annual basis or as part of continuous monitoring. In other entities, management’s assessment may be less structured and less frequent.

The nature, extent and frequency of management’s assessment are relevant to the auditor’s understanding of the entity’s control environment. For example, the fact that management has not made an assessment of the risk of fraud may in some circumstances be indicative of the lack of importance that management places on internal control.

“ICAI Examiner Comments”
Most of the examinees have not understood the topic and failed to answer correctly.

SA 250 “Considerations of Laws and Regulations in an Audit of Financial Statements”

Question 28.
Comment on the following: Management is responsible for compliance with Laws and regulations.
Answer:
Management Responsibility for compliance with laws and regulation:
SA 250 “Consideration of Laws and Regulations in an audit of Financial Statements” states that it is the responsibility of management, with the oversight of TCWG, to ensure that the entity’s operations are conducted in accordance with the provisions of laws and regulations.

For this purpose, management may apply the following procedures:

Monitoring legal requirements and ensuring that operating procedures are designed to meet these requirements.
Instituting and operating appropriate systems of internal control.
Developing, publicising and following a code of conduct. ,
Ensuring employees are properly trained and understand the code of conduct.
Monitoring compliance with the code of conductand acting appropriately to discipline employees who fail to comply with it.
Engaging legal advisors to assist in monitoring legal requirements.
Maintaining a register of significant laws and regulations with which the entity has to comply within its particular industry and a record of complaints.

Question 29.
What are the roles and responsibilities of the statutory auditor in relation to compliance with the laws and regulations by the entity. [Nov. 14 (5 Marks)]
Answer:
Role & Responsibilities of Statutory auditor in relation to compliance of Laws and Regulations:
The auditor shall obtain a general understanding of:
(a) The legal and regulatory framework applicable to the entity and the industry or sector in which the entity operates; and
(b) How the entity is complying with that framework.

The auditor shall obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognized to have a direct effect on the determination of material amounts and disclosures in the financial statements.

The auditor shall perform the following audit procedures to identify instances of non-compliance with other laws and regulations that may have a material effect on the financial statements:
(a) Inquiring of management; and
(b) Inspecting correspondence, if any, with the relevant licensing or regulatory authorities.

During the audit, the auditor shall remain alert to the possibility that other audit procedures applied may bring instances of non-compliance or suspected non-compliance with laws and regulations to the auditor’s attention.

Obtain written representation that all known instances of non-compliance or suspected non-compliance with laws and regulations have been disclosed to the auditor.

“ICAI Examiner Comments”
Very few candidates explained SA 250 and gave general answers. Most of them failed to give the required answer which should be based on the audit procedures to identify instances of non-compliance with other laws and regulations that may have a material effect on the financial statements.

Question 30.
As a statutory auditor of a company, comment on the following: While verifying the employee records in a company, it was found that a major portion of the labour employed was child labour. On questioning the management, the auditor was told that it was outside his scope of the financial audit to look into the compliance with other laws. [Nov. 12 (5 Marks), RTP-May 18, MTP-May 20]
Or
CA. Yusuf has been appointed as an auditor of Ajanta Ltd., a textile entity. While going through the employee records of the company, CA. Yusuf identified that most of the labourers employed are of the age between 11-12 years. On enquiring the same, the management argues that there is no such boundation with regard to employment of such lower age children and contends that it is out of the scope of audit as well to check such compliance. Comment in the context of relevant standard on auditing whether the contention of management is tenable.
Answer:
Auditor’s Responsibility for consideration of other Laws:
SA 250 “Consideration of laws and regulations in an Audit of Financial statements” requires the auditor to obtain sufficient appropriate audit evidence regarding the compliance with the provisions of those laws and regulations generally recognized to have a direct impact on the determination of material amounts and disclosures in the financial statements including tax and labour laws.

For the other laws, the auditor’s responsibility is limited to undertake specified audit procedures to help identify non-compliance with those laws and regulations that may have a material effect on the financial statements.

Non-compliance with other laws and regulations may result in fines, litigation or other consequences for the entity, the costs of which may need to be provided for.

In the instant case, major portion of the labour employed was child labour.

Conclusion: Auditor should ensure the disclosure of above fact and provision of the cost of fines, litigation or other consequences. In case auditor concludes that non-compliance may have a material effect on financial statements, he should modify his opinion accordingly.

Question 31.
R & M Co. wants to be alert on the possibility of non-compliance with Laws and Regulations during the course of audit of SRS Ltd. R & M Co. seeks your guidance for identifying the indications of non-compliance with Laws and Regulations. [May 16 (5 Marks)]
Or
As an Auditor of TRP Ltd., you are suspicious that there might be non-compliance with laws and regulations to which the company is subject to. Indicate the possible areas or aspects where you may have to look out for forming an opinion as to whether your suspicion has some based to further inquire. [May 18 – New Syllabus (4 Marks)]
Answer:
Indicators to be considered for verifying compliance with laws and regulations:
SA 250 “Consideration of Laws and Regulations in an audit of Financial Statements” deals with the auditor’s responsibilities to consider laws and regulations when performing an audit.

To verify the compliance of laws and regulations, auditor is required to consider the following indicators:

Investigation by regulatory organisations Government departments or payment of fines, additional taxes or penalties.
Payments for unspecified services or loans to consultants related parties or employees.
Sales commission or agent’s fees that appear excessive in relation to those ordinarily paid by the entity or in its industry or to the services actually received.
Purchases at prices significantly above or below market price.
Unusual payments in cash.
Unusual payments towards legal and retainership fees.
Unusual transactions with companies registered in tax havens.
Payments for goods or services made other than to the country from which the goods or services originated.
Payments without proper exchange control documentation.
Existence of an information system which fails to provide an adequate audit trail.
Unauthorised transactions or improperly recorded transactions.
Adverse media comment.

“ICAI Examiner Comments”
Candidates failed to mention all the important indications correctly. Some of them discussed the reporting requirement by the auditor in the case of non-compliance instead of indications.

Question 32.
State the reporting responsibility of an auditor in the context of non-compliance of Law and Regulation in an audit of Financial Statement.
Answer:
Reporting requirements as per SA 250 on Non-Compliance with Laws and regulations:
(a) Reporting to Management & TCWG:

The auditor shall communicate with TCWG matters involving non-compliance with laws and regulations that come to the auditor’s attention.
If, in the auditor’s judgment, the non-compliance is believed to be intentional and material, the auditor shall communicate the matter to TCWG as soon as practicable.
If the auditor suspects that management or TCWG are involved in non-compliance, the auditor shall communicate the matter to the next higher level of authority at the entity, if it exists, such as an audit committee or supervisory board. Where no higher authority exists, the auditor shall consider the need to obtain legal advice.

(b) Reporting in Auditor’s Report:

If the auditor concludes that the non-compliance has a material effect on the financial statements and has not been adequately reflected in the financial statements, the auditor shall, express a qualified or adverse opinion on the financial statements.
If the auditor is precluded by management or TCWG from obtaining sufficient appropriate audit evidence, the auditor shall express a qualified opinion or disclaim an opinion.
If the auditor is unable to determine whether non-compliance has occurred because of limitations imposed by the circumstances rather than by management or TC WG, the auditor shall evaluate the effect on the auditor’s opinion.

(c) Reporting to regulatory and Enforcement Authorities:
If the auditor has identified or suspects non-compliance with laws and regulations, the auditor shall determine whether the auditor has a responsibility to report the identified or suspected non-compliance to parties outside the entity.

SA 260 “Communication with Those Charged With Governance”

Question 33.
Discuss with reference to SAs: The auditor shall communicate all significant findings with those charged with Governance.
Or
“The auditors should communicate audit matters of governance interest arising from the audit of financial statements with those charged with the governance of an entity”. Briefly state the matters to be included in such Communication.
Answer:
Communicating Significant Finding to TCWG:
SA 260 “Communication with Those charged with Governance” deals with auditor’s responsibilities to communicate with TCWG in an audit of financial statements.

As per SA 260, auditor should communicate all significant findings with the TCWG, stated as below:

The auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and financial statement disclosures
Significant difficulties, if any, encountered during the audit;
Unless all of those charged with governance are involved in managing the entity:
- Significant matters, arising from the audit that were discussed, or subject to correspondence with management; and
- Written representations the auditor is requesting;
Circumstances that affect the form and content of the auditor’s report, if any; and
Any other significant matter that in the auditor’s professional judgment, are significant to the oversight of the financial reporting process.

Question 34.
State the Significant Difficulties encountered during audit with reference to SA 260.
Answer:
Significant Difficulties encountered during audit:
SA 260 “Communication with Those charged with Governance” deals with auditor’s responsibilities to communicate with TCWG in an audit of financial statements.

As per SA 260 among other things auditor should communicate significant difficulties to the TCWG. Examples of significant difficulties to be communicated are:

Significant delays in management providing required information.
An unnecessarily brief time within which to complete the audit.
Extensive unexpected effort required to obtain SAAE.
Unavailability of expected information.
Restrictions imposed on the auditor by management.
Scope limitation that leads to modification of auditor’s opinion.

Question 35.
Write short note on: Factors governing modes of communication of auditor with those charged with governance.
Answer:
Factors affecting mode of Communication:
SA 260 “Communication with Those charged with Governance” deals with auditor’s responsibilities to communicate with TCWG in an audit of financial statements. As per SA 260 the various factors affecting mode of communication are;

Whether a discussion of the matter will be included in the auditor’s report e.g. Key Audit matters.
Whether management has previously communicated the matter.
The size, operating structure, control environment, and legal structure of the entity.
In the case of an audit of special purpose F.S., whether the auditor also audits the entity’s general purpose F.S.
Legal requirements. In some jurisdictions, a written communication with TCWG is required in a prescribed form by local law.
The expectations of TCWG.including arrangements made for periodic meetings or communications with the auditor.
The amount of ongoing contact and dialogue the auditor has with TCWG.
Whether there have been significant changes in the membership of a governing body.

Question 36.
Compare and explain the following: Reporting to Shareholders vs. reporting to TCWG. [Nov. 14 (3 Marks)]
Answer:
Reporting to Shareholders vs. Reporting to those Charged with Governance:

Reporting to Shareholders	‘ Reporting to TCWG
1. SA 700, 701, 705 & 706 & Section 143 of the Companies Act, 2013 deals with the provisions relating to reporting to Shareholders.	1. SA 260 deals with the provisions relating to reporting to those Charged with Governance.
2. Reporting to shareholder generally focuses on true and fair view of financial statements.	2. Reporting to TCWG generally includes auditor’s responsibilities, planned scope and timing of audit, significant findings from the audit and independence.
3. Reporting to shareholders is an external report and issued in public domain.	3. Reporting to TCWG is an internal report and not issued in public domain.

“ICAl Examiner Comments”
Most of the candidates discussed only meanings of the topic in general.

Question 36A.
Whilst the Audit team has identified few matters, they need your advice to conclude on the same. Engagement Partner have asked them to review the Board minutes and other secretarial/regulatory records based on which the following additional matters were brought to the attention of the Partner:
(i) The long term borrowings from the parent company has no written terms and neither the interest nor the principal has been repaid so far.

(ii) Certain computers were received from the parent company free of cost, the value of which is ₹ 0.23 lac and no accounting or disclosure of the same has been made in the notes to accounts.

(iii) An amount of ₹ 3.25 Lakhs per month is paid to M/s. WE CARE Associates, a partnership firm, which is a ‘related party’ in accordance with the provisions of the Companies Act, 2013 for the marketing services rendered by them. Based on an independent assessment, the consideration paid is higher than the arm’s length pricing by ₹ 0.25 Lakhs per month. Whilst the transaction was accounted in the financial statements based on the amounts’ paid, no separate disclosure of this related party transaction has been made in the notes to accounts forming part of the financial statements highlighting the same as a ‘related party’ transaction.

Audit Manager has reported that she had asked certain information relating to another ‘related party’ transaction (amounting to approx. ₹ 47 lac) but the CFO refused to provide the same since the same is perceived to be confidential and cannot be shared with the Auditors.

You are required to advise about items to be reported to those charged with governance, where applicable, based on your audit findings in the given situation. [MTP-Oct. 20]
Answer:
Reporting to TCWG:
SA 260 “Communication with those charged with Governance” deals with auditor’s responsibilities to communicate with TCWG in an audit of financial statements. As per SA 550, Related Parties, communicating significant matters arising during the audit in connection with the entity’s related parties helps the auditor to establish a common understanding with those charged with governance of the nature and resolution of these matters. The auditor is also required to ensure the compliance of Ind AS 24/AS 18 Related Party Disclosures.

In view of above in the given scenario, the auditor is required to prepare a brief summary of various items to be reported to TCWG in accordance with SA 260:
(i) Receipt of long-term borrowing (on no agreed terms and repayment of interest and principal) and free of cost computers from the Parent Company need separate disclosure in financial statements as per Ind AS 24/AS 18.

(ii) In respect of one of related party transaction amounting ₹ 3.25 lac per month, it is noticed that ₹ 0.25 lac per month exceeds the arm’s length price, which has not been disclosed highlighting the same as related party transactions as per Ind AS 24/AS 18.

(iii) Refusal by CFO of the company to provide the details of related party transaction amounting to ₹ 47 lac on the ground that same is perceived to be confidential and cannot be shared with auditors, is not in order, as denying for the related part details of ₹ 47 lac is imposing limitation of scope of auditor in view of SA 705.

The auditor would also need to assess his reporting requirements under the clause (xiii) of Paragraph 3 of CARO 2020 with respect to related party transactions that whether all transactions with the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where applicable and the details have been disclosed in the Financial Statements etc., as required by the applicable Accounting Standards.

SA 265 “Communicating Deficiencies in Internal Control to Those Charged With Governance”

Question 37.
What do you mean by deficiencies in Internal Control. Explain various indicators of Significant deficiencies.
Answer:
Deficiencies in Internal Control:
SA 265 “Communicating Deficiencies in Internal Control to Those Charged with Governance and Management” states that deficiency in internal control exists when:
(a) A control is designed, implemented or operated in such a way that it is unable to prevent, or detect and correct, misstatements in the financial statements on a timely basis; or

(b) A control necessary to prevent, or detect and correct, misstatements in the financial statements on a timely basis is missing.

Indicators of Significant Deficiencies:

Evidence of ineffective aspects of control environment.
Entity’s Risk assessment process – Absent/ineffective.
Ineffective response to identified significant Risks.
Correction of prior period misstatements arising due to fraud/error.
Management inability to oversee F.S. Preparation.
Misstatements detected by the auditor’s procedures were not prevented or detected and corrected by the entity internal control.

Question 38.
Write short note on: Written communication in respect of deficiencies of internal control.
Answer:
Written communication in respect of deficiencies of internal control:
The auditor shall communicate material weaknesses in internal control identified during the audit on a timely basis to management at an appropriate level of responsibility, and, as required by SA 265 “Communicating Deficiencies in Internal Control to Those Charged with Governance and Management”. This communication should be, preferably, in writing through a letter of weakness.

Important points with regard to such a letter are as follows:
(a) It lists down the area of weaknesses in the internal control system and recommends suggestions for improvement.

(b) It should clearly indicate that this letter-covers only weaknesses which have come to the attention
of the auditor during his evaluation of internal control for the purpose of determining nature, timing and extent of further audit procedures.

(c) Letter should clearly indicate that his examination of internal control has not been designed to determine the adequacy of internal control for management.

(d) This letter serves as a significant means for management and governing body for the purpose of improving the system and its strict implementation.

(e) The letter may also serve to minimize legal liability in the event of a major defalcation or other loss resulting from a weakness in internal control.

SA 299 “Joint Audit of Financial Statements”

Question 39.
KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to conduct auditing for the financial year 2020-21. For the valuation of gratuity scheme of the company, Mr. X, Mr. Y and Mr. Z wanted to refer their own known Actuaries. Due to difference of opinion, all the joint auditors consulted their respective Actuaries. Subsequently, major difference was found in the actuary reports. However, Mr. X agreed to Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be considered in audit report due to majority of votes. Now, Mr. Z is in dilemma.

(i) You are required to briefly explain the responsibilities of auditors when they are jointly and severally responsible in respect of audit conducted by them and also guide Mr. Z in such situation.
(ii) Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on, found faulty. [RTP – Nov. 18]
Answer:
Responsibilities of Joint auditors:
SA 299 “Joint Audit of Financial Statements” lays down the principles for effective conduct of joint audit to achieve the overall objectives of the auditor as laid down in SA 200.

Accordingly, in respect of audit work divided among the joint auditors, each joint auditor shall be responsible only for the work allocated to such joint auditor including proper execution of the audit procedures. All the joint auditors shall be jointly and severally responsible for:

a. the audit work which is not divided among the joint auditors and is carried out by all joint auditors;

b. decisions taken by all the joint auditors under audit planning in respect of common audit areas concerning the NTE of the audit procedures to be performed by each of the joint auditors.

c. matters which are brought to the notice of the joint auditors by any one of them and on which there is an agreement among the joint auditors;

d. examining that the F.S. of the entity comply with the requirements of the relevant statutes;

e. presentation and disclosure of the F.S. as required by the applicable FRF;

f. ensuring that the audit report complies with the requirements of the relevant statutes, the applicable Standards on Auditing and the other relevant pronouncements issued by ICAI.

It shall be the responsibility of each joint auditor to determine the NTE of audit procedures to be applied in relation to the areas of work allocated to said joint auditor.

It is the individual responsibility of each joint auditor to study and evaluate the prevailing system of internal control and assessment of risk relating to the areas of work allocated to said joint auditor.

Reporting Responsibilities in case of differences of opinion:
Joint auditors are required to issue common audit report.

However, in case of any disagreement among joint auditors with regard to the opinion or any matters to be covered by the audit report, they shall express their opinion in a separate audit report.

A joint auditor is not bound by the views of the majority of the joint auditors regarding the opinion or matters to be covered in the audit report and shall express opinion formed by the said joint auditor in separate audit report in case of disagreement.

In case of separate reports, the audit report(s) issued by the joint auditor(s) shall make a reference to the separate audit report(s) issued by the other joint auditor(s). Such reference shall be made under the heading “Other Matter Paragraph” as per SA 706.

In the present case, Mr. Z does not agree with the opinion of Mr. X and Mr. Y, therefore he needs to issue a separate report.

Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”, the auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with another audit evidence.

In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd., referred their own known Actuaries for valuation of gratuity scheme. Mr. Y’s referred actuary has provided the gratuity valuation report, which later on found faulty.

Further, Mr. Z is not agreed with this report therefore he submitted a separate audit report specifically for such gratuity valuation. In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation report of Actuary, to ensure the relevance and reasonableness of assumptions and methods used. They were also required to examine the relevance, completeness and accuracy of source data used for such report before expressing their opinion.

Conclusion: Mr. X and Mr. Y will be held responsible for grossly negligence and using such faulty report without examining the adequacy of expert actuary’s work whereas Mr. Z will not be held liable for the same due to separate opinion expressed by him.

Question 40.
ABC & Co. and DEF & Co. Chartered Accountant firms were appointed as joint auditors of Good Health Care Ltd for 2019-20;An investigation was conducted under Companies Act 2013 during March 2021 and observed gross undeIstatement of Revenue The revenue aspects were looked after by DEF & Co., but there was no documentation for the division of work between the joint auditors.
Or
Dice Ltd. appointed two CA firms MN & Associates and PQ & Co. as joint auditors for conducting audit for the year ended 31st March, 2021. In the course of audit, it has been observed that there is a major understatement in tJe value of Inventory. The inventory valuation work was looked after by MN & Associates but there was no documentation for the division of the work between the joint auditors. Comment on the above situation with regard to responsibilities among joint auditors. [May 19 New Syllabus (5 Marks)]
Answer:
Responsibilities of Joint Auditor:
As per SA 299 Joint Audit of Financial Statements” where joint auditors are appointed, they should, by mutuaL discussion, divide the work among themselves.

After identification and allocation of work among the joint auditors, the work allocation document shall be signed by all the joint auditors and the same shall be communicated to TCWG of the entity. Documentation of allocation of work helps in avoiding any dispute or confusion which may arise among the joint auditors regarding the scope of work to be carried out by them.

Further, the communication of allocation of work to the entity helps in avoiding any dispute or confusion which may arise between the entity and the joint auditors.

In respect of audit work divided among the joint auditors, each joint auditor is responsible only for the work allocated to him, whether or not he has prepared a separate report on the work performed by him.

However, for the work not divided, all the joint auditors are jointly and severally responsible.

In the present case, though the revenue aspects (inventory valuation work) were looked after by DEF & Co. (M N & Associates), but as there is no documentation for division of the work between them, both the joint auditors will be held responsible for it.

Conclusion: Both Joint auditors are jointly and severally responsible.

Note: Conclusion given in Suggested answer of ICAI is different stating that MN & Associates will be held responsible as inventory valuation work was looked after by them. Further, there is a violation of SA 299 as the division of work has not been documented.

Author’s view: As the work is not documented, responsibility will be joint and several.

Question 41.
P Limited is a limited company and its business activities are divided into three regions. The company appointed PY&Co., KL&Co., and MK&Co., Chartered Accountants to conduct a joint Audit and report on the financial statements for the Financial year 2020-21. Explain the relationship among the joint auditors for the audit of the financial statements for the year 2020-21. [Nov. 15 (5 Marks)]
Or
Write a short note on: Responsibility of Joint Auditors.
Answer:
Relationship among Joint Auditors:
SA 299 “Joint Audit of Financial Statements” lays down the principles for effective conduct of joint audit to achieve the overall objectives of the auditor as laid down in SA 200.

(b) decisions taken by all the joint auditors under audit planning in respect of common audit areas concerning the NTE of the audit procedures to be performed by each of the joint auditors.

(c) matters which are brought to the notice of the joint auditors by any one of them and on which there is an agreement among the joint auditors;

(d) examining that the F.S. of the entity comply with the requirements of the relevant statutes;

(e) presentation and disclosure of the F.S. as required by the applicable FRF;

(f) ensuring that the audit report complies with the requirements of the relevant statutes, the applicable Standards on Auditing and the other relevant pronouncements issued by ICAI.

It shall be the responsibility of each joint auditor to determine the NTE of audit procedures to be applied in relation to the areas of work allocated to said joint auditor.

“ICAI Examiner Comment”

Most of the examinees explained the topic correctly but few failed to narrate the situations in which the Joint auditors are jointly add severally responsible.

Question 42.
Your firm is one of the Joint Auditors of FMP Ltd. Under what circumstances joint auditors are jointly liable for the work in relation to audit of Financial statements? Is there any restriction on a joint auditor to communicate a dissenting note differing from the majority opinion of the other joint auditors in the audit report issued under section 143 of the Companies Act, 2013? [Nov. 18-Old Syllabus (5 Marks)]
Answer:
Circumstance in which joint auditors are jointly liable: Refer Answer of Q. No. 41
Restrictions as to communication of dissenting note:
SA 299 requires the Joint auditors to issue common audit report. However, in case of any disagreement among joint auditors with regard to the opinion or any matters to be covered by the audit report, they shall express their opinion in a separate audit report.

In case of separate reports, the audit report(s) issued by the joint auditors] shall make a reference to the separate audit report(s) issued by the other joint auditor(s). Such reference shall be made under the heading “Other Matter Paragraph” as per SA 706.

Question 43.
NMN & Co., LLP and ABC & Associates, LLP are the joint statutory auditors of BHS Ltd. BHS Ltd. is a listed company and has been in existence for the last 50 years. Since beginning this company was audited by MQS & Associates but due to audit rotation, the company had to bring in new auditors.

Considering the size of the company, two auditors were appointed as joint auditors. Since the company is new to these auditors and the concept of joint auditors to whom audit work has been divided, management had a discussion and understood that each joint auditor is responsible only for the work allocated to him, whether or not he has prepared a separate report on the work performed by him. Advise. [MTP-April 19]
Answer:
Reporting in case of Joint Auditors:
SA 299 “Joint Audit of Financial Statements” lays down the principles for effective conduct of joint audit to achieve the overall objectives of the auditor as laid down in SA 200.

SA 299 requires the Joint auditors to issue common audit report. However, in case of any disagreement among joint auditors with regard to the opinion or any matters to be covered by the audit report, they shall express their opinion in a separate audit report.

A joint auditor is not bound by the views of the majority of the joint auditors regarding the opinion or matters to be covered in the audit report and shall express opinion formed by the sai’d joint auditor in separate audit report in case of disagreement.

In case of separate reports, the audit report’s issued by the joint auditor(s) shall make a
reference to the separate audit report(s) issued by the other joint auditors]. Such reference Shall be made under the heading “Other Matter Paragraph” as per SA 706.

Review of work by other joint auditor:

Each joint auditor is entitled to assume that the other joint auditors have carried out their part of the audit work and the work has actually been performed in accordance with the SAs.
It is not necessary for a joint auditor to review the work performed by other joint auditors or perform any tests in order to ascertain whether the work has actually been performed in such a manner.
Each joint auditor is entitled to assume that the other joint auditors have brought to said joint auditor’s notice any departure from applicable FRF or significant observations that are relevant to their responsibilities noticed in the course of the audit.
Before finalizing audit report, the joint auditors shall discuss and communicate with each other their respective conclusions that would form the content of the audit report.

Question 44.
Excellent Bank Ltd. is a Public Limited Company. The said Bank has various branches all over India. The Bank appoints 3 Joint Auditors for the financial year ending 31/03/2021. All the 3 Joint Auditors divide the work with mutual consent. Verification of Consolidation, however, remained undivided. All branches and zones were divided amongst the 3 Joint Auditors. During audit of zones, CA. Z, one of the joint auditors expressed a concern about internal control in one of the large corporate branches situated in his zone. The irregularity was not reported in the final accounts as the other 2 Joint Auditors were not in favour of reporting and decision of not reporting the same was taken on the basis of majority. Subsequently, fraud has been detected in the said branch which was audited by CA. Z.

The Bank seeks your advice about the responsibility of the 3 Joint Auditors in the above situation. [Nov. 19 – Old Syllabus (5 Marks)]
Answer:
Responsibilities of Joint auditors:

SA 299 “Joint Audit of Financial Statements” lays down the principles for effective conduct of joint audit to achieve the overall objectives of the auditor as laid down in SA 200.

(b) decisions taken by all the joint auditors under audit planning in respect of common audit areas concerning the NTE of the audit procedures to be performed by each of the joint auditors.

(c) matters which are brought to the notice of the joint auditors by any one of them and on which there is an agreement among the joint auditors;

(d) examining that the F.S. of the entity comply with the requirements of the relevant statutes;

(e) presentation and disclosure of the F.S. as required by the applicable FRF;

(f) ensuring that the audit report complies with the requirements of the relevant statutes, the applicable Standards on Auditing and the other relevant pronouncements issued by ICAI.

Reporting Responsibilities in case of differences of opinion:
Joint auditors are required to issue common audit report.

However, in case of any disagreement among joint auditors with regard to the opinion or any matters to be covered by the audit report, they shall express their opinion in a separate audit report.

In case of separate reports, the audit report(s) issued by the joint auditor(s) shall make a reference to the separate audit report(s) Issued by the other joint auditor(s). Such reference shall be made under the heading “Other Matter Paragraph” as per SA 706.

In the present case, CA. Z, one of the joint auditors expressed a concern about internal control in one of the large corporate branches situated in his zone..The irregularity was not reported in the final accounts as the other 2 Joint Auditors were not in favour of reporting and decision of not reporting the same was taken on the basis of majority. Subsequently, fraud has been detected in the said branch which was audited by CA. Z.

Conclusion: Mr. Z was required to issue a separate report. He was not bound by the views of other joint auditors. Mr. Z will be held responsible for non-reporting of the matter.

Note: Alternatively, it may be concluded that all the 3 joint auditors will be held responsible for the fraud detected in the branch audited by CA Z, as decision for not reporting the irregularity observed was taken on majority basis.

SA 300 “Planning an Audit of Financial Statements”

Question 45.
Comment on the following: Auditor shall establish an overall strategy that sets the scope, timing and direction of the audit, and that guides the development of the audit plan”.
Answer:
Establishment of Audit Strategy:
(a) SA 300 “Planning an Audit of Financial Statements” requires that the auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit, and that guides the development of the audit plan.

(b) In establishing the overall audit strategy, the auditor shall:

Identify the characteristics of the engagement that define its scope;
Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature of the communications required;
Consider the factors that are significant in directing the engagement team’s efforts;
Consider the results of preliminary engagement activities and, where applicable, whether knowledge gained on other engagements performed by the engagement partner for the entity is relevant; and
Ascertain the NTE of procedures necessary to perform.

Question 46.
Briefly discuss the following statements in view of SA300 “Planning an Audi t of Financial Statements”:
(a) For an initial audit, the auditor may need to expand the planning activities.
(b) Audit planning is not a discrete phase but a continuous phase.
Answer:
(a) Need for expansion of Planning Activities in case of Initial Audit:
As per SA 300 “Planning and Audit of Financial Statements” purpose and objective of planning the audit are the same whether the audit is an initial or recurring engagement. However, for an initial audit, the auditor may need to expand the planning activities because the auditor does not ordinarily have the previous experience with the entity.

For initial audits, additional matters the auditor may consider in establishing the overall audit strategy and audit plan include the following:
Unless prohibited by law or regulation, arrangements to be made with the predecessor auditor, for example, to review his working papers.

Any major issues [including the application of accounting principles or of auditing and reporting standards] discussed with management in connection with the initial selection as auditor, the communication of these matters to TCWG and how these matters affect the overall audit strategy and audit plan.

The audit procedures necessary to obtain SAAE regarding opening balances as prescribed by SA 510 “Initial Engagements-Opening Balances”.

Other procedures required by the firm’s system of quality control for initial audit engagements (for example, review of overall audit strategy by senior partner prior to commencing significant audit procedures or to review reports prior to their issuance).

(b) Audit Planning – A continuous process:
Planning is not a discrete phase of an audit but rather a continuous process. It often begins shortly after (or in connection with) the completion of the previous audit and continues until the completion of the current audit engagement.

Planning, however, includes consideration of the timing of certain activities and audit procedures that need to be completed prior to the performance of further audit procedures. For example, planning includes the need to consider, prior to the auditor’s identification and assessment of the risks of material misstatement, such matters as:

The analytical procedures to be applied as risk assessment procedures.
Obtaining a general understanding of the legal and regulatory framework applicable to the entity and how the entity is complying with that framework.
The determination of materiality.
The involvement of experts.
The performance of other risk assessment procedures.

Question 47.
“The auditor shall document (i) The overall audit strategy; (ii) The audit plan; and (iii) Any significant changes made during the audit engagement to the overall audit strategy or the audit plan, and the reasons for such changes.” Explain.
Answer:
Documentation of Audit Strategy and Audit Plan:
SA 300 “Planning an Audit of Financial Statements” requires that the auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit, and that guides the development of the audit plan. Accordingly, auditor shall document:
(a) The overall audit strategy;
(b) The audit plan; and
(c) Any significant changes made during the audit engagement to the overall audit strategy or the audit plan, and the reasons for such changes.

Documentation of the overall audit strategy is a record of the key decisions considered necessary to properly plan the audit and to communicate significant matters to the engagement team.

Documentation of the audit plan is a record of the planned nature, timing and extent of Risk Assessment procedures and Further Audit Procedures at the assertion level in response to the assessed risks. It also serves as a record of the proper planning of the audit procedures that can be reviewed and approved prior to their performance.

Record of the significant changes to the overall audit strategy and the audit plan, and resulting changes to the planned NTE of audit procedures, explains why the significant changes were made, and the overall strategy and audit plan finally adopted for the audit.

Question 48.
Write short note on: Contents of an Audit Plan. [RTP-Nov. 20]
Answer:
Contents of an Audit Plan:
SA 300 “Planning an Auditof Financial Statements” requires thatthe auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit, and that guides the development of the audit plan. The audit plan shall include a description of:

The nature, timing and extent of planned risk assessment procedures, as determined under SA 315.
The nature, timing and extent of planned further audit procedures at the assertion level, as determined under SA 330.
Other planned audit procedures that are required to be carried out so that the engagement complies with SAs.

The audit plan is more detailed than the overall audit strategy that includes the NTE of audit procedures to be performed by ET members. Planning for these audit procedures takes place over the course of the audit as the audit plan for the engagement develops. For example, planning of the auditor’s RAP occurs early in the audit process. However, planning the NTE of specific further audit procedures depends on the outcome of those RAPs. In addition, the auditor may begin the execution of further audit procedures for some classes of transactions, account balances and disclosures before planning all remaining further audit procedures.

SA 315 “Identifying and Assessing the Risk id Material Misstatements through Understanding the Entity and its Environment”

Question 49.
What are the points to be remembered while evaluating the knowledge of the business in the conduct of an audit? [May 09 (8 Marks)]
Or
What are the broad matters to be considered while obtaining knowledge of business for a new | audit engagement of a manufacturing concern? [May 10 (4 Marks)]
Answer:
Obtaining an understanding of the entity and its environment:
As per SA 315 “Identifying and Assessing the Risk of Material Misstatements through understanding the entity and its environment” auditor is required to obtain an understating of following as a part of risk assessment procedures:
(a) Industry, regulatory, and other external factors including applicable financial reporting framework.

(b) The nature of the entity, including:

its operations;
its ownership and governance structures;
the types of investments that the entity is making and plan to make; &
the way that the entity is structured and how it is financed;

(d) The entity’s objectives and strategies, and those related business risks that may result in risks of material misstatement.

(e) The measurement and review of the entity’s financial performance.
The auditor shall also obtain an understanding of internal controls relevant for an audit.

Question 50.
Explain the concept of Audit Risk at the level of Financial Statements.
Answer:
Audit Risk at the level of financial statements:
SA 315 “Identifying and Assessing Risk of Material Misstatements through Understanding the Entity and its Environment requires the auditor to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels.

Audit risk at the level of financial statements refers to risks of material misstatement that relate pervasively to the financial statements as a whole and potentially affect many assertions.

Risks at the financial statement level may derive in particular from deficient control environment (although these risks may also relate to other factors, such as declining economic conditions).

For example, deficiencies such as management’s lack of competence may have a more pervasive effect on the F.S. and may require an overall response by the auditor.

The auditor’s understanding of internal control may raise doubts about the auditability of an entity’s financial statements. For example:

Concerns about the integrity of the entity’s management may be so serious as to cause the auditor to conclude that the risk of management misrepresentation in the financial statements is such that an audit cannot be conducted.
Concerns about the condition and reliability of an entity’s records may cause the auditor to conclude that it is unlikely that SAAE will be available to support an unqualified opinion on the F.S.

Question 51.
In the course of audit of PB Ltd., You observe that there is a likelihood of misstatement in the account balances and disclosures in the financial statements. What should be your considerations as an auditor for “Assessing the Risk of Material Misstatements”? [Nov. 18-Old Syllabus (4 Marks)]
Answer:
Considerations for assessing the Risk of Material Misstatements:
SA 315 “Identifying and Assessing Risk of Material Misstatements through Understanding the Entity and its Environment” requires the auditor to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels.

As per SA 315, the auditor shall identify and assess the risks of material misstatement at:
(a) the financial statement level; and
(b) the assertion level for classes of transactions, account balances, and disclosures; to provide a basis for designing and performing further audit procedures.

For this purpose, the auditor shall:
(a) Identify risks throughout the process of obtaining an understanding of the entity and its environment, including relevant controls that relate to the risks, and by considering the classes of transactions, account balances, and disclosures in the financial statements;

(b) Assess the identified risks, and evaluate whether they relate more pervasively to the financial statements as a whole and potentially affect many assertions;

(c) Relate the identified risks to what can go wrong at the assertion level, taking account of relevant controls that the auditor intends to test; and

(d) Consider the likelihood of misstatement, including the possibility of multiple misstatements, and whether the potential misstatement is of a magnitude that could result in a material misstatement.

“ICAI Examiner Comments”
Examinees correctly quoted concept covered under SA 315 but only few explained what is to be considered by the auditor in this regard.

Question 52.
The identified risks are assessed by auditor as to its significance on account of its likely impact, by way of material misstatement appearing in financial statements or by affecting internal control system. What may be the points of indication that may direct the Auditor to judge that the risks identified may be significant? [Nov. 18-New Syllabus (4 Marks)]
Answer:
Points of indication that direct the Auditor to judge that the risks identified may be significant:
SA 315 “Identifying and Assessing Risk of Material Misstatements through Understanding the . Entity and its Environment” requires the auditor to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels.

As part of the risk assessment, the auditor shall determine whether any of the risks identified are, in the auditor’s judgment, a significant risk. In exercising this judgment, the auditor shall exclude the effects of identified controls related to the risk.

In exercising judgment as to which risks are significant risks, the auditor shall consider at least the following:
(a) Whether the risk is a risk of fraud;
(b) Whether the risk is related to recent significant economic, accounting, or other developments like changes in regulatory environment, etc., and, therefore, requires specific attention;
(c) The complexity of transactions;
(d) Whether the risk involves significant transactions with related parties;
(e) The degree of subjectivity in the measurement of financial information related to the risk, especially those measurements involving a wide range of measurement uncertainty; and
(f) Whether the risk involves significant transactions that are outside the normal course of business for the entity, or that otherwise appear to be unusual.

“ICAI Examiner Comments”
Majority of the examinees have no idea about the topic.

Question 53.
Z Ltd. has its entire operations including accounting computerised. As the audit partner you are concerned about inherent and control risk for material financial statement assertions. What could be the areas you look forward for deficiencies and risk identification. [May 11 (4 Marks)]
Or
Write short note on; Causes of risk at material misstatement in CIS Environment. [May 14 (4 Marks)]
Answer:
Risk Assessment in CIS Environment:
SA 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity a’nd its Environment”, requires the auditor to make an assessment of inherent and control risk for material financial statement assertions. In a CIS environment, auditor should look into below mentioned area for risk identification:

Program Development and maintenance.
System software support.
Operations including processing of data.
Physical CIS security.
Control over access to specialized utility program.

“ICAI Examiner Comments”
Majority of the candidates have wrongly referred to all types of controls in a computerized environment. Some of them have wrongly referred to various types of risks.

Question 54.
One of the components of an adequate system of internal control is entity’s risk assessment process. Risk relevant to reliable financial reporting include external and internal events, transactions or circumstances that may occur and adversely affect an entity’s ability to initiate, record, process and report financial data consistent with the assertions of management in the financial statements.
In view of the above. Briefly state any six circumstances of entity’s risk assessment Process component under which risks may arise or change.
Or
The Entity’s Risk Assessment Process includes how management identifies business risks relevant to the preparation of financial statements in accordance with the entity’s applicable financial reporting framework, estimates their significance, assesses the likelihood of occurrence and decides upon actions to respond to and manage them and the results thereof. Elucidate the circumstances in which risks can arise or change. |Nov. 19 – New Syllabus (5 Marks)]
Answer:
Circumstances of Entity’s Risk Assessment Process Component under which risk may arise:

As per SA 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment” the entity’s risk assessment process forms the basis for how management determines the risks to be managed. If that process is appropriate to the circumstances, including the nature, size and complexity of the entity, it assists the auditor in identifying RMM. Risk can arise or change due to below mentioned circumstances:

Changes in operating environment: Changes in the regulatory or operating environment can result in changes in competitive pressures and significantly different risks.
New personnel: New personnel may have a different focus on or understanding of internal control.
New or revamped information systems: Significant and rapid changes in information systems can change the risk relating to internal control.
Rapid growth: Significant and rapid expansion of operations can strain controls and increase the risk of a breakdown in controls.
New technology: Incorporating new technologies into production processes or information systems may change the risk associated with internal control.
New business models, products, or activities: Entering into business areas or transactions with which an entity has little experience may introduce new risks associated with internal control.
Corporate restructurings: Restructurings maybe accompanied by staff reductions and changes in supervision and segregation of duties that may change the risk associated with internal control.
Expanded foreign operations: The expansion or acquisition of foreign operations carries new and often unique risks that may affect internal control, for example, additional or changed risks from foreign currency transactions.
New accounting pronouncements: Adoption of new accounting principles or changing accounting principles may affect risks in preparing financial statements.

Question 55.
IT systems also pose specific risks to an entity’s internal control? What are those risks? [May 10 (4 Marks)]
Or
Enumerate the specific risks that Information Technology (IT) systems can pose to an entity’s internal control. [Nov. 17 (5 Marks)]
Answer:
Risk to Internal Control imposed by IT System:
As per SA 315 “Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment”, IT system also poses specific risks to an entity’s Internal Control.
These risks are:
(a) Reliance on systems or programs that are inaccurately processing data, processing inaccurate data or both.

(b) Unauthorised access to data that may result in destruction of data or improper changes to data, including the recording of unauthorized or non-existent transactions, or inaccurate recording of transactions. Particular risk may arise when multiple users access a common database.

(c) The possibility of IT personnel gaining access beyond those necessary to perform their assigned duties thereby breaking down segregation of duties.

(d) Unauthorised changes to data in Master files
(e) Unauthorised changes to systems or programs.
(f) Failure to make necessary changes to systems or programs.
(g) In appropriate manual intervention
(h) Potential loss of data or inability to access data as required.

“ICAI Examiner Comments”
Many Examinees have not enumerated properly the specific risks that IT system poses to an entity’s Internal Control. Only few examinees made a better presentation of the topic. Some examinees wrongly explained the various types of audit risks namely Inherent Risk, Control Risk and Detection Risk while some other examinees wrote general answers like lack of audit trail, segregation of duties, safeguarding of assets, backup, storage etc.

SA 320 “Materiality in Planning and Performing an Audit”

Question 56.
Mr. X was appointed as the auditor of M/s Easy go Ltd. and intends to apply the concept of materiality for the financial statements as a whole. Please guide him as to the factors that may affect the identification of an appropriate benchmark for this purpose. [Nov. 13 (4 Marks), MTP-Aug. 18]
Answer:
Use of benchmark in determining Materiality:
SA 320 “Materiality in Planning and Performing an Audit” prescribes the use of Benchmarks in determining Materiality for the Financial Statements as a Whole. Accordingly determining materiality involves the exercise of professional judgment. A percentage is often applied to a chosen benchmark as a starting point in determining materiality for the financial statements as a whole.

Factors that may affect the identification of an appropriate benchmark include the following:

The elements of the financial statements (for example, assets, liabilities, equity, revenue, expenses);
Whether there are items on which the attention of the users of the particular entity’s financial statements tends to be focused (for example, for the purpose of evaluating financial performance users may tend to focus on profit, revenue or net assets);
The nature of the entity, where the entity is at in its life cycle, and the industry and economic environment in which the entity operates; .
The entity’s ownership structure and the way it is financed (for example, if an entity is financed solely by debt rather than equity, users may put more emphasis on assets, and claims on them, than on the entity’s earnings); and
The relative volatility of the benchmark.

“ICAI Examiner Comments”
Most of the candidates have no idea of the relevant standard and tried to answer the question based on post audit situation rather than pre-audit planning as required in the question. Instead of discussing the factors affecting the identification of appropriate bench mark to apply the concept of materiality, candidates discussed about the concept of materiality, its uses and importance of this concept for audit.

Question 57 .
As an auditor of RST Ltd. Mr. P applied the concept of materiality for the financial statements as a whole. On the basis of obtaining additional information of significant contractual arrangements that draw attention to a particular aspect of a company’s business, he wants to re-evaluate the materiality concept. Please guide him. [May 15 (5 Marks)]
Or
Y & Co., Chartered Accountants have come across in the course of audit of a company that certain machinery had been imported for production of new product. Although the Auditors have applied the concept of materiality for the financial statements as a whole, they now want to re-evaluate the materiality concept for this transaction involving foreign exchange. Give your views in this regard.
[May 18 – New Syllabus (5 Marks)]
Answer:
Re-evaluation of the Materiality Concept:
SA 320 “Materiality in Planning and Performing an Audit”, requires the auditor to determine materiality for the financial statement as a whole, while establishing the overall audit strategy.

If, in the specific circumstances of the entity, there is one or more particular classes of transactions, account balances or disclosures for which misstatements of lesser amounts than the materiality for the financial statements as a whole could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements, the auditor shall also determine the materiality level or levels to be applied to those particular classes of transactions, account balances or disclosures.

The auditor shall revise materiality for the financial statements as a whole and if applicable the materiality levels for particular classes of transactions, account balances or disclosures, in the event of becoming aware of information during the audit that would have caused the auditor to have determined a different amount (or amounts) initially.

If the auditor concludes a lower materiality for the same, then he should consider the fact that whether it is necessary to revise performance materiality and whether the nature, timing and extent of the further audit procedures remain appropriate.

In the instant case, Mr. P, auditor of RST Ltd. has applied the concept of materiality for the financial statements as a whole. But he wants to re-evaluate the materiality concept, on the basis of additional information of significant contractual arrangements which draws attention to a particular aspect of the company’s business.

Conclusion: Mr. P can re-evaluate the materiality concepts after considering the necessity of such revision.

“ICAI Examiner Comments”
Many candidates erred by writing answers based on SA 330 whereas some of them mentioned v SA 320 correctly but failed to explain the required answer.

SA 330 “Auditor’s Responses to Assessed Risks”

Question 58.
In the course of audit of Z Ltd., its auditor wants to rely on audit evidence obtained in previous audit in respect of effectiveness of internal controls instead of re-testing the same during the current audit. As an advisor to the auditor kindly caution him about the factors that may warrant a re-test of controls. [May 13 (4 Marks) RTP – Nov. 18, MTP-Oct. 19]
Answer:
Factors warranting re-test of controls:
As per SA 330 on “The Auditor’s Responses to Assessed Risks”, if the auditor plans to use audit evidence from a previous audit about the operating effectiveness of specific controls, he shall establish the continuing relevance of that evidence by obtaining audit evidence about whether significant changes in those controls have occurred subsequent to the previous audit.

The auditor’s decision on whether to rely on audit evidence obtained in previous audits for control is a matter of professional judgment.
Factors that may warrant a re-test of controls are-

A deficient control environment.
Deficient monitoring of controls.
A significant manual element to the relevant controls.
Personnel changes that significantly affect the application of the control.
Changing circumstances that indicate the need for changes in the control.
Deficient general IT-controls.

“ICAI Examiner Comments”
Many candidates failed to understand the requirement of the question and discussed mainly the procedure of Internal control and reliance on previous auditor rather than the factors that may warrant a re-test of controls.

Question 59.
While carrying out the statutory audit of a large entity, what are the substantive procedures to be performed to assess the risk of material misstatement? [Nov. 12 (8 Marks)]
Answer:
Substantive Procedures to be performed to assess the risk of material misstatement:
SA 330, “The Auditor’s Response to Assessed Risk”, defines substantive procedures as an audit procedure designed to detect material misstatements at the assertion level. They comprise tests of details and substantive analytical procedures.

Test of Details: Irrespective of the assessed risks of material misstatement, the auditor shall design and perform substantive procedures for each material class of transactions, account balance, and disclosure. This requirement reflects the facts that: (i) the auditor’s assessment of risk is judgmental and so may not identify all risks of material misstatement; and (ii) there are inherent limitations to internal control, including management override.

Substantive Analytical Procedure: Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. SA 520,
“Analytical Procedures” establishes requirements and provides guidance on the application of analytical procedures during an audit.

Depending on the circumstances, the auditor may determine that;

Performing only substantive analytical procedures will be sufficient to reduce audit risk to an acceptably low level. For example, where the auditor’s assessment of risk is supported by audit evidence from tests of controls.
Only tests of details are appropriate.
A combination of substantive analytical procedures and tests of details are most responsive to the assessed risks.

Question 60.
While commencing the statutory audit of B Company Limited, the auditor undertook the risk assessment and found that the detection risk relating to certain class of transactions cannot be reduced to acceptance level. Explain. [May 17 (5 Marks)]
Answer:
Assessment of Risk and Acceptable Level:
SA 315 “Identifying and Assessing the RiskofMaterial Misstatement Through Understanding the Entity and its Environment” and SA 330 “The Auditor’s Responses to Assessed Risks” establishes standards on the procedures to be followed to obtain an understanding of the accounting and internal control systems and on audit risk and its components.

SA 315 and SA 330 require that the auditor should use professional judgment to assess risk of material misstatement and to design audit procedures to ensure that it is reduced to an acceptably low level.

Risk of Material Misstatements comprises of Inherent risk and Control Risk. “Detection risk” is the risk that an auditor’s substantive procedures will not detect a misstatement that exists in an account balance or class of transactions that could be material.

The higher the risk of material misstatement, the more audit evidence the auditor should obtain from the performance of substantive procedures. When both inherent and control risks are assessed as high, the auditor needs to consider whether substantive procedures can provide sufficient appropriate audit evidence to reduce detection risk, and therefore audit risk, to an acceptably low level.

The auditor should use his professional judgment to assess audit risk and to design audit procedures to ensure that it is reduced to an acceptably low level. If it cannot be reduced to an acceptable level, the auditor should express a qualified opinion or a disclaimer of opinion as may be appropriate.

Question 61.
While commencing the statutory audit of ABC Company Limited, what should be the considerations of the auditor to assess Risk of Material Misstatement and his response to such risks? [Nov. 14 (4 Marks)]
Answer:
Considerations of Auditor for Assessing the Risk of Material Misstatement:
SA315″IdentifyingandAssessingtheRiskofMaterialMisstatementthroughunderstandingthe Entity and its Environment”, requires the auditor to identify and assess the risks of material misstatement at the financial statement level; and the assertion level for classes of transactions, account balances, and disclosures to provide a basis for designing and performing further audit procedures. For this purpose, the auditor shall:

Identify risks throughout the process of obtaining an understanding of the entity and its environment, including relevant controls;

Assess and evaluate the identified risks;
Relate the identified risks to what can go wrong at the assertion level; and
Consider the likelihood of misstatement.

Auditor’s Responses to the Assessed Risk of Material Misstatement:
As per SA 330 “The Auditor’s Responses to Assessed Risks”, the auditor shall design and implement overall responses to address the assessed risks of material misstatement. In designing the audit procedures to be performed, the auditor shall:

Consider the reasons for the assessment given to the risk of material misstatement at the assertion level for each class of transactions, account balance, and disclosure; and
Obtain more persuasive audit evidence for the auditor’s assessment of risk.

“ICAI Examiner Comments”
Many candidates failed to mention how the auditor shall identify and assess the risks of material misstatement. Most of the candidates failed to discuss SA 330 on Auditor’s response in assessing the risk of material misstatement. Majority of the candidates discussed either SA 315 or SA 330 but not both.

Question 62.
“External confirmation procedures frequently are relevant when addressing assertions associated with account balances and their elements, but need not be restricted to these items.” Explain.
Or
Point out any eight areas where external confirmation used as an audit evidence.
Answer:
Areas where external confirmations may be used:
As per SA 330 “Responses to Assessed Risks” External confirmation procedures frequently are relevant when addressing assertions associated with account balances and their elements, but need not be restricted to these items.

For example, the auditor may request external confirmation of the terms of agreements, contracts, or transactions between an entity and other parties.

Other situations where external confirmation procedures may provide relevant audit evidence in responding to assessed risks of material misstatement include:

Bank balances and other information relevant to banking relationships.
Accounts receivable balances and terms.
Inventories held by third parties at bonded warehouses for processing or on consignment.
operty title deeds held by lawyers or financiers for safe custody or as security.
Investments held for safekeeping by third parties or purchased from stockbrokers but not delivered at the balance sheet date.
Amounts due to lenders, including relevant terms of repayment and restrictive covenants.
Accounts payable balances and terms.

Question 63.
State the factors that may assist the auditor in determining whether external confirmation procedures are to be performed as substantive audit procedures.
Answer:
Factors’ that may assist in determining use of external confirmations as substantive audit procedures:
As per SA 330 “Responses to Assessed Risks” factors that may assist the auditor in determining whether external confirmation procedures are to be External Confirmations performed as substantive audit procedures include:
1. The confirming party’s knowledge of the subject matter – responses may be more reliable if provided by a person at the confirming party who has the requisite knowledge about the information being confirmed.

2. The ability or willingness of the intended confirming party to respond – for example, the confirming party:

May not accept responsibility for responding to a confirmation request;
May consider responding too costly or time consuming;
May have concerns about the potential legal liability resulting from responding;
May account for transactions in different currencies; or
May operate in an environment where responding to confirmation requests is not a significant aspect of day-to-day operations.

In such situations, confirming parties may not respond, may respond in a casual manner or may attempt to restrict the reliance placed on the response.

3. The objectivity of the intended confirming party – if the confirming party is a related party of the entity, responses to confirmation requests may be less reliable.

SA 402 “Audit Considerations in an Entity using Service Organisation”

Question 64.
Durafone Mobile Co. Ltd. have pan India presence and market leader in mobile operation. It has outsourced all its revenue operation including accounting functions to Set Solutions (P) Ltd. As an Auditor of the mobile company, enumerate the factors to be taken into consideration related to its financial reporting. [May 18 – Old Syllabus (5 Marks)]
Answer:
Factors to be taken into consideration related to financial reporting in case of user entities using services of Service Organisation:
SA 402 “Audit Considerations relating to an Entity Using a Service Organisation” deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organisations.

Services provided by a service organisation are relevant to the audit of a user entity’s financial statements when those services, and the controls over them, are part of the user entity’s information system, including related business processes, relevant to financial reporting.

Although most controls at the service organisation are likely to relate to financial reporting, there may be other controls that may also be relevant to the audit, such as controls over the safeguarding of assets.

A service organisation’s services are part of a user entity’s information system, including related business processes, relevant to financial reporting if these services affect any of the following:
(a) The classes of transactions in the user entity’s operations that are significant to the user entity’s financial statements;

(b) The procedures, within both information technology (IT) and manual systems, by which the user entity’s transactions are initiated, recorded, processed, corrected as necessary, transferred to the general ledger and reported in the financial statements;

(c) The related accounting records, either in electronic or manual form, supporting information and specific accounts in the user entity’s financial statements that are used to initiate, record, process and report the user entity’s transactions; this includes the correction of incorrect information and how information is transferred to the general ledger;

(d) How the user entity’s information system captures events and conditions, other than transactions, that are significant to the financial statements;

(e) The financial reporting process used to prepare the user entity’s financial statements, including .significant accounting estimates and disclosures; and

(f) Controls surrounding journal entries, including non-standard journal entries used to record non-recurring, unusual transactions or adjustments.

Question 65.
“As per SA 402, the user auditor shall obtain an understanding of how user entity uses the services of a service organization in the user entity operations” Explain the various matters of which understanding is required.
Or
A Company gets its accounting data processed by a third party to achieve cost reduction. As a Statutory Auditor of such a company, what arc the additional precautions/chccks that you would consider for conduct of the audit?
Or
In the course of the audit of R Ltd., the audit manager of ABC & Co. observed that R Ltd. has outsourced certain activities to an outsourcing agency. As the engagement partner guide the audit manager in the assessment of services provided by the outsourcing agency in relation to the audit. [May 11 (4 Marks)]
Or
G Ltd. is a mobile phone operating company. Barring the marketing function, it had outsourced the entire operations like maintenance of mobile infrastructure, customer billing, payroll, accounting functions, etc. Assist the auditor of G Ltd. as to how he can obtain an understanding of how G Ltd. uses the services of the outsourced agency in its operations. [Nov. 13 (5 Marks), MTP-Oct. 18, RTP-Nov. 18, MTP-Oct. 19]
Answer:
Matters of which understanding is required by user auditor w.r.t. services of a services organization:
A client may use a service organisation such as one that executes transactions and maintains related accounts or records transactions and processes related data. If a client uses a service organisation, certain policies, procedures and records maintained by the service organisation might be relevant to the audit of the financial statements of the client. Consequently, the auditor would consider the nature and extent of activities undertaken by service organisations so as to determine whether those activities are relevant to the audit and, if so, to assess their effect on audit risk.

SA 402 on “Audit Considerations relating to an Entity Using a Service Organisation” deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organisations. Accordingly, the user auditor is required to obtain an understanding of how user entity uses the services of a service organization in the user entity operation, including:

Nature of service provided by the service organization and the significance of those services to the user entity.
The nature and materiality of the transactions processed or financial reporting processes affected by service organizations.
The degree of interaction between activities of service organizations and those of the user entity.
The nature of relationship between user entity and the service organization.

“ICAI Examiner Comments”
Candidates gave only basic idea of gathering knowledge of the outsourced agency but failed to answer specifically as to when obtaining an understanding of the user entity in accordance with SA 315, the user auditor shall obtain an understanding of how a user entity uses the services of a service organization in the user entity’s operations. Some candidates have written general audit procedure instead of explaining in terms of SA 402. A few candidates mentioned irrelevant points like visiting the Service Provider’s premises and.then do the audit/enquiry.

Question 66.
In the course of audit of Raja and Rank Ltd., the audit manager of Sharma & Co. observed that Raja
and Rank Ltd. has outsourced certain activities to an outsourcing agency.
(a) As the engagement partner, guide the audit manager in the assessment of services provided by the outsourcing agency in relation to the audit.
(b) Discuss the procedure to be applied in case the user auditor is unable to obtain a sufficient understanding from the user entity?
Answer:
(a) Factors’ that may assist in determining use of external confirmations as substantive audit procedures:
As per SA 330 “Responses to Assessed Risks” factors that may assist the auditor in determining whether external confirmation procedures are to be External Confirmations performed as substantive audit procedures include:

1. The confirming party’s knowledge of the subject matter – responses may be more reliable if provided by a person at the confirming party who has the requisite knowledge about the information being confirmed.
2. The ability or willingness of the intended confirming party to respond – for example, the confirming party:

May not accept responsibility for responding to a confirmation request;
May consider responding too costly or time consuming;
May have concerns about the potential legal liability resulting from responding;
May account for transactions in different currencies; or
May operate in an environment where responding to confirmation requests is not a significant aspect of day-to-day operations.
In such situations, confirming parties may not respond, may respond in a casual manner or may attempt to restrict the reliance placed on the response.

3. The objectivity of the intended confirming party – if the confirming party is a related party of the entity, responses to confirmation requests may be less reliable.

(b) Procedure to be followed if user auditor is unable to obtain sufficient understanding from user entity:

The user auditor shall determine whether a sufficient understanding of nature and significance of services provided by service organization and their effect on the user entity internal control relevant to the audit has been obtained, to provide basis for identification and assessment of risk of Material Misstatement.
If user auditor is unable to obtain a sufficient understanding from the user entity, the user auditor shall obtain that understanding from one or more of following procedures:
(a) Obtaining a Type 1 or Type 2 Report, if available.
(b) Contacting the service organization, through the user entity, to obtain the sufficient information.
(c) Visiting the service organization.
(d) Using another auditor to perform procedures that will provide the necessary information about the relevant controls at the service organization.

Question 67.
When a sub-service organization performs services for a service organization, there are two al¬ternative methods of presenting the description of controls. The service organization determines which method will be used. As a user auditor what information would you obtain about controls at a sub-service organization? [May 15 (5 Marks)]
Answer:
Information to be obtained w.r.t. controls at a sub-service organisation:
SA 402 on “Audit Considerations relating to an Entity Using a Service Organisation” deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organisations, which in turn may use a sub-service organisation to provide some of the services provided to a user entity that are part of the user entity’s information system relevant to financial reporting.

If a service organisation uses a sub-service organisation, the service auditor’s report may either include or exclude the sub-service organisation’s relevant control objectives and related controls in the service organisation’s description of its system and in the scope of the service auditor’s engagement. These two methods of reporting are known as the inclusive method and the carve-out method, respectively.

If the Type 1 or Type 2 report excludes the controls at a sub-service organisation, and the services provided by the sub-service organisation are relevant to the audit of the user entity’s financial statements, the user auditor is required to apply the requirements of this SA in respect of the sub-service organisation and accordingly obtain an understanding of the following:

Nature of service provided by the sub-service organization and the significance of those services to the user entity.
The nature and materiality of the transactions processed or financial reporting processes affected by sub-service organizations.
The degree of interaction between activities of sub-service organizations and those of the user entity.
The nature of relationship between user entity and the sub-service organization.

The nature and extent of work to be performed by the user auditor regarding the services provided by a sub-service organisation depend on the nature and significance of those services to the user entity and the relevance of those services to the audit.

“ICAI Examiner Comments”
Many candidates referred to SA 402 correctly but failed to explain the information that would be obtained by user auditor about controls at sub-service organization.

Question 68.
ENN Limited is availing the services of APP Private Limited for its payroll operations. Payroll cost accounts for 65% of total cost for ENN Limited. APP Private Limited has provided the type 2 report as specified under SA 402 for its description, design and operating effectiveness of control.

APP Private Limited has also outsourced a material part of payroll operation M/s SMP & Associates in such a way that M/s SMP & Associates is sub-service organization to ENN Limited. The Type 2 report which was provided by APP Private Limited was based on carve-out method as specified under SA 402.

CA Raman while reviewing the unmodified audit report drafted by his assistant found that, a reference has been made to the work done by the service auditor. CA Raman hence asked his assistant to remove such reference and modify report accordingly.
Comment whether CA Raman is correct in removing the reference of the work done by service auditor? [RTP-Nov. 20]
Answer:
Reporting by the User Auditor:
As per SA 402, “Audit Considerations Relating to an Entity Using a Service Organisation”, the user auditor shall modify the opinion in the user auditor’s report in accordance with SA 705, “Modifications to the Opinion in the Independent Auditor’s Report”, if he is unable to obtain sufficient appropriate auditevidence regardingthe services providedby the service organisation relevant to the audit of the user entity’s financial statements.

The User Auditor shall not refer to report of Service auditor unless required by Law & Regulation.

If such reference is required by law or regulation, the user auditor’s report shall indicate that the reference does not diminish the user auditor’s responsibility for the audit opinion.

In the given case, CA Raman while reviewing the unmodified audit report drafted by his assistant found that, a reference has been made to the work done by the service auditor. CA Raman hence asked his assistant to remove such reference and modify report accordingly.

Conclusion: Contention of CA Raman in removing reference of the work done by service auditor is in order as in case of unmodified audit report, user auditor cannot refer to the work done by service auditor.

SA 450 “Evaluation of Misstatements identified during the Audit”

Question 69.
In the course of audit of T Ltd., the audit team is not sure of the possible source of misstatements in the financial statements. As the audit manager identify the sources of misstatements. [May 11 (4 Marks)]
Or
Inaudit plan for T Ltd., as the audit partner you want to highlight the sources of misstatements, arising from other than fraud, to your audit team and caution them. Identify the sources of misstatements. [May 13 (4 Marks), RTP-Nov. 18]
Answer:
Sources of Misstatement:
SA 450 “Evaluation of Misstatements identified during the Audit”, defines the term misstatement as a difference between the amounts, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Accordingly, misstatement may cause due to following:

An inaccuracy in gathering or processing data from which the financial statements are prepared;
An omission of an amount or disclosure;
An incorrect accounting estimate arising from overlooking, or clear misinterpretation of facts; and
Judgments of management concerning accounting estimates that the auditor considers unreasonable or the selection and application of accounting policies that the auditor considers inappropriate.

“ICAI Examiner Comments” ‘
Candidates, in general, mentioned most of the important sources of misstatements arising from other than fraud but some also wrote about sources of misstatements arising from fraud, which was not required.

Question 70.
Discuss the impact of uncorrected misstatements identified during the audit and the auditor’s response to the same. [Nov. 14 (4 Marks)]
Or
The auditor of XY & Co. Ltd. has intimated the management that certain misstatements identified during the course of audit need to be corrected. As an auditor, discuss the impact of such misstatements in case the management does not carry out the said corrections. [Nov. 17 (5 Marks)]
Answer:
Impact of uncorrected misstatements identified during the audit:
SA 450 “Evaluation of Misstatements identified during the audit” deals with the auditor’s responsibility to evaluate the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements.

In accordance with SA 450, the auditor shall determine whether uncorrected misstatements are material, individually or in aggregate. In making this determination, the auditor shall consider the size and nature of the misstatements, both in relation to particular classes of transactions, account balances or disclosures and the financial statements as a whole.

The auditor shall request the management that uncorrected misstatements be corrected. If management refuses to correctsome or all of the misstatements communicated by the auditor, the auditor shall obtain an understanding of management’s reasons for not making the corrections.

Prior to evaluating the effect of uncorrected misstatements, the auditor shall reassess materiality determined in accordance with SA 3 20, to confirm whether it remains appropriate in the context of the entity’s actual financial results.

The auditor shall communicate with TC WG, uncorrected misstatements and the effect that they, individually or in aggregate, may have on the opinion in the auditor’s report.

The auditor shall request a written representation from management and, where appropriate, those charged with governance whether they believe the effects of uncorrected misstatements are immaterial, individually and in aggregate, to the financial statements as a whole.

“ICAI Examiner Comments”
Most of the candidates answered the question in a general manner and failed to explain SA 450 and correlate with the same.

Question 71.
The auditor should take into account the aggregate of all uncorrected misstatements including those involving estimates in his assessment of materiality in audit.
Answer:
Consideration of uncorrected and unidentified misstatements:
SA 320 “Materiality in Planning and Performing an Audit” deals with the auditor’s responsibility to apply the concept of materiality in planning and performing an audit of financial statements.

SA 450, “Evaluation of Misstatements identified during the Audit’’ explains how materiality is applied in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements.

SA 450 requires that the auditor shall determine whether the overall audit strategy and audit plan need to be revised if the nature of identified misstatements and the circumstances of their occurrence indicate that other misstatements may exist that, when aggregated with misstatements accumulated during the audit, could be material or the aggregate of misstatements accumulated during the audit approaches materiality determined in accordance with SA 320.

If the aggregate of misstatements accumulated during the audit approaches materiality determined in accordance with SA 320, there may be a greater risk that possible undetected misstatements, when taken with the aggregate of misstatements accumulated during the audit, could exceed the materiality. Undetected misstatements could exist because of the presence of sampling risk and non-sampling risk.

In such a situation, auditor may request management to examine a class of transactions, account balance or disclosure in order for management to understand the cause of a misstatement identified by the auditor, perform procedures to determine the amount ofthe actual misstatement in the class of transactions, account balance or disclosure, and to make appropriate adjustments to the financial statements. Such a request may be made, for example, based on the auditor’s projection of misstatements identified in an audit sample to the entire population from which it was drawn.

Question 72.
While auditing accounts of a public limited company for the year ended 31st March 2021, an auditor found out an error in the valuation of inventory, which affects the financial statement materially – Comment as per standards on auditing.
Answer:
Errors in Valuation of Inventories and Auditor’s Responsibilities:
SA 450 “Evaluation of Misstatements identified during the audit” deals with the auditor’s responsibility to evaluate the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements.

In accordance with SA 450 auditor should consider requesting the management to adjust the financial information or consider extending his audit procedures. If the management refuses to adjust the financial information and the results of extended audit procedures do not enable the auditor to conclude that the aggregate of uncorrected misstatements is not material, the auditor should express a qualified or adverse opinion, as appropriate.

Conclusion: In the instant case, the auditor has detected the material errors affecting the financial statements; the auditor should communicate his findings to the management on a timely basis, consider the implications on true and fair view and also ensure that appropriate disclosures have been made.

SA 500 “Audit Evidence”

Question 73.
Comment on the following: Z Ltd. had appointed an outside expert to assess accrued gratuity liability of the company. Based on the said report, the company provides ₹ 80 lakhs as gratuity in the financial statements. [May 09 (4 Marks)]
Or
Whatare the procedures to be followed by a statutory auditor for verifying the provision for accrued liability for retirement benefits which is based on a certificate of a reputed actuary? [May 10 (8 Marks)]
Or
Y Ltd. Engaged an actuary to ascertain its employee cost, gratuity and leave encashment liabilities. As the auditor of Y Ltd. You would like to use the report of actuary as an audit evidence. How do you evaluate the work of actuary. [May 11 (8 Marks), May 16 (4 Marks)]
Or
CA. Needle had been appointed as an auditor of M/s Fabric Ltd. in the course of audit, it had been observed that inventory including work-in-process had been valued by management by using experts hired by them. Analyse relevant factors to decide as to whether or not to accept the findings from the work of management expert in valuation of inventories. [May 18 – New Syllabus (5 Marks), MTP-Oct. 20]
Answer:
Evaluating the work of Management Expert:
As per SA 500 “Audit Evidence” when information to be used as audit evidence has been prepared using the work of a management’s expert, the auditor shall perform the following:
(i) Evaluate the competence, capabilities and objectivity of that expert:
For this purpose, auditor may consider his qualification, membership of a professional body or industrial association license to practice etc.

(ii) Obtain an understanding of the work of that expert:
It may include areas of specialty, applicable professional standards and other legal requirements.

(iii) Evaluate the appropriateness of that expert’s work:
With respect to following:
(a) Relevance and reasonableness: of that expert findings and conclusion.
(b) Relevance and reasonableness: of assumptions and methods used; and
(c) Relevance, completeness and accuracy: of source data.

Question 74.
As a Statutory Auditor, how would you deal with the following case: M/s LNK’s group gratuity scheme’s valuation by actuary shows wide variation compared to the previous year’s figures.
Answer:
Using the work of Management Expert as an audit evidence:
SA 500 (Revised), “Audit Evidence” states that the auditor has to evaluate the work of management expert, say, actuary, before adopting the same.
The work of management expert is required to be evaluated in terms of following:

Relevance and reasonableness of that expert findings and conclusion.
Relevance and reasonableness of assumptions and methods used; and (;77) Relevance, completeness and accuracy of source data.

This becomes more crucial since M/s LNK’s group gratuity scheme’s valuation by actuary shows
wide variation compared to previous year’s figures. There is no doubt that appropriateness, reasonableness of assumptions and methods used are the responsibility of the expert, but the auditor has to determine whether they are reasonable based on the auditor’s knowledge of the client’s business and result of his audit procedures. –

In the present case, the auditor must verify the reasonableness of assumptions made and methods adopted by the actuary in the evaluation particularly with reference to factors such as rate of return on investments, retirement age, number and salary of employees, etc.

Conclusion: In view of provisions of SA 500 as discussed above, the auditor has to satisfy himself whether valuation done by the actuary can be adopted, otherwise he may report on his findings for wide variation.

Question 75.
The auditor of SS Ltd. accepted the gratuity liability valuation based on the certificate issued by a qualified actuary. However, the auditor noticed that the retirement age adopted is 65 years as against the existing retirement age of 60 years. The company is considering a proposal to increase the retirement age. Comment. [Nov. 11 (5 Marks), MTP-April 18]
Or
For determining the liability for Gratuity, Actuary’s Report is produced to the auditor. On examination auditor notices a serious wrong assumption in the report. Auditor challenges the Actuary’s report – Comment.
Answer:
Using the work of Management Expert as an audit evidence:

SA 500 (Revised), “Audit Evidence” states that the auditor has to evaluate the work of management expert, say, actuary, before adopting the same.
The work of management expert is required to be evaluated in terms of following:
1. Relevance and reasonableness of that expert findings and conclusion.
2. Relevance and reasonableness of assumptions and methods used; and
3. Relevance, completeness and accuracy of source data.

There is no doubt that appropriateness, reasonableness of assumptions and methods used are the responsibility of the expert, but the auditor has to determine whether they are reasonable based on the auditor’s knowledge of the client’s business and result of his audit procedures.

In the instant case, a qualified actuary has issued a certificate for gratuity liability valuation, for which retirement age adopted is 65 years against the existing retirement age of 60 years; however, the company is considering a proposal to increase the retirement age.

Conclusion; In view of provisions of SA 500 as discussed above, the assumption made by actuary has no relevance and reasonableness as presently retiring age is of 60 years. Hence the auditor is required to bring out the facts to the notice of management and advice the modification accordingly. In case of failure of compliance of the same the auditor may qualify the report.

Question 76.
Y Ltd. Engaged an actuary to ascertain its employee cost, gratuity and leave encashment liabilities. As the auditor of Y Ltd., you would like to use the report of actuary as an audit evidence and for this purpose auditor is required to evaluate the competence, capability and objectivity of the expert. What are the sources from where information about the competence, capability and objectivity of expert may be obtained.
Answer:
Sources of information about competence, capability and objectivity of the expert:

As per SA 500 “Audit Evidence” if any information is prepared by the entity using the work of management expert and auditor has to consider that information as audit evidence, he is required to evaluate the competence, capability and objectivity of that expert. Information regarding the competence, capabilities and objectivity of a management’s expert may come from a variety of sources, such as: ‘

Personal experience with previous work of that expert.
Discussions with that expert.
Discussions with others who are familiar with that expert’s work.
Knowledge of that expert’s qualifications, membership of a professional body or industry association, license to practice, or other forms of external recognition.
Published papers or books written by that expert.
An auditor’s expert, if any, who assists the auditor in obtaining sufficient appropriate audit evidence with respect to information produced by the management’s expert.

Question 77.
Gap Ltd. possesses some investment for which there is no ready market and to assess its fair market value it hires an expert, the result of which it can use in preparing its financial statement. Being an Auditor of the Company, state the matters which may affect the nature, timing and extent of audit procedure to be adopted by you in the instant case. [May 18 – Old Syllabus (5 Marks)]
Answer:
Matters affecting NTE of Audit procedures in case of information being produced using work of management expert:

As per SA 500 “Audit Evidence” if any information is prepared by the entity using the work of management expert and auditor has to consider that information as audit evidence, he is required to evaluate the competence, capability and objectivity of that expert. Matters which may affect nature, timing and extent of audit procedures in such a case are:

The nature and complexity of the matter to which the management’s expert relates.
The risks of material misstatement in the matter.
The availability of alternative sources of audit evidence.
The nature, scope and objectives of the management’s expert’s work.
Whether the management’s expert is employed by the entity, or is a party engaged by it to provide relevant services.
The extent to which management can exercise control or influence over the work of the management’s expert.
Whether the management’s expert is subject to technical performance standards or other professional or industry requirements.
The nature and extent of any controls within the entity over the management’s expert’s Work.
The auditor’s knowledge and experience of the management’s expert’s field of expertise.
The auditor’s previous experience of the work of that expert.

Question 78.
“Obtaining Audit Evidence in performing compliance and Substantive procedures.” Comment.
Answer:
Methods to obtain audit evidence:
SA 500 “Audit Evidence” requires that the auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence.

Audit Procedures to obtain audit evidence:
(a) Risk assessment Procedures
(b) Further Audit procedures: It comprises of

Test of Controls, and
Substantive Procedures: It consists ofTests of Details and Substantive Analytical Procedures

Nature and timing of audit procedures affected by:

Availability of audit evidence in electronic form only.
Availability of audit evidence at certain points/periods in time.

As per SA 500, the auditor can use the following methods while performing compliance and substantive procedures:
(a) Inspection: It involves examining records or documents, whether internal or external, in paper form, electronic form, or other media, or a physical examination of an asset.

(b) Observation: It consists of looking at a process or procedure being performed by others, for example, the auditor’s observation of inventory counting by the entity’s personnel.

(c) External Confirmation: It represents audit evidence obtained by the auditor as a direct written response to the auditor from a third party (the confirming party], in paper form, or by electronic or other medium.

(d) Recalculation: It consists of checking mathematical accuracy of documents or records. It may be performed manually or electronically.

(e) Re-performance: It involves the auditor’s independent execution of procedures or controls that were originally performed as part of the entity’s internal control.

(f) Analytical Procedures: It consists of evaluations of financial information made by a study of relationships among both financial and non-financial data.

(g) Inquiry: It consists of seeking information of knowledgeable persons, both financial and non- financial, within the entity or outside the entity.

Question 79.
Write short note on: Inquiry. [Nov. 10 (4 Marks)]
Or
Write short note on: Inquiry as one of the methods of collecting audit evidence. [May 17 (4 Marks)]
Answer:
Inquiry:
As per SA 500 “Audit Evidence”, inquiry is one of the methods to obtain audit evidences. Inquiry consists of seeking information of knowledgeable persons, both financial and non-financial, within the entity or outside the entity.

Inquiry is used extensively throughout the audit in addition to other audit procedures.

Inquiries may range from formal written inquiries to informal oral inquiries. However, in case oral inquiries, the auditor may consider it necessary to obtain written representations from management and, where appropriate, TCWG to confirm responses to such inquiries.

Evaluating responses to inquiries is an integral part of the inquiry process.

Responses to inquiries may provide the auditor with information not previously possessed or with corroborative audit evidence. Alternatively, responses might provide information that differs significantly from other information that the auditor has obtained. In some cases, responses to inquiries provide a basis for the auditor to modify or perform additional audit procedures.

“ICAI Examiner Comments”
Many candidates mentioned various methods of collecting Auditing Evidence which is not required. Most of them failed to mention about auditor’s role in evaluating the Responses to Inquiry; rather they discussed other irrelevant matters without knowing the exact requirements of SA 500, “Audit Evidence”.

Question 80.
Write short note on: Assessing the reliability of Audit Evidence. [May 09 (4 Marks)]
Answer:
Assessing the reliability of audit evidence:
As per SA 500 “Audit Evidence” the reliability of information to be used as audit evidence, and therefore of the audit evidence itself, is influenced by its source and its nature, and the circumstances under which it is obtained. While recognising that exceptions may exist, the following generalisations about the reliability of audit evidence may be useful:

(a) The reliability of audit evidence is increased when it is obtained from independent sources outside the entity.

(b) The reliability of audit evidence that is generated internally is increased when the related controls, imposed by the entity are effective.

(d) Audit evidence in documentary form, whether paper, electronic, or other medium, is more reliable than evidence obtained orally.

(e) Audit evidence provided by original documents is more reliable than audit evidence provided by photocopies, or documents that have been filmed, digitised or otherwise transformed into electronic form, the reliability of which may depend on the controls over their preparation and maintenance.

SA 501 “Audit Evidence – Specific Considerations for Selected Items”

Question 81.
LMN Ltd. supplies navy uniforms across the country. The company has 4 warehouses at different locations throughout the India and 5 warehouses at the borders. The major stocks are generally supplied from the borders. LMN Ltd. appointed M/s OPQ & Co. to conduct its audit for the financial year 2020-21. Mr. O, partner of M/s OPQ & Co., attended all the physical inventory counting conducted throughout the India but could not attend the same at borders due to some unavoidable reason.

You are required to advise M/s OPQ & Co.,
(a) How sufficient appropriate audit evidence regarding the existence and condition of inventory may be obtained?
(b) How an auditor is supposed to deal when attendance at physical inventory counting is impracticable? [RTP-May 18]
Or
Crush Ltd. is a dealer in fast moving consumer goods. The Company has warehouses throughout the country where the stocks are stored.TheAuditoroftheCompanynormallyconductphysical verification of stocks along with the Management at the end of the financial year. However, the Auditor could not be physically present during stock-tacking at two places on account of certain disturbances in the region.
In the light of the above facts:

How sufficient appropriate audit evidence regarding the condition and existence of inventory may be obtained?
How an Auditor is supposed to deal when attendance at physical inventory counting is impracticable? [May 18 – Old Syllabus (5 Marks)]

Answer:
Auditor’s duties to obtain evidences regarding existence and condition of inventory:

SA 501 “Audit Evidence – Specific Considerations for Specific Items”, requires from the auditor that when inventory is material to the financial statements, he shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by attendance at physical inventory counting, unless impracticable, to: .

Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting;
Observe the performance of management’s count procedures;
Inspect the inventory; and
Perform test counts.

Attendance at physical inventory counting involves:

Inspecting the inventory to ascertain its existence and evaluate its condition, and performing test counts;
Observing compliance with management’s instructions and the performance of procedures for recording and controlling the results of the physical inventory count; and
Obtaining audit evidence as to the reliability of management’s count procedures.

Auditor’s procedures in case of impractical situations:

Perform alternative audit procedures to obtain sufficient appropriate audit evidence regarding existence and condition of inventory.
Alternative Audit Procedure may include inspection of documentation of the subsequent sale of specific inventory items acquired/purchased prior to physical inventory counting.
If it is not possible to do so, modify the opinion in the auditor’s report in accordance with SA 705.

Question 82.
You are the auditor of Easy Communications Ltd. for the year 2020-21. The inventory as at the end of the year i.e. 31.3.21 was ₹ 2.25 crores. Due to unavoidable circumstances, you could not be present at the time of annual physical verification. Under the above circumstances how would you ensure that the physical verification conducted by the management was in order? [Nov. 08 (5 Marks), RTP-May 20]
Answer:
Auditor’s procedures w.r.t. inventory count procedures:
SA 501 “Audit Evidence – Specific Considerations for Specific items”, requires from the auditor that when inventory is material to the financial statements, he shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by attendance at physical inventory counting, unless impracticable, to:

Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting;
Observe the performance of management’s count procedures;
Inspect the inventory; and
Perform test counts.

SA 501 further provides that if the auditor is unable to be present at the physical inventory count on the date planned due to unforeseen circumstances, the auditor should take or observe some physical counts on an alternative date and perform audit procedures on intervening transactions to assess whether the changes in inventory between the date of physical count and the period end date are correctly recorded.

The auditor may also seek management’s written representation on (a) the completeness of information provided regarding the inventory, and (b) assurance with regard to adherence to laid down procedures for physical inventory count.

Question 83.
“If inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence of inventory by attending the physical inventory counting unless impracticable.” Disuses. [Nov. 15 (5 Marks)]
Answer:
Auditor’s procedures w.r.t. inventory count procedures:
SA 501 “Audit Evidence – Specific Considerations for Specific Items”, requires from the auditor that when inventory is material to the financial-statements, he shall obtain sufficientappropriate audit evidence regarding the existence and condition of inventory by attendance at physical inventory counting, unless impracticable, to:

(a) Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting;
(b) Observe the performance of management’s count procedures;
(c) Inspect the inventory; and
(d) Perform test counts;

Attendance at physical inventory counting involves:
(a) Inspecting the inventory to ascertain its existence and evaluate its condition, and performing test counts;
(b) Observing compliance with management’s instructions and the performance of procedures for recording and controlling the results of the physical inventory count; and

(c) Obtaining audit evidence as to the reliability of management’s count procedures.
These procedures may serve as test of controls or substantive procedures depending on the auditor’s risk assessment, planned approach and the specific procedures carried out.

“ICAI Examiner Comments”
Examinees failed to highlight the procedure that an auditor would perform to obtain sufficient appropriate audit evidence by attending the physical inventory counting. Irrelevant I points on AS-2 and CARO were discussed. Some examinees wrote regarding physical verification which was not required. Also, few examinees discussed about audit of stocks.

Question 84.
Your firm has been appointed as the statutory auditors of GBM Private Limited for the financial year 2020-21. While verification of company’s inventories as on 31st March 2020, you found that the significant amount of inventories belonging to the company arc held by other parties. However, the company has kept all the records of the inventories maintained by other parties. What is your duty as an auditor in order to ensure that third parties arc not such with whom the stock should not be held and the stock as disclosed in company’s records actually belongs to them? [RTP-Nov. 19|
Answer:
Inventory under the Custody and Control of a Third Party:

As per SA 501, “Audit Evidence—Specific Considerations for Selected Items” when inventory under the custody and control of a third party is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of that inventory by performing one or both of the following:

(i) Request confirmation from the third party as to the quantities and condition of inventory held on behalf of the entity.

(ii) Perform inspection or other audit procedures appropriate in the circumstances, for example where information is obtained that raises doubt about the integrity and objectivity of the third party, the auditor may consider it appropriate to perform other audit procedures instead of, or in addition to, confirmation with the third party. Examples of other audit procedures include:

Attending, or arranging for another auditor to attend, the third party’s physical counting of inventory, if practicable.
Obtaining another auditor’s report, or a service auditor’s report, on the adequacy of the third party’s internal control for ensuring that inventory is properly counted and adequately safeguarded.
Inspecting documentation regarding inventory held by third parties, for example, warehouse receipts.
Requesting confirmation from other parties when inventory has been pledged as collateral.

SA 505 “External Confirmation”

Question 85.
Write short note on: External Confirmations in audit. [Nov. 09 (4 Marks)]
Answer:
External Confirmations:
As per SA 505 external confirmation may be defined as Audit evidence obtained as a direct written response to the auditor from a third party (the confirming party), in paper form, or by electronic or other medium.

External confirmations are of two types:
(a) Positive confirmation request – A request that the confirming party respond directly to the auditor indicating whether the confirming party agrees or disagrees with the information in the request or providing the requested information.

(b) Negative confirmation request – A request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request.

External confirmation procedures frequently are relevant when addressing assertions associated with account balances and their elements but need not be restricted to these items. For example, the auditor may request external confirmation of the terms of agreements, contracts, or transactions between an entity and other parties.

Question 86.
Write short notes on Situations where external confirmations can be used.
Answer:
Situations where external confirmations can be used:
External confirmation procedures frequently are relevant when addressing assertions associated with account balances and their elements but need not be restricted to these items. For example, the auditor may request external confirmation of the terms of agreements, contracts, or transactions between an entity and other parties.

Other situations where external confirmation procedures may provide relevant audit evidence include:

Bank balances and other information relevant to banking relationships.
Accounts receivable balances and terms.
Inventories held by third parties at bonded warehouses for processing or on consignment.
Property title deeds held by lawyers or financiers for safe custody or as security.
Investments held for safekeeping by third parties or purchased from stockbrokers but not delivered at the balance sheet date.
Amounts due to lenders, including relevant terms of repayment.
Accounts payable balances and terms.

Question 87.
Mr. Z who is appointed as auditor of Elite Co. Ltd. wants to use confirmation request as audit evidence during the course of audit. What are the factors to be considered by Mr. Z when designing a confirmation request? Also state the effects of using positive external confirmation request by Mr. Z. [May 16 (5 Marks)]
Answer:
Factors to be considered while designing confirmation requests:
As per SA 505 “External Confirmations” factors to consider when designing confirmation requests include

Assertion being addressed.
Specific identified RMM.
Layout & presentation of request.
Prior experience on the audit of similar engagements.
Method of communication.
Management authorisation/encouragement to Confirming Party to respond to auditor.
Ability of Confirming Party to provide/confirm requested information.

Effects of Positive Confirmation Requests:
A positive external confirmation request asks the confirming party to reply to the auditor in all cases, either by indicating the confirming party’s agreement with the given information, or by asking the confirming party to provide information.

A response to a positive confirmation request ordinarily is expected to provide reliable audit evidence. There is a risk, however, that a confirming party may reply to the confirmation request without verifying that the information is correct.

The auditor may reduce this risk by using positive confirmation requests that do not state the amount (or other information) on the confirmation request, and ask the confirming party to fill in the amount or furnish other information.

“ICAI Examiner Comments”
Candidates, in general, failed to state all the important factors to be considered while designing the confirmation request and to explain the effect of positive confirmation.

Question 88.
The management of S Ltd. Request you not to seek confirmation from its debtors. As the auditor of j S Ltd., what can be an appropriate response? [May 11 (6 Marks)]
Or
Never Permit Limited refused to allow you to get direct confirmation of the outstanding balances of trade receivables. You want to ensure on grounds of materiality that atleast outstanding above 1 a threshold limit needs to be confirmed and reconciliation is to be carried out before finalising the I audit. If the company does not relent, how will you respond? [May 18 – New Syllabus (4 Marks)]
Or
The auditor of H Ltd. wanted to obtain confirmation from its creditors. But the management made a request to the auditor not to seek confirmation from certain creditors citing disputes. Can the auditor of H Ltd. Accede to this request? [May 13 (4 Marks)]
Or
Your firm has been appointed as the statutory auditors of AGM Private Limited for the financial year 2020-21. While verification of company’s trade receivables as on 31st March 2021, accountant of AGM Ltd. has requested you, not to send balance confirmations to a particular group of trade receivables since the said balances arc under dispute and the matter is pending in the Court. As a Statutory Auditor, how would you deal in this situation? [RTP-May 20]
Answer:
Management refusal to allow auditor to send confirmation request:
SA 505, “External Confirmations”, establishes standards on the auditor’s use of external confirmation as a means of obtaining audit evidence. It requires that the auditor should employ external confirmation procedures irrconsultation with the management.

The auditor may come across certain situations in which the management may request him not to seek external confirmation from certain parties because of some reasons, for example, due to a dispute with the particular creditor or debtor.

If the management refuses to allow the auditor-to a send a confirmation request, the auditor shall:
a. Inquire as to Management’s reasons for the refusal, and seek audit evidence as to their validity and reasonableness,
b. Evaluate the implications ofmanagement’s refusal on the auditor’s assessment of the relevant risks of material misstatement, including the risk of fraud, and on the nature, timing and extent of other audit procedures, and
c. Perform alternative audit procedures designed to obtain relevant and reliable audit evidence.

If the auditor concludes that management’s refusal to allow the auditor to send a confirmation request is unreasonable or the auditor is unable to obtain relevant and reliable audit evidence from alternative audit procedures, the auditor shall communicate with TCWG and also determine its implication for the audit and his opinion.

Question 89.
Moon Limited replaced its statutory auditor for the Financial year 2020-21. During the course of audit, the new auditor found a credit item of ₹ 5 lakhs. On enquiry, the company explained him that it is, a very old credit balance. The creditor had neither approached for the payment nor he is traceable. Under the circumstances, no confirmation of the credit balance is available. [Nov. 09 (5 Marks)]
Answer:
Auditor’s duties in case of non-availability of External Confirmation:
SA 505 “External Confirmations” provides that if the auditor has determined that a response to a positive confirmation request is necessary to obtain sufficient appropriate audit evidence, and alternative audit procedures will not provide the audit evidence the auditor requires, he should determine the implications for the audit and the auditor’s opinion in accordance with SA 705.

In the present case the identities of trade payables are not traceable to confirm the credit balance as appearing in the financial statement of the company. It is also not a case of pending litigation. It might be a case that an income of ₹ 5 lakhs had been hidden in previous year/s.

The statutory auditor should examine the validity of the credit balance as appeared in the company’s financial statements. He should obtain sufficient evidence in support of the balance. He should apply alternative audit procedures to get documentary proof for the transaction/s and should not rely entirely on the management representation. Finally, he should include the matter by way of a qualification in his audit report to the members.

Question 90.
As an auditor how would you deal with the following: When the audit team visited the client to perform substantive audit of debtor, the client produced ledger account of customers and confirmations for the top 10 customers. One of the debtors was more than 5 years old, but it had confirmed his balance. [May 10 (5 Marks)]
Answer:
Auditor’s duties in case of doubt over reliability of external confirmations:
SA 505 “External Confirmations” deals with the auditor’s use of external confirmation procedures to obtain audit evidence. External confirmation is the process of obtaining and evaluating audit evidence through a direct communication from a third party in response to a request for information about a particular item affecting assertions made by the management in the financial statements.

As per SA 505, the auditor is required to maintain a control over the process of selecting those to whom a request will be sent out, the preparation and sending of confirmation requests and responses to those requests. This is because there have been several cases of clients presenting forged confirmation to auditors when such control was absent.

In the present case, one of the debtors of more than 5 years old had confirmed his balance. The auditor should enquire into the debtor whose dues are outstanding for 5 years or more about his financial abilities and why he has not paid, reasons behind the same, and if found adverse, the client should be advised to provide for “Provision for bad debts” and also to confirm that it is not a forged confirmation.

Question 91.
During the course of audit of Star Limited the auditor received some of the confirmation of the balances of trade payables outstanding in the balance sheet through external confirmation by negative confirmation request. In the list of trade payables, there are number of trade payables of small balances except one, old outstanding of ? 15 Lacs, of whom, no confirmation on the credit balance received. Comment with respect to Standard of Auditing. [May 14 (5 Marks), RTP-May 18]
Answer:
Response to Negative Confirmation Request:
As per SA 505, “External Confirmation” Negative Confirmation is a request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request.

Negative confirmations provide less persuasive audit evidence than positive confirmations. In case of negative confirmation request, confirming parties may be more likely to respond indicating their disagreement with a confirmation request when the information in the request is not in their favour, and less likely to respond otherwise.

In the instant case, the auditor sent the negative confirmation requesting the trade payables having outstanding balances in the balance sheet while doing audit of Star Limited. One of the old outstanding of rupees 15 lacs has not sent the confirmation on the credit balance.

Non-response for negative confirmation request does not means that there is some misstatement as negative confirmation request itself is to respond to the auditor only if the confirming party disagrees with the information provided in the request.

In the present case, considering the materiality of the account balance, the auditor may examine subsequent cash disbursements or correspondence from third parties, and other records, such as goods received notes.

Question 92.
M/s ABC & Co., LLP are appointed auditors of Sharp Company Ltd. for the year ended 31st March, 2021. As part of the audit process, they want to use confirmation procedures as audit evidence during the course of audit. In view of the fact that positive confirmations are not responded favourably, the firm also intends to use negative confirmation requests. What are the factors to be considered for the same? [May 19 – Old Syllabus (7 Marks)]
Answer:
Use of negative confirmations:
As per SA 505, “External Confirmation”, Negative Confirmation is a request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request.

Negative confirmations provide less persuasive audit evidence than positive confirmations. Accordingly, the auditor shall use negative confirmation requests as the sole substantive audit procedure only when all of the following conditions are present:
(a) Low Risk of material misstatement and auditor has obtained sufficient appropriate audit t evidence regarding the operating effectiveness of controls.
(b) The population comprises a large number of small, homogeneous, account balances or transactions.
(c) A very low exception rate is expected.
(d) The auditor is not aware of circumstances or conditions that would cause recipients of jf negative confirmation requests to disregard such requests.

SA 510 “Initial Audit Engagements – Opening Balances”

Question 93.
What are Initial Audit Engagement?
Answer:
Initial Audit Engagements:
As per SA 510 “Initial Audit Engagements – Opening Balances”, initial audit engagement is an engagement in which either:

The financial statements for the prior period were not audited; or
The financial statements for the prior period were audited by a predecessor auditor.

Question 94.
Comment on the following: You have been appointed as the auditor of Good Health Ltd. for 2020-21 which was audited by CA Trustworthy in 2019-20. As the Auditor of the company state the steps you would take to ensure that the Closing Balances of 2019-20 have been brought to account in 2020-21 as Opening Balances and the Opening Balances do not contain misstatements. [Nov. 08 (5 Marks), MTP-Aug. 18, RTP-Nov. 18]
Or
What are the procedures to be followed by a Statutory Auditor in the audit of opening balances if the financial statements for the preceding year were audited by another auditor?
Or
You have been appointed as statutory auditor of M/s Moon Ltd. for the financial year 2020-21. As the auditor of the company you want to ensure that closing balances of previous year have been correctly brought forward as opening balances in the current year. State the audit procedures for the same to ensure that there is no-misstatement. [Nov. 19 – Old Syllabus (5 Marks)]
Or
Mr. X has been appointed as an auditor of M/s ABC Ltd., Mr. X wants to be satisfied about the sufficiency and appropriateness of’Opening Balances’ to ensure that they are free from misstatements. Lay down the audit procedure, Mr. X should follow, in the initial audit engagement of M/s ABC Ltd. Also suggest the approach to be followed regarding mention in the audit report if Mr. X is not satisfied about the correctness of’Opening Balances’? [Nov. 19 – New Syllabus (4 Marks)]
Answer:
Audit procedures for verification of opening balances in case of initial audit engagement:

SA 510 “Initial Audit Engagements- Opening Balances”, deals with the auditor’s responsibilities relating to verification of opening balances in case of initial audit engagements. Accordingly, auditor shall obtain sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the current period’s F.S. by:
(a) Determining whether the prior period’s closing balances have been correctly brought forward to the current period or, when appropriate, any adjustments have been disclosed as prior period items in the current year’s Statement of Profit and Loss;

(b) Determining whether the opening balances reflect the application of appropriate accounting policies; and

Where the prior year F.S. were audited, perusing the copies of the audited F.S. including the other relevant documents relating to the prior period F.S,;
Evaluating whether audit procedures performed in the current period provide evidence relevant to the opening balances; or
Performing specific audit procedures to obtain evidence regarding the opening balances.

Approach to be followed while drafting Report:
If the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances, the auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate. Further, If the auditor concludes that the opening balances contain a misstatement that materially affects the current period’s financial statements, and the effect of the misstatement is not properly accounted for or not adequately presented or disclosed, the auditor shall express a qualified opinion or an adverse opinion in accordance with SA 705.

Question 95.
In an initial audit engagement, the auditor will have to satisfy about the sufficiency and appropriateness of ‘Opening balances’ to ensure that they are free from mis-statements, which may materially affect the current financial statements. Lay down the audit procedure, you will follow, when financial statements are audited for the first time.

If, after performing the procedure, you are not satisfied about the correctness of‘Opening Balances’, what approach you will adopt in drafting your audit report? [May 15 (5 Marks), MTP-April 18, Oct. 19]
Answer:
Audit procedures for verification of opening balances in case of initial audit engagement:
As per SA 510 “Initial Audit Engagements-Opening Balances”, the objective of the Auditor while conducting an initial audit engagement with respect to opening balances is to obtain sufficient appropriate audit evidence so that the

opening balances of the preceding period have been correctly brought forward to the current period;
opening balances do not contain any misstatement that materially affect the current period’s financial statements; and
appropriate accounting policies reflected in the opening balances have been consistently applied in the current period’s financial statements, or changes thereto are properly accounted for and adequately presented and disclosed in accordance with the applicable financial reporting framework.

When the audit of financial statements is being conducted for the first time, the auditor has to perform auditing procedures to obtain sufficient appropriate audit evidence. Since opening balances represent effect of transaction and events of the preceding period and accounting policies applied in the preceding period, the auditor need to obtain evidence having regard to nature of opening balances, materiality of the opening balances and accounting policies.

Since it will not be possible for auditor to perform certain procedures, e.g., observing physical verification of inventories, etc. the auditor may obtain confirmation, etc. and perform suitable procedures in respect of fixed assets, investments, etc. The auditor can also obtain management representation with regards to the opening balances.

Considerations while drafting Report:
If the auditor is unable to obtain sufficient appropriate audit evidence regardingthe opening balances, the auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate. Further, If the auditor concludes that the opening balances contain a misstatement that materially affects the current period’s financial statements, and the effect of the misstatement is not properly accounted for or not adequately presented or disclosed, the auditor shall express a qualified opinion or an adverse opinion in accordance with SA 705.

“ICAI Examiner Comments”

Most of the candidates could not write approach for drafting of Audit Report in case of Open- j ing Balance which contains misstatement. Many candidates wrote answer about using previous year audited accounts, while question specifically mentioned that the financial statements were audited for the first time.

Question 96.
CA Mr. Jack, a recently qualified practicing Chartered Accountant got his first audit assignment of Futura (P.) Ltd. for the financial year 2020-21. He obtained all the relevant appropriate audit evidence for the items related to Statement of Profit and Loss. However, while auditing the Balance Sheet items, CA lack left out obtaining appropriate audit evidence, say, confirmations, from the outstanding Accounts Receivable amounting ₹ 100 lakhs, continued as it is from the last year, on the affirmation of the management that there is no receipts and further credits during the year. CA Jack, therefore, excluded from the audit programme, the audit of accounts receivable on the understanding that it pertains to the preceding year which was already audited by predecessor auditor. Comment. [MTP-Oct. 18, May 20]
Answer:
Audit procedures for verification of opening balances in case of initial audit engagement:

As per SA 510 “Initial Audit Engagements- Opening Balances”, the objective of the Auditor while conducting an initial audit engagement with respect to opening balances is to obtain sufficient appropriate audit evidence so that the-

opening balances of the preceding period have been correctly brought forward to the current period;
opening balances do not contain any misstatement that materially affect the current period’s financial statements; and
appropriate accounting policies reflected in the opening balances have been consistently applied in the current period’s financial statements, or changes thereto are properly accounted for and adequately presented and disclosed in accordance with the applicable financial reporting framework.

If the prior period’s financial statements were audited by a predecessor auditor, the auditor may be able to obtain sufficient appropriate audit evidence regarding the opening balances by perusing the copies of the audited financial statements including the other relevant documents relating to the prior period financial statements such as supporting schedules to the audited financial statements.

Ordinarily, the current auditor can place reliance on the closing balances contained in the financial statements for the preceding period, except when during the performance of audit procedures for the current period the possibility of misstatements in opening balances is indicated.

In the given case, the management of Futura (P.] Ltd. has restrained CA Jack, its auditor, from obtaining appropriate audit evidence for balances of Accounts Receivable outstanding as it is from the preceding year. CA Jack, on believing that the preceding year balances have already been audited and on the statement of the management that there are no receipts and credits during the current year, therefore excluded the verification of Accounts Receivable from his audit programme.

Contusion: CA Jack was required to obtain from the management a written representation (as covered by SA 580) for their views and expressions; and to perform appropriate procedures on closing balances of Accounts Receivable to ensure its appropriateness. In the present case, CA Jack will be held guilty for professional misconduct for not exercising due diligence in the conduct of his professional duties as per the Code of Ethics.

SA 520 “Analytical Procedures”

Question 97.
What are the considerations to be kept in mind while performing analytical procedures on data prepared by the client. [May 09 (6 Marks)]
Answer:
Auditor’s considerations while performing analytical procedures;
SA 520 “Analytical Procedures” deals with the auditor’s use of analytical procedures as substantive procedures and as procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial statements.

Accordingly, when the auditor intends to perform analytical procedures on data prepared by the client, he should consider the following:

1. Determine the suitability of particular substantive analytical procedures for given assertions, taking account of the assessed risks of material misstatement and tests of details, if any, for these assertions;

2. Evaluate the reliability of data from which the auditor’s expectation of recorded amounts or ratios is developed, taking account of source, comparability, and nature and relevance of information available, and controls over preparation;

3. Develop an expectation of recorded amounts or ratios and evaluate whether the expectation is sufficiently precise to identify a misstatement that, individually or when aggregated with other misstatements, may cause the financial statements to be materially misstated; and

4. Determine the amount of any difference of recorded amounts from expected values that is acceptable without further investigation.

Question 98.
In the audit of Hotel Great Hay Limited its auditor wants to use the analytical procedure as substantive procedure in respect of room rental income as well as pay roll costs, guide him as to how it can be done. [Nov. 13 (4 Marks)]
Or
You have been appointed as an auditor of M/s Excellent Hotels Ltd. As a senior partner, you want to use analytical procedures in respect of room rentals as well as payroll expenses. Discuss. [May 19 – Old Syllabus (7 Marks)]
Answer:
Applying analytical procedures as substantive procedures:
SA 52 0 “Analytical Procedures” deals with the auditor’s use of analytical procedures as substantive procedures and as procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial statements.

Accordingly, in some cases, predictive model may be effective as an analytical procedure.

In case of Payroll cost – Where an entity has a known number of employees at fixed rates of pay throughout the period, it may be possible for the auditor to use this data to estimate the total payroll costs for the period with a high degree of accuracy, thereby providing audit evidence for a significant item in the financial statements and reducing the need to perform tests of details on the payroll.

In case of Room Rental Income of Hotel, different types of analytical procedures provide different levels of assurance. Analytical procedures involving the prediction of total rental income in case of hotel taking the room tariff rates, the number of rooms and vacancy rates into consideration, can provide persuasive evidence and may eliminate the need for further verification by means of tests of details, provided the elements are appropriately verified.

Question 99.
The reliability of data in influenced by its source and nature and is dependent on the circumstances under which it is obtained. Accordingly, what are the relevant criteria which determine whether the data is reliable for the purposes of designing substantive analytical procedures? [Nov. 15 (4 Marks)]
Or
Write short notes on: Relevant Criteria for determining Reliability of Data as per SA 520 ‘Analytical Procedures’.
Answer:
Criteria for determining the reliability of data used for analytical procedures:
SA 520 “Analytical Procedures” deals with the auditor’s use ofanalytical procedures as substantive procedures and as procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial statements.

Accordingly, when designing and performing substantive analytical procedures, either alone or in combination with tests of details, as substantive procedures in accordance with SA 330, the auditor shall evaluate the reliability of data from which the auditor’s expectation of recorded amounts or ratios is developed, considering the following:

Source of the information available. For example, information maybe more reliable when it is obtained from independent sources outside the entity;
Comparability of the information available. For example, broad industry data may need to be supplemented to be comparable to that of an entity that produces and sells specialised products;
Nature and relevance of the information available. For example, whether budgets have been established as results to be expected rather than as goals to be achieved; and
Controls over the preparation of the information that are designed to ensure its completeness, accuracy and validity. For example, controls over the preparation, review and maintenance of budgets.

“ICAI Examiner Comments”
Examinees did not explain the relevant criteria when determining whether data is reliable for the purpose of designing substantive analytical procedures. Irrelevant points on AS-18 were discussed. Some examinees wrote wrongly about analytical procedures. Also, some examinees answered with respect to source and type of audit evidence instead of reliability of audit evidence.

Question 100.
In audit of DEF Limited, the auditor had made use of certain analytical procedures with regard to certain key data in the statement of profit and loss. The results obtained showed inconsistencies with other relevant information. State the course of action that the Auditor should take to ensure that the risk of Material misstatement would be contained to a low level fixed as per materiality level. [Nov. 18-New Syllabus (4 Marks)]
Answer:
Investigating Results of Analytical Procedures:
S A 520 “Analytical Procedures” deals with the auditor’s use of analytical procedures as substantive procedures and as procedures near the end of the audit that assist the auditor when forming an overall conclusion on the financial statements.

As per SA 520, if analytical procedures performed in accordance with this SA 520 identify fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount, the auditor shall investigate such differences by:
(a) Inquiring of management and obtaining appropriate audit evidence relevant to management’s responses; and
(b) Performing other audit proce3ures as necessary in the circumstances.

Audit evidence relevant to management’s responses may be obtained by evaluating those responses taking into account the auditor’s understanding of the entity and its environment, and with other audit evidence obtained during the course of the audit.

The need to perform other audit procedures may arise when, for example, management is unable to provide an explanation, or the explanation, together with the audit evidence obtained relevant to management’s response, is not considered adequate.

SA 530 “Audit Sampling”

Question 101.
Write short note on: Statistical and Non-Statistical Sampling. [May 12 (4 Marks)]
Answer:
Statistical Sampling and Non-Statistical Sampling:
Statistical Sampling

Statistical sampling has the following characteristics:
- Random selection of the sample items; and ,
- The use of probability theory to evaluate sample results, including measurement of sampling risk.
This method is more scientific as it involves use of laws of probability.
This method has reasonably wide application where a population consists of a large number of similar items.

Non-Statistical Sampling

A sampling approach that does not have characteristics of random selection and use of probability theory is considered as non-statistical sampling.
In this method, the sample size and its composition are determined on the basis of personal experience and knowledge of the auditor.
This method because of its simplicity in operation was in common application for many years.

Question 102.
Write short note on: Sampling Risk.
Or
While planning the audit of S Ltd. you want to apply sampling techniques. What are the risk factors i you should keep in mind? [May 10 (4 Marks)]
Answer:
Risk Factors while Sampling technique:
SA 530 deals with the auditor’s use of statistical and non-statistical sampling when designing and selecting the audit sample, performing tests of controls and tests of details, and evaluating the results from the sample.

While using sampling technique, auditor’s conclusion based on a sample may be different from the conclusion if the entire population were subjected to the same audit procedure. This is known as sampling risk.

Sampling risk can lead to two types of erroneous conclusions:
1. In-the case of a test of controls, that controls are more effective than they actually are, or in the case of a test of details, that a material misstatement does not exist when in fact it does.
The auditor is primarily concerned with this type of erroneous conclusion because it affects audit effectiveness and is more likely to lead to an inappropriate audit opinion.

2. In the case of a test of controls, that controls are less effective than they actually are, or in the case of a test of details, that a material misstatement exists when in fact it does not.
This type of erroneous conclusion affects audit efficiency as it would usually lead to additional work to establish that initial conclusions were incorrect.

Question 103.
Write short note on: Tolerable Misstatement. [May 14 (4 Marks)]
Or
What is tolerable misstatement and tolerable rate of deviation. [May 17 (4 Marks)]
Answer:
Tolerable Misstatement:
A monetary amount set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is not exceeded by the actual misstatement in the population.

When designing a sample, the auditor determines tolerable misstatement in order to address the risk that the aggregate of individually immaterial misstatements may cause the financial statements to be materially misstated and provide a margin for possible undetected misstatements.

Tolerable misstatement is the application of performance materiality, as defined in SA 320, to a particular sampling procedure. Tolerable misstatement may be the same amount or an amount lower than performance materiality.

Tolerable Rate of Deviation:
Rate of deviation from prescribed internal control procedures set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the rate of deviation set by the auditor is not exceeded by the actual rate of deviation in the population.

“ICAI Examiner Comments”
Many candidates wrongly mixed up Material misstatement with Tolerable Misstatement. Answers were general in nature and many candidates failed to narrate the Tolerable misstatement and Tolerable rate of deviation.

Question 104.
Discuss the following: With reference to SA 530, meaning of audit sampling and requirements relating to sample design, sample size & selection of items for testing.
Answer:
Meaning of Audit Sampling, Sample Design, Sample Size and Selection of items for testing:
Audit Sampling: Application of audit procedures to less than 100% of items within a population of audit relevance such that all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to draw conclusions about the entire population is known as audit sampling.

Requirement of SA 530 as to Sample Design, Size and Selection of Items for Testing

When designing an audit sample, the auditor shall consider the purpose of the audit procedure and the characteristics of the population from which the sample will be drawn.
The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level.
The auditor shall select items for the sample in such a way that each sampling unit in the population has a chance of selection.

Question 105.
“In cases where audit sample selection has been done on a random basis, no statistical process for selection of samples needs to be followed”. Comment.
Answer:
Selection of Samples on random basis:
As per SA 530 “Audit Sampling” sampling means application of audit procedures to less than 100% of items within a populatioiyzf audit relevance such that all sampling units have a chance of selection in order to provide the auditor with a reasonable basis on which to draw conclusions about the entire population.

Statistical sampling is an approach to sampling that has the following characteristics:

Random selection of the sample items; and
The use of probability theory to evaluate sample results, including measurement of sampling risk.

Essential features of statistical sampling are random selection and use of probability theory. Examples of Statistical sampling are Random selection, Systematic Selection and Monetary Unit Sampling.

Audit sample collection on a random basis ensures that all items within a population have an equal chance of selection by the use of random number tables or random number generators. This method is considered appropriate provided the population to be sampled consists of reasonably similar units and false within a reasonable range.

Conclusion: For application of statistical sampling techniques, one of the prerequisite is selection on random basis, hence in case of selection of an audit sample on random basis, no other statistical process for selection of samples need to be followed.

Question 106.
“An Auditor while analyzing the errors in a sample need not consider the qualitative aspects of errors detected.” Comment.
Answer:
Consideration of Qualitative Aspects of Errors:
SA 530 “Audit Sampling” requires the auditor to evaluate the results of the sample and determine whether the use of audit sampling has provided a reasonable basis for conclusions about the population that has been tested.

If any error or misstatement identified, auditor shall investigate its nature and cause, and evaluate their possible effect on the purpose of the audit procedure and on other areas of the audit.

In analysing the deviations and misstatements identified, the auditor would also need to consider the qualitative aspects of the misstatements identified by him.

While evaluating the misstatements, auditor may observe that many have a common feature, for example, type of transaction, location, product line or period of time. In such circumstances, the auditor may decide to identify all items in the population that possess the common feature, and extend audit procedures to those items. In addition, such deviations or misstatements may be intentional, and may indicate the possibility of fraud.

Conclusion: The statement that an auditor while analysing the errors in a sample need not consider the qualitative aspects of errors detected is not correct, as he is required to investigate the nature and causes of the errors identified.

Question 107.
Describe the Principal methods of selection of sample. [Nov. 14 (4 Marks)]
Or
The auditor should select sample items in such a way that the sample can be expected to be representative of the population. Comment. [May 17 (5 Marks)]
Or
In the course of your audit assignment of Indraprastha Ltd., you want to guide your audit assistants in selecting sample items in such a way that sample can be expected to be representative of the population and ail items have an opportunity of being selected. Guide your assistants with principal methods of collecting samples. [May 18 – Old Syllabus (4 Marks)]
Answer:
Principal Methods of Selection of Samples:
As per SA 530 “Audit Sampling” principal methods of selection of samples are:
1. Random selection: This method of sampling ensures that all items, within a population stand an equal chance of selection by the use of random number tables or random number generators. The sampling units could be physical items, such as sales invoices or monetary units.

2. Systematic selection: The number of sampling units in the population is divided by the sample size to give a sampling interval, for example 50, and having determined a starting point within the first 50, each 50th sampling unit thereafter is selected.

3. Monetary Unit Sampling: It is a type of value-weighted selection in which sample size, selection and evaluation results in a conclusion in monetary amounts.

4. Haphazard selection: Samples are selected without following a structured technique. Although no structured technique is used, the auditor would nonetheless avoid any conscious bias or predictability. Haphazard selection is not appropriate when using statistical sampling.

5. Block selection: It involves selection of a block(s) of contiguous items from within the population. Block selection cannot ordinarily be used in audit sampling because most populations are structured such that items in a sequence can be expected to have similar characteristics to each other, but different characteristics from items elsewhere in the population.

Question 108.
Write short note on: Haphazard Sampling.
Answer:
Haphazard Sampling:

SA 530 “Audit Sampling” recognises haphazard sampling as one of the sample selection method in which samples are selected without following a structured technique.
Although no structured technique is used, the auditor would nonetheless avoid any conscious bias or predictability (for example, avoiding difficult to locate items, or always choosing or avoiding the first or last entries on a page) and thus attempt to ensure that all items in the population have a chance of selection.
It may be accepted as alternative to random sampling, provided the auditor attempts to draw a representative sample from the population without any biasness.
Haphazard selection is not appropriate when using statistical sampling.

Question 109.
Write short note on: Block Selection.
Answer:
Block Selection:

SA 530 “Audit Sampling” recognises block selection as one of the sample selection method in which samples are selected without following a structured technique.
It involves selection of a block(s) of contiguous items from within the population.
Block selection cannot ordinarily be used in audit sampling because most populations are structured such that items in a sequence can be expected to have similar characteristics to each other, but different characteristics from items elsewhere in the population.
In some circumstances, it may be an appropriate audit procedure to examine a block of items, it would rarely be an appropriate sample selection technique when the auditor intends to draw valid inferences about the entire population based on the sample.

Question 110.
Describe the principal method of design of the samples and its evaluation. [May 17 (4 Marks)]
Answer:
Principal Method of Design of Samples:
SA 530 “Audit Sampling” deals with the auditor’s use of statistical and non-statistical sampling when designing and selecting the audit sample, performing tests of controls and tests of details, and evaluating the results from the sample. Among both methods of designing (Statistical and non- statistical), principal method of design of sample is statistical sampling.

Statistical sampling involves random selection of the sample items an$ use of probability theory to evaluate sample results, including measurement of sampling risk. This method is more scientific as it involves use of laws of probability. This method has reasonably wide application where a population consists of a large number of similar items.

While applying statistical sampling, auditor may also apply stratification, i.e. the process of dividing a population into sub-populations, each of which is a group of sampling units which have similar characteristics (often monetary value).

Evaluation of Sampling Results:

SA 5 30 “Audit Sampling” requires the auditor to evaluate the results of the sample and determine whether the use of audit sampling has provided a reasonable basis for conclusions about the population that has been tested.
If any error or misstatement identified, auditor shall investigate its nature and cause, and evaluate their possible effect on the purpose of the audit procedure and on other areas of the audit.
In analysing the deviations and misstatements identified, the auditor would also need to consider the qualitative aspects of the misstatements identified by him.

“ICAI Examiner Comments”
Majority of the candidates seem not to have understood the requirement of the question on the aspects to be considered by auditor in designing the sample and evaluating the results; rather their answers were concentrated mainly on the principal methods of sampling.

SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures”

Question 111.
“Accounting estimate means an approximation of a monetary amount in the absence of a precise means of measurement”. Discuss explaining the accounting estimates according to SA-540.
Answer:
Accounting Estimates:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and Related Disclosures” defines an accounting estimate as “an approximation of a monetary amount in the absence of a precise means of measurement”. This term is used for an amount measured at fair value where there is estimation uncertainty. The degree of estimation uncertainty affects the risks of material misstatement of accounting estimates.

Examples of Accounting Estimates:

Allowance for doubtful accounts.
Inventory obsolescence.
Warranty obligations.
Depreciation method or asset useful life.
Provision against the carrying amount of an investment
Outcome of long term contracts.
Financial Obligations/Costs arising from litigation settlements and judgments.

Examples of Fair Value Accounting Estimates:

Complex financial instruments, which are not traded in an active and open market.
Share-based payments.
Property or equipment held for disposal.
Certain assets or liabilities acquired in a business combination, including goodwill and intangible assets.
Transactions involving the exchange of assets or liabilities between independent parties without monetary consideration.

Question 112.
During the audit of Data Solutions Ltd., a listed company, your audit manager observed that several estimates are made by the Company. He seeks your guidance to know areas of accounting estimates that may give rise to lower level of risk of material misstatement. Guide him with examples. [Nov. 19 – Old Syllabus (5 Marks)]
Answer:
Areas of accounting estimates that may give rise to lower level of risk of material misstatement:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and Related Disclosures” defines an accounting estimate as “an approximation of a monetary amount in the absence of a precise means of measurement”. This term is used for an amount measured at fair value where there is estimation uncertainty. The degree of estimation uncertainty affects the risks of material misstatement of accounting estimates.

Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements, for example:
(a) Accounting estimates arising in entities that engage in business activities that are not complex.
(b) Accounting estimates that are frequently made and updated because they relate to routine transactions.

(c) Accounting estimates derived from data that is readily available, such as published interest rate data or exchange-traded prices of securities. Such data may be referred to as “observable” in the context of a fair value accounting estimate.

(d) Fair value accounting estimates where the method of measurement prescribed by the applicable financial reporting framework is simple and applied easily to the asset or liability requiring measurement at fair value.

(e) Fair value accounting estimates where the model used to measure the accounting estimate is well-known or generally accepted, provided that the assumptions or inputs to the model are observable.

Question 113.
“Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements whereas for some accounting estimates there may be relatively high estimation uncertainty particularly where they are based on significant assumptions”. Explain by giving examples.
Or
With reference to the Standards on Auditing state the example of accounting estimates that may have a high estimation uncertainty. [Nov. 16 (5 Marks)]
Answer:
Examples of accounting Estimates having high estimation uncertainty:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and related disclosures’’ defines an accounting estimate as “an approximation of a monetary amount in the absence of a precise means of measurement”. This term is used for an amount measured at fair value where there is estimation uncertainty. The degree of estimation uncertainty affects the risks of material misstatement of accounting estimates.

Examples of accounting estimates that may have high estimation uncertainty:

Accounting estimates that are highly dependent upon judgment, for example, judgments about the outcome of pending litigation or the amount and timing of future cash flows dependent on uncertain events many years in the future. .
Accounting estimates that are not calculated using recognised measurement techniques.
Accounting estimates where the results of the auditor’s review of similar accounting estimates made in the prior period financial statements indicate a substantial difference between the original accounting estimate and the actual outcome.
Fair value accounting estimates for which a highly specialised entity developed model is used or for which there are no observable inputs.

Question 114.
While auditing Z Ltd., you observe certain material financial statement assertions have been based on estimates made by the management. As the auditor how do you minimize the risk of material misstatements? [May 11 (6 Marks)]
Answer:
Evaluation of financial statement assertions based oh management estimates:
As per SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates” auditor shall obtain an understanding of the following in order to identify and assess the risks of material misstatement for accounting estimates:

(a) The requirements of the applicable FRF relevant to accounting estimates.

(b) How management identifies those transactions, events and conditions that may give rise to the need for accounting estimates.
In obtaining this understanding, the auditor shall make inquiries of management about changes in circumstances that may give rise to new, or the need to revise existing accounting estimates.

(c) The estimation making process adopted by the management including:
(a) The method, including where applicable the model used in making the accounting estimates.
(b) Relevant controls
(c) Whether management has used an expert.
(d) Assumptions underlying the accounting estimates.
(e) Whether there has been or ought to have been a change from the prior period in the methods for making the accounting estimates, and if so why.
(f) Whether and if so, how the management has assessed the effect of estimation uncertainty.

(d) The auditor shall review the outcome of accounting estimates included in the prior period financial statements.

Question 115.
A Pvt. Ltd. is engaged in the business of real estate. The auditor of the company requested the information from the management to review the outcome of accounting estimates (like estimated costs considered for percentage completion etc.) included in the prior period financial statements and their subsequent re-estimation for the purpose of the current period.
The management has refused the information to the auditor saying that the review of prior period information should not be done by the auditor. Please advise. [RTP-May 19]
Answer:
Review of outcome of Accounting Estimates:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and Related Disclosures” requires the auditor to review the outcome of accounting estimates included in the prior period financial statements, or, where applicable, their subsequent re-estimation for the purpose of the current period.

The nature and extent of the auditor’s review takes account of the nature of the accounting estimates, and whether the information obtained from the review would be relevant to identifying and assessing risks of material misstatement of accounting estimates made in the current period g financial statements.

However, the review is not intended to call into question the judgments made in the prior periods that were based on information available at that time.

The outcome of an accounting estimate will often differ from the accounting estimate recognised in the prior period financial statements. By performing risk assessment procedures to identify and understand the reasons for such differences, the auditor may obtain:
(a) Information regarding the effectiveness of management’s prior period estimation process, from which the auditor can judge the likely effectiveness of management’s current process.
(b) Audit evidence that is pertinent to the re-estimation, in the current period, of prior period accounting estimates.
(c) Audit evidence of matters, such as estimation uncertainty, that may be required to be disclosed in the financial statements.

The review of prior period accounting estimates may also assist the auditor, in the current period, in identifying circumstances or conditions that increase the susceptibility of accounting estimates to, or indicate the presence of, possible management bias. The auditor’s professional skepticism assists in identifying such circumstances or conditions and in determining the nature, timing and extent of further audit procedures.

Question 116.
What are the factors that may influence the degree of estimation uncertainty associated with an , accounting estimate?
Answer:
Factors Influencing Degree of Estimation Uncertainty:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and Related Disclosures” defines an accounting estimate as “an approximation of a monetary amount in the absence of a precise means of measurement”. This term is used for an amount measured at fair value where there is estimation uncertainty. The degree of estimation uncertainty affects the risks of material misstatement of accounting estimates.

The degree of estimation uncertainty associated with an accounting estimate may be influenced by factors such as

The extent to which the accounting estimate depends on judgment.
The sensitivity of the accounting estimate to changes in assumptions.
The existence of recognised measurement techniques that may mitigate the estimation uncertainty (though the subjectivity of the assumptions used as inputs may nevertheless give rise to estimation uncertainty).
The length of the forecast period, and the relevance of data drawn from past events to forecast future events.
The availability of reliable data from external sources.
The extent to which the accounting estimate is based on observable or unobservable inputs.

Question 117.
Mr. L while conducting the audit of ABC Ltd., observed that a substantial amount is recognized in respect of obsolescence of inventory and warranty obligation in the financial statements. Mr. L wants to obtain written representation from the management to determine whether the assumptions and estimates used are reasonable.
Guide Mr. L with reference to the relevant Standard on Auditing. [Nov. 19 – New Syllabus (5 Marks)]
Answer:
Written Representations as to Accounting Estimates:
SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures” requires the auditor to obtain written representations from the management and, where appropriate, those charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable.

SA 580 “Written Representations” discusses the use of written representations. Depending on the nature, materiality and extent of estimation uncertainty, written representations about accounting estimates recognised or disclosed in the financial statements may include representations:
(a) About the appropriateness of the measurement processes, including related assumptions and models, used by management in determining accounting estimates in the context of the applicable FRF, and the consistency in application of the processes.

(b) That the assumptions appropriately reflect management’s intent and ability to carry out specific courses of action on behalf of the entity, where relevant to the accounting estimates and disclosures.

(d) That no subsequent event requires adjustment to the accounting estimates and disclosures included in the financial statements.

SA 550 “Related Parties”

Question 118.
Elaborate how the statutory auditor can verify the existence of related parties for the purpose of reporting under AS 18.
Or
As a statutory auditor, how do you verify the existence of related parties and disclosures of related party transactions. [Nov. 09 (8 Marks)]
Or
In the course of audit of Q Ltd., its statutory auditor wants to be sure of the adequacy of related party disclosures? Kindly guide the auditor in identifying the possible source of related party information. [May 12 (8 Marks), MTP-Oct. 18]
Or
As an Auditor, how will you verify the existence of related parties. [Nov. 12 (8 Marks)]
Or
JY & Co. is appointed as auditor of Breeze Ltd. JY & Co. seeks your guidance for reviewing the records : and documentation of the company regarding ‘related party transactions in the normal course of business’. Describe the steps to be followed. [Nov. 15 (4 Marks)]
Or
The financial statements of Beta Ltd. have been prepared by the Management with due disclosures for related parties and transactions with them. However, as the auditor of the Company, you are not sure of the reliability of the said disclosures. Mention the documents and records that may be helpful in gathering information about related party relationships and transactions. [Nov. 19 – Old Syllabus (5 Marks)]
Answer:
Possible sources of related Party Information:
As per SA 550 “Related Parties” the auditor shall remain alert, when inspecting records or documents with respect to arrangements or information indicating the existence of related party relationships or transactions, not previously identified or disclosed to the auditor.

During the audit, the auditor may inspect records or documents that may provide information about related party relationships a)jd transactions, for example:

Entity income tax returns.
Information supplied by the entity to regulatory authorities.
Shareholder registers to identify the entity’s principal shareholders.
Statements of conflicts of interest from management and TCWG.
Records of the entity’s investments and those of its pension plans.
Contracts and agreements with key management or TCWG.
Significant contracts and agreements not in the entity’s ordinary course of business.
Specific invoices and correspondence from the entity’s professional advisors.
Life insurance policies acquired by the entity.
Significant contracts re-negotiated by the entity during the period.
Internal auditors’ reports.
Documents associated with the entity’s filings with a securities regulator (for example, prospectuses).

Auditor should also obtain further information on significant transactions outside the entity’s normal course of business. It enables him to evaluate whether fraud risk factors, if any, are present.

In addition, the auditor needs to be alert for transactions which appear unusual in the circumstances and which may indicate the existence of previously unidentified related parties. For example: Complex equity transactions such as corporate restructurings or acquisitions, transactions with offshore entities in jurisdictions with weak corporate laws, the leasing of premises etc.

Finally, the auditor should also obtain a written representation from the management concerning the completeness of information provided regarding the identification of related parties.

“ICAI Examiner Comments”
Examinees did not write about the inspection of various records or documents that may provide information about related party relationships and transacdonsMany examinees wrote about related parti4 transactions and Its reporting requirements rather than how to find these.

Question 119.
A statutory auditor is required to follow the procedures so as to Identify the risk of material mis statement associated with related parties. What are the auditor’s duties when he identifies related parÈ&r related paI*6actIons that management not previously disclosed to turn?
Answer:
Verification of existence of related parties:
SA 550 Re1ated Parties” requires the auditor to perform procedures so as to identify the risk of material misstatement associated with related parties. Accordingly, auditor should perform the following:

(a) Inquire the management regarding

Identity of entity’s Related Party, changes from prior period.
Nature of relationships between entity and Related Party.
Type & purpose of transactions with Related Party during the period.

(b) The auditor shall remain alert, when inspecting records or documents, for arrangements or other information that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor.

(c) If the auditor identifies related parties or significant related party transactions that management has not previously identified or disclosed to the auditor, the auditor shall:

Promptly communicate the relevant information to the other members of the engagement team;
Where the applicable FRF establishes related party requirements:
- Request management to identify all transactions with the newly identified related parties for the auditor’s further evaluation; and
- Inquire as to why the entity’s controls over related party relationships and transactions failed to enable the identification or disclosure of the related party relationships or transactions;
Perform appropriate substantive audit procedures relating to such newly identified related parties or significant related party transactions;
Reconsider the risk that other related parties or significant related party transactions may exist that management has not previously identified or disclosed to the auditor, and perform additional audit procedures as necessary; and
If the non-disclosure by management appears intentional (and therefore indicative of a risk of material misstatement due to fraud), evaluate the implications for the audit.

Question 120.
In the course of your audit you have come across a related party transaction which prima facie appears to be biased. How would you deal with this? [Nov. 14 (4 marks)]
Answer:
Related Parties:
As per SA 550 on, “Related Parties”, the auditor should review information provided by the management of the entity identifying the names of all known related parties and for this purpose, he may inspect records or documents that may provide information about related party relationships and transactions. In this case, the auditor is finding a related party transaction which prima facie appears to be biased. So, the auditor is required to confirm the same. For identified significant related party transactions outside the entity’s normal course of business, the auditor shall inspect the underlying contracts or agreements, if any, and evaluate whether:

The business rationale (or lack thereof] of the transactions suggests that they may have been entered into to engage in fraudulent financial reporting or to conceal misappropriation of assets,
The terms of the transactions are consistent with management’s explanations; and
The transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework.

The auditor should also obtain audit evidence that the transactions have been appropriately authorised and approved.

Conclusion: If the auditor concludes that the related party transaction is biased, he should report that the related party relationships and transactions prevent the financial statements from achieving true and fair presentation.

SA 560″Subsequent Events”

Question 121.
Briefly Explain: Audit procedures on subsequent events. [Nov. 09 (4 Marks)]
Or
Briefly describe auditor’s responsibility regarding subsequent events.
Answer:
Audit Procedures on subsequent Events:
SA 560 “Subsequent Events” deals with the auditor’s responsibilities relating to subsequent events in an audit of financial statements.

As per SA 560 the term, Subsequent Events may be defined as the events occurring between the
dates of balance sheet and audit report and the facts that become known to the auditor after the date of the auditor’s report. –

The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence that all events occurring between the date of the financial’statements and the date of the auditor’s report that require adjustment of, hr disclosure in, the financial statements have been identified.

The auditor’s procedures on subsequent events shall include the following:
(a) Obtaining an understanding of the procedures through which management has identified subsequent events.
(b) Inquiring of management and, TCWG as to occurrence of subsequent events which might affect the financial statements.
(c) Reading minutes of management & TCWG meetings that have been held after the date of the financial statements.
(d) Reading the entity’s latest subsequent interim financial statements, if any.

When, as a result of the procedures performed as required the auditor identifies events that require adjustment of, or disclosure in, the financial statements, the auditor shall determine whether each such event is appropriately reflected in those financial statements.

Question 122.
Enquiry from management is helpful for auditor to evaluate subsequent events. Discuss specific enquiries in reference of SA 560, which might have effect on the financial statements.
Or
M/s LMP Associates, Chartered Accountants while conducting the audit of PQR Ltd. want to conduct an inquiry of management and those charged with governance as to whether any subsequent events have occurred which might affect the financial statements. Guide M/s LMP Associates with the matters where specific enquiry may be conducted to evaluate subsequent events. [May 19 – Old Syllabus (7 Marks)]
Answer:
Specific Inquiries having effect on the financial statements:
SA 560 “Subsequent Events” deals with the auditor’s responsibilities relating to subsequent events in an audit of financial statements. SA 560 requires from the auditor to conduct inquiry of management and, where appropriate, TCWG as to whether any subsequent events have occurred which might affect the financial statements. The matters where specific inquiry may be conducted are as listed below:

Whether new commitments, borrowings or guarantees have been entered into.
Whether sales or acquisitions of assets have occurred or are planned.
Whether there have been increases in capital or issuance of debt instruments, such as the issue of new shares or debentures, or an agreement to merge or liquidate has been made or is planned.
Whether any assets have been appropriated by government or destroyed, for example, by fire or flood.
Whether there have been any developments regarding contingencies.
Whether any unusual accounting adjustments have been made or are contemplated.
Whether any events have occurred or are likely to occur that will bring into question the appropriateness of accounting policies used in the financial statements, as would be the case, for example, if such events call into question the validity of the going concern assumption,
Whether any events have occurred that are relevant to the measurement of estimates or provisions made in the financial statements.
Whether any events have occurred that are relevant to the recoverability of assets.

Question 123.
Comment on the following: A Co. Ltd. has not included in the Balance Sheet as on 31-03-2020 a sum of ₹ 1.50 crores being amount in the arrears of salaries and wages payable to the staff for the last 2 years as a result of successful negotiations which were going on,during the last 18 months and concluded on 30-04-2020. The auditor wants to sign the said Balance Sheet and give the audit report on 31-05-2020. The auditor came to know the result of the negotiations on 15-05-2020. [Nov. 10 (5 Marks)]
Answer:
Treatment of subsequent Events:
SA 560 “Subsequent Events” requires that in respect of events occurring between the date of F.S. and date of the Audit Report, the auditor shall perform audit procedures to obtain sufficient & appropriate audit evidence to ensure that events which require adjustments or disclosure in the F.S. have been identified.

If auditor identifies events that require adjustment or disclosure in the F.S., the auditor should determine whether each such event is appropriately reflected in the F.S.

The auditor shall request the management to provide a “Written Representation” that all events occurring subsequent to the date of the F.S. and requires adjustment or disclosure have been adjusted or disclosed.

In the instant case, the amount of ₹ 1.50 crores are a material amount and it is the result of an event, which has occurred after the Balance Sheet date. As per the provisions of AS-4 and AS-29, the obligation requires provision for outstanding expenses.

Conclusion: The facts of the case indicates the event as of adjusting nature as per AS-4 “Contingencies and Events Occurring after the Balance Sheet date” and requires adjustment in assets and liabilities, which has not been made by the management. Auditor should request management to adjust the sum of ₹ 1.50 crores by making provision for expenses. If the management does not accept the request the auditor should qualify the Audit Report.

Question 124.
As a statutory auditor of a company, comment on the following: Afire broke out on 15th May, 2020, in which material worth ₹ 50 lakhs which was lying in inventory since 1st March, 2020 was totally destroyed. The financial statements of the company have not been adopted till the date of fire. The management of the company argues that since the loss occurred in the year, 2020-21, no provision for the loss needs to be made in the financial statements for 2019-20. [Nov. 12(5 Marks)]
Answer:
Event Occurring after the Balance Sheet Date:
As per AS- 4 on ‘Contingencies and Events Occurring After the Balance Sheet Date’, assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate thatthe fundamental accounting assumption of going concern is not appropriate.

AS – 4 also requires disclosure of the non-adjusting event, in the report of approving authority.

Further as per SA 560 “Subsequent Events” the auditor should ensure that all events occurring – subsequent to the date of financial statements and for which applicable financial reporting framework requires adjustment or disclosure have been adjusted or disclosed.

In the instant case, fire took place after the close of the accounting year and does not relate to conditions existing at the balance sheet date.

Conclusion: The event will have no impact on items appearing at the Balance Sheet date and hence not required any adjustment, subject to satisfaction in respect of non-violation of going concern concept. Hence management is correct by not providing provision. However, auditor is required to ensure the proper disclosure in report of approving authority.

Question 125.
Amudhan & Co., are the Auditors of XYZ Company Ltd., for the year ended on 31 /03/2020. The Audit Report for that year was signed by the Auditors on 04/05/2020. The Annual General Meeting was decided to be held during the month of August 2020. On 06/05/2020, tlje Company had received a communication from the Central Government that an amount of Rs. 5800 crore kept pending on account of incentives pertaining to Financial Year 2019-20 had been approved and the amount would be paid to the Company before the end of May 2020. To a query to Chief Financial Officer of the company by the Board, it was informed that this amount had not been recognised in the Audited Financial Statements in view of the same not being released before the close of the financial year and due to uncertainty of receipt.

Now, having received the amount, the Board of Directors wished to include this amount in the Financial Statements of the company for the Financial Year ended on 31.03.2020. On 08.05.2020, the Board amended the accounts, approved the same and requested the Auditor to consider this event and issue a fresh Audit Report for the year ended on 31.03.2020. Analyse the issues involved and give your views as to whether or not the Auditor could accede to the request of the Board of Directors. [Nov. 18-New Syllabus (5 Marks)]
Answer:
Event Occurring after the Balance Sheet Date:
(a) Issues Involved:

Whether the Financial statements can be amended after the signing of audit report, but before being issued to stakeholders?
What are the disclosure requirements if the financial statements are amended after the signing of the audit report?
What are the auditor’s duties if the financial statements are revised after signing the audit report?

(b) Responses to issues:
As the audit report was signed on 04.05.2020 and financial statements amended on 08.05.2020, it appears that financial statements are not yet been issued to stakeholders. Hence, financial statements may be amended so as to incorporate any significant event which provide evidence of conditions that existed at the end of the reporting period, in accordance with Ind-AS 10 “Events after the Reporting period”.

As required by Ind-AS 10, entity shall disclose the date when the financial statements were approved for issue and who gave that approval. If the entity’s owners or others have the power to amend the financial statements after issue, the entity shall disclose that fact.

As per SA 560, “Subsequent Events”, the auditor has no obligation to perform any audit procedures regardingthe financial statements after the date ofthe auditor’s report. However, when, after the date of the auditor’s report but before the date the financial statements are issued, a fact becomes known to the auditor that, had it been known to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s report, the auditor shall

Discuss the matter with management and, where appropriate, those charged with governance.
Determine whether the financial statements need amendment and, if so,
Inquire how management intends to address the matter in the financial statements.

As per SA 560 “Subsequent Events, if management amends the financial statements, the , auditor shall:
(a) Extend the audit procedures to the date ofthe new auditor’s report; and
(b) Provide a new auditor’s report on the amended financial statements.

It is also provided in SA 560 that when law, regulation or FRF does not prohibit management from restricting the amendment of financial statements to the effect of subsequent events, auditorispermitted to restrict theauditprocedures on subsequent events to that amendment. In such case, the auditor shall:
(a) Amend the Audit report to include an additional date restricted to that amendment.
(b) ProvideaneworamendedAuditReportthatincludes Emphasis of Matter/Other matter Para that conveys that auditor’s procedures on subsequent event are restricted solely to amendments of financial statements.

SA 570 “Going Concern”

Question 126.
ABC Company files a law suit against Unlucky Company for ₹ 5 crores. The Attorney of Unlucky Company feels that the suit is without merit, so Unlucky Company merely discloses the existence of the law suit in the notes accompanying its financial statements. As an auditor of Unlucky Company, how will you deal with the situation? [May 14 (5 Marks)]
Answer:
Evaluating appropriateness of going concern assumption:
AS 29 “Provisions, Contingent liabilities and Contingent Assets”, requires that if any future event may cause a possible obligation, a provision should be made in the accounts to recognize the obligation where there is sufficient evidence that the event will occur.

SA 570 “Going Concern” requires that the auditor shall consider whether there are events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy is one of the example of such event.

In the instant case, ABC Company has filed a law suit against Unlucky Company for ₹ 5 crores. The attorney of Unlucky Company feels that the suit is without merit, so the company merely discloses the existence of law suit in the notes accompanying its financial statements.

Conclusion: Auditor should evaluate the source data on which basis the opinion is formed and evaluate the appropriateness of use of going concern assumption. If the auditor finds the uncertainty, he may request the management to adjust the sum of ₹ 5 crore by making provision for expenses as per AS 29. If the management does not accept the request the auditor should qualify the audit report.

Question 127.
A Company’s net worth is eroded and creditors are unpaid due to liquidity constraints. The management represents to the statutory auditor that the promoter’s wife is expected to give an unsecured loan to meet the liquidity constraints and that negotiations are underway to secure large export orders. [May 09 (4 Marks)]
Answer:
Appropriateness of Going Concern Assumption:
SA 570 “Going Concern” requires that the auditor shall consider whether there are events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. Eroded net worth and nonpayment to creditors are one of the examples of such event.

As per SA 5 70, when events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists through performing additional audit procedures, including consideration of mitigating factors.

In the present case, it is subjective, but prima facie a mere expectation of future cash flows from the promoter’s wife without any firm commitment and the possibility of an export order being negotiated, may not that be sufficient appropriate audit evidence of mitigating factors for resolving the going concerns question under SA 570 “Going Concern”.

Conclusion: Based on the results of evaluation of appropriateness of going concern assumption, auditor is required to modify the opinion.

Question 128.
R & Co. is the statutory auditor of S l.td. for the financial year ended on 31st March 2021, S Ltd. had disclosed in the notes (Note No. X) “The state pollution control board had ordered the closure of the company’s only manufacturing plant on the ground that it is environmentally damaging, which the company had challenged in a law suit. Pending the outcome of the law suit the financial statements are prepared on a going concern basis”. Further the financial statements prepared by the management of S Ltd. include financial statements of certain branches which are audited by other auditors. What are the reporting responsibilities of R & Co.? [May 12 (10 Marks)]
Answer:
Reporting responsibilities of Auditor:
(A) Evaluation of appropriateness of Going Concern Assumption:
As per SA 570 “Going Concern” auditor is required to obtain sufficient appropriate audit evidence about the appropriateness of management use of going concern assumption in the preparation and presentation of financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

When the auditor concludes that the use of the going concern assumption is appropriate in the circumstances but a material uncertainty exists, the auditor shall determine whether the financial statements:
(a) Adequately describe the principal events that may cast significant doubt on the entity’s ability to continue as a going concern and management’s plans to deal with these events or conditions; and
(b) Disclose clearly that there is a material uncertainty related to going concern and, therefore, that it may be unable to realize its assets and discharge its liabilities in the normal course of business.

If adequate disclosure is made in the financial statements, the auditor shall express an unmodified opinion and the auditor’s report shall include a separate section under the heading “Material Uncertainty Related to Going Concern”.

Conclusion: In the present case, as disclosure is given in financial statements, R & Co. should include a separate section under the heading “Material Uncertainty Related to Going Concern”.

(B) Reporting of Branches audited by other auditors:
As per SA 600 “Using the work of Another Auditor”, when the principal auditor has to base his opinion on the financial information of an entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity.

Conclusion: R & Co. should include an “Other Matter” paragraph in the audit report on this matter.

Question 129.
While examining the going concern assumption of an entity, what important indications should be evaluated and examined?
Or
What are the Financial indications to be considered by an auditor for evolution of the going Concern assumption? [Nov. 08 (4 Marks)]
Or
Discuss the points and indications to be noted while examining and evaluating the ’Going Concern’ assumption for an entity. [Nov. 17 (6 Marks)]
Or
Enumerate the Operating conditions of an entity that may cast significant doubt on the entity’s ability to continue as a “Going Concern”. [May 19 – Old Syllabus (4 Marks)]
Answer:
Indications to be considered while evaluating Going Concern Assumption:
SA 570 “Going Concern”, requires that auditor should obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements. Accordingly, when performing risk assessment procedures as required by SA 315, the auditor shall consider whether there are events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. Examples of such events or conditions are:

Financial Indications

Net liability or net current liability position.
Fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment; or excessive reliance on short-term borrowings to finance long-term assets.
Indications of withdrawal of financial support by trade payables.
Negative operating cash flows indicated by historical or prospective financial statements.
Adverse key financial ratios.
Substantial operating losses or significant deterioration in the value of assets used to generate cash flows.
Arrears or discontinuance of dividends.
Inability to pay trade payables on due dates.
Inability to comply with the terms of loan agreements.
Change from credit to cash-on-delivery transactions with suppliers.
Inability to obtain financing for essential new product development or other essential investments.

Operating Indications

Management intentions to liquidate the entity or to cease operations.
Loss of key management without replacement.
Loss of a major market, key customer(s), franchise, license, or principal suppliers].
Labour difficulties.
Shortages of important supplies.
Emergence of a highly successful competitor.

Other Indications

Non-compliance with capital or other statutory requirements.
Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able £b satisfy.
Changes in law or regulation or government policy expected to adversely affect the entity.
Uninsured or underinsured catastrophes when they occur.

“ICAI Examiner Comments”
Most of the examinees explained only the Financial indications properly and few examinees . could not highlight the operating and other indications while examining and valuating the ; Going concern assumption as per SA 570. Few examinees could not give the breakup of indicators and mixed up the indicators to produce the general answer.

Question 130.
Yummy Ltd., dealing in manufacturing and trading of milk butter, has a benchmark in its product for so many years. Tasty Ltd., a rival company to Yummy Ltd., has introduced its new product, peanut butter. Due to being health conscious, the consumers have shifted from milk butter to peanut butter within few months. This has result into massive loss during the year to Yummy Ltd. due to non-selling of perishable milk products. The company has also started having negative net worth.

It’s production head, finance head and marketing head have also left the company. The company has no sound action plan to mitigate these situations. Kindly guide the auditor of Yummy Ltd., how ! he should deal with the situation.
Or
M/s T K Projects Limited, a manufacturing company in the Steel industry was allegedly involved in 1 some irregularity relating to allotment of coal blocks for which a complaint was lodged against the ! company by the government. The financial institution stopped additional working capital finance which caused a financial crisis resulting in stoppage of production. The company incurred a massive loss during the year 2020-2021. There were delays in salary and other payments. Certain key managerial personnel including GM Finance and certain other employees left the company. The company has no sound action plan to mitigate these situations. Guide the statutory auditor on how he should deal with this situation. [Nov. 15 (5 Marks)]
Answer:
Evaluation of appropriateness of Going Concern assumption:
SA 570 “Going Concern”, requires the auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern. In evaluating management’s assessment, the auditor shall consider whether management’s assessment includes all relevant information of which the auditor is aware as a result of the audit.

In the instant case, Yummy Ltd. (TK Projects Ltd.) has suffered massive loss. Company has also started having negative net worth and its key managerial personnel have also left the company. The company has no action plan to mitigate these situations. Thus, there are clear indications that there is danger to entity’s ability to continue in future.

Considering the fact that there is no sound plan of action from the management to mitigate these factors and to recover the company from such situations, the going concern assumption does not seems to be appropriate.

Conclusion: Auditor should ask the management for appropriate disclosure in the financial statement and include the same in his report. However, if the management fails to make adequate disclosure, the auditor should express a qualified or adverse opinion.

“ICAI Examiner Comments”
Although majority of examinees have mentioned that the going concern assumption does not seem appropriate yet some examinees failed to explain the disclosure aspects and the expression of opinion by the auditor. Some examinees wrote about liquidity proceedings. A few examinees explained consequences of fraud and reporting by auditor.

Question 131.
Mr. Ram, an auditor, identified some events that cast significant doubt on the entity’s ability to continue as a going concern. What are the additional procedures he should perform as per the related Standard on Auditing? [Nov. 16 (5 Marks)]
Answer:
Additional Procedures required to be performed in case of doubt as to appropriateness of going concern:
As per SA 570 “Going Concern” when events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists through performing additional audit procedures, including consideration of mitigating factors. These procedures shall include:

(a) Where management has not yet performed an assessment of the entity’s ability to continue as a going concern, requesting management to make its assessment.
(b) Evaluating management’s plans for future actions, whether the outcome of these plans is likely to improve the situation and whether management’s plans are feasible in the circumstances.
(c) Where the entity has prepared a cash flow forecast, evaluate the reliability of the underlying data used to prepare the forecast and determine whether there is adequate support for the assumptions underlying the forecast.
(d) Considering whether any additional facts or information have become available since the date on which management made its assessment.
(e) Requesting WR from management and, where appropriate, TCWG, regarding their plans for future actions and the feasibility of these plans.

“ICAI Examiner Comments”
Though most of the examinees mentioned SA 570 correctly but failed to state the additional audit procedure.

Question 132.
Toddle Limited had definite plan of its business being closed within a short period from the close of the accounting year ended on 31st March, 2021. The financial statements for the year ended 31/03/2021 had been prepared on the same basis as it had been in earlier periods with an additional note that the business of the company shall cease in near future and the assets shall be disposed off in accordance with a plan of disposal as decided by the management. The statutory auditors of the company indicated this aspect in Key Audit matters only by a reference as to a possible cessation of business and making of adjustments, if any, thereto to be made at the time of cessation only. Comment on the reporting by the statutory auditor as above. [May 18 – New Syllabus (5 Marks), MTP-March 19, May 20]
Answer:
Inappropriate use of Going Concern basis of accounting:
SA 570 “Going Concern”, requires the auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

If the financial statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of the going concern basis of accounting in the preparation of the financial statements is inappropriate, the auditor shall express an adverse opinion. –

It is irrelevant whether or not the financial statements include disclosure of the inappropriateness of management’s use of the going concern basis of accounting.

In the present case, company has definite plan of its business being closed within a short period from the close of accounting year. Financial Statements had been prepared on the same basis as it had been in earlier periods i.e. going concern basis. Additional note in the financial statements that business of the company shall cease in near future and the assets shall be disposed off in accordance with a plan of disposal as decided by the management is given. Statutory auditor of the company indicated this aspect in Key Audit Matters.

Conclusion: Reporting made by the statutory auditor is not correct as in this situation, based on the requirements of SA 570, an adverse opinion need to be issued.

Question 133.
M/s Airlift Ltd., Carrying on the business of Passenger Transportation by air is running into continuous financial losses as well as reduction in Sales due to stiff competition and frequent break down of its own aircrafts. The Financial Statements for the year ended on 31.03.2020 are to be now finalized. The Management is quite uncertain as to its ability to continue in near future and has informed the Auditors that having seized of this matter, it had constituted a committee to study this aspect and to give suggestions for recovery, if any, from this had situation.

Till the study is completed, according to the Management, the issue involves uncertainty as to its ability to continue its business and it informs the Auditor that the fact of uncertainty clamping on the “Going Concern” would suitably be disclosed in notes to accounts. State the reporting requirement if any, in the Independent Auditor’s Report in respect of this matter. [Nov. 18 – New Syllabus (5 Marks)]
Answer:
Reporting Requirements in the Independent Auditor’s report in respect of Going Concern:
SA 570 “Going Concern”, requires the auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

When events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists through performing additional audit procedures, including consideration of mitigating factors.

Draw attention to the note in the financial statements that discloses the matters set out above; and
State that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in respect of the matter.

In the instant case, the auditor should disclose about the material uncertainty and express an unmodified opinion and in his audit report shall include a separate section under the heading “Material Uncertainty Related to Going Concern” to draw attention to the note in the financial statements that discloses the matters set out Above; and state that these events or conditions indicate that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in respect of the matter.

Question 134.
AQP Limited is one of the prominent players in the chemicals industry. The company is a public company domiciled in India and listed on BSE and NSE. The Company was facing extreme liquidity constraints and there were multiple indicators that casted doubt over the company’s ability to continue as a going concern.

The Company was led into insolvency proceedings by consortium of banks led by PNB and the NCLT ordered the commencement of corporate insolvency process against the Company on 31 August 2019. The company invited prospective lenders, investors and others to submit their resolution plans to the Resolution Professional (RP) latest by 1 January 2020. The RP reviewed the resolution plans and ensured conformity with Insolvency and Bankruptcy Code, 2016. The compliant plans were presented to Committee on Creditors (CoC) on 2 February 2020 and the resolution plan submitted by PQR Ltd. was evaluated as highest evaluated Compliant Resolution Plan. CoC of AQP Ltd. approved the Resolution Plan submitted by PQR Ltd. on 2 March 2020. The approval of NCLT was finally obtained on 4 May 2020.

PQR Ltd. submitted detailed plans and commitments as part of the resolution plan including clearance of all outstanding debts which were leading to negative cash flows.

Please suggest how would you deal with this situation as the auditors of AQP Ltd. [MTP-March 19, RTP-Nov. 19]
Answer:
Evaluation of Appropriateness of Going Concern Basis of Accounting:
As per SA 5 70 Going Concern, if events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern, the auditor shall obtain sufficient appropriate audit evidence to determine whether or not a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern (hereinafter referred to as “material uncertainty”) through performing additional audit procedures, including consideration of mitigating factors.

Additional procedures shall include:
(i) Where management has not yet performed an assessment of the entity’s ability to continue as a going concern, requesting management to make its assessment.

(ii) Evaluating management’s plans for future actions in relation to its going concern assessment, whether the outcome of these plans is likely to improve the situation and whether management’s plans are feasible in the circumstances.

(iii) Where the entity has prepared a cash flow forecast evaluate the reliability of the underlying data generated to prepare the forecast and determine whether there is adequate support for the assumptions underlying the forecast.

(iv) Considering whether any additional facts or information have become available since the date on which management made its assessment.

(v) Requesting written representations from management and, where appropriate, those charged with governance, regarding them plans for future actions and the feasibility of these plans.

The auditor shall evaluate whether sufficient appropriate audit evidence has been obtained regarding, and shall conclude on, the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements. ‘

If events or conditions have been identified that may cast significant doubt on the entity’s ability to continue as a going concern but, based on the audit evidence obtained the auditor concludes that no material uncertainty exists, the auditor shall evaluate whether, in view of the requirements of the applicable financial reporting framework, the financial statements provide adequate disclosures about these events or conditions.

In the instant case, the approval of the resolution plan is a significant mitigating factor to counter the going concern issues of AQP Ltd. PQR Ltd. has submitted a detailed plan and commitments that has been given as part of the resolution plan which includes clearance of all outstanding debts which were leading to negative cash flows.

Conclusion: Events and conditions are mitigated effectively and there is no material uncertainty in relation to the ability of the company to continue as a going concern.

SA 580 – “Written Representations”

Question 135.
Explain what is meant by “Written Representations” and indicate to what extent an auditor can place reliance on such representations.
Answer:
Meaning of Written Representation:
As per SA 580 “Written Representations” it is a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence. Written representations in this context do not include financial statements, the assertions therein, or supporting books and records.

Written representations are necessary information that the auditor requires in connection with the audit, hence they are recognized as audit evidence as a response to inquiries.

Although written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal.

The written representations shall be in the form of a representation letter addressed to the auditor.

Extent of Reliance:
If the auditor has concerns about the competence, integrity, ethical values or diligence of management, the auditor shall determine their effect on the reliability of representations [oral or written) and audit evidence in general.

In particular, if written representations are inconsistent with other audit evidence, the auditor shall perform audit procedures to attempt to resolve the matter.

If the auditor concludes that the written representations are not reliable, the auditor shall take appropriate actions, including determining the possible effect on the opinion

If he claims that there is sufficient doubt about integrity of management, he shall issue a disclaimer of opinion.

Question 136.
State briefly the basic elements of Management Representation Letter. [Nov. 11 (2 Marks)]
Answer:
Basic.Elements of a Management Representation Letter:
As per SA 580 “Written Representations”, some of the basic elements of a Management Representation letter are-

It is a written statement by management provided to the auditor to confirm certain matters or to support other audit evidence.
It does not include financial statements, the assertions therein, or supporting books and records.
The auditor shall request management to provide a written representation that it has fulfilled its responsibility for the preparation of the financial statements in accordance with the applicable financial reporting framework, including where relevant their fair presentation, as set out in the terms of the audit engagement.
The written representations shall be for all financial statements and period[s) referred to in the auditor’s report.
The written representations shall be in the form of a representation letter addressed to the auditor.

“ICAI Examiner Comments”
The candidate mentioned the contents of Management Representation Letter instead of basic elements of it.

Question 137.
In the course of audit of ABC Ltd. its management refuses to provide written representations. As an auditor what is your duty? [May 10 (4 Marks)]
Answer:
Duty of an Auditor if management refuses to provide written representations:
As per SA 580 “Written Representations”, if the management does not provide one or more of the requested written representations, the auditor shall:

Discuss the matter with management,
Re-evaluate the Integrity of the management and evaluate the effect that this may have on the reliability of representations (oral or written) and audit evidence in general, and
Take appropriate actions, includingdeterminingthe possible effect on the opinion in the auditor’s report.
Disclaim an opinion on the financial statements in accordance with SA 705 “Modifications to the Opinion in the Independent Auditor’s Report”.

Question 138.
An auditor of Mohan Ltd. was not able to get the confirmation about the existence and value of certain machineries. However, the management gave him a certificate to prove the existence and value of the machinery as appearing in the books of account. The auditor accepted the same without any further procedure and signed the audit report. Is he right in his approach?
Or
The Auditor of PQR Pvt. Ltd. having turnover of ₹ 12 crores, was not able to get the confirmation about the existence and value of certain stock. However, a certificate from the management has been obtained regarding the existence and value of the stock at the year end. The auditor relied on the same and without any further procedure, signed the Audit Report. Is he right in his approach? [Nov. 14 (5 Marks)]
Or
While auditing a lawyer company, Mr. X, the statutory auditor of the company, was unable to get the confirmation about the existence and value of certain books existed in the library worth ₹ 35 lakhs. However, the management gave him a certificate to prove the existence and value of the books as appearing in the books of account. The auditor accepted the same without any further procedure and signed the audit report. Is he right in his approach?
Answer:
Validity of Management Representation:
The physical verification of fixed assets (Inventory) ‘is the primary responsibility of the management. The auditor, however, is required to examine the verification program adopted by the management. He must satisfy himself about the existence, ownership and valuation of fixed assets (inventory).

In the case of Mohan Ltd., the auditor has not been able to verify the existence and value of some machinery (inventory) despite the verification procedure followed in routine audit. He accepted the certificate given to him by the management without making any further enquiry.

As per SA 580 “Written Representation” the representations received from management are recognised as audit evidence, but they do not constitute Sufficient and appropriateness.

Auditor is required to seek corroborative audit evidence from other sources inside or outside the entity, to evaluate whether such representations are reasonable and consistent with other evidences. Representation received from Management cannot be a substitute for other audit evidence that the auditor could reasonably expect to be available.

If the auditor is unable to obtain sufficient appropriate audit evidence that he believes would be available regarding a matter, which has or may have a material effect on the financial information, this will constitute a limitation on the scope of his examination even if he has obtained a representation from management on the matter.

Conclusion: The approach adopted by the auditor is not right.

Question 139.
PRSH & Co. is the statutory auditor of Make My Journey Ltd. The company is in the business of tours and travels. Annual turnover of the company is INR 2000 crores and profits are INR 190 crores. During the planning meeting of the management and the auditors, it was discussed that the management needs to provide written representation letter to the auditors for the preparation of the financial statements and for the completeness of the information provided to the auditor At the time of closure of the audit, there has been some confusion about the requirements of the written representation letter.

Management argued that representation need not be written, it can also be verbal which has been provided to the audit team during the course of their audit. Auditors have completed their documentation and hence in a way, representation based on verbal discussions with the auditors has also got documented. Auditors explained that this is mandatory to obtain written representation in accordance with the requirements of SA 580. However, still some confusion remains regarding the date and period covered by the written representation. You are required to advise about the date of and period covered by written representation in view of SA 580. [RTP-May 19]
Answer:
Date of and period covered by written representation:
SA 580 “Written Representations” provides the following:
The date of the written representations shall be as near as practicable to the date of the auditor’s report. However, it should not be after the date of auditor’s report. The written representations shall be for all financial statements and period(s) referred to in the auditor’s report.

In some circumstances it may be appropriate for the auditor to obtain a written representation about a specific assertion in the financial statements during the course of the audit. Where this is the case, it may be necessary to request an updated written representation.

The written representations are for all periods referred to in the auditor’s report because
management needs to reaffirm that the written representations it previously made with respect to the prior periods remain appropriate. The auditor and management may agree to a form of written representation that updates written representations relating to the prior periods by addressing whether there are any changes to such written representations and, if so, what they are. «,

Situations may arise where current management were not present during all periods referred to in the auditor’s report. Such persons may assert that they are not in a position to provide some or all of the written representations because they were not in place during the period. This fact, however, does not diminish such persons’ responsibilities for the financial statements as a whole. Accordingly, the requirement for the auditor to request from them written representations that cover the whole of the relevant period(s) still applies.

Question 140.
In the course of audit of K Ltd., its auditor Mr. ‘N’ observed that there was a special audit conducted at the instance of the management on a possible suspicion of a fraud and requested for a copy of the report to enable him to report on the fraud aspects. Despite many reminders it was not provided. In absence of the special audit report, Mr. ‘N’ insisted that he be provided with at least a written representation in respect of fraud on/by the company. For this request also, the management remained silent. Please guide Mr. ‘N’. [May 14 (5 Marks), RTP-May 18, MTP-Oct. 18]
Answer:
Auditors Responsibilities Relating to Fraud:
As per SA 240, “The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements”, the primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. In addition, an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.

As per SA 580, “Written Representations”, if management does not provide the requested written representations, the auditor shall discuss the matter with management; re-evaluate the integrity of management and evaluate the effect that this may have on the reliability of representations (oral or written) and audit evidence in general; and take appropriate actions, including determining the possible effect on the opinion in the auditor’s report.

The auditor shall disclaim an opinion on the financial statements if the auditor concludes that there is sufficient doubt about the integrity of management such that the written representations are not reliable; or management does not provide the written representations.

In the instant case, in the course of audit of K Ltd., its auditor Mr! N observed that there was a special audit conducted at the instance of the management on a possible suspicion of fraud. Therefore, the auditor requested for special audit report, which was not provided by the management despite of many reminders. Mr. N also insisted for written representation in respect of fraud on/by the company. For this request also, management remained silent.

Section 143(12] of Companies Act, 2013 requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. For this purpose, Rule 13 prescribes the amount of ₹ 1 Cr. or more.

Para ’3(xi] of CARO, 2020 also requires the company auditor to report whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.

Conclusion: Auditor is required to state the facts in his report and he should also disclaim an opinion on the financial statements. In exceptional circumstances, he may also consider whether it is appropriate to withdraw from engagement.

Question 141.
Comment on the following: Statutory auditor of 0 Ltd. requested the management for a written representation in respect of obsolescence of inventory and warranty obligations recognized by the company in its financial statements. The management denied the representation on the ground that during the course of audit, all the required procedures were performed by the auditor and after obtaining sufficient appropriate audit evidence, auditor has issued a clean report. Please comment. . [MTP-March 19]
Answer:
Written Representations as to Accounting Estimates:
SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures” requires the auditor to obtain written representations from the management and, where appropriate, those charged with governance whether they believe significant assumptions used in making accounting estimates are reasonable.

Depending on the nature, materiality and extent of estimation uncertainty, written representations about accounting estimates recognised or disclosed in the financial statements may include representations:
(a) About the appropriateness of the measurement processes, including related assumptions and models, used by management in determining accounting estimates in the context of the applicable FRF, and the consistency in application of the processes.

(d) That no subsequent event requires adjustment to the accounting estimates and disclosures included in the financial statements.

For those accounting estimates not recognised or disclosed in the financial statements, written representations may also include representations about:
(a) The appropriateness of the basis used by management for determining that the recognition or disclosure criteria of the applicable financial reporting framework have not been met.

(b) The appropriateness of the basis used by management to overcome the presumption relating to the use of fair value set forth under the entity’s applicable financial reporting framework, for those accounting estimates not measured or disclosed at fair value.

Conclusion: Management’s contention on the ground that during the course of audit, all the required procedures were performed by the auditor and after obtaining sufficient appropriate audit evidence, auditor has issued a clean report, for not providing written representation is not correct. The management should provide written representations to the auditor.

SA 600 “Using the Work of Another Auditor”

Question 142.
“There should be sufficient liaison between a principal auditor and other auditors”. Discuss the above statement and state in this context the reporting considerations, when the auditor uses the work performed by other auditor
Answer:
Coordination between Principal Auditor and Other Auditor:
SA 600 “Using the work of Another Auditor” applies in situation where an auditor (principal auditor), reporting on the financial information of an 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. To ensure coordination among both of them, SA 600 provides the followings:

There should be sufficient liaison between the principal auditor and the other auditor.
For this purpose, the principal auditor may find it necessary to issue written communication(s) to the other auditor.
The other auditor, knowing the context in which his work is to be used by the principal auditor, should co-ordinate with the principal auditor.
- Adhering to time-table.
- Bringing to the attention of PA any significant finding.
- Compliance with relevant statutory requirements.
- Respond to detailed questionnaire.

Reporting Considerations:

When the principal auditor concludes, based on his procedures, that the work of the other auditor cannot be used and
The principal auditor has not been able to perform sufficient additional procedures regarding the financial information of the component audited by the other auditor,
The principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation on the scope of audit.

Question 143.
Describe the relevance of SA 600 while auditing consolidation of Financial Statements. [Nov. 15 (4 Marks)]
Answer:
Audit Procedure when principal auditor is using the work of another auditor:
SA 600 “Using the work of Another Auditor” guides principal auditor regarding the procedures to be performed when he is using the work of another auditor. In case of audit of Consolidated financial statements, principal auditor will use the work of auditor of subsidiary company, associates and joint venture. As per SA 600, auditor of Consolidated Financial Statements is supposed to perform the following:

(a) When principal auditor plans to use the work of another auditor, he should consider the professional competence of the other auditor in the context of specific assignment if the other auditor is not a member of the ICAI.

(b) 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.

(d) The principal auditor should document in his audit working papers the followings

Components audited by another;
Audit procedures adopted and results thereof;
Conclusion that particular component is not material;
Manner of dealing with modification in another auditor’s report

(e) When the principal auditor concludes, based on his procedures, that the work of the other auditor cannot be used and the principal auditor has not been able to perform sufficient additional procedures regarding the financial information of the component audited by the other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation on the scope of audit.

(f) When the principal auditor has to base his opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity.

“ICAI Examiner Comments”
Examinees failed to explain the various aspects the principal auditor would consider while complying with the requirements of SA 600, ‘Using the Work of another Auditor’. Many examinees described only consolidation of financial statements rather than using the work of another auditor.

Question 144.
B Ltd. is the Subsidiary company of A Ltd. ABC & Associates has been appointed as auditor of A Ltd. for the Financial year 2020-2021 and XYZ & Associates has been appointed as auditor of B Ltd. for the year 2020-21. Explain the role of ABC & Associates and XYZ & Associates as auditors of the parent company and subsidiary respectively. [Nov. 16 (4 Marks)]
Answer:
Role of Auditor of Parent Company and Subsidiary Company:
SA 600 “Using the work of Another Auditor” establishes the standard when an auditor, reporting on the financial statements of a group [consolidated financial statements], uses the work of another auditor on the financial information of one or more components included in the financial statements of the entity.

Accordingly, role of auditor of parent company and subsidiary are as follows:
Role of Auditor of Parent Company:
(a) Consider the professional competence of Other Auditor, if Other Auditor is not a member of 1CAI.
(b) Visit component and examine books of account, if essential.
(c) Obtain sufficient appropriate evidence, that work of Other Auditor is adequate for Principal Auditor’s purposes.
(d) Discuss audit procedures applied by Other Auditor.
(e) Review a written summary of Other Auditor’s procedures and findings through questionnaires/ checklist.
(f) Consider significant findings of Other Auditor and discuss audit findings with Other Auditor.
(g) Perform supplemental tests if necessary.

Role of Auditor of Subsidiary Company:
The auditor of subsidiary company, knowing the context in which his work is to be used by the principal auditor, should co-ordinate with the principal auditor w.r.t. following:
(a) Adhering to time-table.
(b) Bringing to the attention of PA any significant finding.
(c) Compliance with relevant statutory requirements.
(d) Respond to detailed questionnaire.

“ICAI Examiner Comments”
Examinees arc not aware of the role of auditor of parent company and subsidiary company.

SA 610 “Using the Work of Internal Auditor”

Question 145.
State the important aspects to be considered by the External auditor in the evaluation of Internal Audit Function. [Nov. 08 (4 Marks)]
Or
You are appointed statutory auditor of X Ltd. X Ltd. has an internal audit system and reports for the same are given to you. Mention the factors you will consider to ensure that the said system of internal audit of X Ltd. is commensurate with the size of the company and nature of its business. [May 09 (8 Marks)]
Or
CA Mr. X, a practicing chartered accountant has been appointed as an internal auditor of Textile Ltd. He conducted the physical verification of the inventory at the year-end and handed over the report of such verification to CA Mr. Y, the statutory auditor of the Company, for his view and reporting. Can CA Mr. Y rely on such report? [MTP-Oct. 18]
Or
In the course of the statutory audit of Z Ltd., its statutory auditors, having determined that the work of internal auditor is likely to be adequate for the purpose of statutory audit, wanted to use the work of internal auditor in respect of physical verification of fixed assets. How an evaluation of this specific work done by the internal auditor can be done? [May 12, Nov. 15 (5 Marks)]
Or
Rajpanth Ltd. appointed you as its statutory auditor for the current financial year. During the course of auditing, you meticulously analysed that the work performed by company’s internal auditor is likely to be adequate for the purpose of statutory audit. Consequently, you decided to use the work of internal auditor in respect of physical verification of tangible assets specifically.

State how you would evaluate the specific work performed by internal auditor to determine its adequacy and who would be responsible for expression of opinion on financial statements.
Answer:
Evaluation of Internal Audit function so as to reply on work of Internal Auditor:
SA 610 “Using the work of Internal auditors” deals with the external auditor’s responsibilities regarding the work of internal auditors when the external auditor has determined, in accordance with SA 315 that the internal audit function is likely to be relevant to the audit.

For this purpose, external auditor is required to evaluate the following:
A. Objectivity of Internal Auditor: Objectivity refers to the ability to perform without allowing bias to override professional judgments. Factors that may affect the external auditor’s evaluation include the following:

Organizational status of the internal audit function.
Conflicting responsibilities.
Oversight functions of TCWG w.r.t. employment decisions related to the internal audit function.
Constraints or restrictions placed on the internal audit function by management or TCWG.

B. Level of Competency: Competence of the internal audit function refers to the attainment of knowledge and skills to enable assigned tasks to be performed diligently. Factors that may affect the external auditor’s determination include the following:

Policies for hiring, training and assigning internal auditors to internal audit engagements.
Adequate of technical training and proficiency in auditing of internal auditors.
Knowledge of internal auditors w.r.t. entity’s financial reporting and the applicable FRF.
Membership of relevant professional bodies that oblige internal auditors to comply with the relevant professional standards.

C. Systematic and Disciplined Approach: Factors that may affect the external auditor’s determination of whether the internal audit function applies a systematic and disciplined approach include the following:

Existence, adequacy and use of documented internal audit procedures.
Existence of appropriate quality control policies and procedures for internal audit function.

Conclusion: In the present case, if the statutory auditor is satisfied about the appropriateness of the verification, he can rely on the report but if he finds that the verification is not in order, he has to decide otherwise. The ultimate responsibility to express opinion on the financial statement is that of the statutory auditor.

“ICAI Examiner Comments”

Most of the examinees discussed how to verify fixed assets instead of explaining about evaluation be carried out of specific work done by the internal auditor. Some examinees wrote about the 1mponce of internal audit which was not required.

Question 146.
Mr. A was appointed as statutory auditor of X Ltd. X Ltd. has an internal audit system and Mr. A is of the opinion that internal auditors can be used to provide direct assistance for the purpose of statutory audit. Advise Mr. A whether he can take direct assistance of internal auditor and if yes, what are the precautions he need to take.
Or
Moon Ltd. of which you are the statutory auditor, have an internal audit being conducted by an outside agency. State the factors that weigh considerations in opting to make use of direct assistance of the internal auditors for the purpose of statutory audit. [May 18 – New Course (4 Marks)]
Answer:
Using direct assistance of internal auditor:
As per SA 610 “Using the Work of Internal Auditor” statutory auditor can take direct assistance of internal auditor subject to following conditions:

The external auditor is not prohibited by law or. regulation from obtaining direct assistance from internal auditors.
There are no significant threats to the objectivity of the internal auditor.
The internal auditor is sufficient competent to perform the proposed work.

Precautions to be taken while using direct assistance:
1. The external auditor shall not use internal auditors to provide direct assistance to perform procedures that:
(a) Involve making significant judgments in the audit;
(b) Relate to higher assessed risks of material misstatement;
(c) Relate to work with which the internal auditors have been involved; or
(d) Relate to decisions the external auditor makes in accordance with this SA regarding the internal audit function and the use of its work or direct assistance.

2. Prior to using internal auditors to provide direct assistance for purposes of the audit, the external auditor shall:
(a) Obtain written agreement from an authorized representative of the entity that the internal auditors will be allowed to follow the external auditor’s instructions, and that the entity will not intervene in the work the internal auditor performs for the external auditor; and

(b) Obtain written agreement from the internal auditors that they will keep confidential specific matters as instructed by the external auditor and inform the external auditor of any threat to their objectivity.

3. The external auditor shall direct, supervise and review the work performed by internal auditors on the engagement in accordance with SA 220.

Question 147.
Mr. A is appointed as statutory auditor of XYZ Ltd. XYZ Ltd. is required to appoint internal auditor as per statutory provisions given in the Companies Act, 2013 and appointed Mr. B as its internal auditor. The external auditor Mr. A asked internal auditor to provide direct assistance to him regarding evaluating significant accounting estimates by the management and assessing the risk of material misstatements.
(a) Discuss whether Mr. A, statutory auditor, can ask direct assistance from Mr. B, internal auditor as stated above in view of auditing standards.
(b) Will your answer be different, if Mr. A ask direct assistance from Mr. B, internal auditor with respect to external confirmation requests and evaluation of the results of external confirmation procedures? [RTP-May 20]
Answer:
(a) Direct Assistance from Internal Auditor:
As per SA 610 “Using the Work of Internal Auditor”, the external auditor shall not use internal auditors to provide direct assistance to perform procedures that involve making significant judgments in the audit. The external auditor shall not use internal auditors to provide direct assistance to perform procedures that:

(a) Involve making significant judgments in the audit;
Significant judgments include the following:

Assessing the risks of material misstatement;
Evaluating the sufficiency of tests performed;
Evaluating the appropriateness of management’s use of the going concern assumption;
Evaluating significant accounting estimates; and
Evaluating the adequacy of disclosures in the financial statements, and other matters affecting the auditor’s report

(b) Relate to higher assessed risks of material misstatement;
(c) Relate to work with which the internal auditors have been involved; or
(d) Relate to decisions the external auditor makes in accordance with this SA regarding the internal audit function and the use of its work or direct assistance.

In the present case, Mr. A asked internal auditor to provide direct assistance regarding evaluating significant accounting estimates and assessing the risk of material misstatements.

Conclusion: Evaluation of Accounting estimates and assessing Risk of Material Misstatements involve significant judgments, hence Mr. A should not insists for direct assistance in these areas.

(b) Direct Assistance from Internal Auditor in case of External Confirmation Procedures:
SA 610 “Using the Work of Internal Auditor”, provide relevant guidance in determining the nature and extent of work that may be assigned to internal auditors.

In determining the nature ofworkthat maybe assigned to internal auditors, the external auditor is careful to limit such work to those areas that would be appropriate to be assigned.

In accordance with SA 50 5, “External Confirmation” the external auditor is required to maintain control over external confirmation requests and evaluate the results of external confirmation procedures, it would not be appropriate to assign these responsibilities to internal auditors.

Conclusion: It would not be appropriate to use direct assistance w.r.t. obtaining external confirmation requests and their evaluation. Assistance may be used in assembling information necessary for the external auditor to resolve exceptions in confirmation responses.

Question 148.
OPQ Ltd. is in the business of software consultancy. The company has had large balances of accounts receivables in the past years which have been assessed as area of high risk. For the year ended 31 March 2021, in respect of the valuation of accounts receivable, the statutory auditor has assigned the checking of the accuracy of the aging of the accounts receivables and provision based on ageing to the internal auditor providing direct assistance to him. Please advise. [MTP-April 19, RTP-May 19, MTP-Oct. 19]
Answer:
Direct Assistance from Internal Auditor:
As per SA 610 “Using the Work of Internal Auditor”, the external auditor shall not use internal auditors to provide direct assistance to perform procedures that involve making significant judgments in the audit. The external auditor shall not use internal auditors to provide direct assistance to perform procedures that:

(a) Involve making significant judgments in the audit;
(b) Relate to higher assessed risks of material misstatement;
(c) Relate to work with which the internal auditors have been involved; or
(d) Relate to decisions the external auditor makes in accordance with this SA regarding the internal audit function and the use of its work or direct assistance.

In the present case, Statutory auditor assigned internal auditor to provide direct assistance regarding checking of the accuracy of the aging of the accounts receivables and provision based on ageing. Valuation of accounts receivable is assessed as an area of higher risk.

Conclusion: Statutory auditor could assign the checking of the accuracy of the aging to an internal auditor providing direct assistance. However, because the evaluation of the adequacy of the provision based on the aging would involve more than limited judgment, it would not be appropriate to assign that latter procedure to an internal auditor providing direct assistance.

SA 620 “Usingthe Work of Auditor’s Expert”

Question 149.
What are the factors that may influence the auditor’s decision on whether to use an auditor’s expert, when management has used a management’s expert in preparing the financial statements?
Answer:
Factors influencing the auditor’s decision w.r.t. use of auditor’s expert when management had used a management expert:
SA 620 “Using the work of an Auditor’s Expert” deals with the auditor’s responsibilities regarding the use of an individual or organisation’s work in a field of expertise other than accounting or auditing, when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence. Accordingly, factors influencing the auditor’s decision w.r.t. use of auditor’s expert when management had used a management expert are:

The nature, scope and objectives of the management’s expert’s work.
Whether the management’s expert is employed by the entity, or is a party engaged by it to provide relevant services.
The extent to which management can exercise control or influence over the work of the management’s expert.
The management’s expert’s competence and capabilities.
Whether the management’s expert is subject to technical performance standards or other professional or industry requirements.
Any controls within the entity over the management’s expert’s work.

Question 150.
While doing audit, Ram, the Auditor requires reports from experts for the purpose of audit evidence. What types of reports/opinions he can obtain and to what extent he can rely upon the same? [Nov. 10 (4 Marks)]
Answer:
Types of Reports/Opinion:
As per SA 620, “Using the work of an Auditor’s Expert”, the auditor can obtain the following types
of reports, or opinions or statements of an expert for the purpose of audit evidence:

The valuation of complex financial instruments, land and buildings, plant and machinery, jewellery, works of art, antiques, intangible assets, assets acquired and liabilities assumed in business combinations and assets that may have been impaired.
The actuarial calculation of liabilities associated with insurance contracts or employee benefit plans.
The estimation of oil and gas reserves.
The valuation of environmental liabilities, and site clean-up costs.
The interpretation of contracts, laws and regulations.
The analysis of complex or unusual tax compliance issues.

Extent to which Expert work can be relied upon:
When the auditor intends to use the work of an expert, he shall evaluate the adequacy of the auditor’s
expert’s work, w.r.t. the following:

Findings and Conclusions: To ensure the evaluate the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence;
Significant Assumptions and Methods: If the expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods should be evaluated.
Source Data used: Auditor is required to evaluate the relevance, completeness, and accuracy of that source data.

If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’s purposes, he shall agree with that expert on the nature and extent of further work to be performed by that.expert; or perform further audit procedures appropriate to the circumstances.

Question 151.
X Ltd. had a net worth of INR 1300 crores because of which Ind AS became applicable to them. The company had various derivative contracts-options, forward contracts, interest rate swaps etc. which were required to be fair valued for which company got the fair valuation done through an external third party. The statutory auditors of the cofnpany involved an auditor’s expert to audit valuation of derivatives. Auditor and auditor’s expert were new to each other i.e. they were working for the first time together but developed a good bonding during the course of the audit. The auditor did not enter into any formal agreement with the auditor’s expert. Please advise. [MTP-Oct. 18]
Answer:
Agreement with Auditor’s Expert:
As per SA 620 “Using work of Auditor’s Expert” the auditor shall agree, in writing when appropriate, on the following matters with the auditor’s expert:

Nature, scope & objectives of Auditor’s Expert work (may include relevant technical standards or other professional and industry requirements).
Respective roles & responsibilities of auditors & Auditor Expert.
Nature, timing & extent of communication, including form of report.
Need for Auditor Expertto observe confidentiality requirements under ethical requirements or Law and regulation.

In the instant case X Ltd. had various derivative contracts – options; forward contracts, interest rate swaps etc. which were required to be fair valued for which company got the fair valuation done through an external third party. The statutory auditors of the company involved an auditor’s expert to audit valuation of derivatives.

Conclusion: Considering the complexity involved in the valuation and volume of derivatives and also due to the fact that the auditor and auditor’s expert were new to each other, auditor should have signed a formal agreement/engagement letter with the auditor’s expert in respect of the work assigned to him in accordance with SA 620.

Question 152.
Mr. Mohan, an auditor of KTEN Limited wants to use the work of an expert. With reference to the Standard on Auditing state the factors which suggest the need for details and written agreement between the auditor and the auditor’s expert. [Nov. 16 (5 Marks)]
Answer:
Factors suggesting detailed and written agreement between the auditor and the auditor’s expert:
As per SA 62 0 “Using work of Auditor’s Expert” the auditor shall agree, in writing when appropriate, on the following matters with the auditor’s expert:

Nature, scope & objectives of Auditor’s Expert work (may include relevant technical standards or other professional and industry requirements).
Respective roles & responsibilities of auditors & Auditor Expert.
Nature, timing & extent of communication, including form of report.
Need for Auditor Expert to observe confidentiality requirements under ethical requirements or Law and regulation.

Factors suggesting detailed and written agreement between the auditor and the auditor’s expert may be listed as follow:

The auditor’s expert will have access to sensitive or confidential entity information.
The respective roles or responsibilities of the auditor and the auditor’s expert are different from those normally expected.
Multi-jurisdictional legal or regulatory requirements apply.
The matter to which the auditor’s expert’s work relates is highly complex.
The auditor has not previously used work performed by that expert.
The greater the extent of the auditor’s expert’s work, and its significance in the context of the audit.

“ICAI Examiner Comments”
Majority of the examinees failed to state the factors necessitating the need for detailed agreement. Resulting in below average performance.

Question 153.
State what may be the evaluative or review procedures that the Statutory Auditor may do before concluding as to relevance and reasonableness of Auditor’s Expert work for using it for his audit purposes. [Nov. 18-New Syllabus (5 Marks)]
Or
CA Dabu has been appointed as an auditor of M/s MAP Technocraft Ltd. to conduct statutory audit. 1 While conducting audit, he came across some difficulties which the management could not explain to him properly and, therefore, he decided to take services of Mr. Jay, an engineering consultant. Mr. jay performed his work and submitted details to CA Dabu. State the specific procedure which CA Dabu should follow to evaluate the adequacy of work performed by Mr. jay. [May 19-New Syllabus (5 Marks)]
Answer:
Evaluation of Work of Auditor’s expert:
As per SA 620 “Using the work of an Auditor’s Expert” the auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including:
(a) The relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence;

(b) If that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods in the circumstances; and

(c) If that expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data.

Specific procedures to evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes may include:
(a) Inquiries of the auditor’s expert.
(b) Reviewing the auditor’s expert’s working papers and reports.
(c) Corroborative procedures, such as:

Observing the auditor’s expert’s work;
Examining published data, such as statistical reports from reputable, authoritative sources;
Confirming relevant matters with third parties;
Performing detailed analytical procedures; and
Re-performing calculations.

(d) Discussion with another expert with relevant expertise when, for example, the findings or conclusions of the auditor’s expert are not consistent with other audit evidence.

(e) Discussing the auditor’s expert’s report with management.

Question 154.
What are the procedures to be followed by a statutory auditor for verifying the provisions for accrued liability for retirement benefits which is based on a certificate of a reputed actuary engaged by the auditor for the purpose.
Or
Explain the procedures to be performed for evaluating the work of auditor’s expert.
Answer:
Evaluation of Work of Auditor’s expert;
As per SA 620 “Using the work of an Auditor’s Expert” the auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including:
(a) The relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence.

(b) If that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods in the circumstances; and

(c) If that expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data.

If the auditor determines that the work of the auditor’s expert is not adequate for the auditor’s purposes, the auditor shall:
(a) Agree with that expert on the nature and extent of further work to be performed by that expert; or
(b) Perform further audit procedures appropriate to the circumstances.

Question 155.
State your views on reference to an expert in the Auditor’s report.
Answer:
Reference of Expert in Auditor’s Report:
(a) SA 620 “Using the work of an Auditor’s Expert” deals with the auditor’s responsibilities regarding the use of an individual or organisation’s work in a field of expertise other than accounting or auditing, when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence.

(b) With respect to reference of Expert in Auditor’s Report, SA 620 provides the following:

The auditor shall not refer to the work of an auditor’s expert in an auditor’s report containing an unmodified opinion unless required by law or regulation to do so.
If such reference is required by law or regulation, the auditor shall indicate in the auditor’s report that the reference does not reduce the auditor’s responsibility for the audit opinion.

(c) If the auditor makes reference to the work of an auditor’s expert in the auditor’s report because such reference is relevant to an understanding of a modification to the auditor’s opinion, the auditor shall indicate in the auditor’s report that such reference does not reduce the auditor’s responsibility for that opinion.

Question 156.
O Ltd. is in the business of manufacturing of steel. The manufacturing process requires raw material as iron ore for which large stock was maintained by the company at year end – 31 March 2021. The nature of raw material is such that its physical verification requires involvement of an expert. Management hired their expert for stock take and auditors also involved auditor’s expert for the stock take.

The auditor observed that the work of the auditor’s expert was not adequate for auditor’s purposes and the auditor could not resolve the matter through additional audit procedures which included further work performed by both the auditor’s expert and the auditor.

Basis above, the auditor concluded that it would be necessary to express a modified opinion in the auditor’s report because the auditor has not obtained sufficient appropriate audit evidence. However, the auditor issued a clean report and included the name of the expert in his report to reduce his responsibility for the audit opinion. Comment. [MTP-April 19]
Answer:
Auditor’s responsibility in case of use of work of Auditor’s Expert:
As per SA 620, “Using the work of an Auditor’s Expert”, if the auditor concludes that the work of the auditor’s expert is not adequate for the auditor’s purposes and the auditor cannot resolve the matter through the additional audit, which may involve further work being performed by both the expert and the auditor, Sr include employing or engaging another expert, it may be necessary to express a modified opinion in the auditor’s report in accordance with SA 705 because the auditor has not obtained sufficient appropriate audit evidence

In addition, the auditor shall not refer to the work of an auditor’s expert in an auditor’s report containing an unmodified opinion unless required by law or regulation to do so. If such reference is required by law or regulation, the auditor shall indicate in the auditor’s report that the reference does not reduce the auditor’s responsibility for the audit opinion.

If the auditor makes reference to the work of an auditor’s expert in the auditor’s report because such reference is relevant to an understanding of a modification to the auditor’s opinion, the auditor shall indicate in the auditor’s report that such reference does not reduce the auditor’s responsibility for that opinion.

Conclusion: The auditor cannot reduce his responsibility by referring the name of auditor’s expert and thereby issuing a clean report. Auditor should have issued a modified report and could have given reference to the work of an auditor’s expert in that report if such reference was relevant to understanding of a modification to the auditor’s opinion but even in that case the auditor should have indicated in his report that such reference of auditor’s expert does not reduce his responsibility for that opinion.

SA 700 “Forming an Opinion and Reporting on Financial Statements”

Question 157.
Enumerate the basic elements of Audit Report as enshrined in SA 700.
Answer:
Basic Elements of the Auditor’s Report:
As per SA 700 “Forming an Opinion and Reporting on Financial Statements”, the auditor’s report includes the following basic elements:
1. Title: Audit Report should have a title clearly stating that it is a report of an independent auditor.

2. Addressee: Audit Report is normally addressed to those for whom Audit Report is prepared, i.e. shareholders or TCWG.

3. Opinion Section: This section states the auditor’s opinion on true and fair view of financial statements. Opinion Section of the Auditor’s Report shall also cover the following:

Identify the entity whose FS have been audited.
State that Financial Statements have been audited.
Identify title of each statement that comprises F.S.
Refer to the notes, including the summary of significant accounting policies; and
Specify date of period covered by each Financial Statement.

4. Basis for Opinion Section: The auditor’s report shall include a section, directly following the Opinion section, with the heading “Basis for Opinion”, that:
(a) States that the audit was conducted in accordance with SA;
(b) Refers to the section of the auditor’s report that describes the auditor’s responsibilities under the SAs;

(c) Includes a statement that the auditor is independent of the entity in accordance with the relevant ethical requirements relating to the audit, and has fulfilled the auditor’s other ethical responsibilities in accordance with these requirements. The statement shall refer to the Code of Ethics issued by ICAI

(d) States whether the auditor believes that the audit evidence the auditor has obtained is sufficient and appropriate to provide a basis for the auditor’s opinion.

5. Going Concern: Where applicable, the auditor shall report in accordance with SA 570.

6. Key Audit matters: For audits of complete set of general purpose F.S. of listed entities, the auditor shall communicate key audit matters in the auditor’s report in accordance with SA 701.

7. Other Information: Where applicable, auditor shall report in accordance with SA 720.

8. Management’s Responsibility for the Financial Statements: Describe responsibility of Management for preparation of Financial Statements in the manner in which responsibility is described in Terms of Engagement.

9. Auditor’s Responsibility Section: It shall state the auditor’s objectives to obtain reasonable assurance about whether the F.S. as a whole are free from material misstatement, whether due to fraud or error; and to Issue an auditor’s report that includes the auditor’s opinion. This section also enumerates the auditor’s responsibilities as prescribed under different Standards on Auditing.

10. Other ReportingResponsibilities: This Section covers reporting over those additional matters on which auditor is required to report under statutory requirements.

11. Signature of the Auditor: Audit report to be signed in auditor’s personal name. Where firm appointed as auditor, report signed in personal name & in name of audit firm.

12. Date of Auditor’s Report: It should not be earlier than date on which auditor has obtained Sufficient Appropriate Audit Evidence on which to base auditor’s opinion.

13. Place of signature: It is ordinarily the city where audit report is signed.

Question 158.
What is included in Auditor’s Responsibility Paragraph? [May 17 (5 Marks)
Answer:
Auditor’s Responsibility Paragraph:
As per SA 700 “Forming an Opinion and Reporting on Financial Statements”, the auditor’s responsibility paragraph shall state the following:
(a) State that the objectives of the auditor are to obtain reasonable assurance about whether the F.S. as a whole are free from material misstatement, whether due to fraud or error and issue an auditor’s report that includes the auditor’s opinion.

(b) State that reasonable assurance is a high level of assurance but is not a guarantee that an audit will always detect a material misstatement when it exists.

(c) State that misstatements can arise from fraud or error and will be considered when appears material in accordance with the applicable FRF.

(d) State that, as part of an audit in accordance with SAs, the auditor exercises professional judgment and maintains professional skepticism throughout the audit.

(e) Describe an audit by stating that the auditor’s responsibilities are:

To identify and assess the Risk of Material Misstatements of the Financial statements, whether due to fraud or error;
To design and perform audit procedures responsive to those risks;
To obtain audit evidence that is sufficient and appropriate to provide a basis for the auditor’s opinion.
To obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances
To evaluate the appropriateness of accounting policies used and the reasonableness of ‘ accounting estimates and related disclosures made by management.
To conclude on the appropriateness of management’s use of the going concern basis of accounting.

“ICAI Examiner Comments”
Many candidates were able to highlight only few matters included in Auditor’s Responsibility paragraph. Some candidates unnecessarily discussed about Management’s responsibility instead of Auditor’s responsibility.

Question 159.
Write short note on: Unqualified opinion in the context of the Auditor’s report. [May 09 (4 Marks)]
Answer:
Unqualified opinion:
SA 700 “Forming an opinion and Reporting on Financial Statements” requires the auditor to express an unqualified opinion when he concludes that the financial statements give a true and fair view in accordance with the financial reporting framework used for preparation and presentation of the financial statements.

An unqualified opinion indicates the following:

The financial statements have been prepared using the generally accepted accounting principles and being constantly followed.
The financial statements comply with relevant statutory requirements and regulations.
All material matters relevant to proper presentation of the financial information, subject to statutory requirement, if applicable, have been adequately disclosed.

Question 160.
KPI Ltd. is a company on which International Standards on Auditing are applicable along with Standard on Auditing issued by the ICAI. The company appointed new auditors for the audit of the financial statements for the year ended 31 March 2021 after doing all appointment formalities. In the auditor’s report, auditor referred the International Standard on Auditing in addition to the Standard on Auditing issued by the ICAI.
As an expert, you are required to advise the auditor regarding auditor’s report for audits conducted in accordance with both the Standards. [RTP-Nov. 19]
Answer:
Auditor’s Report for Audits Conducted in Accordance with Both Standards on Auditing Issued by ICAI and International Standards on Auditing:

As per SA 700, “Forming an Opinion and Reporting on Financial Statements”, an auditor may be required to conduct an audit in accordance with the International Standards on Auditing, in addition to the Standards on Auditing issued by 1CAI. If this is the case, the auditor’s report may refer to Standards on Auditing in addition to the International Standards on Auditing, but the auditor shall do so only if:

(a) There is no conflict between the requirements in the International Auditing Standards and those in SAs that would lead the auditor:

to form a different opinion, or
not to include an Emphasis of Matter paragraph or Other Matter paragraph that, in the particular circumstances, is required by SAs; and

(b) The auditor’s report includes, at a minimum, each of the elements set out in Auditor’s Report Prescribed by Law or Regulation discussed above when the auditor uses the layout or wording specified by the Standards on Auditing.

When the auditor’s report refers to both the ISAs and the Standards on Auditing issued by ICAI, the auditor’s report shall clearly identify the same including the jurisdiction of origin of the other auditing standards.

SA 701 “Communicating Key Audit Matters in the Independent Auditor’s Report”

Question 161.
Write a short note on: Purpose of communicating key audit matters. [RTP – Nov.18]
Answer:
Purpose of communicating key audit matters:

As per SA 701 “Communicating Key Audit matters in the Independent Auditor’s Report” Key Audit Matters are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the F.S. of the current period. Key audit matters are selected from matters communicated with TCWG.

Various purposes of Key audit matters may be listed as:

To enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed.
To provide additional information to intended users of the financial statements to assist them in understanding those matters that, in the auditor’s professional judgment, were of most significance in the audit of the F.S. of the current period.
To assist intended users in understanding the entity and areas of significant management judgment in the audited F.S.
To provide a basis to further engage with management and TCWG about certain matters relating to the entity, the audited F.S. or the audit that was performed.

Question 162.
Mr. A was appointed as statutory auditor of X Ltd. While doing audit, Mr. A is required to determine the key audit matters which are required to be mentioned in the audit report. You are required to advise Mr. A about the considerations which Mr. A shall take into account while determining key audit matters.
Or
“The auditor shall determine, from the matters communicated with those charged with governance, those matters that required significant auditor attention in performing the audit. In making this determination, the auditor shall take into account the key factors”. You are required to define key audit matters and briefly discuss the factors determining the key audit matters. [RTP-April 18]
Or
As an auditor of a listed company for the year ended 31st March, 2021, how would you determine the ‘Key Audit Matters’? |May 19 – Old Syllabus (5 Marks)]
Answer:
Considerations to determine Key Audit Matters:
As per SA 701 “Communicating Key Audit matters in the Independent Auditor’s Report” Key Audit Matters are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the F.S. of the current period. Key audit matters are selected from matters communicated with TCWG.

The auditor shall determine, from the matters communicated with TCWG, those matters that required significant auditor attention in performing the audit. In making this determination, the auditor shall consider the following:

(a) Areas of higher assessed RMM, or significant risks identified in accordance with SA 315;
(b) Significant auditor judgments relating to areas in the RS. that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty.
(c) The effect on the audit of significant events or transactions that occurred during the period.

The auditor shall determine which of the matters so determined above were of most significance in the audit of the RS. of the current period and therefore are the key audit matters.

Question 163.
C.A. Amar has come across certain key matters while auditing the accounts of PR Ltd. for the financial year 2020-21. He, being the associate of your firm, seeks your advice on “Communicating Key Audit Matters” in the Auditor’s report. Guide him. [Nov. 18-Old Syllabus (5 Marks)]
Answer:
Communicating Key Audit Matters:
As per SA 701 “Communicating Key Audit matters in the Independent Auditor’s Report” Key Audit Matters are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the F.S. of the current period. Key audit matters are selected from matters communicated with TCWG.

The auditor shall describe each key audit matter, using an appropriate subheading, in a separate section of the auditor’s report under the heading “Key Audit Matters”.

The introductory language in this section of the auditor’s report shall state that:
(a) Key audit matters are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period; and

(b) These matters were addressed in the context of the audit of the F.S. as a whole, and in forming the auditor’s opinion thereon, and the auditor does not provide a separate opinion on these matters.

The description of each key audit matter in the Key Audit Matters section of the auditor’s report shall include a reference to the related disclosure, if any, in the F.S. and shall address:
(a) Why the matter was considered to be one of most significance in the audit and therefore determined to be a key audit matter? and
(b) How the matter was addressed in the audit?

The auditor shall describe each key audit matter in the auditor’s report unless:

Law or regulation precludes public disclosure about the matter; or
In extremely rare circumstances, the auditor determines that the matter should not be communicated in the auditor’s report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. This shall not apply if the entity has publicly disclosed information about the matter.

The auditor shall not communicate a matter in the Key Audit Matters section of the auditor’s report when the auditor would be required to modify the opinion in accordance with SA 705 (Revised) as a result of the matter.

Question 164.
State the circumstances in which a matter determined to he a key audit matter is not required to be communicated in the Auditor’s Report.
Answer:
Circumstances in which key audit matters not required to be communicated:
As per SA 701 “Communicating Key Audit matters in the Independent Auditor’s Report” Key Audit s Matters are those matters that, in the auditor’s professional judgment, were of most significance in the audit of the F.S. of the current period. Key audit matters are selected from matters communicated with TCWG.

The auditor shall describe each key audit matter in the auditor’s report unless:
(a) Law or regulation precludes public disclosure about the matter; or
(b) In extremely rare circumstances, the auditor determines that the matter should not be communicated in the auditor’s report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication. This shall not apply if the entity has publicly disclosed information about the matter.

Question 165.
The property,‘plant and equipment of ABC Ltd. included Rs. 25.75 crores of earth removing machines of outdated technology which had been retired from active use and had been kept for disposal after knock down. These assets appeared at residual value and had been last inspected ten years back. As an auditor, what may be your reporting concern as regards matters specified above? [May 18 – New Syllabus (5 Marks)]
Answer:
Reporting Concerns in relation to significant events:
Auditor is required to report under the various requirements of Standards of Auditing, legal and Regulatory provisions. In the present situation, major reporting requirements will be:

(a) As per the requirement of SA 260 “Communication with Those Charged with Governance” auditor should communicate significant matters arising during the audit that were discussed, or subject to correspondence, with management.

(b) The situation as given in the question appears to be a Key Audit Matter and hence auditor is required to report the situation in the audit report as Key Audit Matter.

Whether the company is maintaining proper records showing full particulars, including quantitative details and situation of property, plant and equipment;
whether these property, plant and equipment have been physically verified by the management at reasonable intervals.

In the present case, physical verification of assets held under disposal, was done ten years back.

Conclusion: In the present case, auditor reporting concerns will be as per the requirement of SA 260, SA 701 and Para 3(i) of CARO, 2020.
Alternative Answer: Answer of this question may also be based on the reporting issues like Valuation, Accounting and Disclosures as per the requirements of applicable FRF. In that case, if auditor is not satisfied with the valuation, accounting and disclosures, he may qualify the report as per the requirements of SA 705.

Question 166.
AKY Ltd. is a listed company engaged in the business of software and is one of the largest company operating in this sector in India. The company’s annual turnover is ₹ 40,000 crores with profits of ₹ 5,000 crores. Due to the nature of the business and the site of the company, the operations of the company arc spread out in India as well as outside India. The company’s contracts with its various customers are quite complicated and different. During the course of the audit, the audit team spends significant time on audit of revenue – be it planning, execution or conclusion. This matter was also discussed with management at various stages of audit.

The efforts towards audit of revenue also involve significant involvement of senior members of the audit team including the audit partner. After completion of audit for the year ended 31 March 2021, the audit partner was discussing significant matters with the management wherein they also communicated to the management that he plans to include revenue recognition as key audit matter in his audit report. The management did not agree with revenue recognition to be shown as key audit matter in the audit report. Comment. [MTP-Oct. 19]
Answer:
Determining Key Audit Matters:
SA 701, “Communicating Key Audit Matters in the Independent Auditor’s Report”, deals with the auditor’s responsibility to communicate key audit matters in the auditor’s report. As per SA 701, the auditor shall determine, from the matters communicated with TCWG, those matters that required significant auditor attention in performing the audit. In making this determination, the auditor shall take inth account the following:

Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with SA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment.
Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty.
The effect on the audit of significant events or transactions that occurred during the period.

The auditor shall determine which of the matters determined in accordance with above were of most significance in the audit of the financial statements of the current period and therefore are the key audit matters.

In the instant case, AKY Ltd., a listed company engaged in the business of software and its contracts with its various customers are also quite complicated and different. Further, the audit team spends significant time on audit of revenue and efforts towards audit of revenue also involve significant involvement of senior members of the audit team including audit partner during audit. This matter was also discussed with management at various stages. After completion of audit, the audit partner communicated the management regarding inclusion of paragraph on revenue recognition as key audit matter in his audit report.

Conclusion: Assessment of the auditor is valid as concerned matter qualifies to be a key audit matter; hence, it should be reported accordingly by the auditor in his audit report.

SA 705 “Modifications to the Opinion in the Independent Auditor’s Report”

Question 167.
When should an auditor make a disclaimer opinion in his Audit report? [May 09 (5 Marks)]
Answer:
Disclaimer of Opinion:
SA 705 “Modification to the Opinion in the Independent Auditor’s Report” requires the auditor to disclaim an opinion

when the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and
the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive.

If auditor disclaims the opinion auditor is required to add a para in the audit report “Basis for Disclaimer of Opinion Para” describing therein the auditor’s inability to collect the sufficient appropriate audit evidence.

Auditor is also required to amend the description of auditor’s responsibility para as “Our responsibility is to express an opinion on the financial statements based on conducting the audit in accordance with Standards on Auditing issued by the 1CAI, Because of the matter(s) described in the Basis for Disclaimer of Opinion paragraph, however, we were not able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion”.

Question 168.
Under the applicable Standards on Auditing, in what circumstances does the report of the statutory auditor require modifications? What are the types of modifications possible to the said report? [Nov. 12 (8 Marks)]
Or
Explain the circumstances which require a modification to the Auditor’s Opinion. [Nov. 17 (6 Marks)]
Or
If financial statements prepared in accordance with the requirements of a fair presentation frame-work do not achieve fair presentation, the auditor shall discuss the matter with management and, depending on the requirements of the applicable financial reporting framework and how the matter is resolved, shall determine whether it is necessary to modify the opinion in the auditor’s report in accordance with SA 705.
Under SA705, in what circumstances does the report of the statutory auditor require modifications? What are the types of modifications possible in the said report?
Or
ADKS & Co LLP are the newly appointed statutory auditors of PKK Ltd. During the course of audit, the statutory auditors have come across certain significant observations which they believe could lead to material misstatement of financial statements. Management has a different view and does not concur with the view of the statutory auditors. Considering this the statutory auditors are determining as to how to address these observations in terms of their reporting requirement. Please advise. [MTP-April 19]
Answer:
Circumstances in which a modified opinion may be issued:
As per SA 705 “Modifications to the Opinion in the Independent Auditor’s Report” a modified opinion may be expressed in the following circumstances:

(a) The auditor concludes that, based on the audit evidence obtained, the F.S. as a whole are not free from material misstatement, may be due to following reasons:

Inappropriate method of selection of Accounting Policies;
Accounting policies are not consistent with applicable FRF;
Disclosures as required by FRF are not given.

(b) The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement, may be due to following reasons:

Limitations imposed by management
Circumstances beyond entity control (For Ex.: Accounting records destroyed by fire)
Circumstances related to Nature and Timing of auditor’s work.

Types of Modified Opinion:
(a) Qualified opinion: It is issued under following circumstances:

Financial statements are materially misstated which in the auditor’s judgments are not pervasive.
Auditor is unable to obtain Sufficient and appropriate audit evidence which in the auditor judgment are not pervasive

(b) Adverse Opinion: It is issued when financial statements are materially misstated which in the auditor’s judgments is having pervasive effect.

(c) Disclaimer of Opinion: It is issued when auditor is unable to obtain Sufficient and appropriate audit evidence which in the auditor judgment are having pervasive effect.

Question 169.
The auditor’s inability to obtain sufficient appropriate audit evidence (also referred to as a limitation on the scope of the audit) may arise from:

Circumstances beyond the control of the entity;
Circumstances relating to the nature or timing of the auditor’s work; or
Limitations imposed by management.

Explain with the help of examples. – [RTP-May 20]
Answer:
Examples of situations in which auditor is unable to obtain sufficient and appropriate evidences
(A) Circumstances beyond entity control

The entity’s accounting records have been destroyed.
The accounting records of a significant component have been seized indefinitely by governmental authorities.

(B) Circumstances related to Nature and Timing of auditor’s work

The entity is required to use the equity method of accounting for an associated entity, and the auditor is unable to obtain sufficient appropriate audit evidence about the latter’s financial information to evaluate whether the equity method has been appropriately applied.
The timing of the auditor’s appointment is such that the auditor is unable to observe the counting of the physical inventories.
The auditor determines that performing substantive procedures alone is not sufficient, but the entity’s controls are not effective.

Management prevents the auditor from observing the counting of the physical inventory.
Management prevents the auditor from requesting external confirmation of specific account balances.

Question 170.
After accepting the statutory audit of M/s All in One Ltd., a departmental store, you became aware of the fact that management of the company have imposed certain limitations on the scope of your assurance function which may adversely affect and result in your inability to obtain sufficient appropriate audit evidence to discharge your responsibility required by the statute. Indicate the consequences and your response to the limitations imposed by the management on your scope. [May 19 – New Syllabus (4 Marks)]
Answer:
Limitation after the auditor has accepted the engagement:
As per SA 705 “Modifications to the Opinion in the Independent Auditor’s Report”, if, after accepting the engagement, the auditor becomes aware that management has imposed a limitation on the scope of the audit that the auditor considers likely to result in the need to express a qualified opinion or to disclaim an opinion on the financial statements, the auditor shall request that management remove the limitation.

If management refuses to remove the limitation, the auditor shall communicate the matter to those charged with governance, unless all of those charged with governance are involved in managing the entity, and determine whether it is possible to perform alternative procedures to obtain sufficient appropriate audit evidence.

If the auditor is unable to obtain sufficient appropriate audit evidence, the auditor shall determine the implications as follows:
(a) If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive, the auditor shall qualify the opinion; or

(b) If the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive so that a qualification of the opinion would be inadequate to communicate the gravity of the situation, the auditor shall:

Withdraw from the audit, where practicable and possible under applicable law or regulation; or
If withdrawal from the audit before issuing the auditor’s report is not practicable or possible, disclaim an opinion on the financial statements.

If the auditor withdraws, before withdrawing, the auditor shall communicate to those charged with governance any matters regarding misstatements identified during the audit that would have given rise to a modification of the opinion.

Question 171.
“When the auditor modifies the audit opinion, the auditor shall use the heading “Qualified Opinion,” “Adverse Opinion,” or “Disclaimer of Opinion,” as appropriate, for the Opinion section.” As an expert you are required to brief the special considerations required for expressing:
(a) Qualified Opinion;
(b) Adverse Opinion and
(c) Disclaimer of Opinion. [RTP-Nov. 18, May 20]
Answer:
Special Considerations required for modified opinion:
(a) Special consideration required for expressing Qualified Opinion:
When the auditor expresses a qualified opinion due to a material misstatement in the financial statements, the auditor shall state that, in the auditor’s opinion, except for the effects of the matter(s) described in the Basis for Qualified Opinion section:

(i) When reporting in accordance with a fair presentation framework, the accompanying financial statements present fairly, in all material respects (or give a true and fair view of) […] in accordance with [the applicable FRF]; or

(ii) When reporting in accordance with a compliance framework, the accompanying financial statements have been prepared, in all material respects, in accordance with [the applicable FRF],
When the modification arises from an inability to obtain sufficient appropriate audit evidence, the auditor shall use the corresponding phrase “except for the possible effects of the matter(s) …” for the modified opinion.

(b) Special consideration needed for expressing Adverse Opinion:
When the auditor expresses an adverse opinion, the auditor shall state that, in the auditor’s opinion, because of the significance of the matter(s) described in the Basis for Adverse Opinion section:

(i) When reporting in accordance with a fair presentation framework, the accompanying financial statements do not present fairly (or give a true and fair view of) […] in accordance with [the applicable FRF]; or

(ii) When reporting in accordance with a compliance framework, the accompanying financial statements have not been prepared, in all material respects, in accordance with [the applicable FRF],

(c) Special consideration is required for expressing Disclaimer of Opinion: When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the auditor shall:
(i) State that the auditor does not express an opinion on the accompanying financial statements;

(ii) State that, because of the significance of the matter(s) described in the Basis for Disclaimer of Opinion section, the auditor has not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on the financial statements; and

(iii) Amend the statement required in SA 700 (Revised), which indicates that the financial statements have been audited, to state that the auditor was engaged to audit the financial statements.

Unless required by law or regulation, when the auditor disclaims an opinion on the financial statements, the auditor’s report shall not include a Key Audit Matters section in accordance with SA 701.

Question 172.
“The Company’s has been unable to re-negotiate or obtain replacement financing. This situation indicates the existence of a material uncertainty that may cast significant doubt on the Company’s ability to continue as a going concern and therefore, the Company may be unable to realize its assets and discharge its liabilities in the normal course of business. The financial statements (and notes thereto) do not fully disclose this fact.” You are required to identify the type of opinion and draft the same.
Answer:
Type of Opinion to be expressed:
As per SA 570 “Going Concern” if adequate disclosure about the material uncertainty is not made in the F.S., the auditor shall:
(a) Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705; and
(b) In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state that a material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern and that the F.S. do not adequately disclose this matter.

In the present case, Company’s has been unable to re-negotiate or obtain replacement financing. This situation indicates the existence of a material uncertainty that may cast significant doubt on the Company’s ability to continue as a going concern and therefore, the Company may be unable to realize its assets and discharge its liabilities in the normal course of business. The financial statements (and notes thereto) do not fully disclose this fact. This situation requires the auditor to express a qualified opinion.

Draft Opinion Para:
In our opinion, except for the incomplete disclosure of the information referred to in the Basis for Qualified Opinion paragraph, the financial statements give the information required by the Companies Act, 2013, in the manner so required and give a true and fair view in conformity with the accounting principles generally accepted in India:
a. in the case of the Balance Sheet, of the state of affairs of the company as at March 31, 20X1;
b. in the case of the Profit and Loss Account, of the profit/loss for the year ended on that date; and
c. in the case of the cash flow statement, of the cash flows for the year ended on that date.

Question 173.
The Company’s financing arrangements expired and the amount outstanding was payable on March 31, 2021. The Company has been unable to re-negotiate or obtain replacement financing and is considering filing for bankruptcy. These events indicate a material uncertainty that may cast significant doubt on the Company’s ability to continue as a going concern and therefore it may be unable to realize its assets and discharge its liabilities in the normal course of business. The financial statements (and notes thereto) do not disclose this fact. You arc required to identify the type of opinion and draft the same.
Answer:
Type of Opinion to be expressed:
As per SA 5 70 “Going Concern” If the financial statements have been prepared using the going concern basis of accounting but, in the auditor’s judgment, management’s use of the going concern basis of accounting in the preparation of the F.S. is inappropriate, the auditor shall express an adverse opinion.

In the present case, financing arrangements of the company expired and the Company has been unable to re-negotiate or obtain replacement financing and is considering filing for bankruptcy. This indicates that going concern of the entity is not maintainable. Under these situations, auditor is required to express an adverse opinion as per SA 705.

Draft Opinion Para:
In our opinion, because of the omissio* of the information mentioned in the Basis for Adverse Opinion paragraph, the financial statements do not give the information required by the Companies Act, 2013, in the manner so required and also, do not give a true and fair view in conformity with the accounting principles generally accepted in India:

(a) in the case of the Balance Sheet, of the state of affairs of the company as at March 31,2021; and
(b) in the case of the Profit and Loss Account, of the profit/loss for the year ended on that date; and
(c) in the case of the cash flow statement, of the cash flows for the year ended on that date.

Question 174.
As an auditor of ABC Limited, in view of given circumstances, you are required to draft qualified ! opinion and basis for qualified opinion due to the departure from the applicable Financial Reporting Framework:

Audit of a complete set of financial statements of a company other than a listed company (registered under the Companies Act, 2013) using a fair presentation framework.
The financial statements are prepared by management of the entity in accordance with the Accounting Standards prescribed under section 133 of the Companies Act, 2013 (a general purpose framework).
The terms of the audit engagement reflect the description of management’s responsibility for the financial statements in SA 210.
A departure from the applicable financial reporting framework resulted in a qualified opinion.
The relevant ethical requirements that apply to the audit are the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013.
Based on the audit evidence obtained, the auditor has concluded that a material uncertainty docs not exist related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern in accordance with SA 570 (Revised).
Between the date of the financial statements and the date of the auditor’s report, there was a fire in the entity’s production facilities, which was disclosed by the entity as a subsequent event. In the auditor’s judgment, the matter is of such importance that it is fundamental to users’ understanding of the financial statements. The matter did not require significant auditor attention in the audit of the financial statements in the current period.
The auditor is not required, and has otherwise not decided, to communicate key audit matters in accordance with SA 701.
Those responsible for oversight of the financial statements differ from those responsible for the preparation of the financial statements.
In addition to the audit of the financial statements, the auditor has other reporting responsibilities required under the Companies Act, 2013. [MTP-Aug. 18]

Answer:
Qualified Opinion:
We have audited the standalone financial statements of ABC Limited (“the Company”), which comprise the balance sheet as at March 31, 20X1, and the statement of Profit and Loss, (statement of changes in equity) and the statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information (in which are included the Returns for the year ended on that date audited by the branch auditors of the Company’s branches located at (location of branches))2.

In our opinion and to the best of our information and according to the explanations given to us, except for the effects of the matter described in the Basis for Qualified Opinion section of our report, the aforesaid financial statements present fairly, in all material respects, or give a true and fair view in conformity with the accounting principles generally accepted in India of the state of affairs of the Company as at March 31st, 2XXX and profit/loss, (changes in equity) and its cash flows for the year ended on that date.

Basis for Qualified Opinion
The Company’s short-term marketable securities are carried in the statement of financial position at xxx. Management has not marked these securities to market but has instead stated them at cost, which constitutes a departure from the Accounting Standards prescribed in section 133 of the Companies Act, 2013. The Company’s records indicate that had management marked the marketable securities to market, the Company would have recognized an unrealized loss of Rs. xxx in the statement of comprehensive income for the year. The carrying amount of the securities in the statement of financial position would have been reduced by the same amount at March 31, 20X1, and income tax, net income and shareholders’ equity would have been reduced by Rs. xxx, Rs. xxx and Rs. xxx, respectively.

We conducted our audit in accordance with Standards on Auditing (SAs). Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the Financial Statements section of our report. We are independent of the Company in accordance with the ethical requirements that are relevant to our audit of the financial statements under the provisions of the Companies Act, 2 013, and we have fulfilled our other ethical responsibilities in accordance with these requirements and the ICAI’s Code of Ethics. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion.

Question 175.
As an auditor of XYZ Limited, in view of given circumstances, you are required to draft Adverse Opinion and basis for adverse opinion due to a Material Misstatement of the Consolidated Financial Statements.

Audit of a complete set of consolidated financial statements of a listed company (incorporated under the Companies Act, 2013) using a fair presentation framework. The audit is a group audit of an entity with subsidiaries (i.e., SA 600 applies).
The consolidated financial statements are prepared by management of the entity in accordance with the Accounting Standards prescribed under section 133 of the Companies Act. 2013 (a general purpose framework).
The terms of the audit engagement reflect the description of management’s responsibility for the consolidated financial statements in SA 210.
The consolidated financial statements are materially misstated due to the non-consolidation of a subsidiary. The material misstatement is deemed to be pervasive to the consolidated financial statements. The effects of the misstatement on the consolidated financial statements have not been determined because it was not practicable to do so (i.e., an adverse opinion is appropriate).
The relevant ethical requirements that apply to the audit are the ICAI’s Code of Ethics and the provisions of the Companies Act, 2013.
Based on the audit evidence obtained, the auditor has concluded that a material uncertainty does not exist related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern in accordance with SA 570 (Revised).
SA 701 applies; however, the auditor has determined that there are no key audit matters other than the matter described in the Basis for Adverse Opinion section.
Those responsible for oversight of the consolidated financial statements differ from those responsible for the preparation of the consolidated financial statements.
In addition to the audit of the consolidated financial statements, the auditor has other reporting responsibilities required under the Companies Act, 2013. [MTP-April 18]

Answer:
Adverse Opinion:
We have audited the accompanying consolidated financial statements of XYZ Company Limited (hereinafter referred to as the “Holding Company”) and its subsidiaries (the Holding Company and its subsidiaries together referred to as “the Group”), its associates and jointly controlled entities, which comprise the consolidated balance sheet as at March 31, 2XXX, the consolidated statement of profit and Loss, (consolidated statement of changes in equity){where applicable} and the consolidated statement of cash flows for the year then ended, and notes to the consolidated financial statements, including a summary of significant accounting policies (hereinafter referred to as the “consolidated financial statements”).

In our opinion and to the best of our information and according to the explanations given to us, because of the significance of the matter discussed in the Basis for Adverse Opinion section of our report, the accompanying consolidated financial statements do not give a true and fair view in conformity with the accounting principles generally accepted in India, of their consolidated state of affairs of the Group, its associates and jointly controlled entities, as at March 31, 20XX, of its consolidated profit/loss, (consolidated position of changes in equity) (where applicable} and the consolidated cash flows for the year then ended.

Basis for Adverse Opinion
As explained in Note X, the Group has not consolidated subsidiary PQR Company that the Group acquired during 20XX because it has not yet been able to determine the fair values of certain of the subsidiary’s material assets and liabilities at the acquisition date.

This investment is therefore accounted for on a cost basis. Under the accounting principles generally accepted in India, the Group should have consolidated this subsidiary and accounted for the acquisition based on provisional amounts. Had PQR Company been consolidated, many elements in the accompanying consolidated financial statements would have been materially affected. The effects on the consolidated financial statements of the failure to consolidate have not been determined.

We conducted our audit in accordance with Standards on Auditing (SAs) specified under section 143(10) of the Companies Act, 2013. Our responsibilities under those Standards are further described in the Auditor’s Responsibilities for the Audit of the Consolidated Financial Statements section of our report. We are independent of the Group, its associates and jointly controlled entities, in accordance with the Code of Ethics and provisions of the Companies Act, 2013 that are relevant to our audit of the consolidated financial statements in India under the Companies Act, 2013, and we have fulfilled our other ethical responsibilities in accordance with the Code of Ethics and the requirements under the Companies Act, 2013. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our adverse opinion.

Question 176.
As an auditor of ABC Limited, in view of given circumstances, you are required to draft disclaimer of opinion and basis for disclaimer of opinion due to the Auditor’s Inability to Obtain Sufficient Appropriate Audit Evidence about Multiple Elements of the Financial Statement.

Audit of a complete set of financial statements of an entity other than a company incorporated under the Companies Act, 2013, using a fair presentation framework. The audit is not a group audit (i.e., SA 600, docs not apply).
The financial statements are prepared by management of the entity in accordance with the Accounting Standards issued by the Institute of Chartered Accountants of India (a general purpose framework).
The terms of the audit engagement reflect the description of management’s responsibility for the financial statements in SA 210.
The auditor was unable to obtain suffici&ntappropriate audit evidence about multiple elements
of the financial statements, that is, the auditor was also unable to obtain audit evidence about the entity’s inventories and accounts receivable. The possible effects of this inability to obtain sufficient appropriate audit evidence are deemed to be both material and pervasive to the financial statements. .
The relevant ethical requirements that apply to the audit are I CAI’s Code of Ethics and applicable law/regulation
Those responsible for oversight of the financial statements differ from those responsible for the preparation of the financial statements.
A more limited description of the auditor’s responsibilities section is required.
In addition to the audit of the financial statements, the auditor has other reporting responsibilities required under relevant law/regulation.

Answer:
Disclaimer of Opinion:
We were engaged to audit the financial statements of ABC & Associates (“the entity”), which comprise the balance sheet as at March 31, 20XX, the statement of Profit and Loss, (the statement of changes in equity)(where applicable) and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies.

We do not express an opinion on the accompanying financial statements of the entity. Because of the significance of the matters described in the Basis for Disclaimer of Opinion section of our report, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion on these financial statements.

Basis for Disclaimer of Opinion
We were not appointed as auditors of the Company until after March 31, 20X1 and thus did not observe the counting of physical inventories at the beginning and end of the year. We were unable to satisfy ourselves by alternative means concerning the inventory quantities held at March 31, 20X0 and 20X1, which are stated in the Balance Sheets at ₹ xxx and ₹ xxx, respectively. In addition, the introduction of a new computerized accounts receivable system in September 20X1 resulted in numerous errors in accounts receivable.

As of the date of our report, management was still in the process of rectifying the system deficiencies and correcting the errors. We were unable to confirm or verify by alternative means accounts receivable included in the Balance Sheet at a total amount of ₹ xxx as at March 31, 20X1. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up the statement of Profit and Loss [and statement of cash flows)(Where applicable).

Question 177.
As an auditor of a company registered under section 8 of the Companies Act, 2013 you find that as per the notification of the Ministry of Corporate Affairs regarding applicability of Indian Accounting Standards (Ind-AS), the company has to prepare its financial statements for the year ended 31st March, 2021 under Ind-AS.The management of the company is however of the strong view that being a section 8 company having charitable objects, Ind-AS cannot apply to the company. The financial statements are therefore prepared by the management under the earlier GAAP and a note for the same is given in the financial statements. How would you report on these financial statements? [Nov. 17 (5 Marks), MTP-Aug. 18, MTP – March 19, Nov. 19 – New Syllabus (5 Marks)]
Answer:
Reporting on financial statements:
As per SA 200 “Overall Objectives of the Independent Auditor and Conduct of Audit in accordance with Standards on Auditing” in conducting an audit of financial statements, the overall objectives of the auditor are: „
(a) To obtain reasonable assurance about whether the F. S. as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the F.S. are prepared, in all material respects, in accordance with an applicable FRF, and

(b) To report on the F.S. and communicate as required by the SAs, in accordance with the auditor’s findings.

In all cases when reasonable assurance cannot be obtained and a qualified opinion in the auditor’s report is insufficient, the SAs require that the auditor disclaim an opinion or withdraw from the engagement.

In the present case, company was required to prepare its financial statements as per Ind-AS, but the financial statements are being prepared under the earlier GAAR FRF followed by the company is not acceptable.

Conclusion: Financial reporting framework applied by the management is unacceptable and hence auditor is required to disclaim the opinion in accordance with SA 705 or withdraw from the engagement.

Note: Answer given in Suggested Answer of 1CA1 is based on the provisions of Sec. 129 and Sec. 133 and specifies that the auditor is required to ensure applicable monetary limits w.r.t. Ind AS and advise the management to prepare the F.S. as per Ind AS.

Answer given in suggested answer does not seems to be appropriate as requirement of question was how the auditor report on such financial statements, whereas answer is given on applicability I of Ind AS as per legal requirements of company law.

Examiner comment on this answer was: Examinees did not discuss the requirements of section 133 and section 129 of the Companies Act, 2013, that Companies registered u/s 8 are not exempted from the complying with Ind AS while preparation of their financial statements. Only selected examinees mentioned that the auditor is required to ensure the applicable monetary limits with respect to applicability of Ind AS. Few examinees answered wrongly in the pretext on applicability of the Accounting standards to Charitable organisation whereas the question is on the applicability of Ind AS to section 8 companies.

SA 706 “Emphasis of Matter Paragraph and Other Paragraphs in the Independent Auditor’s Report”

Question 178.
Write short note on: Emphasis of Matter paragraph in Audit Report.
Answer:
Emphasis of Matter Para in Audit Report:
As per 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report” Emphasis of Matter is a paragraph of Matter is a paragraph which is included in auditor’s report to draw users’ attention to important matter (s) which are already disclosed in Financial Statements and are fundamental to users’ for understanding of Financial Statements.

EOM is used when there is a uncertainty relating to future outcome of exceptional litigation, regulatory action, etc.; or there is early application (where permitted] of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date.

Auditor shall include an Emphasis of Matter paragraph in the auditor’s report provided:
(a) The auditor would not be required to modify the opinion in accordance with SA 705 as a , result of the matter; and
(b) When SA 701 applies, the matter has not been determined to be a key audit matter to be communicated in the auditor’s report.

When the auditor includes an EOM paragraph in the auditor’s report, the auditor shall:
(a) Include the paragraph within a separate section of the auditor’s report with an appropriate heading that includes the term “Emphasis of Matter”;

(b) Include in the paragraph a clear reference to the matter being emphasized and to where relevant disclosures that fully describe the matter can be found in the financial statements. The paragraph shall refer only to information presented or disclosed in the financial statements; and

Question 179.
Beta Limited, is a company registered with SEB1, having five subsidiaries. M/s XYZ, Chartered Accountants, have been appointed as Statutory Auditors for the audit of the consolidated Financial Statements for the year ending March 31,2021. Out of five subsidiaries, the audit of one subsidiary was conducted by another auditor, M/s Badnam and Company, Chartered Accountants. The “Opinion” para of audit report furnished by M/s XYZ Chartered Accountants is given below:
Opinion
In Our opinion and to the best of our information and according to the explanations given to us the consolidated financial statements give a true and fair view, except the financial statement of one subsidiary whose accounts were audited by M/s Badnam and company, Chartered Accountants and about the same we are not in a position to express our opinion as the audit has not been performed by us:

In the case of the consolidated Balance Sheet, of the state of affairs of the company as at March 31, 2021.
In the case of the consolidated profit and loss account, of the profit/loss for the year ended on that date

Do you find any deficiencies in the opinion para? If yes, you are required to give your suggestions and redraft the opinion para. [Nov. 13 (5 Marks)]
Answer:
Identification of deficiencies in opinion Para:
The opinion para contains the following deficiencies:

Out of five subsidiaries, the audit of one subsidiary was conducted by another auditor, M/s Badnam and Company – needs to be reported in other matter para.
Opinion regarding cash flow statement has not been covered.
As per SA 700 & 706 the redrafted opinion para and other matter para are given here under:

Opinion Para
In our opinion and to the best of our information and according to the explanations given to us and based on the consideration of the reports of the other auditors on the financial statements of the subsidiaries as noted below, the consolidated financial statements give a true and fair view in conformity with the accounting principles generally accepted in India:

(a) in the case of the consolidated Balance Sheet, of the state of affairs of the Company as at March 31,2021;
(b) in the case of the consolidated Profit and Loss Account, of the profit/loss for the year ended on that date; and
(c) in the case of the consolidated Cash Flow Statement, of the cash flows for the year ended on that date.

Other Matter Para
We did not audit the financial statements*cf one subsidiary, whose financial statements reflect total assets (net) of XXXX as at March 31,2021, total revenues ofXXXX and net cash outflows amounting to XXXX for the year then ended. These financial statements have been audited by other auditor’s M/s Badnam and Company, Chartered Accountants whose reports have been furnished to us by the Management, and our opinion is based solely on the reports of the other auditors. Our opinion is not qualified in respect of this matter.

Question 180.
Compare and Explain the following: Audit Qualification and Emphasis of Matter. [Nov. 14 (3 Marks)]
Answer:
Audit Qualification and Emphasis of Matter:
SA 705 “Modifications to the Opinion in the Independent Auditor’s Report”, deals with the provisions relating to Audit Qualification. Audit Qualifications are given when auditor is having reservations on some of the items out of the financial statements.

It is issued under following circumstances:

Financial statements are materially misstated which in the auditor’s judgments are not pervasive.
Auditor is unable to obtain Sufficient and appropriate audit evidence which in the auditor judgment are not pervasive

As per 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report” Emphasis of Matter is a paragraph which is included in auditor’s report to draw users’ attention to important matter (s) which are already disclosed in Financial Statements and are fundamental to users’ for understanding of Financial Statements.

EOM is used when there is an uncertainty relating to future outcome of exceptional litigation, regulatory action, etc.; or there is early application (where permitted) of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date.

Question 181.
D Ltd., a Delhi based company having turnover of ₹ 25 crores, has a branch at USA having a turnover of ₹ 10 lakhs (as converted from US dollars). The area where the branch office is located in USA was severely affected by storms and the office along with all accounting records was completely destroyed. Due to the unavailability of records, the financial statements of D Ltd. for the financial year 2020-21 did not include the figures pertaining to the said branch. As the statutory auditor of D Ltd., how will you report on the same? [Nov. 17 (5 Marks)]
Answer:
Reporting on financial statements when information of component is not included:
As per SA 200 “Overall Objectives of the Independent Auditor and Conduct of Audit in accordance with Standards on Auditing” in conducting an audit of financial statements, the overall objective of the auditor is to obtain reasonable assurance about whether the Financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable FRF. In all cases when reasonable assurance cannot be obtained and a qualified opinion in the auditor’s report is insufficient, the SAs require that the auditor disclaim an opinion or withdraw from the engagement.

In the present case, D Ltd., a Delhi based company having turnover of ₹ 2 5 crores, has a branch at USA having a turnover of ₹ 10 lakhs (as converted from US dollars). The area where the branch office is located in USA was severely affected by storms and the office along with all accounting records was completely destroyed. Due to the unavailability of records, the financial statements of D Ltd. for the financial year 2020-21 did not include the figures pertaining to the said branch.

In the present situation, company«is required to make appropriate disclosures in the notes to accounts in this regard. Based on the disclosures made in the financial statements, auditor is required to include an Emphasis of Matter Para in the auditor’s report as per requirement of SA 706. If, however no disclosure is made in the financial statements, auditor need to qualify the audit report as turnover of the branch is only ₹ 10 lakhs which does not seems to have pervasive effect as the total turnover of the company is ₹ 25 Crores.

Conclusion: If appropriate disclosures are given in Notes to Accounts, an unmodified opinion with Emphasis of Matter para need to be issued. However, if appropriate disclosures are not given in Notes to Accounts, auditor should qualify the report in accordance with SA 705.

Note: Answer given in Suggested Answer of 1CAI is based on the provisions of Sec. 143(8) and specifies who can conduct branch audit.

Answer given in suggested answer does not seems to be appropriate as requirement of question was how the auditor report, whereas content of answer is primarily on the basis of who can conduct branch audit. In a case where branch records arc not available, then there is no logic of mentioning the provisions relating to the concept of branch audit. Answer need to be given from perspective of company auditor, how to deal in such a situation.

Examiner comment on this answer was: Examinees lacked knowledge in applying the required provisions of the Companies Act, 2013 to the given question. Few examinees have misunderstood the question and explained SA 600 on ‘Using the Work of Another Auditor’.

Question 182.
Enumerate certain important matters which can be included in ‘Emphasis of Matter Paragraph* in an Auditor’s Report. (Nov. 19 – Old syllabus (5 Marks)]
Answer:
Matters which can be included in Emphasis of Matter Paragraph in Auditor’s Report:
As per 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report’’ Emphasis of Matter is a paragraph which is included in auditor’s report to drawusers’ attention to important matter (s) which are already disclosed in Financial Statements and are fundamental to users’ for understanding of Financial Statements.

Matters which can be included in ‘Emphasis of Matter Paragraph’ in an Auditor’s Report, may be listed as below:
(a) An uncertainty relating to the future outcome of an exceptional litigation or regulatory action.
(b) A significant subsequent event that occurs between the date of the financial statements and the date of the auditor’s report.
(c) Early application (where permitted) of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date.
(d) A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.

Question 183.
AKB Associates, a renowned audit firm in the field of CA practice for past two decades. The firm was appointed to conduct statutory audit of Rica Ltd. an unlisted company, which is engaged in the business of paper manufacturing. It decided to commence the audit for the recently concluded financial year. Once after making significant progress in the audit, the auditors made the following observations:

Observation 1: The management had disclosed in the financials that, during the year, one of the warehouses of the Company was affected due to a major flood. As a result of the same, the Company had incurred some losses. But the management was of the view that it was not material.

Observation 2: Due to flood, few records maintained by the Company with respect to a particular transaction was completely destroyed and there was no duplicate record maintained by the Company. However, those details were not pervasive, butt material.
You are required to advise, whether AKB Associates should report Observations 1 and 2 in its audit report? If so, under which heading should it be reported? [RTP-Nov. 20]
Answer:
Reporting of modifications and EOM Para:
Observation 1:
Facts of the case: The management had disclosed in the financials that, during the year, one of the warehouses of the Company was affected due to a major flood. As a result of the same, the Company had incurred some losses. But the management was of the view that it was not material.

Relevant provisions: As per SA 706, “Emphasis of Matter Paragraph & Other Matter Paragraph in the Independent Auditor’s Report”, an Emphasis of Matter Paragraph refers to matter appropriately disclosed in the financials, that in the auditor’s judgment is of such importance that it is fundamental to users’ understanding of the financials.

Reporting requirements: The auditor shall report about the consequences of the flood which affected the Company’s warehouse under Emphasis of Matter Paragraph.

Observation 2:
Facts of the case: Due to flood, few records maintained by the Company with respect to a particular transaction was completely destroyed and there was no duplicate record maintained by the Company. However, those details were not pervasive, but material.

Relevant provisions: As per SA 705, “Modification to Opinion in the Independent Auditor’s Report”, where the auditor is unable to obtain sufficient and appropriate audit evidence and where such mater is material but not pervasive, the auditor shall issue a qualified opinion.

Thus, in the given situation, on account of flood few records pertaining to particular transactions was completely destroyed and in the absence of duplicate records, the auditor was unable to obtain sufficient and appropriate audit evidence and those details were material but not pervasive.

Reporting requirements: In accordance with SA 705, the auditor is required to issue qualified opinion.

SA710 “Comparative Information – Corresponding Figures and Comparative Financial Statements”

Question 184.
Write short note on: Corresponding Figures. [May 13 (4 Marks)]
Or
What are the auditor’s responsibilities in respect of corresponding figures? [May 10 (4 Marks)]
Or
Write short notes on the following: Auditor’s responsibilities regarding comparatives. [RTP-Nov. 18]
Answer:
Auditor’s Procedures in respect of examination of corresponding figures:
1. SA 710 “Comparative Information – Corresponding Figure and Comparative Financial Information deals with the auditor’s responsibilities regarding comparative information in an audit of financial statements.

2. The term Corresponding Figures refers to Comparative information where amounts and other disclosures for the prior period, are included as an integral part of current period F.S., and are intended to be read only in relation to the amounts and other disclosures relating to the current period.

3. To examine the corresponding figures, auditor is required to perform the following procedures:
(a) Determine whether F.S. include Comparative information required by FRF, & Whether such information is classified appropriately.

(b) Evaluate the following:

Whether the comparative information agrees with the amounts and other disclosures presented in the prior period; and
Whether the accounting policies reflected in the comparative information are consistent with those applied in the current period.
Whether, changes in accounting policies, if any, have been properly accounted for and adequately presented and disclosed.

(c) In case, auditor has doubt over existence of Possible Material Misstatement, then auditor is required to perform additional audit procedures to obtain sufficient appropriate audit evidence to determine existence of material misstatement.

(d) Obtain Written Representation from management to re-affirm that the Written Representation it previously made with respect to the prior period remain appropriate.

Question 185.
The audit report of P Ltd. for the year 2019-20 contained a qualification regarding non-provision of doubtful debts. As the statutory auditor of the company for the year 2020-21, how would you report, if:
(а) The company does not make provision for doubtful debts in 2020-21?
(b) The company makes adequate provision for doubtful debts in 2020-21? [May 09 (8 Marks), Nov. 14 (5 Marks)]
Or
For the year ended 31st March, 2020, the audit report of Avinash Ltd., contained a qualification regarding non-provision for diminution in the value of investments to the extent of Rs. 50 lacs. As an Auditor of the Company for the year 2020-21, how would you report, if:

The Company does not make provision for diminution in the value of investments in the year 2020-2021.
The Company makes adequate provision for diminution in the year 2020-2021. [May 18 – Old Syllabus (5 Marks)]

Answer:
Auditor’s responsibilities w.r.t. Corresponding figures:
As per SA 710, “Comparative Information – Corresponding Figures and Comparative Financial Statements” When the auditor’s report on the prior period, as previously issued, included a modified opinion and the matter which gave rise to the modified opinion is resolved and properly accounted for or disclosed in the financial statements in accordance with the applicable FRF, the auditor’s opinion on the current period need not refer to the previous modification.

SA 710 further states that if the auditor’s report on the prior period, as previously issued, included a modified opinion and the matter which gave rise to the modification is unresolved, the auditor shall modify the auditor’s opinion on the current period’s financial statements.

In the Basis for Modification paragraph in the auditor’s report, the auditor shall either:
(i) Refer to both the current period’s figures and the corresponding figures in the description of the matter giving rise to the modification when the effects or possible effects of the matter on the current period’s figures are material; or

(ii) In other cases, explain that the audit opinion has been modified because of the effects or ‘ possible effects of the unresolved matter on the comparability of the current period’s figures and the corresponding figures.

Conclusion:
(a) If P Ltd. does not make provision forTloubtful debts the auditor will have to modify his report for both current and previous year’s figures as mentioned above.
(b) If however, the provision is made, the auditor need not refer to the earlier year’s modification.

Question 186.
Mr. A, a practicing Chartered Accountant, audited the financial statements of C Ltd. for the previous year 2019-20 and expressed an unmodified opinion. C Ltd. was of the view that Mr. A is not conducting the audit properly and therefore, for the current year 2020-21, it appointed Ms. B, a leading practicing Chartered Accountant to conduct the audit and present Comparative Financial Statements. Ms. B, while performing the auditing procedures, found that C Ltd. has undercharged the wages of ₹ 10 lakhs during the previous year resulting in overstatement of profits. What are the further procedures, Ms. B is required to pursue?
Answer:
Auditor’s Procedures in respect of examination of Comparative F.S.:
1. SA 710 “Comparative Information” – Corresponding Figure and Comparative Financial Information deals with the auditor’s responsibilities regarding comparative information in an audit of financial statements.

2. To examine the comparative information, auditor is required to perform the following procedures:

Determine whether F.S. include Comparative information required by FRF, & Whether such information is classified appropriately.
Evaluate Whether the comparative information agrees with the amounts and other disclosures presented in the prior period; and

3. In the present case, auditor identified material misstatement for the previous year, financial statements of which are audited by Mr. A. Ms. B Current Auditor is required to discuss the matter with the management and issue suitable report based on the action taken by the management in this regard.

Conclusion: Ms. B is required to communicate the matter to the management and request them to inform the same to Mr. A. After revision or non-revision of the prior period’s financial statements, Ms. B may report accordingly.

Question 187.
It was observed from the modified audit report of the financial statements of AS Ltd. for the year ended 31st March, 2020 that depreciation of Rs. 2.50 crore for the year 2019-20 had been charged off to the statement of Profit and Loss instead of including it in “Carrying value of asset under construction”. State in relation to the audit for the year ended 31st March 2021, whether such modification in the previous year’s audit report would have any audit implication for the current year and if yes, how would you deal with it in your audit report? [Nov. 18-Old Syllabus (5 Marks), MTP – Oct. 20]
Answer:
Impact of Modification in the predecessor auditor’s report:
SA710 “Comparative Information – Corresponding Figure and Comparative Financial Information deals with the auditor’s responsibilities regarding comparative information in an audit of financial statements.

As per SA 710, if the auditor’s report on the prior period, as previously issued, included a modified opinion and the matter which gave rise to the modification is unresolved, the auditor shall modify the auditor’s opinion on the current period’s financial statements. In the Basis for Modification paragraph in the auditor’s report, the auditor shall either:
(a) Refer to both the current period’s figures and the corresponding figures in the description of ’ the matter giving rise to the modification when the effects or possible effects of the matter on the current period’s figures are material; or

(b) In other cases, explain that the audit opinion has been modified because of the effects or possible effects of the unresolved matter on the comparability of the current period’s figures and the corresponding figures.

Further, if the financial statements of the prior period were audited by a predecessor auditor and the auditor is permitted by law or regulation to refer to the predecessor auditor’s report on the corresponding figures and decides to do so, the auditor shall state in an Other Matter paragraph in the auditor’s report:
(a) That the financial statements of the prior period were audited by the predecessor auditor;
(b) The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the reasons therefor; and
(c) The date of that report.

In the instant case, it was observed from the modified audit report of the financial statements of AS Ltd. for the year ended 31st March, 2019 that depreciation of Rs. 2.50 crore for the year 2018-19 had been charged off to the statement of Profit and Loss instead of including it in “Carrying value of asset under construction”.

Conclusion: Modification in the predecessor audit report will impact the current period audit report and auditor shall deal in accordance with SA 710 as mentioned above.

SA 720 “The Auditor’s Responsibilities relating to Other Information.”

Question 188.
SA 720 requires the auditor to read and consider the other information because other information that is materially inconsistent with the F.S. or the auditor’s knowledge obtained in the audit may I indicate that there is a material misstatement of the F.S. or that a material misstatement of the other information exists, either of which may undermine the credibility of the F.S. and the auditor’s report thereon. Explain the meaning of the term Other Information and state the requirements of SA 720 as to obtaining and considering the other information.
Answer:
Other Information and Requirements of SA 720:

SA 720 “The Auditor’s Responsibilities relating to Other Information” deals with the auditor’s responsibilities relating to Other Information, whether financial or non-financial information included in an entity’s annual report. SA 720 defines the term other information as Financial or non-financial information (other than F.S. and the auditor’s report thereon) included in an entity’s annual report.

Requirements of SA 720 as to obtaining the other information:
The auditor shall:
(a) Determine, through discussion with management, which documents comprises the annual report, and the entity’s planned manner and timing of the issuance of such documents;

(b) Make appropriate arrangements with management to obtain in a timely manner and, if possible, prior to the date of the auditor’s report, the final version of the documents comprising the annual report; and

(c) When some or all of the documents determined above will not be available until after the date of the auditor’s report, request management to provide a written representation that the final version of the documents will be provided to the auditor when available, and prior to its issuance by the entity, such that the auditor can complete the procedures required by this SA.

Requirements of SA 720 as to considering the Other information:
The auditor shall read the other information and, in doing so shall:
(a) Consider whether there is a material inconsistency between the other information and the financial statements. As the basis for this consideration, the auditor shall, to evaluate their consistency, compare selected amounts or other items in the other information (that are intended to be the same as, to summarize, or to provide greater detail about, the amounts or other items in the financial statements) with such amounts or other items in the financial statements; and

(b) Consider whether there is a material inconsistency between the other information and the auditor’s knowledge obtained in the audit, in the context of audit evidence obtained and conclusions reached in the audit.

While reading the other information, the auditor shall remain alert for indications that the other information not related to the financial statements or the auditor’s knowledge obtained in the audit appears to be materially misstated.

Question 189.
ING Associates, Chartered Accountants, conducting the audit of XYZ Ltd., a listed Company for the year ended 31st March 2021 is concerned with the auditor’s responsibilities relating to misstatements in other information, both financial and non-financial, included in the Company’s annual report. While reading other information, ING Associates considers whether there is any material misstatement of the other information in the Company. After performing their procedures, the auditor concludes that a material misstatement of the other information exists.

ING Associates discussed with the Management about the other information that appeared to be materially misstated to the auditor and also requested management to provide evidence for the basis of management’s statements in the other information along with supporting documents. Guide ING Associates as to how to respond to that material misstatement of other information obtained prior to the date of auditor’s report. Will your answer be different in case ING Associates conclude the same after the date of auditor’s report? [MTP-Oct. 20]
Answer:
Auditor’s responses on a material misstatement in the Other Information:
SA 720 “The Auditor’s Responsibilities relating to Other Information” deals with the auditor’s responsibilities relating to Other Information, whether financial or non-financial information included in an entity’s annual report.

If the auditor concludes that a material misstatement of the other information exists, the auditor shall request management to correct the other information. If management:
(a) Agrees to make the correction, the auditor shall determine that the correction has been made; or
(b) Refuses to make the correction, the auditor shall communicate the matter with TCWG and request that the correction be made.

If the auditor concludes that a material misstatement exists in other information obtained prior to the date of the auditor’s report, and the other information is not corrected after communicating with TCWG, the auditor shall take appropriate action, including:
(a) Considering the implications for the auditor’s report and communicating with TCWG about how the auditor plans to address the material misstatement in the auditor’s report,
(b) Withdrawing from the engagement, where withdrawal is possible under applicable law or regulation.

If the auditor concludes that a material misstatement exists in other information obtained after the date of the auditor’s report, the auditor shall:
(a) If the other information is corrected, perform the procedures necessary in the circumstances; or
(b) If the other information is not corrected after communicating with TCWG, take appropriate action considering the auditor’s legal rights and obligations, to seek to have the uncorrected material misstatement appropriately brought to the attention of users for whom the auditor’s report is prepared.

Question 190.
LMP Associates, Chartered Accountants, conducting the audit of PQR Ltd., a listed Company for the year ended 31st March, 2021 is concerned with the auditor’s responsibilities relating to other information, both financial and non-financial, included in the Company’s annual report. While regarding other information, LMP Associates considers whether there is a material inconsistency between other Information and the financial statements. As a basis for the consideration the auditor shall evaluate their consistency, compare selected amounts or other items in the other information with such amounts or other items in the financial statements. Guide LMP Associates with examples of “Amounts” or “other items” that may be included in the “other information” with reference to SA 720. [Nov. 19 – New Syllabus (5 Marks)]
Answer:
Reading and considering the Other information:
SA 720 “The Auditor’s Responsibilities relating to Other Information” deals with the auditor’s responsibilities relating to Other Information, whether financial or non-financial information included in an entity’s annual report.

Other information may include amounts or other items that are intended to be the same as, to summarize, or to provide greater detail about, the amounts or other items in the financial statements. Examples of such amounts or other items may include:

(A) Amounts:

Items in a summary of key financial results, such as net income, earnings per share, dividends, sales and other operating revenues, and purchases and operating expenses.
Selected operating data, such as income from continuing operations by major operating area, or sales by geographical segment or product line.
Special items, such as asset dispositions, litigation provisions, asset impairments, tax adjustments, environmental remediation provisions, and restructuring and reorganization expenses.
Liquidity and capital resource information, such as cash, cash equivalents and marketable securities; dividends; and debt, capital lease and minority interest obligations.
Capital expenditures by segment or division.
Amounts involved in, and related financial effects of, off-balance sheet arrangements.
Amounts involved in guarantees, contractual obligations, legal or environmental claims, and other contingencies.
Financial measures or ratios, such as gross margin, return on average capital employed, return on average shareholders’ equity, current ratio, interest coverage ratio and debt ratio. Some of these may be directly reconcilable to the financial statements.

(B) Other Items:

Explanations of critical accounting estimates and related assumptions.
Identification of related parties and descriptions of transactions with them.
Articulation of the entity’s policies or approach to manage commodity, foreign exchange or interest rate risks, such as through the use of forward contracts, interest rate swaps, or other financial instruments.
Descriptions of the nature of off-balance sheet arrangements.
Descriptions of guarantees, indemnifications, contractual obligations, litigation or environmental liability cases, and other contingencies, including management’s qualitative assessments of the entity’s related exposures.
Descriptions of changes in legal or regulatory requirements, such as new tax or environmental regulations, that have materially impacted the entity’s operations or fiscal position, or will have a material impact on the entity’s future financial prospects.
Management’s qualitative assessments of the impacts of new financial reporting standards
that have come into effect during the period, or will come into effect in the following period, on the entity’s financial results, financial position and cash flows.
General descriptions of the business environment and outlook.
Overview of strategy.
Descriptions of trends in market prices of key commodities or raw materials.
Contrasts of supply, demand and regulatory circumstances between geographic regions.
Explanations of specific factors influencing the entity’s profitability in specific segments.

Note : AS 800, 805, 810, SRE, SAE and SRS excluded from syllabus by ICAI vide announcement dated 24.6.2019, 3.7-2019 and 22.07.2019.

Auditing Standards, Statements and Guidance Notes-An Overview – CA Final Audit Question Bank

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