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Functional Level Strategies – CA Inter SM Notes is designed strictly as per the latest syllabus and exam pattern.

Functional Level Strategies – CA Inter SM Study Material

Question 1.
Rohit Bhargava is the Managing Director of Smooth and Simple Pvt Ltd. The company established in 2011, with 35 employees grew very fast to become an organisation with 335 employees in the year 2016. With the increase in size Rohit started facing difficulty in managing things. Many a times he finds that personnel at the functional level are not in sync with the strategies of the top. He felt that strategies need to be segregated into viable plans and policies that are compatible with each other and com-municated down the line.
Why does Rohit need to segregate the strategies into functional plans? Discuss. (RTP Nov. 2018)
OR
ABC Ltd. is a company that has grown eleven times its size in last five years. With the increase in size the company is facing difficulty in manag-ing things. Many a time’s functional level is not in sync with the corporate level. What will you like to advise to the company and why?
(RTP May 2019; RTP May 2020)
OR
Rohit Bhargava needs to break higher level strategies into functional strategies for implementation. These functional strategies, in form of Marketing, Finance, Human Resource, Production, Research and Development help in achieving the organisational objective. (RTP Nov. 2018)
OR
RTP MAY. 19: The higher-level corporate strategies need to be segregated into viable plans and policies that are compatible with each other and communicated down the line. The higher-level strategies need to be broken into functional strategies for implementation. These functional strategies, in form of marketing, finance, human resource, production, research and development help in achieving the organizational objective.
(RTP May 2019)
Answer:
The reasons why functional strategies are needed can be enumerated as follows:

• Functional strategies lay down clearly what is to be done at the func-tional level. They provide a sense of direction to the functional staff.
• They are aimed at facilitating the implementation of corporate strategies and the business strategies formulation at the business level.
• They act as basis for controlling activities in the different functional areas of business.
• They help in bringing harmony and coordination as they are formulated to achieve major strategies.
  Similar situations occurring in different functional areas are handled in a consistent manner by the functional managers.

Additional Points:

• Once higher level corporate and business strategies have been de-veloped, management need to formulate and implement strategy for each of the functional areas of business.
• For effective implementation, strategists have to provide direction to functional managers regarding the plans and policies to be adopted.
• Different functional areas of the business are interwoven together and how a functional strategy is synergised with other functional strategies determines its effectiveness.
• Functional strategies are designed to help in the implementation of corporate and business unit level strategies.
• In fact, the effectiveness of strategic management depends critically on the manner in which strategies are implemented.
• Functional strategies play two important roles.
• Firstly, they provide support to the overall business strategy.
• Secondly, they spell out as to how functional managers will work so as to ensure better performance in their respective functional areas.
• Strategies in functional areas including marketing, financial, production, R & D and human resource management are based on the functional capabilities of an organisation.
• For each functional area
  • first the major sub areas are identified and
  • then for each of these sub areas, content of functional strategies, important factors, and their importance in the process of strategy implementation are identified.
  • In terms of the levels of strategy formulation, functional strategies operate below the SBU or business-level strategies.

Question 2.
Explain the term marketing. (May 2018; 5 Marks)
Answer:

1. Marketing is an activity performed by all business organizations.
2. It is an activity that creates and sustains exchange relationships among those who are willing and able to buy and sell products, services, sat-isfaction and even ideas.
3. In the present day business, marketing encompasses all the activities related to identifying the needs of customers and taking such actions to satisfy them in return of some consideration.
4. The term marketing constitutes different processes, functions, exchanges and activities that create perceived value by satisfying needs of individuals.

Question 3.
What are the objectives that must be kept In mind while designing a pricing strategy of a new product? (RTP Nov. 2018)
Answer:
For a new product pricing strategies for entering a market need to be designed.
In pricing a really new product at least three objectives must be kept in mind.

• Making the product acceptable to the customers.
• Producing a reasonable margin over cost.
• Catering to a market that helps in developing market share.

Question 4.
Ronit Roy has started a new business of manufacturing washing powder. Make a plan for him to promote his product. (RTP May 2018)
OR
Explain the marketing mix in the context of modern marketing. (Nov. 2018; 5 Marks)
Answer:
Marketing mix is a set of controllable marketing variables that the firm blends to produce the response that it wants in the target market. Marketing mix consists of everything that the firm can do to influence the demand for its product. The original framework of marketing mix comprises of product, price, place and promotion.

Modern marketing is highly promotional oriented and include personal selling, advertising, publicity and sales promotion.
(After this explain: personal selling, advertising, publicity and sales pro-motion.)

1. Promotion stands for activities that communicate the merits of the product and persuade target consumers to buy it.
2. Strategies are needed to combine individual methods such as advertising, personal selling, and sales promotion into a coordinated campaign.
3. In addition promotional strategies must be adjusted as a product move from an earlier stage from a later stage of its life.
4. Modern marketing is highly promotional oriented. Organizations strive to push their sales and market standing on a sustained basis and in a profitable manner under conditions of complex direct and indirect competitive situations.
5. Promotion also acts as an impetus to marketing. It is simultaneously a communication, persuasion and conditioning process.

Question 5.
Briefly explain four major direct promotional methods or tools.
Answer:

(i) Personal selling:

1. It is one of the oldest forms of promotion.
2. It involves face-to-face interaction of sales force with the prospec-tive customers and provides a high degree of personal attention to them.
3. In personal selling, oral communication is made with potential buyers of a product with the intention of making a sale.
4. It may initially focus on developing a relationship with the potential buyer, but end up with efforts for making a sale.
5. Personal selling suffers from a very high costs as sales personnel are expensive. They can physically attend only one customer at a time. Thus it is not a cost-effective way of reaching a large number of people.
6. However, as it is a highly effective method to persuade a potential customer into making a purchase, the personal selling is used in all kind of industries for all products.

(ii) Advertising:

1. Advertising is a non-personal, highly flexible and dynamic pro-motional method.
2. The media for advertising includes pamphlets, brochures, news-papers, magazines, hoardings, display boards, radio, television and internet.
3. Choice of appropriate media is important for effectiveness of the message.
4. The media may be local, regional, or national.
5. The type of the message, copy, and illustration are a matter of choice and creativity.
6. Advertising may be directed towards consumers, middlemen or opinion leaders.
7. Advertising is likely to succeed in promoting the sales of an orga-nization but its effectiveness in respect to the expenditure cannot be directly measured.
8. A sale is a function of several variables out of which advertising is only one.

(iii) Publicity:

1. Publicity is also a non-personal form of promotion similar to advertising.
2. However, no payments are made to the media as in case of advertising.
3. Organizations skilfully seek to promote themselves and their products without payment.
4. Publicity is communication of a product, brand or business by placing information about it in the media without paying for the time or media space directly.
5. Thus, it is way of reaching customers with negligible cost.
6. Basic tools for publicity are press releases, press conferences, reports, stories, and internet releases. These releases must be of interest to the public.

(iv) Sales promotion:

1. Sales promotion is an omnibus term that includes all activities that are undertaken to promote the business but are not specifically included under personal selling, advertising or publicity. [Omnibus means: comprising several items]
2. Activities like discounts, contests, money refunds, instalments, kiosks, exhibitions and fairs constitute sales promotion. All these are meant to give a boost to the sales.
3. Sales promotion done periodically may help in getting a larger market share to an organization.

Question 6.
Explain Expanded Marketing Mix in brief.
Answer:

• Typically, all organizations use a combination of 4 Ps in some form or the other.
• However, the above elements of marketing mix are not exhaustive.
• It is pertinent to discuss a few more elements that may form part of an organizational marketing mix strategy.
• They have got more currency in recent years.
• Growth of services has its own share for the inclusion of newer ele-ments in marketing.
• A few Ps included later are as follows:
  1. People: Allhuman actors who play a part in delivery of the market offering and thus influence the buyer’s perception, namely the firm’s personnel and the customer.
  2. Process:The actual procedures, mechanisms and flow of activities by which the product/service is delivered.
  3. Physical evidence:The environment in which the market offering is delivered and where the firm and customer interact.

Question 7.
Explain Strategic Marketing Techniques.
Answer:

1. SOCIAL MARKETING
2. AUGMENTED MARKETING
3. DIRECT MARKETING
4. RELATIONSHIP MARKETING
5. SERVICES MARKETING
6. PERSON MARKETING
7. ORGANIZATION MARKETING
8. PLACE MARKETING
9. ENLIGHTENED MARKETING
10. DIFFERENTIAL MARKETING
11. SYNCHRO-MARKETING
12. CONCENTRATED MARKETING
13. DE-MARKETING

SOCIAL MARKETING (MAY 18; 2.5 MARKS):
It refers to the design, implementation, and control of programs seeking to increase the acceptability of a social ideas, cause, or practice among a target group. For instance, the publicity campaign for prohibition of smoking in Delhi explained the place where one can and can’t smoke.

AUGMENTED MARKETING: (NOV. 2018; 2 MARKS)

1. It is provision of additional customer services and benefits built around the core and actual products.
2. It relate to introduction of hi-tech services like movies on demand, online computer repair services, secretarial services, etc.
3. Such innovative offerings provide a set of benefits that promise to elevate customer service to unprecedented levels (never done or known before).

DIRECT MARKETING:
Marketing through various advertising media that interact directly with consumers, generally calling for the consumer to make a direct response. Direct marketing includes catalogue selling, e-mail, telecomputing, electronic marketing, shopping, and TV shopping.

RELATIONSHIP MARKETING:
The process of creating, maintaining, and enhancing strong, value-laden relationships with customers and other stakeholders. For example, Airlines offer special lounges at major airports for frequent flyers. Thus, providing special benefits to select customers to strengthen bonds. It will go a long way in building relationships.

SERVICE MARKETING (MAY 18; 2.5 MARKS):
It is applying the concepts, tools, and techniques, of marketing to services. Services is any activity or benefit that one party can offer to another that is essentially intangible and does not result in the banking, savings, retailing, educational or utilities.

PERSON MARKETING:
People are also marketed. Person marketing consists of activities undertaken to create, maintain or change attitudes and behaviour towards particular person. For example, politicians, sports stars, film stars, etc. ie., market themselves to get votes, or to promote their careers.

ORGANIZATION MARKETING:
It consists of activities undertaken to create, maintain, or change attitudes and behaviour of target audiences towards an organization. Both profit and non-profit organizations practice organization marketing.

PLACE MARKETING:
Place marketing involves activities undertaken to create, maintain, or change attitudes and behaviour towards particular places say, business sites marketing, tourism marketing.

ENLIGHTENED MARKETING:

1. It is a marketing philosophy holding that a company’s marketing should support the best long-run performance of the marketing system.
2. Its five principles include:
   1. customer-oriented marketing,
   2. innovative marketing,
   3. value marketing,
   4. sense-of-mission marketing, and
   5. societal marketing.

DIFFERENTIAL MARKETING:

1. It is a market-coverage strategy in which a firm decides to target several market segments and designs separate offer for each.
2. For example, Hindustan Unilever Limited has Lifebuoy, Lux and Rexona in popular segment and Dove and Pears in premium segment.
3. Differentiation can be achieved through variation in size, shape, colour, brand names and so on.

SYNCHRO-MARKETING:

1. When the demand for a product is irregular due to:
   • season,
   • some parts of the day, or on hour basis, causing idle capacity or overworked capacities, synchro-marketing can be used
2. Synchro Marketing find ways to alter the pattern of demand through flexible pricing, promotion, and other incentives.
3. It can be done through flexible pricing, promotion, and other incentives.
4. For example, products such as movie tickets can be sold at lower price over week days to generate demand.

CONCENTRATED MARKETING:
It is a market-coverage strategy in which a firm goes after a large share of one or few sub-markets.

DEMARKETING:

1. It includes marketing strategies to reduce demand temporarily or permanently.
2. The aim is not to destroy demand, but only to reduce or shift it.
3. This happens when there is overfull demand.
4. For example, buses are overloaded in the morning and evening, roads are busy for most of times, zoological parks are over-crowded on Saturdays, Sundays and holidays.
5. Here demarketing can be applied to regulate demand.

Question 8.
A web company initially started as an online marketplace for books. From “biggest E – Bookstore,” its owners wants to expand into an e-com-merce platform selling electronic goods. Implementation of this needs additional funds.
What are the different sources of raising funds and their impact on the financial strategy which you as a financial manager will consider? (RTPNov. 2019)
Answer:

1. Successful strategy implementation often requires additional capital. Basic sources of capital are:
   • net profit from operations
   • sale of assets,
   • debt and
   • equity.
2. Being a financial manager to determine an appropriate mix of debt and equity in a firm’s capital structure can be vital to successful strategy implementation.
   Theoretically, an enterprise should have enough debt in its capital structure to boost its return on investment by applying debt to products and projects earning more than the cost of the debt.
   In low earning periods, too much debt in the capital structure of an organization can endanger stockholders’ return and jeopardize company survival.
   • Many debt ridden real estate companies find things very difficult at time of recession.
   • Fixed debt obligations generally must be met, regardless of cir-cumstances.
   • This does not mean that stock issuances are always better than debt for raising capital.
     Some special stock is issued to finance strategy implementation; ownership and control of the enterprise are diluted.
   • This can be a serious concern in today’s business environment of hostile takeovers, mergers, and acquisitions.
3. The maj or factors regarding which strategies have to be made includes:
   • capital structure;
   • procurement of capital and working capital borrowings;
   • reserves and surplus as sources of funds; and
   • relationship with lenders, banks and financial institutions.
4. Strategies related to the sources of funds are important since they determine how financial resources will be made available for the implementation of strategies.
5. Organizations have a range of alternatives regarding the sources of funds. While one company may rely on external borrowings, another may follow a policy of internal financing.

Question 9.
What do you mean by financial strategy of an organization? How the worth of a business is evaluated?
OR
“Evaluating the worth of a business is central to strategy implementation.” In the light of this statement, explain the methods that can be used for determining the worth of a business. (RTP May 2020)
OR
Discuss various approaches for evaluating the worth of a business. (RTP Nov. 2019; 5 Marks)
Answer:
The financial strategies of an organization are related to several finance/accounting concepts considered to be central to strategy implementation. These are: acquiring needed capital/sources of fund, developing projected financial statements/budgets, management/usage of funds, and evaluating the worth of a business.

Various approaches/methods for determining a business’s worth can be grouped Into three main approaches:

1. DETERMINING NET WORTH/STOCKHOLDERS’ EQUITY.

• Net worth is the total assets minus total outside liabilities of an organisation.
• Net worth represents the sum of common stock, additional paid-in capital, and retained earnings.
• After calculating net worth, add or subtract an appropriate amount for goodwill and overvalued or undervalued assets. This total provides a reasonable estimate of a firm’s monetary value.

2. FUTURE BENEFITS TO OWNERS THROUGH NET PROFITS:

• These benefits are considered to be much greater than the amount of profits.
• The worth of any business should be based largely on the future benefits its owners may derive through net profits.
• A conservative rule of thumb is to establish a business’s worth as five times the firm’s current annual profit. A five-year average profit level could also be used.

3. MARKET-DETERMINED BUSINESS WORTH (INVOLVES THREE METHODS).

1. Base the firm’s worth on the selling price of a similar company. A potential problem, however, is that sometimes comparable figures are not easy to locate.
2. Price-earnings ratio method. To use this method, divide the market price of the firm’s common stock by the annual earnings per share and multiply this number by the firm’s average net income for the past five years.
3. Outstanding shares method. To use this method, simply multiply the number of shares outstanding by the market price per share and add a premium. The premium is simply a per-share amount that a person or firm is willing to pay to control (acquire) the other company.

Question 10.
Briefly explain Logistics Strategy.
Answer:

1. Management of logistics is a process which integrates:
   • the flow of supplies into,
   • through and
   • out of an organization,
2. This helps to achieve a level of service which ensures that the right materials are available at the right place, at the right time, of the right quality, and at the right cost.
3. Organizations try to keep the cost of transporting materials as low as possible consistent with safe and reliable delivery.
4. For a business organization effective logistics strategy will involve raising and finding solutions to the questions relating to raw material, manufacturing locations, products, transportation and deployment of inventory.
5. Improvement in logistics can result in saving in cost of doing business.
6. When a company creates a logistics strategy, it is defining the service levels at which its logistics systems are highly effective.
7. A company may develop a number of logistics strategies for specific product lines, specific countries or specific customers to address dif-ferent categorical requirements.

Question 11.
What is supply chain management? Is it same as logistics manage-ment? Discuss.
Answer:

1. The term supply chain refers to the linkages between suppliers, man-ufacturers and customers.
2. Supply chains involve all activities like sourcing and procurement of material, conversion, and logistics. Planning and control of supply chains are important components of its management.
3. Naturally, management of supply chains include closely working with channel partners – suppliers, intermediaries, other service providers and customers. Technological changes and reduction in information communication costs with increase in its speed has led to changes in coordination among the members of the supply chain network.
4. Supply chain management is defined as the process of planning, im-plementing, and controlling the supply chain operations.
5. It is a cross-functional approach to managing the movement of raw materials into an organization and the movement of finished goods out of the organization toward the end-consumer who are to be satisfied as efficiently as possible.
6. It encompasses all movement and storage of raw materials, work- in-process inventory, and finished goods from point-of-origin to point-of-consumption. Organizations are finding that they must rely on the chain to successfully compete in the global market.
7. Modern organizations are striving to focus on core competencies and reduce their ownership of sources of raw materials and distribution channels. These functions can be outsourced to other business organizations that specialize in those activities and can perform in better and cost effective manner. In a way organizations in the supply chain do tasks according to their core-competencies.
8. Working in the supply chain improve trust and collaboration amongst partners and thus improve flow and management of inventory.

Question 12.
Discuss the major steps in implementing supply chain management system in a business organIzation. (Nov. 2018; 5 Marks)
OR
Implementing supply chain management in a business organization has several steps. Discuss. (RTP Nov.2019)
Answer:

1. A successful implementation of supply management system requires a change from managing individual functions to integrating activities into key supply chain processes.
2. It involves collaborative work between buyers and suppliers, joint product development, common systems and shared information.
3. A key requirement for successfully implementing supply chain will be network of information sharing and management.
4. The partners need to link together to share information through elec-tronic data interchange and take decisions in timely manner.

Implementing and successfully running supply chain management system will involve:

1. Procurement: Procurement requires careful resource planning, quality issues, identifying sources, negotiation, order placement, inbound transportation and storage. Organizations have to coordinate with suppliers in scheduling without interruptions. Suppliers are involved in planning the manufacturing process.

2. Product Development: Customers and suppliers must work together in the product development process. Right from the start the partners will have knowledge of all Involving all partners will help in shortening the life cycles. Products are developed and launched in shorter time and help organizations to remain competitive.

3. Manufacturing: Flexible manufacturing processes must be in place to respond to market changes. They should be adaptive to accommodate customization and changes in the taste and preferences. Manufacturing should be done on the basis of just-in-time (JIT) and minimum lot sizes. Changes in the manufacturing process be made to reduce manufacturing cycle.

4. Physical Distribution: Delivery of final products to customers is the last position in a marketing channel. Availability of the products at the right place at right time is important for each channel participant. Through physical distribution processes serving the customer become an integral part of marketing. Thus supply chain management links a marketing channel with customers.

5. Customer Services: Organizations through interfaces with the com-pany’s production and distribution operations develop customer rela-tionships so as to satisfy them. They work with customer to determine mutually satisfying goals, establish and maintain relationships. This in turn helps in producing positive feelings in the organization and the customers.

6. Performance Measurement: There is a strong relationship between the supplier, customer and organisation. Supplier capabilities and customer relationships can be correlated with a firm performance. Performance is measured in different parameters such as costs, customer service, productivity and quality.

7. Outsourcing: Outsourcing is not limited to the procurement of mate-rials and components, but also includes outsourcing of services that traditionally have been provided within an organization. The company will be able to focus on those activities where it has competency and everything else will be outsourced.

Question 13.
How would you argue that Research and Development Personnel are important for effective strategy implementation? (RTP Nov. 2020)
Answer:

1. Research and development (R&D) personnel can play an integral part in strategy implementation.
2. These individuals are generally charged with developing new products and improving old products in a way that will allow effective strategy implementation.
3. R&D employees and managers perform tasks that include:
   • transferring complex technology,
   • adjusting processes to local raw materials,
   • adapting processes to local markets, and
   • altering products to particular tastes and specifications.
4. Strategies such as product development, market penetration, and concentric diversification require that new products be successfully developed and that old products be significantly improved. But the level of management support for R&D is often constrained by resource availability.

Question 14.
Describe the Guidelines regarding whether a firm should develop research and development expertise internally or outside to external agencies.
Answer:
A critical question is whether a Finn should develop research and development expertise internall or outside to external agencies. The following guidelines can be used to help make this decision:

1. If the rate of technical progress is slow, the rate of market growth is moderate, and there are significant barriers to possible new entrants, then in-house R&D is the preferred solution. The reason is that R&D, if successful, will result in a temporaty product or process monopoly that the company can exploit.
2. If technology is changing rapidly and the market is growing slowly, then a major effort in R&D may be very risky, because it may lead to the development of an ultimately obsolete technology or one for which there is no market.
3. If technology is changing slowly but the market is growing quickly, there generally is not enough time for in-house development. The prescribed approach is to obtain R&D expertise on an exclusive or non-exclusive basis from an outside firm.
4. If both technical progress and market growth are fast, R&D expertise should be obtained through acquisition of a well-established firm in the industry.

Question 15.
What are the three major R&D approaches for implementing Strat-egies?
Answer:
There are at least three major R&D approaches for implementing strategies:

1. The first strategy is to be the first firm to market new technological products. This is a glamorous and exciting strategy but also a dangerous one. Firms such as 3M and General Electric have been successful with this approach, but many other pioneering firms have fallen, with rival firms seizing the initiative.

2. A second R&D approach is to be an innovative imitator of successful products, thus minimizing the risks and costs of start up. This approach entails allowing a pioneer firm to develop the first version of the new product and to demonstrate that a market exists. Then, laggard firms develop a similar product. This strategy requires excellent R&D per-sonnel and an excellent marketing department.

3. A third R&D strategy is to be a low-cost producer by mass-producing products similar to but less expensive than products recently introduced. As a new product accepted by customers, price becomes increasingly important in the buying decision. Also, mass marketing replaces personal selling as the dominant selling strategy. This R&D strategy requires substantial investment in plant and equipment, but fewer expenditures in R&D than the two approaches described earlier.

Question 16.
State the factors of human resource that Influence on employee’s competence. (RTP May 2018)
Answer:
Human resource management has been accepted as a strategic partner in the formulation of organization’s strategies and in the implementation of such strategies through human resource planning, employment, training, appraisal and reward systems.

The following points should be kept in mind:

1. Recruitment and selection: The workforce will be more competent if a firm can successfully identify, attract, and select the most competent applicants.
2. Training: The workforce will be more competent if employees are well trained to perform their jobs properly.
3. Appraisal of performance: The performance appraisal is to identify any performance deficiencies experienced by employees due to lack of competence. Such deficiencies, once identified, can often be solved through counselling, coaching or training.
4. Compensation: A firm can usually increase the competency of its work-force by offering pay and benefit packages that are more attractive than those of their competitors. This practice enables organizations to attract and retain the most capable people.

Question 17.
Explain the strategic role of Human Resources Manager. (RTP May 2019)
Explain the prominent areas where the Human Resource Manager can play a strategic role. (May 2019; 5 Marks)
Answer:
The prominent areas where the human resource manager can play strategic role arc as follows:

1. Building core competency:

• • A core competence is a unique strength of an organization which may not be shared by others. This may be in the form of human resources, marketing capability, or technological capability.
  • If the business is organized on the basis of core competency, it is likely to generate competitive advantage.
  • Because of this reason, many organizations have restructured their businesses by divesting those businesses which do not match core competence.
  • Organization of business around core competence implies leveraging the limited resources of a firm. It needs creative, courageous and dynamic leadership having faith in organization’s human resources.

2. Creating competitive advantage:

• There are two important ways a business can achieve a competitive advantage over the others.
  • cost leadership which means the firm aims to become a low cost leader in the industry.
  • differentiation under which the firm seeks to be unique in the industry in terms of dimensions that are highly valued by the customers.
• Putting these strategies into effect carries a heavy premium on having a highly committed and competent workforce.

3. Providing purposeful direction:

• The human resource manager must be able to lead people and the organization towards the desired direction involving people right from the beginning.
• The most important task of a HR manager is to ensure that the objectives of an organization are internalized by each individual working in the organization.
• Objectives of an organization state the very purpose and justification of its existence.

4. Empowerment of human resources:

• Empowerment means authorizing every member of an organization to take up his/her own destiny realizing his/her full potential.
• It involves giving more power to those who, at present, have little control what they do and little ability to influence the decisions being made around them.

5. Managing workforce diversity:

• Workforce diversity can be observed in terms of male and female workers, young and old workers, educated and uneducated workers, unskilled and professional employee, etc.
• Moreover, many organizations also have people of different castes, religious and nationalities.
• The workforce in future will comprise more of educated and self
  conscious workers. They will ask for higher degree of participation and avenues for fulfilment.
• Money will no longer be the sole motivating force for majority of the z workers. Non-financial incentives will also play an important role in motivating the workforce.

6. Facilitation of change:

• The human resource manager will be more concerned with:
  • substance rather than form,
  • accomplishments rather than activities, and
  • practice rather than theory.
• The HR function will be responsible for furthering the organization not just maintaining it.
• Human resource manager will have to devote more time to promote changes than to maintain the status quo.

7. Development of works ethic and culture:

• Greater efforts will be needed to achieve cohesiveness because employees will have transient commitment to groups.
• As changing work ethic requires increasing emphasis on individuals, jobs will have to be redesigned to provide challenge.
• Flexible starting and quitting times for employees may be necessary. Focus will shift from extrinsic to intrinsic motivation.
• A vibrant work culture will have to be developed in the organizations to create an atmosphere of trust among the employees and to encourage creative ideas by them.

Question 18.
Mr. Vicky Verma, a Gwalior based entrepreneur, has entered into an exclusive-retail deal with an Italian company selling *Fantasy-3B’, a Hologram LED Fan, which is being used for advertising at public places. Mr. Verma procured a total of 500 units of the product and paid upfront as per the seller’s policy. This resulted in blocking of his working capital significantly and the shipment is expected in a month. Meanwhile his continued efforts of establishing relations with the marketing heads of corporates resulted in a series of meetings, where he demonstrated his specialist product knowledge by changing the hologram images to personalise basis specifications of the customer. The management of a big automative company was impressed with the quality and adaptability of the product, and awarded a contract of 125 units to be displayed in the ; auto-maker’s showrooms. Identify and explain the product promotion strategy adopted by Mr. Verma. (RTP Nov. 2020)
Answer:
Mr. Vicky Verma established personal contacts with potential buyers of the product and persuaded the marketing department over several physical meetings, and was finally able to make sales.

The personal relation establishment and physical demonstration, indicates that Mr. Verma used the Personal Selling method of Promotion.

Modern marketing is highly promotional oriented and include personal selling, advertising, publicity and sales promotion.

Personal selling involves face to face interaction of sales persons with the prospective customers and provides a high degree of personal attention.

It involves working with one customer at a time and hence not cost effective. The intention of oral communication is sale

Organisation and Strategic Leadership – CA Inter SM Notes is designed strictly as per the latest syllabus and exam pattern.

Organisation and Strategic Leadership – CA Inter SM Study Material

Question 1.
Manoj started his telecom business in 2010. Over next five years, he gradually hired fifty people for various activities such as to keep his accounts, administration, sell his products in the market, create more customers, provide after sales service, coordinate with vendors.
Draw the organization structure Manoj should implement in his organization and name it. {Nov. 2018; 5 Marks)
Answer:
Manoj has started a telecom business. Accounts, Administration, Marketing (customer creation, after sales service, vendor coordination) are the functional areas that are desired in the organisational structure. Further there is inherent need to have a department for the management of telecom services/operations.

Thus, the functional structure in the telecom business of Manoj can be as follows:

Question 2.
Discuss the concept of Multi Divisional Structure. (RTP May 2019)
Answer:

1. The multi divisional (M- form) structure:
   • is composed of operating divisions
   • where each division represents a separate business
   • to which the top corporate officer delegates responsibility for day-to-day operations and business unit strategy to division managers.
   • By such delegation, the corporate office is responsible for formulating and implementing overall corporate strategy and manages divisions through strategic and financial controls.
2. The multi divisional or M-form structure was developed in the 1920s, in response to coordination and control related problems in large firms. Functional departments often had difficulty dealing with distinct product lines and markets, especially in coordinating conflicting priorities among the products. Costs were not allocated to individual products, so it was not possible to assess an individual product’s profit contribution. Loss of control meant that optimal allocation of firm resources between products was difficult (if not impossible).
3. Top managers became over-involved in solving short-run problems (such as coordination, communications, conflict resolution) and neglected long-term strategic issues.
4. The new, innovative structure called for
   1. Creating separate divisions, each representing a distinct business;
   2. Each division would house its functional hierarchy;
   3. Division managers would be given responsibility for managing day-to-day operations;
   4. A small corporate office that would determine the long-term strategic direction of the firm and exercise overall financial control over the semi-autonomous divisions.

Question 3.
What is a strategic business unit? What are its advantages? (RTP May 2020)
Answer:
A strategic business unit (SBU) is any part of a business organization which is treated separately for strategic management purposes. The concept of SBU is helpful in creating an SBU organizational structure. It is discrete element of the business serving product markets with readily identifiable competitors and for which strategic planning can be concluded. It is created by adding another level of management in a divisional structure after the divisions have been grouped under a divisional top management authority based on the common strategic interests

Advantages of SBU are:

1. Establishing coordination between divisions having common strategic interests.
2. Facilitates strategic management and control on large and diverse organizations.
3. Fixes accountabilities at the level of distinct business units.
4. Allows strategic planning to be done at the most relevant level within the total enterprise.
5. Makes the task of strategic review by top executives more objective and more effective.
6. Helps allocate corporate resources to areas with greatest growth opportunities.

Question 4.
Describe the three distinct phases proposed by Davis and Lawrence for development of matrix structure. (RTP Nov 2018)
Answer:
For development of matrix structure Davis and Lawrence, have proposed three distinct phases:

1. Cross-functional task forces: Temporary cross-functional task forces are initially used when a new product line is being introduced. A project manager is in charge as the key horizontal link.
2. Product/brand management. If the cross-functional task forces become more permanent, the project manager becomes a product or brand manager and a second phase begins. In this arrangement, function is still the primary organizational structure, but product or brand managers act as the integrators of semi permanent products or brands.
3. Mature matrix: The third and final phase of matrix development involves a true dual authority structure. Both the functional and product structures are permanent. All employees are connected to both a vertical functional superior and a horizontal product manager. Functional and product managers have equal authority and must work well together to resolve disagreements over resources and priorities.

Question 5.
‘A network structure is suited to unstable environment.’ Elaborate.
Answer:

• Network structure is a newer and somewhat more radical organizational design.
• The network structure could be termed a “non-structure” as it virtually eliminates in-house business functions and outsource many of them.
• An organisation organized in this manner is often called a virtual organization because it is composed of a series of project groups or collaborations linked by constantly changing non-hierarchical, cobweb-like networks.
• The network structure becomes most useful when the environment of a firm is unstable and is expected to remain so. Under such conditions, there is usually a strong need for innovation and quick response. Instead of having salaried employees, it may contract with people for a specific project or length of time.
• Long-term contracts with suppliers and distributors replace services that the company could provide for itself.
• Example: Companies like Airtel use the network structure in their operations function by sub-contracting manufacturing to other companies in low cost.

Question 6.
What is an Hourglass structure? How is it beneficial for an organization? (May 2019; 3 Marks)
OR
Discuss the concept of Hourglass Structure. (RTP Nov. 2019)
Answer:

• In the recent years information technology and communications have significantly altered the functioning of organizations. The role played by middle management is diminishing as the tasks performed by them are increasingly being replaced by the technological tools.
• Hourglass organization structure consists of three layers with constricted middle layer. The structure has a short and narrow middle-management level.
• Information technology links the top and bottom levels in the organization taking away many tasks that are performed by the middle level managers.
• A shrunken middle layer coordinates diverse lower level activities. Contrary to traditional middle level managers who are often specialist, the managers in the hourglass structure are generalists and perform wide variety of tasks.
  
• They would be handling cross-functional issues emanating such as j those from marketing, finance or production.
• Hourglass structure has obvious benefit of reduced costs. It also helps in enhancing responsiveness by simplifying decision making.
• Decision making authority is shifted close to the source of information so that it is faster.
• However, with the reduced size of middle management the promotion opportunities for the lower levels diminish significantly.
• Continuity at same level may bring monotony and lack of interest and to overcome these problems by assigning challenging tasks, transferring laterally and having a system of proper rewards for performance.

Question 7.
Delta is an organization specializing in Information Technology en-ables Services (ITeS) and Communications business. Previous year the organization had successfully integrated an Artificial Intelligence (AI) tool named ‘Zeus’ into the existing ERP system.

The AI tool using Deep Learning technique provided a digital leap trans-formation in various business processes and operations. It has significantly diminished the role played by specialist managers of the middle management. This technological tool in addition to saving organisational costs by replacing many tasks of the middle management, has also served as a link between top and bottom levels in the organization and assists in faster decision making. The skewed middle level now perform cross-functional duties. Which type of organisational structure is the company transitioning into? (RTPNov 2020)
Answer:
The company Delta is transitioning into the Hourglass organization structure because it has used technological tools to transform various business processes and operations and has significantly diminished the role played by specialist managers of the middle management.

The technological tool in addition to savings organisational costs by replacing many tasks of the middle management has also served as a link between top and bottom levels in the organization and assists in faster decision making. The skewed middle level managers now perform cross-functional duties. All these factors indicate towards Hourglass organization structure.

Question 8.
Discuss the leadership role played by the managers in pushing for good strategy execution. (May 2019; 5 Marks)
OR
Suresh Sinha has been recently appointed as the head of a strategic busi-ness unit of a large multiproduct company. Advise Mr Sinha about the leadership role to be played by him in execution of strategy. (RTP May 2018)
Answer:
A strategy manager has many different leadership roles to play: vision-ary, chief entrepreneur and strategist, chief administrator, culture builder, resource acquirer and allocator, capabilities builder, process integrator, crisis solver, spokesperson, negotiator, motivator, arbitrator, policy maker, policy enforcer, and head cheerleader.

Managers have five leadership roles to play in pushing for good strategy execution:

1. Staying on top of what is happening, closely monitoring progress, fer-reting out issues, and learning what obstacles lie in the path of good execution.
2. Promoting a culture and esprit de corps that mobilizes and energizes organizational members to execute strategy in a competent fashion and perform at a high level.
3. Keeping the organization responsive to changing conditions, alert for new opportunities, bubbling with innovative ideas, and ahead of rivals in developing competitively valuable competencies and capabilities.
4. Exercising ethics leadership and insisting that the company conduct its affairs like a model corporate citizen.
5. Pushing corrective actions to improve strategy execution and overall strategic performance.

Question 9.
What are the different responsibilities of a Strategic Leader?
OR
KaAthens Ltd., a diversified business entity having business operations across the globe. The company leadership has just changed as Mr. D. Bandopadhyay handed over the pedals to his son Aditya Bandopadhyay, due to his poor health. Aditya is a highly educated with an engineering degree from IIT, Delhi. However, being very young he is not clear about his role and responsibilities.
In your view, what are the responsibilities of Aditya Bandopadhyay as CEO of the company. (RTP Nov 2018; RTP May 2020)
Answer:
Aditya Bandopadhyay, an effective strategic leader of KaAthens Ltd. must be able to deal with the diverse and cognitively complex competitive situations that are characteristic of today’s competitive landscape.

A Strategic leader has several responsibilities, including the following:

• Making strategic decisions.
• Formulating policies and action plans to implement strategic decision.
• Ensuring effective communication in the organisation.
• Managing human capital (perhaps the most critical of the strategic leader’s skills).
• Managing change in the organisation.
• Creating and sustaining strong corporate culture.
• Sustaining high performance over time.

Question 10.
Distinguish between Transformational Leadership Style and Trans-actional Leadership Style. (Nov. 2019; 5 Marks) (RTP Nov. 2020)
OR
Ram and Shyam are two brothers engaged in the business of spices. Both have different approaches to management. Ram prefers the conventional and formal approach in which authority is used for explicit rewards and punishment. While, on the other hand, Shyam believes in democratic par-ticipative management approach, involving employees to give their best.
Analyse the leadership style followed by Ram and Shyam. (May 2018)
OR
Ramesh is owner of a popular brand of Breads. Yashpal, his son after completing Chartered Accountancy stated assisting his father in running of business.
The approaches followed by father and son in management were very different.
While Ramesh preferred to use authority and having a formal system of defining goals and motivation with explicit rewards and punishments, Yashpal believed in involving employees and generating enthusiasm to inspire people to deliver in the organization.
Discuss the difference in leadership style of father and son. (RTP May 2019)
Answer:
[Ramesh is a follower of transactional leadership style, while Yashpal is follower of transformational leadership style.]

1. TRANSFORMATIONAL LEADERSHIP STYLE

• Use charisma and enthusiasm to inspire people to exert them for the good of the organization.
• Transformational leadership style may be appropriate in turbulent environments, in industries at the very start or end of their life-cycles, in poorly performing organizations when there is a need to inspire a company to embrace major changes.
• Transformational leaders offer excitement, vision, intellectual stimu-lation and personal satisfaction.
• They inspire involvement in a mission, giving followers a ‘dream’ or ‘vision’ of a higher calling so as to elicit more dramatic changes in organizational performance.
• Such a leadership motivates followers to do more than originally af-fected to do by stretching their abilities and increasing their self-con-fidence, and also promote innovation throughout the organization.

2. TRANSACTIONAL LEADERSHIP STYLE

• Focus more on designing systems and controlling the organization’s activities and are more likely to be associated with improving the current situation.
• Transactional leaders try to build on the existing culture and enhance current practices.
• Transactional leadership style uses the authority of its office to exchange rewards, such as pay and status.
• They prefer a more formalized approach to motivation, setting clear goals with explicit rewards or penalties for achievement or non-achievement.
• Transactional leadership style may be appropriate in settled environ-ment, in growing or mature industries, and in organizations that are performing well.
• The style is better suited in persuading people to work efficiently and run operations smoothly.

Question 11.
Define corporate culture. Also elucidate the statement “Culture is a strength that can also be a weakness”. (Nov 2018; 5 Marks)
OR
How can a corporate culture be both strength and weakness of an organ-isation?
Answer:
The phenomenon which often distinguishes good organizations from bad ones could be summed up as ‘corporate culture’.

Corporate culture refers to a company’s values, beliefs, business principles, traditions, ways of operating and internal work environment.

Every corporation has a culture that exerts powerful influences on the 2 behaviour of managers. Culture affects not only the way managers behave z within an organization but also the decisions they make about the organi-zation’s relationships with its environment and its strategy.
“Culture is a strength that can also be a weakness”. This statement can be explained by splitting it into two parts.

Culture as a strength:
As a strength, culture can facilitate communication, decision-making & control and create cooperation & commitment. An organization’s culture could be strong and cohesive when it conducts its business according to a clear and explicit set of principles and values, which the management de-votes considerable time to communicating to employees and which values are shared widely across the organization.

Culture as a weakness:
As a weakness, culture may obstruct the smooth implementation of strategy by creating resistance to change. An organization’s culture could be charac-terized as weak when many sub-cultures exist, few values and behavioural norms are shared and traditions are rare. In such organizations, employees do not have a sense of commitment, loyalty and sense of identity.

Question 12.
Write a short note on importance of corporate culture.
OR
Explain briefly the role of culture in promoting better strategy execution.
Answer:

• A culture where creativity, embracing change, and challenging the status quo are pervasive themes is very conducive to successful execution of a product innovation and technological leadership strategy.
• A culture built around such business principles as listening to customers, encouraging employees to take pride in their work, and giving employees a high degree of decision-making responsibility is very conducive to successful execution of a strategy of delivering superior customer service.
• A strong strategy-supportive culture nurtures and motivates people to do their jobs in ways conducive to effective strategy execution; it provides structure, standards, and a value system in which to operate; and it promotes strong employee identification with the company’s vision, performance targets, and strategy.
• All this makes employees feel genuinely better about their jobs and work environment and the merits of what the company is trying to accomplish.
• Employees are stimulated to take on the challenge of realizing the company’s vision, do their jobs competently and with enthusiasm, and collaborate with others as needed to bring the strategy to success.

Question 13.
Jupiter Electronics Ltd, is known for its ability to come out with path-breaking products. Though the work environment at Jupiters is relaxed and casual, yet, there is a very strong commitment to deadlines. The employees believe in “work hard play hard” ethic. The organisation has moved away from formal and hierarchical set up to a more results -driven approach. Employees are committed to strategies and work to-wards achieving them. They guard innovations, maintain confidentiality and secrecy in their working. They are closely related to values, practices, and norms of organisations.
What aspects of an organization that are being discussed? Explain. (RTP Nov. 2019)
Answer:

1. The scenario being referred to is culture in Jupiter Electronics.
2. Strong culture promotes good strategy execution when there’s fit and impels execution when there’s negligible fit.
3. A culture grounded in values, practices, and behavioural norms that match what is needed for good strategy execution helps energize people throughout the organization to do their jobs in a strategy-supportive manner.
4. A culture built around such business principles as listening to customers, encouraging employees to take pride in their work, and giving employees a high degree of decision-making responsibility.
5. This is very conducive to successful execution of a strategy of delivering superior customer service.
6. A strong strategy-supportive culture makes employees feel genuinely better about their jobs and work environment and the merits of what the company is trying to accomplish.
7. Employees are stimulated to take on the challenge of realizing the organizational vision, do their jobs competently and with enthusiasm, and collaborate with others.

Question 14.
Define Entrepreneur. What are the characteristics of an entrepreneur? (RTP May 2018)
Answer:

1. Entrepreneurship is the attempt to create value through:
   • recognition of business opportunity,
   • the management of risk taking appropriate to the opportunity and
   • through management skills to mobilize financial, human and material resources necessary to create an enterprise.
2. Entrepreneurship involves creation of a business idea and the fusion of capital, technology and human talent to give practical shape to the idea.
3. The person who perceives the business idea and take steps to implement the idea is known as an entrepreneur.
4. An entrepreneur is an individual who conceives the idea of starting a new venture, takes all types of risks, not only to put the product or service into reality but also to make it an extremely demanding one.
5. An entrepreneur is one who:
   • Initiates and innovates a new concept.
   • Recognises and utilises opportunity.
   • Arranges and coordinates resources such as man, material, machine and capital.
   • Faces risks and uncertainties.
   • Establishes a startup company.
   • Adds value to the product or service.
   • Takes decisions to make the product or service a profitable one.
   • Is responsible for the profits or losses of the company.

Strategy Implementation and Control – CA Inter SM Notes is designed strictly as per the latest syllabus and exam pattern.

Strategy Implementation and Control – CA Inter SM Study Material

Question 1.
HQ is a service company? Two years back the company hired a re-puted management consultant to formulate its strategy. The consultant recommended an aggressive expansion plan. Now in an internal review meeting the company finds that many of the suggestions are not even fully considered. Which part of strategic management process is missing in HQ? (RTP May 2019)
Answer:

1. Implementation is the managerial exercise of putting a chosen strategy into action which is missing in case of HQ.
2. It deals with the managerial exercise of supervising the ongoing quest of strategy, making it work, improving the ability with which it is executed and showing measurable progress in attaining the targeted % results.
3. Strategic implementation is concerned with translating a strategic decision into action, which pre-supposes that the decision itself (i.e., the strategic choice) was made with some thought being given to feasibility and acceptability.
4. The apportionment of resources to new courses of action will need to be undertaken, and there may be a need for familiarizing the organi-zation’s structure to handle new activities as well as training personnel and formulating appropriate systems.
5. It is crucial to realize the difference between the formulation and implementation because they both require very different skills.
6. Also, a company will be successful only when the strategy formulation is sound and implementation is excellent.

Question 2.
Write a short note on strategic change and explain the process of strategic change. (Alov 2018; 7 Marks)
OR
Specify the steps that is needed to initiate & bring changes in the strategic building of any organization.
OR
Write a short note on Steps for initiating a strategic change.
Answer:
Meaning Of Strategic Change:

Changes in the environmental forces require businesses to bring modifi-cations in existing strategies and bring out new strategies.
Strategic change is a complex process that involves a corporate strategy focused on new markets, products, services, etc.

Steps to initiate strategic change: For initiating strategic change, three steps can be identified as under:

1. Recognize the need for change:

• First step is to identify which facets of the present corporate culture are strategy supportive and which are not.
• This basically means going for environmental scanning involving appraisal of both internal and external capabilities may be through SWOT analysis and then deciding where the gap lies and scope for change exists.

2. Create a shared vision to manage change:

• Objectives of both individuals and organization should coincide. There should be no conflict between them.
• This is possible only if the management and the organization members follow a shared vision.
• Senior managers need to constantly and consistently communi-cate the vision to all the organizational members,
• They have to convince all those concerned that the change in business culture is not superficial or cosmetic.
• The actions taken have to be credible, highly visible and unmis-takably indicative of management’s seriousness to new strategic initiatives and associated changes.

3. Institutionalise the change:

• This is basically an action stage which requires implementation of changed strategy.
• Creating and sustaining a different attitude towards change is essential to ensure that the firm does not slip back into old ways of thinking or doing things.
• Capacity for self-renewal should be a fundamental anchor of the new culture of the firm. Besides, change process must be regularly monitored and reviewed to analyse the after effects of change.

Any discrepancy or deviation should be brought to the notice of per-sons concerned so that the necessary corrective actions are taken, ft takes time for the changed culture to prevail.

Question 3.
Distinguish between Strategy Formulation and Strategy Implementa-tion. (May 2019; 3 Marks)
Answer:
Strategy implementation is fundamentally different from strategy formulation in the following ways:

Strategy Formulation	Strategy Implementation
♦ Strategy formulation focuses on effectiveness. ♦ Strategy formulation is primarily an intellectual process. ♦ Strategy formulation requires conceptual intuitive and analytical skills. ♦ Strategy formulation requires co­ordination among the executives at the top level.	♦ Strategy implementation focuses on efficiency. ♦ Strategy implementation is primar­ily an operational process. ♦ Strategy implementation requires motivation and leadership skills. ♦ Strategy implementation requires coordination among the execu­tives at the middle and lower levels.

Question 4.
What is strategic change? Explain the change process proposed by Kurt Lewin that can be useful in implementing strategies?
OR
ABC Ltd. plans to introduce changes in its structure, technology and people Explain how Kurt Lewin’s change process can help this firm.
Answer:
The changes in the environmental forces frequently require businesses to make alterations in their current strategies and bring out new strategies, Strategic change is a complex process and it involves a corporate strategy focused on new markets, products, services and new ways of doing business.

To make the change lasting, Kurt Lewin proposed three phases of the change process namely unfreezing, changing and refreezing for moving the organization from the present to the future explained as follows:

(a) Unfreezing the situation: The process of unfreezing simply makes the individuals or organizations conscious of the need for change and pre-pares them for such a change. Lewin suggests that the changes must not come as a surprise to the members of the organization. Abrupt and unexpected change would be socially destructive and morale lowering. The management must pave the way for the change by first “unfreezing the situation”, so that members would be organized and prepared to accept the change.

Unfreezing is the procedure of breaking down the old attitudes and behaviours, customs and traditions so that they start with a clean slate. This can be achieved by making announcements, holding meetings and promoting the ideas throughout the organization.

(b) Changing to New situation: Once the unfreezing process has been accomplished and the members of the organization identify the need for change and have been completely prepared to accept such change, their behaviour patterns is required to be redefined.

H.C. Kellman has proposed three methods for reassigning new patterns of behaviour. These are, internalization, identification and compliance.

Internalization: Internalization includes some internal changing of the individual’s thought processes in order to adjust to a new environment. They have given freedom to learn and adopt new behaviour in order ® to succeed in the new set of circumstances.

Identification: Identification occurs when members are psychologically impressed upon to recognize themselves with some given role models whose behaviour they would like to adopt and try to become like them.

Compliance: It is attained by stringently imposing the reward and punishment strategy for good or bad behaviour. Fear of punishment, actual punishment or actual reward appears to change behaviour for the better.

(c) Refreezing: Refreezing occurs when the new behaviour becomes a normal way of life. The new behaviour must swap the previous be-haviour entirely for successful and permanent change to take place. In order for the new behaviour to become permanent, it must be continuously strengthened so that this new acquired behaviour does not diminish or extinguish.

Change process is not a one-time application but a continuous process due to dynamism and ever changing environment. The process of unfreezing, changing and refreezing is a cyclical one and remains continuously in action.

Question 5.
What is strategic control? Briefly explain the different types of strategic control. (May 2018; 5 Marks)
OR
What is implementation control? Discuss its basic forms. (RTPNov 2019)
Answer:
Strategic control concentrates on the twin questions of whether:
(1) the strategy is being implemented as planned; and
(2) the results produced by the strategy are those intended.
There are four types of strategic control as follows:

* PREMISE CONTROL: A strategy is designed on the basis of certain as-sumptions or premises about the complex and unstable organizational environment. Over a period of time these premises may not remain effective. Premise control is a device for methodical and non-stop monitoring of the environment to confirm the validity and correctness of the premises on which the strategy has been built. It mainly includes monitoring two types of factors:

1. Environmental factors such as economic (inflation, liquidity, interest rates), technology, social and legal-regulatory.
2. Industry factors such as competitors, suppliers, substitutes.

STRATEGIC SURVEILLANCE: Opposing to the premise control, the strategic surveillance is unfocussed. It involves over-all monitoring of various sources of information to uncover unexpected information having a bearing on the organizational strategy. It involves informal environmental browsing. Reading financial and other newspapers, business magazines, attending meetings, conferences, discussions and so on can help in strategic surveillance.
Strategic surveillance may be free form of strategic control, but is capable of exposure to information relevant to the strategy.

SPECIAL ALERT CONTROL: At times, unpredicted events may force or-ganizations to reassess their strategy. Abrupt changes in Government, natural calamities, terrorist attacks, unexpected merger/acquisition by competitors, industrial disasters and other such events may cause an immediate and vigorous assessment of strategy. To manage with such possibilities, the organisations form crisis management teams to process the situation.

IMPLEMENTATION CONTROL:
Managers implement strategy by translating major plans into concrete, chronological actions that form incremental steps. Implementation control is focused towards assessing the need for changes in the overall strategy in light of disclosing events and results connected with incremental steps and actions.

Strategic implementation control is not a replacement to operational control. Unlike operational control, it endlessly monitors the basic direction of the strategy. The two basic forms of implementation control are:

1. Monitoring strategic thrusts: Monitoring strategic thrusts helps managers to determine whether the overall strategy is developing as desired or whether there is need for modifications.
2. Milestone Reviews: All key activities essential to implement strategy are separated in terms of time, events or major resource apportionment. It typically includes a complete reconsideration of the strategy. It also measures the requirement to continue or refocus the direction of an organization.

Question 6.
Explain the concept and need of Strategy Audit. (May 2018; 4 Marks)

Kewal Kapadia is the Managing Director of KK industries located in Kan-pur. In a review meeting with the head of finance, Kuldeep Khaitan he said that in the first five years of last decade the company grew between 8-10 per cent every year, then the growth rate started falling and in previous year the company managed 1 per cent. Kuldeep replied that the company is facing twin issues, one the strategy is not being implemented as planned; and two the results produced by the strategy are not in conformity with the intended goals. There is mismatch between strategy formulation and implementation. Kewal disagreed and stated that he takes personal care in implementing all strategic plans.

You have been hired as a strategy consultant by the KK Industries. Advise way forward for the company to identify problem areas and correct the strategic approaches that have not been effective. (RTP May 2018)
Answer:
MEANING OF STRATEGY AUDIT:
A strategy audit is an examination and evaluation of areas affected by the operation of a strategic management process within an organization. The audit of management performance with regard to its strategies helps an organization identify problem areas and correct the strategic approaches that have not been effective.

A strategy audit is needed under the following conditions:

• When the performance indicators reflect that a strategy is not working properly or is not producing chosen outcomes.
• When the goals and objectives of the strategy are not being achieved.
• When a main change takes place in the external environment of the organization.
• When the top management plans:

(a) to adjust the current strategies and present new strategies and
(b) to confirm that a strategy that has operated in the past continues to be in-tune with slight internal and external changes that may have happened since the construction of strategies.
Tolerable and timely feedback is the foundation of actual strategy audit. Strategy audit can be no better than the information on which it is built.

Strategy Audit includes three basic activities:

1. Examining the underlying bases of a firm’s strategy,
2. Comparing expected results with actual results, and Taking corrective actions to ensure that performance conforms to plans.

Question 7.
What is Strategy Audit? Explain briefly the criteria for strategy audit given by Richard Rumelt’s. (RTP Nov 2018)
Answer:
A strategy audit is an examination and assessment of areas affected g by the operation of a strategic management process within an organization.

Richard Rumelt’S Criteria For Strategy Audit

A. Consistency: A strategy should not present irregular goals and policies. Organizational struggle and interdepartmental disputes are often symptoms of managerial disorder, but these problems may also be a sign of strategic inconsistency. (Bickering means: Argue about petty matters)

Three guidelines help determine if organizational problems are due to inconsistencies in strategy:

• If managerial problems continue in spite of change in personnel and if they manage to be issue-based instead of people-based, then strategies may be unreliable.
• If success for one organizational department means, or is inter-preted to mean, failure for another department, then strategies may be inconsistent.
• If policy problems and issues continue to be brought to the top for resolution, then strategies may be inconsistent.

B. Consonance: Consonance refers to the need for strategists to examine sets of trends, as well as individual trends, in auditing strategies. A strategy must represent an adaptive response to the external envi-ronment and to the critical changes occurring within it.

One trouble in matching a firm’s key internal and external factors in the preparation of strategy is that most trends are the outcome of interactions among other trends. For example, the day-care school/ centre came about as a combined result of many trends that included a growth in the average level of education, need for different education training, increase in income, inflation, and an increase in women in the workforce. Even though single economic or demographic trends might appear stable for many years, there are waves of change going on at the interaction level.

C. Feasibility: A strategy must neither over tax available resources nor create unsolvable sub-problems. The final broad test of strategy is its feasibility; that is, can the strategy be attempted within the physical, human, and financial resources of the enterprise? The financial re-sources of a business are the easiest to quantify and are normally the first constraint against which strategy is reviewed. It is occasionally overlooked, however, that innovative approaches to financing are every so often possible.

Devices, such as captive subsidiaries, sale-leaseback arrangements, and tying plant mortgages to long-term contracts, have all been used well to help win key positions in unexpectedly expanding industries. A less measurable, but actually more rigid, limitation on strategic choice is that executed by individual and organizational capabilities. In auditing a strategy, it is important to examine whether an organization has demonstrated in the past that it possesses the abilities, competencies, skills, and talents needed to carry out a given strategy.

D. Advantage: A strategy must provide for the creation and/or main-tenance of a competitive advantage in a selected area of activity. Competitive advantages normally are the result of superiority in one of three areas:

1. resources,
2. skills, or
3. position.

The idea that the positioning of firm’s resources that enhance their combined effectiveness is familiar to military theorists and chess players. Position can also play a crucial role in an organization’s strategy. Once gained, a good position is defensible—meaning that it is so costly to capture that rivals are deterred from full- scale attacks. Positional advantage tends to be self-sustaining as long as the key internal and environmental factors that inspire it to remain stable. This is why entrenched firms can be almost impossible to unseat, even if their skill levels are only average.

Although not all positional advantages are related with size, it is true that bigger organizations have a tendency to operate in markets and use procedures that turn their size into advantage, while smaller firms seek product/market positions that exploit other types of advantage. The main characteristic of good position is that it authorizes the firm to obtain advantage from policies that would not similarly benefit rivals without the same position. Therefore, in auditing strategy, organizations should examine the nature of positional advantages associated with a given strategy.

Question 8.
Why Strategy Audit is more difficult in present scenario? (May 2018; 3 Marks)
Answer:
Reasons why strategy evaluation is more difficult today include the following trends:

• A spectacular increase in the environment’s complexity.
• The increasing difficulty of predicting the future with accuracy.
• The increasing number of variables in the environment.
• The rapid rate of obsolescence of even the best plans.
• The increase in the number of both domestic and world events affect-ing organizations.
• The decreasing time span for which planning can be done with any degree of certainty.

Question 9.
Explain concept and nature of BPR. (Nov. 2019; 5 Marks)
Answer:
BPR stands for business process re-engineering which means starting all over again from scratch. It refers to the analysis and redesign of workflows and processes both within and between the organisations. Its objective is to improve performance in terms of time, cost, quality, and responsiveness to customers. It implies giving up old practices and adopting the improved ones. It is an effective tool of realising new strategies.

Improving business processes is paramount for businesses to stay compet-itive in today’s marketplace. New technologies are rapidly bringing new capabilities to businesses, thereby raising the strategical options and the need to improve business processes dramatically. Even the competition has become harder. In today’s marketplace, major changes are required to just stay even.

Question 10.
India’s luxurious domestic airline Indijet in an attempt to retain its leadership in aviation sector lias hired J S Dutta as its Chief Executive. Mr Dutta wishes to reorient company to make it a domestic discount carrier.

He desires to introduce no frills business model by offering extremely low fares and improve margins by cutting down traditional amenities such as reclining seats and complimentary meals. At the same time setting the stage for a new air revolution, he wishes to brand itself as on-time airlines having proper systems in place and removing additional and wasteful activities and processes.
What steps will you advise to Mr Dutta? (RTP Nov 2019)
Answer:
[Mr Dutta should adopt business process reengineering (BPR).]

1. Business Process Reengineering (BPR) is an approach to unusual improvement in operating effectiveness through the redesigning of critical business processes and supporting business systems.
2. It is revolutionary redesign of key business processes that involves examination of the basic process itself.
3.  It looks at the minute details of the process, such as why the work is done, who does it, where is it done and when it is done.
4. BPR refers to the analysis and redesign of workflows and processes both within the organization and between the organization and the external entities like suppliers, distributors, and service providers.
5.  The orientation of redesigning efforts is basically radical. In other words, it is a total deconstruction and rethinking of business process in its entirety, unconstrained by its existing structure and pattern.
   6. Its objective is to obtain quantum jump in process performance in terms of time, cost, output, quality, and responsiveness to customers.

BPR is a revolutionary redesigning of key business processes. BPR involves the following steps:

1. Determining objectives and framework: Objectives are the desired end results of the redesign process which the management and organization attempts to achieve. This will provide the required focus, direction, and motivation for the redesign process. It helps in building a comprehensive foundation for the reengineering process.
2. Identify customers and determine their needs: The designers have to understand customers – their profile, their steps in acquiring, using and disposing a product. The purpose is to redesign business process that clearly provides added value to the customer.
3. Study the existing process: The existing processes will provide an important base for the redesigners. The purpose is to gain an under-standing of the ‘what’, and ‘why’ of the targeted process. However, some companies go through the reengineering process with clean perspective without laying emphasis on the past processes.
4. Formulate a redesign process plan: The information obtained through the earlier steps is translated into an ideal redesign process. Formu-lation of redesign plan is the real crux of the reengineering efforts. Customer focused redesign concepts are identified and formulated. In this step alternative processes are considered and the best is selected.
5. Implement the redesign: It is easier to formulate new process than to implement them. Implementation of the redesigned process and application of other knowledge gained from the previous steps is key to achieve dramatic improvements. It is the joint responsibility of the designers and management to operationalize the new process.

Question 11.
Identify three aspects of impact of IT Systems on Business Process Reengineering and list three areas where it provides business value. (Nov 2018; 3 Marks)
Answer:
Impact of IT-systems are identified as:

• Compression of time
• Overcoming restrictions of geography and/or distance
• Restructuring of relationships.

IT-initiatives, thus, provide business values in three distinct areas:

• Efficiency – by way of increased productivity,
• Effectiveness – by way of better management,
• Innovation – by way of improved products and services

All these can bring about a fundamental change in the quality of products and services, thereby improving the competitiveness and customer satis-faction. Information technology (IT) is a critical factor in the success of bringing this change.

Question 12.
What is Benchmarking? Explain briefly the elements involved in Benchmarking process. (RTP May 2018; RTP May 2019)
OR
What is Benchmarking? Explain the various steps in Benchmarking pro-cess. (May 2019; 7 Marks)
OR
Swift Ltd and Quick Ltd are two companies that are in the business of light industrial machines. While Swift is the market leader the sales of Quick has been falling. In the year 2017-18 the market share of the two companies was forty per cent and five per cent respectively. During the last five years the market share of quick reduced from third to sixth position.

As an immediate corrective measure top management of Quick decided to emulate the successful standards of Swift Ltd and set them as their own yardsticks. With the help of standards they intended to compare, measure and judge their performance.
What is the strategic tool Quick Ltd is adopting? How is it implemented? (RTP Nov 2018)
Answer:

• It is a process of finding the best practices within and outside the in-dustry to which an organisation belongs. Knowledge of the best helps in standards setting and finding ways to match or even surpass own performances with the best performances.
• Benchmarking is an approach of setting goals and measuring produc-tivity of firms based on best industry practices or against the products, services and practices of its competitors or other acknowledged leaders in the industry.
• It developed out of need to have information against which perfor-mance can be measured.
• Benchmarking helps businesses in improving performance by learning from the best practices and the processes by which they are achieved.
• Thus, benchmarking is a process of continuous improvement in search for competitive advantage.
• Firms can use benchmarking practices to achieve improvements in diverse range of management functions like product development, customer services, human resources management, etc.
• The top management of Quick Ltd is doing benchmarking.
• The benchmarking helps an organization to get ahead of competition.
• A benchmark may be defined as a standard or a point of reference against which things may be compared and by which something can be measured and judged.
• In simple words, benchmarking is an approach of setting goals and measuring productivity based on best industry practices. In recent years, different commercial and non-commercial organizations are discovering the value of benchmarking and are applying it to improve their processes and systems.]

The various steps in Benchmarking Process are as under:

1. Identifying the need for benchmarking: This step will define the ob-jectives of the benchmarking exercise. It will also involve selecting the type of benchmarking. Organizations identify realistic opportunities j for improvements.
2. Clearly understanding existing decisions processes: The step will con-tain compiling information and data on performance.
3. Identify best processes: Within the selected framework best processes are identified. These may be within the same organization or external to them.
4. Comparison of own process and performance with that of others: Benchmarking process also includes comparison of performance of the organization with performance of other organization. Any deviation between the two is analyzed to make additional improvements.
5. Prepare a report and implement the steps necessary to close the performance gap: A report on benchmarking initiatives containing recommendations is prepared. Such a report also contains the action plans for implementation.
6. Evaluation: Business organizations evaluate the results of the bench-marking process in terms of improvements vis-a-vis objectives and other criteria set for the purpose. It also periodically evaluates and reset the benchmarks in the light of changes in the conditions that impact the performance.

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

Audit of Items of Financial Statements – CA Inter Auditing Notes

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

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

Trade Receivable

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

2. The following shall be shown separately:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(c) When auditor attend inventory taking, he ensures that the instructions given for inventory taking is followed.

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

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

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

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

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

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

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

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

5. Compare recorded costs with replacement costs.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(b) Goodwill:

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

(c) Patents:

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

(d) Trade Marks and Copyrights:

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

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

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

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

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

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

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

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

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

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

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

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

(A) Examination of Records:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(a) a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or
(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made.

Recognition Principle of Contingent Liabilities

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

(c) Measurement: Depreciation and amortisation expenses have been measured appropriately.

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

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

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

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

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

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

Audit Procedure to Vouch Power and Fuel expenses:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Audit Report – CA Inter Auditing Notes is designed strictly as per the latest syllabus and exam pattern.

Audit Report – CA Inter Auditing Notes

Question 1
In order to form the audit opinion as required by SA 700, the auditor shall conclude as to whether the auditor has obtained reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. Explain the conclusions that the auditor shall take into account. Also explain the objective of auditor as per SA 700.
[MTP-Aug. 18]
Or
“An auditor is required to make specific evaluations while forming an opinion in an audit report.” State them. [Nov. 18 (5 Marks)]
Answer:
Forming an Opinion on the Financial Statements:
SA 700 “Forming an Opinion & Reporting on Financial Statements” requires that auditor shall form an opinion on whether the Financial statements (F.S.) are prepared in all material respects in accordance with the applicable financial reporting framework (FRF).
To form this opinion, auditor needs to conclude as to whether he has obtained reasonable assurance that FS as a whole are free of material misstatements, whether due to fraud or error. The conclusion shall take into account:
(a) The auditor’s conclusion, in accordance with SA 330, whether sufficient appropriate audit evidence has been obtained;

(b) The auditor’s conclusion, in accordance with SA 450, whether uncorrected misstatements are material, individually or in aggregate; and

(c) The evaluations mentioned below:
1. Whether the financial statements are prepared, in all material respects, in accordance with the requirements of the applicable FRF. This evaluation shall include consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s judgments.

2. Whether, in view of the requirements of the applicable FRF:

• The F.S. adequately disclose the significant accounting policies selected and applied;
• The accounting policies selected and applied are consistent with the applicable FRF and are appropriate;
• The accounting estimates made by management are reasonable;
• The information presentedin the F.S. isrelevant,reliable, comparableand understandable;
• The F.S. provide adequate disclosures to enable the intended users to understand the effect of material transactions and events on the information conveyed in the F.S., and
• The terminology used in the F.S., including the title of each F.S., is appropriate.

3. When the F.S. are prepared in accordance with a fair presentation framework, auditor is required to evaluate whether the F.S. achieve fair presentation by considering the following:

• The overall presentation, structure and content of the F.S. and
• Whether the F.S., including the related notes, represent the underlying transactions and events in a manner that achieves fair presentation.
• Whether the F.S. adequately refer to or describe the applicable FRF.

Question 2.
The auditor’s report shall include a section with a heading “Responsibilities of Management for the j Financial Statements.” SA 200 explains the premise, relating to the responsibilities of management ! and, where appropriate, those charged with governance, on which an audit in accordance with SAs is conducted. Explain. [RTP-Nov. 18, MTP-April 19, May 20]
Answer:
Responsibilities of Management for the Financial Statements:
As per SA 700 “Forming an Opinion & Reporting on Financial Statements” the auditor’s report shall include a section with a heading “Responsibilities of Management for the Financial Statements.”

This section of the auditor’s report shall describe management’s responsibility for:
(a) Preparing the F.S. in accordance with the applicable FRF, and for such internal control as management determines is necessary to enable the preparation of F.S. that are free from material misstatement, whether due to fraud or error; and

(b) Assessing the entity’s ability to continue as a going concern and whether the use of the going concern basis of accounting is appropriate as well as disclosing, if applicable, matters relating to going concern. The explanation of management’s responsibility for this assessment shall include a description of when the use of the going concern basis of accounting is appropriate.

Question 3.
When does an auditor issue unqualified opinion and what does it indicate. [May 08 (4 Marks)]
Or
The Auditor is fully satisfied with the audit of an entity in respect of its systems and procedures and wants to issue a report without any hesitation. What type of opinion can be given and give reasoning. [MTP-April 19]
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 4.
State any six elements of the Auditor’s Report. [Nov. 12 (6 Marks)]
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 sets 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 Reporting Responsibilities: 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 5.
The auditor’s report shall include a section, directly following the Opinion section, with the heading “Basis for Opinion”. Explain what is included in this “Basts for Opinion” section, [RTP-Nov. 19, May 20, Nov. 20]
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 sets 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 Reporting Responsibilities: 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 6.
The first section of the auditor’s report shall include the auditor’s opinion, and shall have the heading “Opinion.’’ The Opinion section of the auditor’s report shall also Identify the entity whose financial statements have been audited. Apart from the above, explain the other relevant points to be included in opinion section. [RTP-May 20]
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 sets 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 Reporting Responsibilities: 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 7.
Communicating Key Audit Matter is not a substitute for disclosure in the Financial Statements rather Communicating key audit matters in the auditor’s report is in the context of the Auditor having formed an opinion on the financial statements as a whole. Analyse. [RTP-May 18]
Answer:
Scope of SA 701:
This SA deals with the auditor’s responsibility to communicate key audit matters in the auditor’s report.

Communicating key audit matters in the auditor’s report is not:
(a) A substitute for disclosures in the F.S. that the applicable FRF requires management to make, or that are otherwise necessary to achieve fair presentation;
(b) A substitute for the auditor expressinga modified opinion when required by the circumstances of a specific audit engagement in accordance with SA 705;
(c) A substitute for reporting in accordance with SA 570 when a material uncertainty exists relating to events or conditions that may cast significant doubt on an entity’s ability to continue as a going concern; or
(d) A separate opinion on individual matters.

• SA 701 applies to audits of complete sets of general purpose F.S. of listed entities and circumstances when the auditor otherwise decides to communicate key audit matters in the auditor’s report.
• SA 701 also applies when the auditor is required by law or regulation to communicate key audit matters in the auditor’s report.
• SA 705 prohibits the auditor from communicating key audit matters when the auditor disclaims an opinion on the financial statements, unless such reporting is required by law or regulation.

Question 8.
Explain clearly the 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 communicating Key Audit matters as per SA 701 are:

• 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 9.
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
How would an auditor determine Key Audit Matters as per SA – 701, “Communicating Key Audit Matters in the Independent Auditor’s Report”? [Nov. 20 (3 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 F.S. 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 F.S. of the current period and therefore are the key audit matters.

Question 10.
State the circumstances in which a matter determined to be 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 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 11.
What is a qualified auditor report? Under what circumstances a qualified report is issued. [May 07 (8 Marks)]
Answer:
Qualified Opinion:
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

SA 705 “Modification to the Opinion in the Independent Auditor’s Report” requires the auditor to add one more para named as “Basis for Qualified Opinion Para” in the audit report immediately before the opinion para stating therein the reasons for the qualified opinion.
The opinion para in case of qualified opinion will be worded as follow:
“Except for the effects of the matter(s) described in the Basis for Qualified Opinion paragraph, the Financial statements gives a true and fair view in all material respects in accordance with the applicable FRF”.

Question 12.
What is clean audit report. Explain how it is different from qualified report affecting Auditor’s opinion. [Nov. 07 (8 Marks)]
Answer:
Clean Audit Report:
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.

Qualified Opinion:
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

SA 705 “Modification to the Opinion in the Independent Auditor’s Report” requires the auditor to add one more para named as “Basis for Qualified Opinion Para” in the audit report immediately before the opinion para stating therein the reasons for the qualified opinion.
The opinion para in case of qualified opinion will be worded as follow:
“Except for the effects of the matter(s) described in the Basis for Qualified Opinion paragraph, the Financial statements gives a true and fair view in all material respects in accordance with the applicable FRF”.

Question 13.
Write short note on: Disclaimer of opinion. [Nov. 08 (5 Marks)]
Or
State briefly the circumstances when an auditor issues a disclaimer of opinion. [Nov. 10 (4 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 ICAI. 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 14.
Differentiate between ‘Qualified Report’ and ‘Adverse Report’. [May 10 (5 Marks)]
Answer:
Distinction between Qualified Report and Adverse Report:

	Qualified report	Adverse report
Circumstances in which it is issued	A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with management is not so material and pervasive as to require an adverse opinion, or limitation on scope is not so material and pervasive as to require a disclaimer of opinion.	An adverse opinion should be expressed when the effect of a disagreement is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is not adequate, to disclose the misleading or incomplete nature of the financial statements.
Reporting	In qualified report, the auditor’s reservation is generally written as “subject to or except for, we report that the Balance Sheet shows a true and fair view”.	In adverse report, the auditor states that “the financial statements do not present a true and fair view of the state of affairs and working results”.

Question 15.
State the circumstances which could lead to any of the following in an Auditors Report:
(i) A modification of opinion
(ii) Disclaimer of opinion
(iii) Adverse opinion
(iv) Qualified opinion [May 13 (8 Marks)]
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 16.
Discuss the following: The Auditor’s Report is considered to be modified under certain circumstances. [May 15 (5 Marks)]
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:
4 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 thatthe 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: Itis issued when auditor is unable to obtain Sufficient and appropriate audit evidence which in the auditor judgment are having pervasive effect.

Question 17.
Write short note on: Qualified Opinion. [Nov. 15 (4 Marks)]
Answer:
Qualified Opinion:
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

SA 705 “Modification to the Opinion in the Independent Auditor’s Report” requires the auditor to add one more para named as “Basis for Qualified Opinion Para” in the audit report immediately before the opinion para stating therein the reasons for the qualified opinion.
The opinion para in case of qualified opinion will be worded as follow:
“Except for the effects of the matter(s) described in the Basis for Qualified Opinion paragraph, the Financial statements gives a true and fair view in all material respects in accordance with the applicable FRF”.

Question 18.
What is Emphasis of matter Paragraph? State the circumstances when EOM para can be included in Auditor’s report
Answer:
Emphasis of Matter Paragraph:
SA 706 “Emphasis of matter Paragraph and Other Paragraphs in the Independent Auditor’s Report” defines Emphasis of Matter paragraph as Para included in Auditor’s Report that refers to a matter appropriately presented/ disclosed in financial statement that in the auditor’s judgment is of such importance that it is fundamental to users’ understanding of financial statements.

EOM paragraph is not a substitute for need for expression of qualified opinion, adverse opinion or Disclaimer of opinion or the disclosures to be made by management in Financial statements as required by applicable FRF.

Circumstances when EOM Para can be included in Auditor’s Report:
An uncertainty relating to the future outcome of an exceptional litigation or regulatory action.
Early application (where permitted) of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date.
A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.

Question 19.
What is Modified Reports? Discuss disclosure pattern when the auditor includes an Emphasis of Matter Paragraph in the Auditor’s Report. (May 14 (5 Marks)]
Answer:
Modified Reports:
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

SA 705 “Modification to the Opinion in the Independent Auditor’s Report” requires the auditor to add one more para named as “Basis for Qualified Opinion Para” in the audit report immediately before the opinion para stating therein the reasons for the qualified opinion.
The opinion para in case of qualified opinion will be worded as follow:
“Except for the effects of the matter(s) described in the Basis for Qualified Opinion paragraph, the Financial statements gives a true and fair view in all material respects in accordance with the applicable FRF”.

Disclosure pattern of EOM paragraph:
As per SA 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent 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

(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.

Question 20.
What is an Emphasis of Matter paragraph, when it is used and manner of its use in an audit report? [May 17 (4 Marks)]
Or
Define emphasis of matter paragraph and how it should be disclosed in the independent auditor’s report? [May 18 (5 Marks)]
Or
Define Emphasis of Matter paragraph. When the auditor shall include an Emphasis of Matter paragraph in the auditor’s report? Also explain how the auditor would include an Emphasis of Matter in the auditor’s report? [RTP-May 19]
Answer:
Emphasis of Matter Paragraph:
SA 706 “Emphasis of matter Paragraph and Other Paragraphs in the Independent Auditor’s Report” defines Emphasis of Matter paragraph as Para included in Auditor’s Report that refers to a matter appropriately presented/ disclosed in financial statement that in the auditor’s judgment is of such importance that it is fundamental to users’ understanding of financial statements.

EOM paragraph is not a substitute for need for expression of qualified opinion, adverse opinion or Disclaimer of opinion or the disclosures to be made by management in Financial statements as required by applicable FRF.

Circumstances when EOM Para can be included in Auditor’s Report:
An uncertainty relating to the future outcome of an exceptional litigation or regulatory action.
Early application (where permitted) of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date.
A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.

Disclosure ofEmphasis ofMatter Paragraph in the Auditor’s report:
Modified Reports:
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive.

SA 705 “Modification to the Opinion in the Independent Auditor’s Report” requires the auditor to add one more para named as “Basis for Qualified Opinion Para” in the audit report immediately before the opinion para stating therein the reasons for the qualified opinion.
The opinion para in case of qualified opinion will be worded as follow:
“Except for the effects of the matter(s) described in the Basis for Qualified Opinion paragraph, the Financial statements gives a true and fair view in all material respects in accordance with the applicable FRF”.

Disclosure pattern of EOM paragraph:
As per SA 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent 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

(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.

Circumstances when EOM Para can be included in Auditor’s Report:
Emphasis of Matter Paragraph:
SA 706 “Emphasis of matter Paragraph and Other Paragraphs in the Independent Auditor’s Report” defines Emphasis of Matter paragraph as Para included in Auditor’s Report that refers to a matter appropriately presented/ disclosed in financial statement that in the auditor’s judgment is of such importance that it is fundamental to users’ understanding of financial statements.

EOM paragraph is not a substitute for need for expression of qualified opinion, adverse opinion or Disclaimer of opinion or the disclosures to be made by management in Financial statements as required by applicable FRF.

Circumstances when EOM Para can be included in Auditor’s Report:
An uncertainty relating to the future outcome of an exceptional litigation or regulatory action.
Early application (where permitted) of a new accounting standard that has a pervasive effect on the financial statements in advance of its effective date.
A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.

Question 21.
State clearly the objective of the Auditor as per SA 706. Also define emphasis of matter paragraph and other matter paragraph. [MTP-Oct. 20]
Answer:
Objectives of the Auditor as per SA 706:
The objective of the auditor, having formed an opinion on the financial statements, is to draw users’ attention, when in the auditor’s judgment it is necessary to do so, by way of clear additional communication in the auditor’s report, to:
(a) A matter, although appropriately presented or disclosed in the financial statements, that is of such importance that it is fundamental to users’ understanding of the financial statements; or

(b) As appropriate, any other matter that is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

Definition of EOM and OM Para:
SA 706 defines the emphasis of matter paragraph as a Para included in Auditor’s Report that refers to a matter appropriately presented/disclosed in financial statement that in the auditor’s judgment is of such importance that it is fundamental to users’ understanding of financial statements.

SA 706 defines the Other Matter paragraph as a paragraph included in the auditor’s report that refers to a matter other than those presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

Question 22.
The nature of the comparative information that is presented in an entity’s financial statements depends on the requirements of the applicable financial reporting framework. There are two different broad approaches to the auditor’s reporting responsibilities in respect of such comparative information: corresponding figures and comparative financial statements. Explain clearly stating the essential audit reporting differences between the approaches. Also define comparative information and audit procedures regarding comparative information. [RTP-May 19]
Answer:
Meaning of Comparative Information:
SA 710 “Comparative Information – Corresponding Figures and Comparative Financial Statements” defines the term comparative information as the amounts and disclosures included in the financial statements in respect of one or more prior periods in accordance with the applicable FRF.

Comparative information where amounts and other disclosures for the prior period, are included as an integral part of current period financial statements and are intended to be read only in relation to the amounts and other disclosures relating to the current period is known as Corresponding Figures.

Comparative information where amounts and other disclosures for the prior period, are included for comparison with the financial statements of the current period but, if audited, are referred to in the auditor’s opinion is known as Comparative financial statements.

Essential reporting difference:
The essential audit reporting differences between the approaches are:
(a) For corresponding figures, the auditor’s opinion on the financial statements refers to the current period only; whereas
(b) For comparative financial statements, the auditor’s opinion refers to each period for which financial statements are presented.
Audit procedures regarding comparative information:

Auditor’s responsibilities w.r.t. Comparative Information:
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.

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.

When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding figures because the auditor’s opinion is on the current period financial statements as a whole including the corresponding figures.

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.

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.
TAXMAMM’

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.

Question 23.
What are the auditor’s responsibilities in respect of corresponding figures.
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 24.
The extent of audit procedures performed on corresponding figures is less compared to audit of current period figure’s reporting. Justify the statement with regard to auditor’s duties for reporting of comparatives under SA 710. [May 10 (5 Marks)]
Answer:
Auditor’s responsibilities w.r.t. Comparative Information:
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.

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.

When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding figures because the auditor’s opinion is on the current period financial statements as a whole including the corresponding figures.

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.

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.
TAXMAMM’

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.

Question 25.
When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding figures except in some circumstances. Explain those circumstances. [MTP-Aug. 18]
Or
When corresponding figures are presented, the auditors’ opinion shall not refer to the corresponding figures. Discuss the exceptions of the above statement when the prior period financial statements are audited. [Nov. 19 (4 Marks)]
Answer:
Audit reporting on Corresponding Figures:
When corresponding figures are presented, the auditor’s opinion shall not refer to the corresponding
figures except in the following circumstances.
1. If the auditor’s report on the prior period, as previously issued, included a qualified opinion, a disclaimer of opinion, or an adverse opinion and the matter which gave rise to the modification is unresolved, the auditor shall modify the auditor’s opinion on the current period’s financial statements. In the Basis for Modification paragraph in the auditor’s report, the auditor shall either:

(a) Refer to both the current period’s figures and the corresponding figures in the description of the matter giving rise to the modification when the effects or possible effects of the matter on the current period’s figures are material; or

(b) In other cases, explain that the audit opinion has been modified because of the effects or possible effects of the unresolved matter on the comparability of the current period’s figures and the corresponding figures.

2. If the auditor obtains audit evidence that a material misstatement exists in the prior period financial statements on which an unmodified opinion has been previously issued, the auditor shall verily whether the misstatement has been dealt with as required under the applicable financial reporting framework and, if that is not the case, the auditor shall express a qualified opinion or an adverse opinion in the auditor’s report on the current period financial statements, modified.

3. Prior Period Financial Statements Not Audited: If the prior period financial statements were not audited, the auditor shall state in an Other Matter paragraph in the auditor’s report that the corresponding figures are unaudited. Such a statement does not, however, relieve the auditor of the requirement to obtain sufficient appropriate audit evidence that the opening balances.

Objective Type Questions (Correct/Incorrect)

Question 1.
SA 700 deals with modification to the opinion in the independent Auditor’s Report.
Answer:
Statement is incorrect.

• SA 700 “Forming an opinion and Reporting on Financial Statements” does not deals with modifications to the opinion, it deals with forming an opinion and reporting on financial statements.
• Modifications to the opinion have been dealt by SA 705.

Question 2.
An adverse report is one where an auditor gives an opinion subject to certain reservation. [May 07 (2 Marks)]
Answer:
Statement is incorrect.

• SA 705 “Modifications to the opinion in the Independent Auditor’s Report” requires the auditor to express an adverse opinion when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements.
• If opinion is subject to certain reservations, auditor is required to issue qualified report.

Question 3.
Where the accounts of the company do not present a “true and fair” view, the auditor should express disclaimeil^f opinion. A [Nov. 07 (2 Marks)]
Answer:
Statement is incorrect.
SA 70 5 “Modifications to the opinion in the Independent Auditor’s Report” requires the auditor to express an adverse opinion when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements.

Disclaim of opinion is issued 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.

Question 4.
AAS 25 (SA 710) on ‘comparatives’ is applicable to corresponding previous year figures and not to comparative financial statement. [June 09 (2 Marks)]
Answer:
Statement is Incorrect as SA 710 “Comparative Information – Corresponding Figures and Comparative Financial statements” the comparative information may be in the either of two forms:

1. Corresponding Figures or
2. Comparative Financial Statements.

Question 5.
Disclaimer of opinion is issued when an auditor confronts a different stand by management in respect of a material issue which auditor does not approve of. [June 09 (2 Marks)]
Answer:
Statement is incorrect.

• If the auditor confronts a different stand with the management in respect of a material issue, he should issue a qualified report or express an adverse opinion.
• Disclaimer of opinion is issued when the auditor is not able to frame an opinion due to non availability of sufficient appropriate audit evidences.

Question 6.
The Auditor disagreed with the management with regard to the acceptability of the Accounting Policies and the inadequacy of disclosures in the financial statements and issued a disclaimer. [Nov. 09 (2 Marks)]
Answer:
Statement is incorrect.

• The auditor is wrong in issuing a disclaimer.
• If the auditor disagrees with the management in the matters relating to the acceptability of Accounting Policies selected and inadequacy of the disclosures in the financial statements, he should issue a qualified report or express an adverse opinion.

Question 7.
Emphasis of Matter paragraph in the Auditor’s Report is a substitute of Disclaimer of Opinion. [Nov. 14 (2 Marks)]
Answer:
Statement is incorrect.

• As per SA 706 “Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report”, the inclusion of an Emphasis of Matter paragraph in the auditor’s report does not affect the auditor’s opinion.
• Disclaimer of opinion is issued 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 could be both material and pervasive.

Question 8.
The auditor shall not modify the opinion in the auditor’s report. [May 15 (2 Marks)]
Answer:
Statement is incorrect.
As per SA 705 “Modifications to the Opinion in the Independent Auditor’s Report” a modified opinion is required when the auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are not free from material misstatement or the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement.

Question 9.
An auditor issues unqualified opinion when he concludes that the financial statements give true and fair view.
Answer:
Statement is correct.
An unqualified opinion should be expressed when the auditor concludes that the financial statements give a true and fair view in accordance with the financial reporting framework used for the preparation and presentation of the financial statements.

It indicates, implicitly, that any changes in the accounting principles or in the method of their application, and the effects thereof, have been properly determined and disclosed in the financial statements.

Question 10.
If Financial statements are misstated, and in the auditor’s judgment such misstatement is material and pervasive, he should issue a stated, qualified opinion. [May 17 (2 Marks), MTP-Oct. 19]
Answer:
Statement is incorrect.

• As per SA 705 “Modification to the Opinion in the Independent Auditor’s Report” if financial statements are misstated, and in the auditor’s judgment such misstatement is material and pervasive, he should issue an adverse opinion.
• Qualified opinion is issued if financial statements are misstated, and in the auditor’s judgment such misstatement is material, but not pervasive.

Question 11.
The auditor shall express an adverse opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive. [MTP-March 18, Aug. 18]
Answer:
Statement is incorrect.
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or

(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive

Question 12.
Other matter paragraph is paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users understanding of the financial statements. [MTP-March 18, Aug. 18, Oct. 18, March 19]
Answer:
Statement is incorrect: Emphasis of Matter paragraph is a paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements.

Question 13.
The statutory auditor of ABC Ltd. is of the opinion that communicating key audit matters in the auditor’s report constitutes a substitute for disclosure in the financial statements. [May 18 (2 Marks), MTP-April 19]
Answer:
Statement is incorrect.
As per SA 701 “Communicating Key Audit Matters in the Independent Auditor’s Report” communicating key audit matters in the auditor’s report is not a substitute for disclosures in the F.S. that the applicable FRF requires management to make, or that are otherwise necessary to achieve fair presentation.

Question 14.
The auditor shall express a qualified opinion when:
(i) The auditor concludes that misstatements are material but not pervasive to the financial statements; or
(ii) The auditor is unable to obtain sufficient appropriate audit evidence but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive. [MTP-Oct. 18, March 19]
Answer:
Statement is correct.
The auditor shall express a qualified opinion when:
(a) The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are material, but not pervasive, to the financial statements; or
(b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the auditor concludes that the possible effects on the financial statements of undetected misstatements, if any, could be material but not pervasive

Question 15.
An auditor should issue disclaimer of opinion when there is difference of opinion between him and the management on a particular point. [Nov. 18 (2 Marks)]
Answer:
Statement is incorrect.

• If the auditor confronts a different stand with the management in respect of a material issue, he should issue a qualified report or express an adverse opinion.
• Disclaimer of opinion is issued when the auditor is not able to frame an opinion due to non-availability of sufficient appropriate audit evidences.

Question 16.
An Audit report is an opinion drawn on the entity’s financial statements to make sure that the records are true and correct representation of the transactions they claim to represent. [RTP-May 20]
Answer:
Statement is incorrect.

• The purpose of an audit is to enhance the degree of confidence of intended users of the financial statements. The aforesaid purpose is achieved by the expression of an independent reporting by the auditor as to whether the financial statements exhibit a true and fair view of the affairs of the entity.
• Thus, an Audit report is an opinion drawn on the entity’s financial statements to make sure that the records are true and fair representation of the transactions they claim to represent.

Partnership Accounts – CA Inter Advanced Accounting Study Material is designed strictly as per the latest syllabus and exam pattern.

Partnership Accounts – CA Inter Advanced Accounting Study Material

Theory Questions

Question 1.
What is Piecemeal payments method under Partnership Dissolution? Briefly explain the two methods followed for determining the order in which the payments are made? (2 marks) (May 2010)
Answer:
Generally, the assets sold upon dissolution of partnership are realized only in small instalments over a period of time. In such circumstances the choice is either to distribute whatever is collected or to wait till whole amount is collected. Usually, the first course is adopted. In order to ensure that the distributed cash amongst the partners is in proportion to their interest in the partnership concern either of the two methods described below may be followed for determining the order in which the payment should be made.

(i) Maximum Loss Method: Each instalment realized is considered to be the final payment i.e. outstanding assets and claims are considered worthless and partners’ accounts are adjusted on that basis each time when a deposit is made following either Garner Vs. Murray rule or the profit-sharing ratio rule.

(ii) Highest Relative Capital Method: According to this method, the partner who has the higher relative capital, that is, whose capital is greater in proportion to his profit-sharing ratio is first paid off. This method is also called as proportionate capital method.

Question 2.
Explain Garner V/S Murray rule applicable in the case of partnership firms. State, when is this rule not applicable? (4 marks) (May 2013)
Answer:
Garner vs. Murray rule- Applicability

When a partner is unable to pay his debt due to the firm, he is said to be insolvent and the share of loss is to be borne by other solvent partners in accordance with the decision held in the English case of Garner vs. Murray. According to this decision, normal loss on realisation of assets is to be brought in cash by all partners (including insolvent partner) in the profit-sharing ratio but a loss due to insolvency of a partner has to be borne by the solvent partners in their capital ratio. In order to calculate the capital ratio, no adjustment will be made in case of fixed capitals. However, in case of fluctuating capitals, ratio should be calculated on the basis of adjusted capital before considering profit or loss on realization at the time of dissolution.

Non-Applicability of Garner vs Murray rule:

1. When the solvent partner has a debit balance in the capital account. Only solvent partners will bear the loss of capital deficiency of insolvent partner in their capital ratio. If incidentally a solvent partner has a debit balance in his capital account, he will escape the liability to bear the loss due to insolvency of another partner.
2. When the firm has only two partners.
3. When there is an agreement between the partners to share the deficiency in capital account of insolvent partner.
4. When all the partners of the firm are insolvent.

Question 3.
Explain the Limitations of Liability of Limited Liability Partnership (LLP) and its partners.
Answer:
Under section 27(3) of the LLP Act, 2008 an obligation of an LLP arising out of a contract or otherwise, shall be solely the obligation of the LLP;

• The Liabilities of an LLP shall be met out of the properties of the LLP;
• Under section 28(1) a partner is not personally liable, directly or indirectly, for an obligation referred to in Section 27(3) above, solely by reason of being a partner in the LLP;
• Section 27(1) states that an LLP is not bound by anything done by a partner in dealing with a person, if:
• The partner does not have the authority to act on behalf of the LLP in doing a particular act; and
• The other person knows that the partner has no authority or does not know or believe him to be a partner in the LLP
• Under section 30( 1) the liability of the LLP and the partners perpetrating fraudulent dealings shall be unlimited for all or any of the debts or other liabilities of the LLP.

Question 4.
Under what circumstances, an LLP can be wound up by the Tribunal. (4 marks) (May 2015)
Answer:
Under following circumstances, an LLP can be wound up by the Tribunal:

1. If the LLP decides that it should be wound up by the Tribunal;
2. If for a period of more than six months, the number of partners of the LLP is reduced below two;
3. If the LLP is unable to pay its debts;
4. If the LLP has acted against the interests of the integrity and sovereignty of India, the security of the state or public order;
5. If the LLP has defaulted in the filing of the Statement of Account and Solvency with the Registrar for five consecutive financial years;
6. If the Tribunal is of the opinion that it is just and equitable that the LLP be wound up.

Question 5.
What is the distinction between an Ordinary Partnership Firm and a Limited Liability Partnership (LLP)? (4 marks) (May 2016)
Answer:
Distinction between Partnership (LLP) an ordinary partnership firm and a Limited Liability

	Key Elements	Partnerships	LLPs
1	Applicable Law	Indian Partnership Act, 1932	Limited Liability Partnerships Act, 2008
2	Registration	Optional	Compulsory with ROC
3	Creation	Created by an Agreement	Created by Law
4	Body Corporate	Not a body corporate	Yes, after registration with ROC, it becomes a body corporate
5	Separate Legal Identity	It has no separate legal identity	Yes, all body corporate is said to have a separate legal identity.
6	Perpetual Succession	Partnerships do not have perpetual succession	It has perpetual succession and individual partners may come and go
7	Number of Partners	Minimum 2 and Maximum 20 (subject to 10 for banks)	Minimum 2 but no maximum limit
8	Ownership of Assets	Firm cannot own any assets. The partners own the assets of the firm	The LLP as an independent entity can own assets
9	Liability of Partners/ Members	Liability of the partners is unlimited. Partners are severally and jointly liable for actions of other partners and the firm and their liability extends to personal assets	Liability of the partners is limited to the extent of their contribution towards LLP except in case of intentional fraud or wrongful act of omission or commission by a partner.
10	Principal Agent Relationship	Partners are the agents of the firm and of each other.	Partners are agents of the firm only and not of other partners

Question 6.
Write short notes on Designated Partner in a Limited Liability Partnership and what are their liabilities. (4 marks) (Nov 2016)
Answer:
“Designated partner” means any partner designated as such pursuant to section 7 of the Limited Liability Partnerships (LLPs) Act, 2008.

As per section 7 of the LLP Act, every limited Liability Partnership shall have at least 2 designated Partners who are individuals and at least one of them shall be a resident in India:

Provided that in case of Limited Liability Partnership in which all the partners are bodies corporate or in which one or more partners are Individuals and bodies corporate, at least 2 individuals who are partners of such limited liability Partnership or Nominees of such Bodies corporate shall act as designated partners.

“Liabilities of designated partners”

As per Section 8 of LLP Act, unless expressly provided otherwise in this Act, a designated partner shall be-

(a) responsible for the doing of all acts, matters and things as are required to be done by the limited liability partnership in respect of compliance of the provisions of this Act including filling of any document, return, statement and the like report pursuant to the provisions of this Act and as may be specified in the limited liability partnership agreement; and

(b) liable to all penalties imposed on the limited liability partnership for any contravention of those provisions.

Question 7.
State the circumstances when LLP can be wound up by the Tribunal. (4 marks) (May 2017)
Answer:
Under section 64 of the LLP Act, 2008, an LLP may be wound up by the Tribunal:

• If the LLP decides that it should be wound up by the Tribunal;
• If for a period of more than six months, the number of partners of the LLP is reduced below two;
• If the LLP is unable to pay its debts;
• If the LLP has acted against the interests of the integrity and sovereignty of India, the security of the state or public order;
• If the LLP has defaulted in the filing of the Statement of Account and Solvency with the Registrar for five consecutive financial years;
• If the Tribunal is of the opinion that it is just and equitable that the LLP be wound up.

Question 8.
Explain the nature of Limited Liability Partnership. Who can be a designated partner in a Limited Liability Partnership? (4 marks) (Nov 2017)
Answer:
Nature of Limited Liability Partnership: A limited liability partnership is a body corporate formed and incorporated under the LLP Act, 2008 and is a legal entity separate from that of its partners. A limited liability partnership shall have perpetual succession and any change in the partners of a limited liability partnership shall not affect the existence, rights or liabilities of the limited liability partnership.

Designated partners: Every limited liability partnership shall have at least two designated partners who are individuals and at least one of them shall be a resident in India.

In case of a limited liability partnership in which all the partners are bodies corporate or in which one or more partners are individuals and bodies corporate, at least two individuals who are partners of such limited liability partnership or nominees of such bodies corporate shall act as designated partners.

Question 9.
Differentiate on ordinary partnership firm with an LLP (Limited Liability Partnership) in respect of the following:
(1) Applicable Law
(2) Number of Partners
(3) Ownership of Assets
(4) Liability of Partners/Members (4 Marks) (May 2018)
Answer:
Distinction between an ordinary partnership firm and an LLP

Key Elements	Partnerships	LLPs
Applicable Law	Indian Partnership Act, 1932	The Limited Liability Partnerships Act, 2008
Number of Partners	Minimum 2 and Maximum 20 (subject to 10 for banks)	Minimum 2 but no maximum limit
Ownership of Assets	Firm cannot own any assets. The partners own the assets of the firm.	The LLP as an independent entity can own assets
Liability of Partners/ Members	Unlimited: Partners are severally and jointly liable for actions of other partners and the firm and their liability extends to personal assets.	Limited to the extent of their contribution towards LLP except in case of intentional fraud or wrongful act of omission or commission by a partner.

Question 10.
Write short notes on extent of liability of LLP and its Partners. (5 Marks) (May 2018)
Answer:
Every partner of an LLP for the purpose of its business is an agent of the LLP but is not an agent of other partners. Obligations of LLP are solely its obligations and liabilities of LLP are to be met out of properties of LLP.

The partners of an LLP in the normal course of business are not liable for the debts of the LLP. The LLP is liable if a partner of LLP is liable to any person as a result of wrongful or omission on his part in the course of business of the LLP or with his authority. However, a partner will be liable for his own wrongful acts or commissions, but will not be liable for the wrongful acts or commissions of other partners of the LLP. Thus, a partner may be called to pay the liability of an LLP under exceptional circumstances.

If an LLP or any of its partners act with the intent to defraud creditors of the LLP or any other person or for any fraudulent purpose, then the liability of the LLP and the concerned partners is unlimited. However, where the fraudulent act is carried out by a partner, the LLP is not liable if it is established by the LLP that the act was without the knowledge or authority of the LLP. Where the business is carried out with fraudulent intent or for fraudulent purpose, every person who was knowingly a party is punishable with imprisonment and fine.

Question 11.
Can a partner be called upon to pay the liability of the LLP? If yes, under what circumstances?
Answer:
Under section 27(3) of the LLP Act, 2008, any obligation of the LLP arising out of a contract or otherwise will be the sole obligation of the LLP.

The partners of an LLP in the normal course of business are not liable for the debts of the LLP. However, under section 28(2) of the LLP Act, 2008, a partner will be liable for his own wrongful acts or commissions, but will not be liable for the wrongful acts or commissions of other partners of the LLP.

Thus, a partner may be called to pay the liability of an LLP under exceptional circumstances.

Question 12.
L, M and N were in partnership sharing profits and losses in the ratio of 3:2:1 respectively. They decided to dissolve the partnership firm on 31.3.2016, when the Balance Sheet of the firm appeared as under:
Balance Sheet of the firm as on 31.3.2016

The following details are relevant for dissolution:

1. The joint life policy was surrendered for ₹ 1,74,375.
2. L took over plant and machinery for ₹ 6,75,000.
3. L also agreed to discharge bank overdraft and loan from Mrs. L.
4. Furniture and stocks were divided equally between L and M at an agreed valuation of ₹ 2,70,000.
5. Sundry debtors were assigned to firm’s creditors in full satisfaction of their claims.
6. Commission receivable was received in time.
7. A bill discounted was subsequently returned dishonoured and proved valueless ₹ 23,062 (including ₹ 375 noting charges).
8. L paid the expenses of dissolution amounting to ₹ 13,500.

You are required to prepare:

(i) Realisation Account
(ii) Partners’ Capital Accounts and
(iii) Cash Account. (RTP)

Answer:
Realisation A/c

Partner’s Capital A/c’s

Cash A/c

Note:
There will be no entry for assignment of sundry debtors to sundry creditors in full satisfaction of their claims.

Question 13.
P, Q and R are partners sharing profits and losses in the ratio of 2: 2: 1. Their Balance Sheet as on 31st March, 2009 is as follows:

They decided to dissolve the firm. The following are the amounts realized from the assets:

Creditors allowed a discount of 5% and realization expenses amounted to ₹ 1,500. A bill for ₹ 4,200 due for sales tax was received during the course of realization and this was also paid.
You are required to prepare:
(a) Realization account
(b) Partners’ capital accounts
(c) Cash account. (6 Marks) (Nov 2009)
Answer:
Realisation A/c

Partners’ Capital A/c

Cash A/c

Question 14.
A, V, R and S are partners in a firm sharing profits and losses in the ratio of 4:1:2: 3. The following is their Balance Sheet as at 31st March, 2014:

On 31st March, 2014, the firm is dissolved and the following points are agreed upon:
(a) A is to takeover sundry debtors at 80% of book value.
(b) S is to take over the stocks at 95% of the value.
(c) R is to discharge sundry creditors.
(d) Other assets realise ₹ 6,00,000 and the expenses of realisation come to ₹ 60,000.
(e) V is found insolvent and ₹ 43,800 is realized from his estate.
You are required to prepare Realisation Account and Capital Accounts of the partners. Show also the Cash A/c. The loss arising out of capital deficiency may be distributed following the decision in Garner vs Murray. (RTP)
Answer:
Realisation A/c

Partners’ Capital A/c’s

Cash A/c

Note:
V’s deficiency will be borne by A and S in the ratio of 7:3 i.e. on opening capitals of ₹ 14,00,000 and ₹ 6,00,000. R will not bear any portion of the loss since at the time of dissolution he had a debit balance in his capital account.

Question 15.
A, B, C and D are sharing profits and losses in the ratio 5: 5: 4: 2. Frauds committed by C during the year were found out and it was decided to dissolve the partnership on 31st March, 2010 when their Balance Sheet w as as under:

Following information is given to you:

1. A cheque for ₹ 4,300 received from debtor was not recorded in the books and was misappropriated by C.
2. Investments costing ₹ 5,400 were sold by C at ₹ 7,900 and the funds transferred to his personal account. This sale was omitted from the firm’s books.
3. A creditor agreed to take over investments of the book value of ₹ 5,400 at ₹ 8,400. The rest of the creditors were paid off at a discount of 2%.
4. The other assets realized as follows:
   Building 105% of book value Stock ₹ 78,000
   Investments The rest of investments were sold at a profit of ₹ 4,800
   Debtors The rest of the debtors were realized at a discount of 12%
5. The bills payable was settled at a discount of ₹ 400.
6. The expenses of dissolution amounted to ₹ 4,900
7. It was found out that realization from C’s private assets would only be ₹ 4,000.

Prepare the necessary Ledger Accounts. (16 Marks) (Nov 2010)

Answer:
Realisation A/c

Cash A/c

Partner’s Capital A/c’s

Working Notes:

1.

2.

3.

4.

This deficiency of ₹ 17,063 in C’s capital account will he shared by other partners A, B and D in their capital ratio of 90: 90: 35
Thus,
A’s share of deficiency = [17,063 × (90/2 15)] = 7,143
B’s share of deficiency = [17,063 × (90/215)] = 7,143
D’s share oF deficiency = [17,063 × (35/215)] = 2,777

Question 16.
P, Q, R and S had been carrying on business In partnership sharing profits & losses in the ratio of 4:3:2:1. They decided to dissolve the partnership on the basis of following Balance Sheet as on 30th April, 2011:

1. The assets were realized as under:
   Land & building ₹ 2,30,000
   Furniture & fixtures ₹ 42,000
   Stock ₹ 72,000
   Debtors ₹ 65,000
2. Expenses of dissolution amounted to ₹ 7,800.
3. Further creditors of ₹ 18,000 had to be met.
4. R became Insolvent and nothing was realized from his private estate.

Applying the principles laid down in Garner Vs. Murray, prepare the Realisatlon Account, Partners’ Capital Accounts and Cash Account. (16 Marks) (Nov 2011)
Answer:
Realisation A/c

Partner’s Capital A/c

Cash A/c

Working Note:
As per Garner Vs. Murray rule, solvent partners have to bear loss of insolvent partner in their capital ratio.

Computation of Capital Ratio (of Solvent Partners)

Though S is a solvent partner yet he cannot be called upon to bear loss on account of insolvency of R because his capital account has a debit balance.
Therefore, capital ratio of P & Q = 216: 144 = 3: 2
Deficiency of R = ₹ {(25,000 + 20,060) – (19,000 + 5,000)} = ₹ 45,060 – ₹ 24,000 = ₹ 21,060. Deficiency of R will be shared by P & Q in the capital ratio of 3: 2 i.e.
P = ₹ 21,060 × 3/5 = ₹ 12,636
Q = ₹ 21,060 × 2/5 = ₹ 8,424

Question 17.
A and B are in equal partnership. Their Balance Sheet stood as under on 31st March, 20X1 when the firm was dissolved:


The assets realized as under:

The expenses of realisation amounted to ₹ 775. A’s private estate is not sufficient even to pay his private debts, whereas B’s private estate has a surplus of ₹ 200 only. Show necessary ledger accounts to close the books of the firm.
Answer:
Realisation A/c

Cash A/c

Sundry Creditors A/c

Partners’ Capital A/c’s

Deficiency Account

Question 18.
A partnership firm was dissolved on 30th June, 2016. Its Balance Sheet on the date of dissolution was as follows:

The assets were realized in instalments and the payments were made on the proportionate capital basis. Creditors were paid ₹ 29,000 in full settlement of their account. Expenses of realization were estimated to be ₹ 5,400 but actual amount spent was ₹ 4,000. This amount was paid on 15th September. Draw up a statement showing distribution of cash, which was realized as follows:

The partners shared profits and losses in the ratio of 2:2:1. Prepare a statement showing distribution of cash amongst the partners by ‘Highest Relative Capital’
method. (.RTP)
Answer:
Statement showing distribution of cash amongst the partners

Working Notes:

1. Scheme of Distribution

2. Distribution of IInd Instalment

Question 19.
A partnership firm was dissolved on 30th June, 2018. Its Balance Sheet on the date of dissolution was as follows:

The assets were realized in instalments and the payments were made on the proportionate capital basis. Creditors were paid ₹ 58,000 in full settlement of their account. Expenses of realization were estimated to be ₹ 10,800 but actual amount spent was ₹ 8,000. This amount was paid on 15th September. Draw up a statement showing distribution of cash, which was realized as follows:

The partners shared profits and losses in the ratio of 2: 2: 1. Prepare a statement showing distribution of cash amongst the partners by ‘Highest Relative Capital’ method. (RTP)
Answer:
Statement showing distribution of cash amongst the partners

1. Scheme of Distribution

2. Distribution of IInd Instalment

Question 20.
Ajay Enterprises, a Partnership firm in which A, B and C are three partners sharing profits and losses in the ratio of 4: 3: 3. the balance sheet of the firm as on 31st December, 2011 is as below:

On balance sheet date all the three partners have decided to dissolve their partnership. Since the realization of assets was protracted, they decided to distribute amounts as and when feasible and for this purpose they appoint C who was to get as his remunerations 1% of the value of the assets realized other than cash at Bank and 10% of the amount distributed to the partners.
Assets were realized piece-meal as under:

Prepare a statement showing distribution of cash amongst the partners by ‘Highest Relative capital method’. (16 Marks) (May 12)
Answer:
Statement showing distribution of cash amongst the partners

Working Note:
Scheme of distribution

Therefore, first ₹ 3,750 will be paid to C. Then A and C will receive in proportion of 4:3 upto ₹ 8,750 to bring the capital of all partners A, B and C in proportion to their profit-sharing ratio. Thereafter, balance available will be paid to all partners viz A, B and C in their profit-sharing ratio of 4:3:3.

Question 21.
The partners P, Q & R have called you to assist them in winding up the affairs of their partnership on 31.12.2013. Their balance sheet as on that date is given below:

(а) The partners share profit and losses in the ratio of 4:3:2.
(b) Cash is distributed to the partners at the end of each month,
(c) A summary of liquidation transactions are as follows:

January 2014

• ₹ 9,000 – collected from debtors; balance is uncollectable.
• ₹ 8,000 – received from the sale of entire furniture
• ₹ 1,000 – Liquidation expenses paid.
• ₹ 6,000 – Cash retained in the business at the end of month February 2014
• ₹ 1,000 – Liquidation expenses paid.
• As part payment of his capital, R accepted a machinery for ₹ 9,000 (book value ₹ 3,500)
• ₹ 2,000 – Cash retained in the business at the end of month March 2014
• ₹ 38,000 – received on the sale of remaining plant and machinery.
• ₹ 10,000 – received from the sale of entire stock.
• ₹ 1,700 – Liquidation expenses paid.
• ₹ 41,000 – Received on sale of land & building.
• No Cash is retained in the business.

You are required to prepare a schedule of cash payments amongst the partners by “Higher Relative Capital Method”. (16 Marks) (May 2014)

Answer:

Working Note:

(i) Scheme of Distribution

(ii) Distribution of cash for March:

Question 22.
X, Y and Z are in partnership sharing profits and losses in the ratio of 5:4:4. The Balance Sheet of the firm as on 31st March, 2016 is as below:

On Balance Sheet date, all the three partners have decided to dissolve their partnership. Since the realisation of assets was protracted, they decided to distribute amounts as and when feasible and for this purpose they appoint Z who was to get as his remuneration 1% of the value of the assets realized other than cash at bank and 10% of the amount distributed to the partners.

Assets were realized piecemeal as under:

You are required to prepare a statement showing distribution of cash amongst the partners by “Highest Relative Capital Method”. (16 Marks) (Nov 2016)
Answer:
Statement showing distribution of cash amongst the partners

Working Note:

1. ₹ 1100 added to the first instalment received on sale of assets represents the Cash in Bank
2. The amount due to Creditors at the end of the utilization of First Instalment is ₹ 3046. However, since the creditors were settled for ₹ 63,600 only the balance 646 were paid and the balance ₹ 2400 was transferred to the Profit & Loss Account.
3. Scheme of Distribution

Therefore, firstly ₹ 2,000 is to be paid to Z, then X and Z to be paid in proportion of 5:4 upto ₹ 18,000 to bring the capital of all partners X, Y and Z in proportion to their profit-sharing ratio. Thereafter, balance available will be paid in the profit-sharing ratio 5:4:4 to all partners viz X, Y and Z.

Question 23.
E, F and G were partners in a firm, sharing profits and losses in the ratio of 3:2:1, respectively. Due to extreme competition, it was decided to dissolve the partnership on 31st December, 2017. The balance sheet on that date was as follows:

The realization of assets is spread over the next few months as follows:
February, Debtors, ₹ 51,900; March, Machinery, ₹ 1,39,500; April, Furniture, etc. ₹ 18,000; May, G agreed to take over investment at ₹ 6,300; June, Stock, ₹96,000.

Dissolution expenses, originally provided, were ₹ 13,500, but actually amounted to ₹ 9,600 and were paid on 30th April. The partners decided that after creditors were settled for ₹ 50,400, all cash received should be distributed at the end of each month in the most equitable manner.

You are required to prepare a statement of actual cash distribution as received using “Maximum loss basis” method. (20 Marks) (November 2018)
Answer:
Statement Showing Distribution of Cash

Working Note:

Statement showing the cash available for distribution:

Feb. ₹ 29,700 + 51,900 – 13,500 = ₹ 68,100
March ₹ 1,39,500
April ₹ 18,000 + 3,900 = 21,900
May Nil
June ₹ 96,000

Question 24.
A, B and C are in partnership sharing profits and losses in the ratio of 5:4:4. The Balance Sheet of the firm as on 31st March, 2018 is as below:

On Balance Sheet date, all the three partners have decided to dissolve their partnership. The partners decided to distribute amounts as and when feasible and for this purpose they appoint C who was to get as his remuneration 1% of the value of the assets realized other than cash at bank and 10% of the amount distributed to the partners.
Assets were realized piecemeal as under:

You are required to prepare a statement showing distribution of cash amongst the partners by “Highest Relative Capital Method”. (RTP)
Answer:
Statement showing distribution of cash amongst the partners

Working Note:

1. ₹ 2,200 added to the first instalment received on sale of assets represents the Cash in Bank
2. The amount due to Creditors at the end of the utilization of First Instalment is ₹ 6,092. However, since the creditors were settled for ₹ 1,27,200 only the balance ₹ 1,292 were paid and the balance ₹ 4,800 was transferred to the Profit & Loss Account.
3. Scheme of Distribution

Therefore, firstly 74,000 is to be paid to C, then A and C to be paid in proportion of 5:4 up to ₹ 36,000 to bring the capital of all partners A, B and C in proportion to their profit-sharing ratio. Thereafter, balance available will be paid in the profit-sharing ratio 5:4:4 to all partners viz A, B and C.

Sale To A Company

Question 25.
‘S’ and T were carrying on business as equal partner. Their Balance Sheet as on 31st March, 20X1 stood as follows:

The operations of the business were carried on till 30th September, 20X1. S and T both withdrew in equal amounts half the amount of profits made during the current period of 6 months after 10% per annum had been written off on building and plant and 5% per annum written off on furniture. During the current period of 6 months, creditors were reduced by ₹ 50,000, Bills payable by ₹ 11,500 and Bank overdraft by ₹ 75,000. The Joint Life policy was surrendered for ₹ 47,500 on 30th September, 20X1. Stock was valued at ₹ 3,17,000 and debtors at ₹ 3,25,000 on 30th September, 20X1. The other items remained the same as on 31st March, 20X1.

On 30th September, 20X1 the firm sold its business to ST Ltd. The value of goodwill was estimated at ₹ 5,40,000 and the remaining assets were valued on the basis of the Balance Sheet as on 30th September, 20X1. The ST Ltd. paid the purchase consideration in equity shares of ₹ 10 each. You are required to prepare a Realisation Account and Capital accounts of the partners.
Answer:
Realisation A/c

Partners ’ Capital A/c’s

Working Notes:

(1) Computation of total capital:

Balance Sheet as at 30th September, 20X1

(2) Profit earned for the period of six months till 30 September, 20X1

(3) Computation of Purchase consideration:

Question 26.
M, N and O were Partners sharing Profits and Losses in the ratio of 5:3:2 respectively. The Trial Balance of the Firm 31st March, 2014 was the following:


Interest on Capital Accounts at 10% p.a. on the amount standing to the credit of Partners’ Capital Account at the beginning of the year, was not provided before preparing the above Trial Balance. On the above date, they formed a MNO Private Limited Company with an Authorized Share Capital of 2,00,000 in shares of ₹ 10 each to be divided in different classes to take over the business of Partnership firm.

You are required as under:

1. Machinery is to be transferred at ₹ 1,40,000.
2. Shares in the Company are to be issued to the partners, at par, in such numbers, and in such classes as will give the partners, by reason of their shareholdings alone, the same rights as regards interest on capital and the sharing of profit and losses as they had in the partnership.
3. Before transferring the business, the partners wish to draw from the partnership profits to such an extent that the bank balance is reduced to ₹ 1,00,000. For this purpose, sufficient profits of the year are to be retained in profit-sharing ratio.
4. Assets and liabilities except Machinery and Bank, are to be transferred at their book value as on the above date.
You are required to prepare:

(а) Statement showing the workings of the Number of Shares of each class to be issued by the company, to each partner.
(b) Capital Accounts showing all adjustments required to dissolve the Partnership.
(c) Balance Sheet of the Company immediately after acquiring the business of the Partnership and Issuing of Shares. (RTP)

Answer:

(a) Number of Shares to be issued to Partners

(b) Partners’ Capital A/c

Note:
Gain on Transfer of Machinery = ₹ 1,40,000 – (₹ 2,00,000 – 80,000) = ₹ 20,000 in 5:3:2 ratio.

(c) Balance sheet of MNO Ltd. as on 31st March, 2014
(After Takeover)

Notes to Accounts

Working Note:

1. Profit & Loss Appropriation Account for the year ended 31st March

2. Statement showing Additional Drawings

(a) Funds available for Drawings

(b) Computation of Additional Drawings

Question 27.
X and Y were carrying on business sharing profits and losses equally. The firm’s Balance Sheet as at 31.12.2013 was as follows:

The business was carried on till 30.6.2014. The partners withdrew in equal amounts half the amount of profits made during the period of six months after charging depreciation at 10% p.a. on machinery and after writing off 5% on leasehold premises. In the half year, sundry creditors were reduced by ₹ 20,000 and bank overdraft by ₹ 30,000.

On 30.6.2014, stock was valued at ₹ 1,50,000 and Debtors at ₹ 1,20,000; the Joint Life Policy had been surrendered for ₹ 18,000 before 30.6.2014 and other items remained the same as at 31.12.2013.

On 30.6.2014, the firm sold the business to a Limited Company. The value of goodwill was fixed at ₹ 2,00,000 and the rest of the assets were valued on the basis of the Balance Sheet as at 30.6.2014. The company paid the purchase consideration in Equity Shares of ₹ 10 each.

You are required to prepare:
(a) Balance Sheet of the firm as at 30.6.2014;
(b) Realisation Account;
(c) Partners’ Capital Accounts showing the final settlement between them. (RTP)
Answer:
(a) Balance Sheet as on 30.6.2014

(b) Realisation A/c

(c) Partners’ Capital A/c’s

Working Notes:

(1) Ascertainment of profit for the period of 6 months ending 30th June, 2014

(2) Computation of purchase consideration:
Closing net assets (as above) ₹ 4,79,600 + Goodwill ₹ 2,00,000 = ₹ 6,79,600.

Question 28.
A and V, sharing profits and losses equally, desired to convert their business into a limited company on 31st December, 2016 when their balance sheet stood as follows:

(a) The goodwill of the firm was to be valued at two years’ purchase of the profits average of the previous three years.
(b) The loan creditor was agreed to accept 71/2% redeemable preference shares in settlement of his claim.
(c) Land and buildings and plant and machinery were to be valued at ₹ 4,00,000 and ₹ 96,000 respectively.
(d) The vendors (sundry creditors) were to be allotted equity shares of the value of ₹ 4,20,000.
(e) The past working results of the firm showed that they had made profits of ₹ 1,20,000 in 2014, ₹ 1,44,000 in 2015 and ₹ 1,68,000 in 2016 after setting aside ₹ 8,000 to reserve fund each year.

You are required to show realisation account and partners’ capital accounts in the books of the firm assuming that all the transactions are duly completed. (RTF)

Answer:
Realisation A/c

Partners’ Capital A/c’s

Working Notes:

1. Goodwill = (1,20,000 + 1,44,000 + 1,68,000 + 24,000*)/3 × 2 Years = 3,04,000
   * Profit transferred to reserve @ ₹ 8,000 for 3 years.
2. Computation of Purchase Consideration

Question 29.
A, B and C share profits and losses of a business as to 3:2:1 respectively. Their balance sheet as at 31st March, 2017 was as follows:


The partners decide to convert their firm into a Joint Stock Company. For this purpose, ABC Ltd. was formed with an authorized capital of ₹ 10,00,000 divided into ₹ 100 equity Shares. The business of the firm was sold to the company as at the date of balance sheet given above on the following terms:

1. Motor car, furniture, investments, loose tools, debtors and cash are not to be taken over by the company.
2. Liabilities for bills payable and bank overdraft are to be taken over by the company.
3. The purchase price is settled at ₹ 1,95,500 payable as to ₹ 75,500 in cash and the balance in company’s fully paid shares of ₹ 100 each.
4. The remaining assets and liabilities of the firm are directly disposed of by the firm as per details given below:
   Investments are taken over by A for ₹ 13,000; debtors realize in all ₹ 20,000; Motor Car, furniture and loose tools fetch ₹ 24,000, ₹ 4,000, and ₹ 1,000 respectively. A agrees to pay his wife’s loan. The creditors were paid ₹ 94,000 in final settlement of their claims. The realization expenses amount to ₹ 500.
5. The equity share received from the vendor company are to be divided among the partners in profit-sharing ratio.

You are required to prepare the necessary ledger accounts in the books of the partnership firm. (RTF)
Answer:
Realization A/c

ABC Ltd. A/c

Partners’ Capital A/c’s

C’s Current A/c

Shares in ABC Ltd. A/c

Cash A/c

Question 30.
XYZ & Co. is a partnership firm consisting of Mr. X, Mr. Y and Mr. Z who share profits and losses in the ratio of 2:2:1 and ABC Ltd. is a company doing similar business.
Following is the summarized Balance Sheet of the firm and that of the company as at 31.3.2017:

It was decided that the firm XYZ & Co. be dissolved and all the assets (except cash in hand and cash at bank) and all the liabilities of the firm be taken over by ABC Ltd. by issuing 50,000 shares of ₹ 10 each at a premium of ₹ 2 per share.

Partners of XYZ & Co. agreed to divide the shares issued by ABC Ltd. in the profit-sharing ratio and bring necessary cash for settlement of their capital.
The trade payables of XYZ & Co. include ₹ 1,00,000 payable to ABC Ltd. An unrecorded liability of ₹ 25,000 of XYZ & Co. must also be taken over by ABC Ltd.

Prepare:

(i) Realisation account, Partners’ capital accounts and Cash in hand/Bank account in the books of XYZ & Co.
(ii) Pass journal entries in the books of ABC Ltd. for acquisition of XYZ & Co. and draw the Balance Sheet after the takeover. (RTP)

Answer:
(i) In the books of XYZ & Co.
Realisation A/c

Partners’ Capital A/c’s

Cash and Bank A/c

Note:

It is assumed that cash at bank has been withdrawn to pay ₹ 80,000 to partner Y. However, payment to Y of ₹ 80,000 can also be made by cash ₹ 70,000 & by cheque ₹ 10,000.

(ii) In the Books of ABC Ltd.
Journal Entries

Balance Sheet of ABC Ltd. as at 31.3.2017 (After takeover of XYZ & Co.)

Notes to Accounts

Working Note:

Computation of purchase consideration:
50,000, Equity shares of 12 (10+2) each = ₹ 6,00,000
Equity shares distributed among partners:

Question 31.
P, Q and Rare partners sharing profits and losses in the ratio 3: 2: 1 after allowing interest on capital @ 9% p.a. Their Balance Sheet as at 31st March, 2012 are as follows:

They applied for conversion of the firm into a Private Limited Company named PQR Pvt. Ltd. and the certificate was received on 01-04-2012. They decided to maintain same profit-sharing ratio and to preserve the priority in regard to repayment of capital as far as possible. For that purpose, they decided to insert a clause of Issuance of Preference shares in Memorandum of Association In addition to issuance of Equity shares of ₹ 10 each.

On 01-04-2012, the value of goodwill is to be determined on the basis of 2 years’ purchase of the average profit from the business of the last 5 years. The particulars of profits are as under:

The loss for the year ended 3 1-03-2009 was on account of loss by strike to the extent of ₹ 10,000.
It was agreed that rest of the assets are valued on the basis of the Balance Sheet as at 31-03-2012 except Plant & Machinery which is valued at ₹ 1,02,000.
You are required to prepare (a) the Balance Sheet of the Company as at 01-04-20 12,
(b) Partners’ Capital Accounts and
(c) Statement showing the final settlement between the partners taking Q’s capital as basis. (16 Marks) (Nov 2012)
Answer:
(a) Balance Sheet of the PQR Pvt Ltd. as on 1-4-2012

Notes to Accounts

(b) In the books of Partnership Firm
Partners’ Capital A/c’s

(c) Statement showing the final settlement between the Partners taking Q ‘s capital as basis

Taking Q’s capital as basis, both P and R have ₹ 5,000 each as excess in their capital account balances. Since interest on capital is meant to compensate those whose capital is in excess of proportionate limits and since in the case of partners it is an appropriation of profit, it will be proper to give 9% preference shares to P and R for ₹ 5,000 each and the remaining amount of ₹ 1,80,000 in the form of Equity Shares to he divided among P, Q and R in the ratio 3:2:1. They will then share the company’s profit in the ratio 3:2:1 after allowing preference dividend.

Working Notes:

1. Computation of goodwill

2. Computation of Purchase consideration

Question 32.
P and Q were carrying on business sharing profits and losses equally. The firm’s Balance Sheet as at 31.12.2013 was:

The operations of the business were carried on till 30.06.2014. P and 0 both withdrew in equal amount half the amount of profit made during the current period of six months after charging depreciation at 10% per annum on plant and after writing off 5% on building.

During the current period of six months, creditors were reduced by ₹ 20,000 and bank overdraft by ₹ 5,000.
The joint life policy was surrendered for ₹ 6,000 before 30th June 2014. Stock was valued at ₹ 84,000 and debtors at ₹ 68,000 on 30th June 2014. The other items remained the same as at 31.12.2013.

On 30.06.2014, the firm sold its business to PQ Ltd. The value of goodwill was estimated at ₹ 1,30,000 and the remaining assets were valued on the basis of the balance sheet as on 30.06.2014.

PQ Ltd. paid the purchase consideration in equity shares of ₹ 10 each. You are required to prepare:
(a) Balance sheet of the firm as at 30.06.2014,
(b) Realisation account,
(c) Partners’ Capital Accounts showing the final settlement between them. (16 Marks) (Nov 2014)

Answer:

(a) Balance sheet of the firm as at 30.06.2014

(b) Realisation A/c

(c) Partner’s Capital A/c’s

Working Notes

(1) Ascertainment of profit for the period of 6 Months ending 30.06.2014

(2) Computation of purchase consideration

Question 33.
Ali and Beta were carrying on business, sharing profits and losses equally. The firm’s balance sheet as at 31-12-2015 was:

The business was carried on till 30-06-2016. The partners withdrew the amounts equal to half the amount of profit made during the period of six months ended on 30-06-2016, in equal proportion. The profit was calculated after charging depreciation at 10% p.a. on machinery and after writing off 5% on leasehold premises. In the half year, sundry creditors were reduced by ₹ 24,000 and bank overdraft by ₹ 36,000.

On 30-06-2016, stock was valued at ₹ 1,80,000 and debtors at ₹ 1,44,000; the Joint Life Policy had been surrendered for ₹ 21,600 before 30-06-2016 and other items remained the same as at 31-12-2015.

On 30-06-2016, the firm sold the business to a limited company. The value of goodwill was fixed at ₹ 2,40,000 and the rest of the assets were valued on the basis of the balance sheet as at 30-06-2016. The company paid the purchase consideration in equity shares of 10 each.

You are required to prepare:

(a) Balance Sheet of the firm as at 30-06-2016;
(b) Realisation Account; and
(c) Partners’ Capital Accounts showing the final settlement between them. (16 Marks) (May 2017)

Answer:

(a) Balance Sheet of the Firm as at 30.6.2016

(b) Realization A/c

(c) Partners’ Capital A/c

Working Notes:

(1) Computation of purchase consideration

(2) Ascertainment of profit for the period of 6 month ending 30th June, 2016

Question 34.
Sunil and Sachin carrying on business in partnership sharing profit and losses equally, wished to dissolve the firm and sell the business to Sargam Ltd. on 31-3-2018, when the firm’s position was as follows:

The arrangement with Sargam Ltd. was as follows:

1. Land and Building was purchased at 25% more than the book value.
2. Furniture and stock were purchased at book values less 20%.
3. The goodwill of the firm was valued at ₹ 2,00,000.
4. The firm’s debtors, cash and creditors were not to be taken over, but Sargam Ltd. agreed to collect the book debts of the firm and discharge the creditors of the firm as an agent, for which services, the company was to be paid 7.5% on all collections from the firm’s debtors and 4.5% on cash paid to firm’s creditors.
5. The purchase price was to be discharged by the company in fully paid equity shares of ₹ 15 each at a premium of ₹ 5 per share.
6. The partners distributed the company’s shares between themselves in their final claim ratio.
   The company collected all the amounts from debtors. The creditors were paid off less by ₹ 10,000, allowed by them as discount. The company paid the balance due to the vendors in cash.

Prepare the Realisation account, the Capital Accounts of the partners and the cash account in the books of partnership firm. (16 Marks) (May 2018)
Answer:
Realisation A/c

Partners’ Capital A/c’s

Cash A/c

Working Notes:

1. Computation of Purchase consideration

2. Shares received from Sargam Ltd.

The shares received from Sargam Ltd. have been distributed between the two partners Sunil & Sachin in the ratio of their final claims i.e., 8,28,600: 5,78,600.
No. of shares received from the company \(\frac{13,85,000}{20}\) = 69,250
Sunil gets \(\frac{69,250 \times 8,28,600}{14,07,200}\) = 40,776 shares valued at ₹ 20 = ₹ 8,15,520.
Sachin gets the remaining 28,474 shares, valued at ₹ 5,69,480 (28,474 × ₹ 20)

3 Computation of net amount received from Sargam Ltd.

Question 35.
A and B carrying on business in partnership sharing profits and losses equally, wished to dissolve the firm and sell the business to AB Limited Company on 31.03.2018 when the firm’s position was as follows:

The arrangement with AB Limited Company was as follows:

1. Land and Building was purchased at 20% more than the book value.
2. Furniture and stock were purchased at book value less 15%.
3. The Goodwill of the firm was valued at ₹ 2,00,000.
4. The firm’s debtors, cash and creditors were not to be taken over, but the company agreed to collect the book debts of the firm and discharge the creditors of the firm as an agent, for which services the company was to be paid 5% on all collections from the firm’s debtors and 3% on cash paid to firm’s creditors.
5. The purchase price was to be discharged by the company in fully paid equity shares of ₹ 10 each at a premium of ₹ 2 per share.

The company collected all the amounts from the debtors. The creditors were paid off less by ₹ 5,000 allowed as discount. The company paid the balance due to the vendors in cash.
Prepare the Realisation A/c, the Capital Accounts of the Partners and the Cash Account in the books of the Partnership firm. (15 Marks) (May 2018)
Answer:
Realization A/c

Partner’s Capital A/c’s

Cash A/c

Working Notes:

1. Computation of Purchase consideration:

2. Distribution of shares among partners
The shares received from the company have been distributed between the two partners A & B in the ratio of their final claims i.e., 8,37,325: 5,87,325*.
*No. of shares received from the company = 13,95,000/12 = 1,16,250

A gets [(1,16,250 × 8,37,325)/14,24,650] = 68,325 shares valued at 68,325 × 12 = ₹ 8,19,900. B gets the remaining 47,925 shares, valued at ₹ 5,75,100 (47,925 × 12)

3. Computation of net amount received from AB Ltd. on account of amount realized from debtors less amount paid to creditors.

Note:

Shares received from AB Ltd. Company have been distributed between two partners A and B in the ratio of their final claims.

Question 36.
L, M and N share profits and losses in the ratio of 5:3:2. Their firm was dissolved due to misconduct of M and their balance sheet on that date was as under:
Balance Sheet as at 31-3-2016


The whole business of the firm was sold to Preet Limited, on that day on the following terms:

(i) Preet Limited will issue the following securities in consideration for transfer of business:
10,000 equity shares @ ₹ 15 each, 15,000 preference shares @ ₹ 15 each; and 20,000 debentures @ ₹ 14.725.

(ii) The agreed value of assets and liabilities of partnership firm are as follows:
Land & Building – ₹ 3,00,000, Plants – ₹ 1,50,000, Inventory – ₹ 1,40,000, Trade Receivable – ₹ 97,500, and Trade Payable – ₹ 1,18,000.

It was mutually decided that preference shares and debentures will be distributed in profit sharing ratio and cash brought in by the partner (if any) will be shared equally by the remaining partners before distribution of equity shares. Equity shares are distributed on residual basis at the end.
You are required to prepare Realization Account, Cash Account, Partners’ sij Current and Capital Accounts at the time of closing close the books of the firm.
Answer:
Realization A/c

Cash A/c

Partners’ Current A/c

Partners’ Capital A/c’s

Working Notes:

1. Computation of Purchase consideration
Net Payment Method

2. As whole business of the firm was sold to Preet Limited, cash balance of the firm ₹ 1,00,000 is also transferred to realization account. Cash brought in by N equal to Dr. balance appearing in his account, after distribution of preference shares and debentures in profit sharing ratio would be shared by L and M equally. The balance amount payable to L and M would be settled by transfer of equity shares in Preet Company.

Question 37.
The following is the Balance Sheet of M/s. P and Q as on 31st March, 2012:

It was agreed that Mr. R is to be admitted for a fourth share in the future profits from 1st April, 2012. He is required to contribute cash towards goodwill and ₹ 15,000 towards capital.

The following further information is furnished:
(a) P & Q share the profits in the ratio 3: 2.
(b) P was receiving salary of ₹ 750 p.m. from the very inception of the firm in 2005 in addition to share of profit.
(c) The future profit ratio between P, Q & R will be 2:1:1. P will not get any salary after the admission of R.
(d) It was agreed that the value of goodwill of the firm shall appear in the books of the firm. The goodwill of the firm shall be determined on the basis of 3 years’ purchase of the average profits from business of the last 5 years. The particulars of the profits are as under:

The above Profits and Losses are after charging the Salary of P. The Profit of the year ended 31st March, 2008 included an extraneous profit of ₹ 40,000 and the loss for the year ended 31st March, 2010 was on account of less by strike to the extent of ₹ 20,000.
(e) The cash trading profit for the year ended 31st March, 2013 was ₹ 50,000 before depreciation.
(f) The partners had drawn each 1,000 p.m. as drawings.
(g) The value of other assets and liabilities as on 31st March, 2013 were as under:
Machinery (before depreciation) ₹ 60,000
Furniture (before depreciation) ₹ 10,000
Investment ₹ 50,000
Stock ₹ 15,000
Debtors ₹ 30,000
Creditors ₹ 20,000
(h) Provide depreciation @ 10% on Machinery and @ 5% on Furniture on the Closing Balance and interest is accumulated @ 6% on Q’s loan. The loan along with interest would be repaid within next 12 months.
(i) Investments are held from inception of the firm and interest is received @ 10% p.a.
(j) The partners applied for conversion of the firm into a Private Limited Company. Certificate was received on 1st April, 2013. They decided to convert Capital A/cs of the partners into share capital in the ratio of 2:1:1 on the basis of a total Capital as on 31 st March, 2013. If necessary, partners have to subscribe to fresh capital or withdraw.
Prepare the Profit and Loss Account of the firm for the year ended 31 st March, 2013 and the Balance Sheet of the Company on 1st April, 2013. (16 Marks) (May 2013)
Answer:
Profit and Loss Account for the year ending on 31st March, 2013

Balance Sheet of the PQR Pvt. Ltd. as on 1st April, 2013

Notes to Accounts

Working Notes:

1. Computation of goodwill

2. Computation of sacrificing ratio of Partners P and Q on admission of R

3. Goodwill entry

4. Partners’ Capital A/c’s

5. Balance Sheet of the firm as on 31st March, 2013

6. Cash balance (Closing)

7. Distribution of shares to partner’s

P and Q should withdraw capital of ₹ 9,000 (₹ 79,800 – ₹ 70,800) and ₹ 11,500 (₹ 46,900 – ₹ 35,400) respectively and R should subscribe shares of ₹ 20,500 (₹ 35,400 – ₹ 14,900).

Question 38.
Firm B & Co. consists of partners Murli and Honey sharing Profits and Losses in the ratio of 3 : 2. The firm C & Co. consists of partners Honey and Prince sharing Profits and Losses in the ratio of 5 : 3. On 31st March, 2017 it was decided to amalgamate both the firms and form a new firm BC & Co., wherein Murli, Honey and Prince would be partners sharing Profits and Losses in the ratio of 4:5:1.
Balance Sheet as at 31.3.2017

The following were the terms of amalgamation:

1. Goodwill of B & Co., was valued at ₹ 1,50,000. Goodwill of C & Co. was valued at ₹ 80,000. Goodwill account not to be opened in the books of the new firm but adjusted through the Capital accounts of the partners,
2. Building, Machinery and Vehicles are to be taken over at ₹ 4,00,000, ₹ 2,00,000 and ₹ 1,48,000 respectively.
3. Provision for doubtful debts ₹ 10,000 in respect of B & Co. and ₹ 8,000 in respect of C & Co. are to be provided.

You are required to:

(i) Show, how the value of Goodwill is to be adjusted amongst the partners,
(ii) Prepare the Balance Sheet of BC & Co. as at 31.3.2017 by keeping partners’ capital in their profit-sharing ratio by taking capital of ‘Honey’ as the basis. The excess or deficiency to be kept in the respective Partners’ Current accounts. (RTP)

Answer:
(i) Adjustment for goodwill (net impact)

(ii) Balance Sheet of BC & Co. (New firm) as on 31.3.2017

Working Notes:

1. Balance of Capital Accounts at the time of amalgamation of firms

2. Balance of Capital Accounts in the balance sheet of the new firm as on 31.3.2017

Question 39.
P and Q are partners of P & Co. sharing Profit and Losses in the ratio of 3:1 and Q and Rare partners of R & Co., sharing profits and losses in the ratio of 2:1. On 31st March, 2009, they decide to amalgamate and form a new firm M/s PQR & Co., wherein P, Q and R would be partners sharing profits and losses in the ratio of 3:2:1. The Balance Sheets of two firms on the above date are as under:

The amalgamated firm took over the business on the following terms:

(a) Building of P & Co. was valued at ₹ 1,00,000.
(b) Plant and machinery of P & Co. was valued at ₹ 2,50,000 and that of R & Co. at ₹ 2,00,000.
(c) All stock in trade is to be appreciated by 20%.
(d) Goodwill value of P & Co. at ₹ 1,20,000 and R & Co. at ₹ 60,000, but the same will not appear in the books of PQR & Co.
(e) Partners of new firm will bring the necessary cash to pay other partners to adjust their capitals according to the profit-sharing ratio.
(f) Provisions for doubtful debts has to be carried forward at ₹ 12,000 in respect of debtors of P & Co. and ₹ 26,000 in respect of debtors of R & Co.
You are required to prepare the Balance Sheet of new firm and capital accounts of the partners in the books of old firms. (16 Marks) (May 2010), (16 Marks) (May 2016)

Answer:

Balance Sheet of M/s PQR & Co. as at 31st March, 2009

₹ 20,000 + ₹ 10,000 + ₹ 1,53,000 + ₹ 30,000 – ₹ 1,83,000 = ₹ 30,000

In the books of P & Co. Partners’ Capital A/c’s

In the books of R & Co.
Partners’ Capital A/c’s

Working Notes:

1. Computation of purchase consideration

2. Computation of proportionate capital

3. Computation of Capital Adjustments

4. In the books of P & Co.
Realisation A/c

5. In the books of R & Co. Realisation A/c

Question 40.
A and B are partners of AB & Co. sharing profits and losses in the ratio of 2:1 and C and D are partners of CD & Co. sharing profits and losses in the ratio of 3:2. On 1st April 2011, they decided to amalgamate and form a new firm M/s. AD & Co. wherein all the partners of both the firm would be partners sharing profits and losses in the ratio of 2:1:3:2 respectively to A,B,C and D.
Their balance sheets on that date were as under:

The amalgamated firm took over the business on the following terms:

(a) Building was taken over at ₹ 1,00,000 and ₹ 1,25,000 of AB & Co. and CD & Co. respectively. And machinery was taken over at ₹ 1,25,000 and ₹ 1,10,000 of AB & Co. and CD & Co. respectively.
(b) Goodwill of AB & Co. was worth ₹ 75,000 and that of CD & Co. was worth ₹ 50,000. Goodwill account was not to be opened in the books of the new firm; the adjustments being recorded through capital accounts of the partners.
(c) Provision for doubtful debts has to be carried forward at ₹ 5,000 in respect of debtors of AB & Co. and ₹ 8,000 in respect of CD & Co.

You are required:

(i) Compute the adjustments necessary for goodwill.
(ii) Pass the Journal Entries in the books of AD & Co. assuming that excess/ deficit capital (taking D’s capital as base) with reference to share in profits are to be transferred to current accounts. (16 Marks) (May 2011)

Answer:
(i) Adjustment of goodwill (net impact)

(ii) In the books of AD & Co.
Journal Entries

Working Notes:

(1) Computation of Revaluation Profit

(2) Balance of capital accounts of partners on transfer of business to AD & Co.

(a) AB & Co.

(b) CD & Co.

(3) Calculation of capital of each partner in the new firm

* Taking D’s capital as the base which is 2/8th of total capital; total capital will be 1,05,150× 8/2 ie. ₹ 4,20,600.

Question 41.
Avi and Bishnu are partners of Abhay & Co. sharing profit and losses in the ratio 3:1 and Bishnu and Joe are partners of Bijoy & Co. sharing profit and losses in the ratio 2:1. On 31st March, 2013, they decided to amalgamate and form a new firm M/s Abeejay & Co., wherein Avi, Bishnu and Joe would be partners sharing profit and losses in the ratio 3:2:1. The Balance Sheets of the two firms on 31st March, 2013 were as under:

The amalgamated firm M/s Abeejay & Co. took over the business on the following terms:
(a) Goodwill of Abhay & Co. was worth ₹ 42,000 and that of Bijoy & Co. ₹ 30,000. Goodwill account was not to be opened in the books of the new firm; the adjustments being recorded through capital accounts of the partners.
(b) The following assets were valued as below:

(c) Provision for doubtful debt was carried forward at 4,000 in respect of Debtors of Abhay & Co. and ₹ 3,000 in respect of Debtors of Bijoy & Co.
(d) Partners of new firm brought necessary cash to pay other partners to adjust their capitals according to the profit-sharing ratio.

You are required to:

(i) Prepare the Balance Sheet of the new firm as on 31st March, 2013.
(ii) Prepare Capital Accounts of the partners in the books of old firms. (16 Marks) (Nov. 2013)

Answer:
Balance Sheet of M/s Abeejay & Co. as at 31st March, 2013


* ₹ 20,000 + ₹ 1,59,000 + ₹ 25,667 – ₹ 184,667 = ₹ 20,000.

Partners’ Capital A/c’s (in the books of Abhay & Co.)

Partners ’ Capital A/c’s (in the books of Bijoy & Co.)

Working Notes:

1. Computation of purchase consideration

2. Computation of proportionate capitals

3. Computation of Capital Adjustments

4. Realisation A/c (in the books of Abhay & Co.)

5. Realisation Account (in the books of Bijoy & Co.)

Question 42.
Ketan Kumar acquires the business of M/s Shiv and Nath on payment of ₹ 1,20,000 on 31st March 2013. The book value of assets and liabilities taken over by him as follows:
Debtors 52,500
Furniture 4,500
Stock 69,000
Creditors 15,000

There was no change between 1st January, 2013 and 31st March, 2013 in the book value of the assets and liabilities not taken over. The same set of books has been continued after the acquisition and no entries of the acquisition have been passed except for the payment of ₹ 1,20,000 made by Ketan Kumar.

From the following balance sheet and trial balance prepare Business Purchase Account, Profit and Loss Account for the year ended 31st December, 2013 and Balance Sheet at that date.
Balance Sheet as at December, 2012

On 31st December 2013 the trial balance is:

(RTP)
Answer:
Business Purchase Account

Profit & Loss Account of Ketan for the year ended 31st December, 2013

Balance Sheet of Ketan as on 31st December, 2013

Working Notes:

(1) ComputatIon of Goodwill

(2) Increase in net assets upto 31st March 2013:

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

Audit of Banks – CA Inter Auditing Notes

Question 1.
The functioning of banking industry in India is regulated by the Reserve Bank of India which acts as the Central Bank of our country. Explain.
Answer:
Regulation of Banking Industry:
In India, banking industry is regulated by the Reserve Bank of India (RBI) known as the Central Bank. Major functions and responsibilities of RBI are:

• development and supervision of the banks and non-banking financial institutions
• determining, the monetary and credit policies.
• issuance and regulation of currency;
• acting as banker to the central and state governments, commercial and other types of banks including term-lending institutions.
• to regulate the activities of commercial and other banks.

Question 2.
Write short note on: Principal Enactments governing Bank Audit.
Answer:
Principal Enactments governing Bank Audit:
(a) Banking Regulation Act, 1949;
(b) Reserve Bank of India Act, 1934;
(c) Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970;
(d) State Bank of India Act, 1955;
(e) State Bank of India (Subsidiary Banks) Act, 1959;
(f) Regional Rural Banks Act, 1976;
(g) Companies Act, 2013;
(h) Cooperative Societies Act, 1912 or the relevant State Cooperative Societies Acts;
(i) Information Technology Act, 2000;
(j) Prevention of Money Laundering Act, 2002;
(k) Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002;
(l) Credit Information Companies Regulation Act, 2005; and
(m) Payment and Settlement Systems Act, 2007

Question 3.
In the case of a nationalised bank, the auditor is required to make a report to the Central Govern-ment. The report of auditors of State Bank of India is also to be made to the Central Government and is almost identical to the auditor’s report in the case of a nationalised bank. Explain what would the auditor state in his report. [MTP-Oct. 18]
Answer:
Auditor’s Report in case of Nationalised Banks:
In the case of a nationalised bank, the auditor is required to make a report to the Central Government
in which the auditor should state the following:

• Whether, in the auditor’s opinion, the balance sheet is a full and fair balance sheet containing all the necessary particulars and is properly drawn up so as to exhibit a true and fair view of the affairs of the bank.
• In case the auditor had called for any explanation or information, whether it has been given and whether it is satisfactory.
• Whether or not the transactions of the bank, which have come to the auditor’s notice, have been within the powers of that bank.
• Whether or not the returns received from the offices and branches of the bank have been found adequate for the purpose of audit.
• Whether the profit and loss account show a true balance of profit or loss for the period covered by such account.
• Any other matter which the auditor considers should be brought to the notice of the Central Government.

Question 4.
Write a short note on Long Form Audit Report.
Answer:
Long Form Audit Report:

• The long form Audit Report has to be furnished by the auditor of a bank in addition to the audit report as per the statutory requirement.
• The matters which the banks require their auditor to deal with in the form of Long Form Audit Report have been specified by the RBI.
• The LFAR is to be submitted before 3 0th June every year. To ensure timely submission of LFAR, proper planning for completion of the LFAR is required. While the format of LFAR does not require an executive summary to be given, members may consider providing the same to bring out the key observations from the whole document.

Question 5.
“If an accounting professional, whether in the course of internal or external audit or in the process of institutional audit finds anything susceptible to be fraud or fraudulent activity or act of excess power or smells any foul play in any transaction, he should refer the matter to the regulator. Any deliberate failure on the part of the auditor should render himself liable for action”. Analyse and explain the above RBI Circular regarding liability of accounting and auditing profession.
Answer:
Reporting of Fraud to RBI:

• Circular issued by RBI regarding liability of accounting and auditing profession, provides that “If an accounting professional, whether in the course of internal or external audit or in the process of institutional audit finds anything susceptible to be fraud or fraudulent activity or act of excess power or smell any foul play in any transaction, he should refer the matter to the regulator. Any deliberate failure on the part of the auditor should render himself liable for action”
• This requirement is applicable to all scheduled commercial banks excluding Regional Rural Banks. Auditor is not expected to look into each and every transaction but to evaluate the system as a whole.
• While reporting such kind of matters as stated in the circular, auditor need to consider the provisions of SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”.
• SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements” further expounds the concept and states that 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.

Question 6.
Management develops controls and uses performance indicators to aid in managing key business and financial risks. Explain in this reference the requirements of an effective risk management system in a bank.
Or
Write short note on: Requirements of a Risk Management Process/System in a bank.
Or
Mr. Piyush, the Bank Manager develops controls to aid in managing key business and financial risks. Discuss the various requirements for an effective risk management system in a bank. [May 19 (4 Marks)]
Answer:
Understanding the Risk Management Process:
An effective risk management system in a bank generally requires the following:
(a) Involvement of TCWG: Risk Management policies should be approved by TC WG. While approving the policies, TCWG should ensure that the policies should be consistent with the bank’s business objectives and strategies, capital strength, management expertise, regulatory requirements and the types and amounts of risk it considers as acceptable.

(b) Identification, measurement & monitoring of risks: Risks that may significantly affect the achievement of bank’s goals and objectives should be identified, measured and monitored against pre-approved limits and criteria.

(c) Control activities: Banks must have appropriate controls to manage its risks, including the following:

• effective segregation of duties,
• verification and approval of transactions,
• setting of limits, and
• reporting and approval of exception.

(d) Monitoring activities: Independent risk management unit should be set up which regularly assess the risk management models, methodologies and assumptions used to measure and manage risk.

(e) Reliable information systems: Banks must have a reliable information system that provide adequate financial, operational and compliance information on a timely and consistent basis to management and TCWG.

Question 7.
“The engagement team should hold discussions to gain better understanding of the bank and its environment, Including internal control, and also to assess the potential for material misstatements of the financial statements. All these discussions should be appropriately documented for future reference”. Explain.
Or
The engagement team of FRN & Co.- Auditors of Bank of Baroda held discussions to gain better understanding of the bank and its environment, including internal control, and also to assess the potential for material misstatements of the financial statements.

The discussion between the members of the engagement team and the audit engagement partner are being done on the susceptibility of the bank’s financial statements to material misstatements.
These discussions are ordinarily done at the planning stage of an audit.
Analyse and Advise the matters to be discussed in the engagement team discussion. [MTP-March 18, March 19]
Or
You are appointed as an auditor of Banking Co., and hold discussions with engagement team. List out matters which you would discuss at planning stage of an audit to gain better understanding of the bank and its environment. [May 19 (4 Marks)]
Or
The discussion between members of the engagement team members and the audit engagement partner should be done on the susceptibility of the bank’s financial statements to material mis-statements. Briefly discuss the points ordinarily included in discussion of the engagement team. [Nov. 19 (3 Marks)]
Answer:
Engagement Team Discussions:
Engagement team should hold discussions to gain better understanding of banks and its environment, including internal control, and also to assess the potential for material misstatements of the financial statements. All these discussions should be appropriately documented for future reference. The discussion should be done on the susceptibility of the bank’s financial statements to material misstatements. These discussions are ordinarily done at the planning stage of an audit.

Benefits of discussion:

• Opportunity for team members to share their insights based on their knowledge of the bank and its environment.
• Opportunity for team members to exchange information about the bank’s business risks.
• To make an understanding amongst the team members about effect of the results of the risk assessment procedures on other aspects of the audit, including decisions about the NTE of further audit procedures.

Matters to be discussed:
(a) Errors that may be more likely to occur;
(b) Errors which have been identified in prior years;
(c) Method by which fraud might be perpetrated by bank personnel or others within particular account balances and/or disclosures;
(d) Audit responses to Engagement Risk, Pervasive Risks, and Specific Risks;
(e) Need to maintain professional skepticism throughout the audit engagement;
(f) Need to alert for information or other conditions that indicates that a material misstatement may have occurred.

Question 8.
An asset becomes NPA when it ceases to generate income for the Bank. Explain the criteria for classification of advance as Non-Performing Advance.
Answer:
Criteria for classification of advance as NPA;
An Advance will be classified as NPA if:
(a) It ceases to generate income for a bank.
(b) Interest and/or instalment of principal in respect of such an advance have remain overdue or out of order for a specified period of time

• Overdue: An amount is said to be ‘Overdue’, if it is not paid on the due date fixed by the Bank.
• Out of Order: An account should be treated as ‘Out-of-order’ if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power.

Or

If there are no credits continuously for 90 days as on the balance sheet date or the credits are not enough to cover the interest debited during the same period.

NPA classification w.r.t. specified advances

• Term Loans; Term loan will become NPA if interest and/or Instalment of principal has remained overdue for a period exceeding 90 days.
• CC/OD: CC/OD account will become NPA if the account has remained out-of-order for a period exceeding 90 days.
• Bills Purchased & Discounted: Bills purchased & Discounted will become NPA when bill re-mains overdue & unpaid for a period exceeding 90 days.

Question 9.
Shy & Co. had been allotted the branch audit of a nationalized bank for the year ended 31st March, 2018. In the audit planning, the partner of Shy & Co. observed that the allotted branches are predominantly based in rural areas and major portion of the advances were for agricultural purpose. He needs your assistance in incorporating the criteria prescribed for determination of NPA norms in respect of agricultural advance, in audit plan.
Answer:
Criteria for determination of NPA norms in respect of agricultural advances;
An agricultural advance is classified as NPA is interest and/or instalment of principal is overdue for

• two crop seasons, in case loans granted for Short Duration crops,
• one crop season, in case loans granted for Long Duration crops (i.e. more than 1 year)

For this purpose, the following points are to be considered:

• Long duration crops mean the crops with crop season longer than one year.
• Short Duration Crops means the crops, other than long duration crops.
• Crop season means the period up to harvesting of the crops, as determined by the State Level Bankers’ Committee in each State.
• The above norms should be made applicable to all direct agricultural advances as listed in the Master Circular on Lending to Priority Sectors. In respect of all other agricultural loans, identification of NPAs would be done on the same basis as non-agricultural advances, which, at present, is the 90 days delinquency norm.
• If natural calamities impair the repaying capacity of agricultural borrowers, banks may decide on their own as a relief measure conversion of the short-term production loan into a term loan or re-schedulement of the repayment period; and the sanctioning of fresh short-term loan, subject to guidelines issued by RBI.

Question 10.
“Ramjilal & Co. had been allotted the branch audit of a nationalised bank for the year ended 31st March, 2019. In the audit planning, the partner of Ramjilal & Co., observed that the allotted branches are predominantly based in rural areas and major portion of the advances were for agricultural purpose.”
Now he needs your assistance on the following points so as to incorporate them in the audit plan:
(a) for determine of NPA norms for agricultural advances
(b) for accounts where there is erosion in the value of security/frauds committed by the borrow-ers. [Nov. 18 (5 Marks)]
Answer:
(i) NPA Norms for agricultural advances:
An agricultural advance is classified as NPA is interest and/or instalment of principal is overdue for

• two crop seasons, in case loans granted for Short Duration crops,
• one crop season, in case loans granted for Long Duration crops [i.e. more than 1 year)

For this purpose, the following points are to be considered:

• Long duration crops mean the crops with crop season longer than one year.
• Short Duration Crops means the crops, other than long duration crops.
• Crop season means the period up to harvesting of the crops, as determined by the State Level Bankers’ Committee in each State.

(ii) NPA Norms where there is erosion in the value of security/frauds committed by the borrowers
In case there arise erosion in the value of security or any fraud is committed by Borrowers, banks can directly classify these accounts as Doubtful Assets or Loss Assets, irrespective of the period for which the account has remained NPA.

1. Erosion in the value of securities by more than 50% of the value assessed by the bank or accepted by RBI inspection team at the time of last inspection, as the case may be, would be considered as “significant”, requiring the asset to be classified as doubtful straightaway and provided for adequately.

2. The realisable value of security as assessed by bank/approved valuers/RBI is less than 10% of the outstanding in the borrowal accounts, the existence of the security should be ignored and the asset should be classified as loss asset. In such cases the asset should either be written off or fully provided for.

Question 11.
State the internal controls in the area of Loans and Advances of Banks.
Or
“The Auditor should examine the efficiency ofvarious internal controls over advances, to determine the nature, timing and extent of his substantive procedures.” Discuss briefly.
[Nov. 18 (5 Marks), MTP-April 19]
Or
The auditor should examine the efficacy of various internal controls over advances in case of Banks to determine the nature, timing and extent of his substantive procedures. Explain what is included in the internal controls over advances. [RTP-May 19]
Answer:
Aspects of Internal Control in the area of loans and advances:
To determine the nature, timing and extent of substantive procedures over advances, auditor should examine the efficacy of various internal controls over advances.

• Advances should be made only after evaluating credit worthiness of the borrowers and obtaining sanction from the proper authorities of the bank.
• All the loan documents like promissory notes, letters of hypothecation, guarantee letter, etc. should be executed by the parties before advances are made.
• While determining the loan amount to be sanctioned, sufficient margin should be kept against securities taken so as to cover any decline in the value thereof and also to comply with RBI directives.
• Securities should be received and returned by responsible officer and should be kept in the joint custody of atleast two responsible officers,
• Securities requiring registration should be registered in the name of the bank.
• In the case of physical possession of goods as security, the goods should be test checked at the time of receipts. In respect of hypothecated goods not in possession of the bank, surprise checks should be made.
• Personal inquiries should be made so as to determine market value of goods.
• For any increase/decrease in the value of securities, drawing power should be adjusted. All the accounts should be kept within both the drawing power and the sanctioned limit at all times.
• All irregular accounts should be brought to the notice of the H.O. regularly.
• The operation in each advance should be reviewed at least once every year.
• There should exist a proper system for post disbursement supervision and follow-up.
• Classification of advances should be made as per RBI Guidelines.
• Ensure that the funds disbursed should be utilized only for the purpose for which advances has been granted.

Question 12
Your firm of Chartered Accountants has been appointed as the Auditor of two branches of OBC which are located in the Industrial area. Considering that the location of the branches of bank in industrial area, these would be “advances oriented branches and audit of advances would require the major attention of the auditors. Advise how would you proceed to obtain evidence in respect of audit of advances. [RTP-May 18, MTP-Oct. 19]
Or
The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation of internal controls relating to advances. Explain in the context of Audit of Banks. [RTP-Nov. 19]
Answer:
Collection of Evidences in respect of Advances:
Evidences in respect of advances may be collected by performing compliance and substantive procedures.

Compliance Procedures:
(a) Examine the following:

• loan documentation;
• validity of the recorded amounts;
• existence, enforceability and valuation of the security;

(b] Ensure compliance with the

• terms of sanction
• end use of funds
• loan Policy of Bank as well as RBI norms including appropriate classification and provisioning
• review the operation of the accounts.

Substantive Procedures:
(a) Verify that amounts included in balance sheet in respect of advances are outstanding at the date of the balance sheet.
(b) Verify that advances represent amount due to the bank.
(c) Ensure that outstanding amount is appropriately supported by Loan documents.
(d) Ensure that there are no unrecorded advances.
(e) Verify the appropriateness of basis of valuation of advances.
(f) Ensure that the recoverability of advances is recognised in their valuation.
(g) Check that the advances are disclosed, classified and described in accordance with recognised accounting policies and relevant statutory and regulatory requirements.
(h) Ensure that appropriate provisions towards advances have been made as per the RBI norms.

Question 13.
Mr. A approaches a bank for financial assistance for his upcoming project The bank branch manager, after verifying the proposal, is agreeable to financial Mr. A, but asks for the security of be offered to the bank. Discuss the nature of securities required to be offered to the bank. [May 18 (4 Marks)]
Answer:
Nature of Securities to be offered:
(a) Primary security: Security offered by the borrower for bank finance or the one against which credit has been extended by the bank.

(b) Collateral security: It is an additional security and can be in any form i.e. tangible or intangible asset, movable or immovable asset.

Security may be created by different modes like Mortgage, Pledge, Hypothecation, Lien, Assignment.
(a) Mortgage: Registered Mortgage can be affected by a ‘Mortgage Deed’ signed by the mortgagor. Equitable mortgage, is affected by a mere delivery of title deeds or other documents of title with intent to create security thereof.

(b) Pledge: It involves physical delivery of goods by the borrower to the lending bank with the intention of creating a charge thereon as security for the advance. Legal ownership of the goods remains with the pledger while the lending banker gets certain defined interests in the goods.

(c) Hypothecation: Hypothecation is the creation of an equitable charge, which is created in favour of the lending bank by execution of hypothecation agreement in respect of the movable securities belonging to the borrower. Borrower holds the physical possession of the goods. Neither ownership nor possession are transferred to the bank. Borrower periodically submits statements regarding quantity and value of hypothecated assets (like stocks, debtors, etc.) to the bank on the basis of which the drawing power of the borrower is fixed.

(d) Assignment: Assignment represents a transfer of an existing or future debt, right or property belonging to a person in favour of another person. Only actionable claims such as book debts and life insurance policies are accepted by banks as security by way of assignment. An assignment gives the assignee absolute right over the moneys/debts assigned to him.

(e) Set-off: Set-off is a statutory right of a creditor to adjust, wholly or partly, the debit balance in the debtor’s account against any credit balance lying in another account of the debtor.

(f) Lien: Lien is creation of a legal charge with consent of the owner, which gives lender a legal right to seize and dispose/liquidate the asset under lien.

Question 14.
Advances generally constitute the major part of the assets of the bank. There are large number of borrowers to whom variety of advances are granted. The audit of advances requires the major attention from the auditors. In carrying out audit of advances, the auditor is primarily concerned with obtaining evidence about, among other points, the amounts included in balance sheet in respect of advances are outstanding at the date of the balance sheet. Explain. [RTP-Nov. 19]
Answer:
Audit of Advances: Refer Substantive Procedures in answer of Q. No. 12

Collection of Evidences in respect of Advances:
Evidences in respect of advances may be collected by performing compliance and substantive procedures.

Compliance Procedures:
(a) Examine the following:

• loan documentation;
• validity of the recorded amounts;
• existence, enforceability and valuation of the security;

(b] Ensure compliance with the

• terms of sanction
• end use of funds
• loan Policy of Bank as well as RBI norms including appropriate classification and provisioning
• review the operation of the accounts.

Substantive Procedures:
(a) Verify that amounts included in balance sheet in respect of advances are outstanding at the date of the balance sheet.
(b) Verify that advances represent amount due to the bank.
(c) Ensure that outstanding amount is appropriately supported by Loan documents.
(d) Ensure that there are no unrecorded advances.
(e) Verify the appropriateness of basis of valuation of advances.
(f) Ensure that the recoverability of advances is recognised in their valuation.
(g) Check that the advances are disclosed, classified and described in accordance with recognised accounting policies and relevant statutory and regulatory requirements.
(h) Ensure that appropriate provisions towards advances have been made as per the RBI norms.

Question 15.
“There is no difference in provisioning of NPA as regards to categories of NPA, whether the debt is secured or unsecured.” Critically evaluate the statement on the basis of provisioning norms of NPA of nationalised bank. [Nov. 19 (4 Marks)]
Answer:
Provisioning Requirements of NPA:
Statement that “There is no difference in provisioning of NPA as regards to categories of NPA, whether the debt is secured or unsecured” is not correct as the provisioning requirements for substandard and doubtful categories of NPA are different for secured and unsecured advances.
(a) For Substandard advances: Additional provision is required @ 10% (5% for infrastructure advances).
(b) For Doubtful Advances: Provisioning requirements are given below:

	Secured Portion	Unsecured Portion
Doubtful upto 1 year	25%	100%
Doubtful 1 to 3 years	40%	100%
Doubtful above 3 years	100%	100%

Question 16.
Newton Ltd. has made loans and advances on the basis of following securities to various borrowers. As an’ auditor what type of documents can be verified to ensure that the company holds a legally enforceable security?
(i) Shares and Debentures
(ii) Life Insurance Policy
(iii) Hypothecation of goods. [MTP-May20]
Answer:
Documents to be seen in case of Securities:

Types of Security	Documents etc. to be seen
Shares and debentures	The scrip and the endorsement thereon of the name of the transferee, in the case of transfer.
Life Insurance Policy	Assignment of policy in favour of the lender, duly registered with the insurer
Hypothecation of goods	Deed of hypothecation or other document creating the charge, together with a statement of inventories held at the Balance Sheet date

Question 17.
Distinguish between Primary Security and Collateral Security with reference to audit of Banks. Also give examples of most common types of securities accepted by the Banks. [RTP-Nw 20]
Answer:
Primary Security and Collateral Security:
Primary security refers to the security offered by the borrower for bank finance or the one against which credit has been extended by the bank. This security is the principal security for an advance.

Collateral security is an additional security. Security can be in any form i.e. tangible or intangible asset, movable or immovable asset.
Examples of most common types of securities accepted by banks are the following:

• Personal Security of Guarantor
• Goods/Stocks/Debtors/Trade Receivables
• Gold Ornaments and Bullion
• Immovable Property
• Plantations (For Agricultural Advances)
• Third Party Guarantees
• Banker’s General Lien
• Life Insurance Policies
• Stock Exchange Securities and Other Instruments

Question 18.
Depending on the nature of the item concerned, creation of security may take the form of a mortgage, pledge, hypothecation, assignment, set-off or lien. Explain with specific reference to Audit of Banks. [RTP-Nov. 20]
Answer:
Nature of Securities to be offered:
(a) Primary security: Security offered by the borrower for bank finance or the one against which credit has been extended by the bank.

(b) Collateral security: It is an additional security and can be in any form i.e. tangible or intangible asset, movable or immovable asset.

Security may be created by different modes like Mortgage, Pledge, Hypothecation, Lien, Assignment.
(a) Mortgage: Registered Mortgage can be affected by a ‘Mortgage Deed’ signed by the mortgagor. Equitable mortgage, is affected by a mere delivery of title deeds or other documents of title with intent to create security thereof.

(b) Pledge: It involves physical delivery of goods by the borrower to the lending bank with the intention of creating a charge thereon as security for the advance. Legal ownership of the goods remains with the pledger while the lending banker gets certain defined interests in the goods.

(c) Hypothecation: Hypothecation is the creation of an equitable charge, which is created in favour of the lending bank by execution of hypothecation agreement in respect of the movable securities belonging to the borrower. Borrower holds the physical possession of the goods. Neither ownership nor possession are transferred to the bank. Borrower periodically submits statements regarding quantity and value of hypothecated assets (like stocks, debtors, etc.) to the bank on the basis of which the drawing power of the borrower is fixed.

(d) Assignment: Assignment represents a transfer of an existing or future debt, right or property belonging to a person in favour of another person. Only actionable claims such as book debts and life insurance policies are accepted by banks as security by way of assignment. An assignment gives the assignee absolute right over the moneys/debts assigned to him.

(e) Set-off: Set-off is a statutory right of a creditor to adjust, wholly or partly, the debit balance in the debtor’s account against any credit balance lying in another account of the debtor.

(f) Lien: Lien is creation of a legal charge with consent of the owner, which gives lender a legal right to seize and dispose/liquidate the asset under lien.

Question 19.
Explain income recognition norms with respect to advances in case of a banking company
Answer:
Income Recognition norms w.r.t. Advances:

Any income which exceeds

• one per cent of the total income of the bank if the income is reckoned on a gross basis
  or
• one per cent of the net profit before taxes if the income is reckoned net of costs, should be considered on accrual as per AS-9 (subject to certainty as to their ultimate collection). Other incomes may be recognised when received.
• In case of NPA, RBI guidelines require that banks should not recognize income until it is actually realised.
• Interest on advances against Term Deposits, National Savings Certificates (NSCs), Indira Vikas Patras (IVPs), Kisan Vikas Patras (KVPs) and Life policies may be taken to income account on the due date, provided adequate margin is available in the accounts.
• In the case of outstanding bills purchased and discounted the discount received thereon should be properly apportioned.
• Fees and Commission earned by the bank as a result of rescheduling of advances should be recognized on accrual basis over the period covered by the rescheduled extension of credit period.

Question 20.
Write a short note on reversal of income under bank audit.
Answer:
Reversal of Income:
(a) First time NPAs: If a Loan/Advance is treated as NPA for the first time, interest accrued which has not been realized but credited to the Income Account should be reversed or provided for.

(b) Commission/other Income: If interest income is recognized on cash basis, then Commission and other such income with respect to the same Borrower, which has been recognized on accrual basis in the previous year but has not been realized, should be reversed or provided for with respect to previous year.

(c) Finance Charge of leased assets: The finance charge component of finance income [as defined in AS 19 -Leases] on the leased asset which has accrued and was credited to income account before the asset became non-performing, and remaining unrealised, should be reversed or provided for in the current accounting period.

Question 21.
In view of the significant uncertainty regarding ultimate collection of income arising in respect of non-performing assets, the guidelines require that banks should not recognize income on nonperforming assets until it is actually realised. When a credit facility is classified as non-performing for the first time, interest accrued and credited to the income account in the corresponding previous year which has not been realized should be reversed or provided for. This will apply to Government guaranteed accounts also. Analyse and Explain. [RTP-May 20]
Answer:
Reversal of Income:
If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, the entire interest accrued and credited to income account in the past periods, should be reversed or provided for if the same is not realised. This will apply to Government guaranteed accounts also.

In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected.

Further, in case of banks which have wrongly recognised income in the past should reverse the interest if it was recognised as income during the current year or make a provision for an equivalent amount if it was recognized as income in the previous year(s].

Furthermore, the auditor should enquire if there are any large debits in the Interest Income accountthat have not been explained. It should be enquired whether there are any communications from borrowers pointing out differences in interest charge and whether appropriate action has been taken in this regard.

Question 22.
How would you verify the Interest Expenditure while carrying out audit of a bank.
Answer:
Verification of Interest Expenditure:
(a) Obtain from the bank an analysis of various types of deposits outstanding at the end of each quarter and compute a weighted average interest rate. The rate so computed should be compared with the actual average rate and enquire into the difference, if material.

(b) Compare the average rate of interest paid on deposits with the corresponding figures for the previous years and enquire into the difference, if material.

(c) Verify the calculation of interest and ensure the following:

• Interest has been provided on all deposits u pto the date of the balance sheet and determine whether there is any excess or short credit.
• Interest rates are in accordance with the bank’s internal regulations, RBI directives and agreements with the depositors;
• In relation to fixed deposits, examine whether the interest rate in the accounting system are same as mentioned in the Fixed Deposit Receipt/Certificate.
• Interest on Savings Account should be checked on a test check basis in accordance with the rules framed by the bank.
• Interest on inter-branch balances has been provided at the rates prescribed by the head office.
• Interest on overdue/matured term deposits should be estimated and provided for.

(d) Ascertain whether there are any changes in interest rate on saving deposits and term deposits during the period.

Question 23.
Write short note on: Audit procedures for verification of provisions and contingencies in case of bank audit.
Or
You are appointed as Statutory Auditor of DEF Bank Limited for the year 2020-21. As an Auditor how will you verify Provisions created by DEF Bank Limited? [Nov. 20 (4 Marks)]
Answer:
Audit Procedure for Verification of Provisions and Contingencies:

• Ascertain compliance with the various regulatory requirements for provisioning as contained in the various circulars.
• Obtain an understanding as to how the Bank computes provision on standard assets and non-performing assets. It includes the basis of the classification of loans into standard, sub-standard, doubtful and loss assets.
• Obtain the detailed break up of standard loans, non-performing loans and agree the outstanding balance with the general ledger.
• Examine whether the provisions in respect of standard loans and NPA comply with the regulatory requirements.
• Obtain statement of computation of tax provision from the bank’s management and verify the nature of items debited and credited to profit and loss account to ascertain that the same are appropriately considered in the tax provision computation.
• Re-compute the provision for tax by applying the applicable tax rate after considering the allowances and disallowances as per Income Tax Act, 1961.
• Other provisions for expenditure should be examined vis-a-vis the circumstances warranting the provisioning and the adequacy of the same by discussing and obtaining the explanations from the bank’s management.

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

Question 1.
RBI has been entrusted with the responsibility of regulating the activities of commerce l banks only.
Answer:
Statement is incorrect.

• RBI has been entrusted with the responsibility of regulating the activities of entire banking system in India which covers commercial as well as other banks.

Question 2.
In the computerised environment, the auditor is not required to be familiar with latest applicable RBI guidelines that have bearing on the classification/provisions and income recognition.
Answer:
Statement is incorrect.

• While carrying out audit of a bank whether in a Computerised environment or manual, auditor must be familiar with all the norms/parameters as per the latest applicable RBI guidelines that have a bearing on the classification/provisions and income recognition.

Question 3.
Collateral security refers to the security offered by the borrower for bank finance or the one against which credit has been extended by the bank.
Answer:
Statement is incorrect:

• Security offered by the borrower for bank finance or the one against which credit has been extended by the bank is known as primary security.
• Collateral security is an additional security and can be in any form i.e. tangible or intangible asset, movable or immovable asset.

Question 4.
Registered mortgage is affected by a mere delivery of title deeds or other documents of title with intent to create security thereof.
Answer:
Statement is incorrect.

• Registered Mortgage can be affected by a ‘Mortgage Deed’ signed by the mortgagor.
• Equitable mortgage, is affected by a mere delivery of title deeds or other documents of title with intent to create security thereof.

Question 5.
Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid within 90 days of becoming due.
Answer:
Statement is incorrect.

• An amount is said to be ‘Overdue’, if it is not paid on the due date fixed by the Bank.

Question 6.
An account should be treated as ‘out of order’ if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power.
Answer:
Statement is correct.

• An account should be treated as ‘Out-of-order’ if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power, or
• If there are no credits continuously for 90 days as on the balance sheet date or the credits are not enough to cover the interest debited during the same period.

Question 7.
The matters which the banks require their auditors to deal with in the long form audit report have been specified by the Central Government. [MTP-March 18, March 19]
Answer:
Statement is incorrect.

• The matters which the banks require their auditors to deal with in the long form audit report have been specified by the Reserve Bank of India.

Question 8.
Banks recognize income on Non-Performing Assets on accrual basis. [Nov. 18 (2 Marks)]
Answer:
Statement is incorrect.
In case of NPA, RB! guidelines require that banks should not recognize income until it is actually realised.

Question 9.
Auditor of a Nationalised bank is to be appointed at the annual general meeting of the shareholders. [May 19 (2 Marks)]
Answer:
Statement is incorrect.
Auditor of a nationalised bank is to be appointed by the bank concerned acting through its Board of Directors.

Question 10.
An account should be treated as ‘out of order’ if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 180 days as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as ‘out of order’. [RTP-May 20]
Answer:
Statement is incorrect:
An account should be treated as ‘out of order’ if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power.

In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as ‘out of order’.

Question 11.
Classification as NPA should be based on the availability of security and asset classification would be facility wise and not borrower wise. [Nov. 20 (2 Marks)]
Answer:
Statement is incorrect:
Classification as NPA should be based on the record of recovery. Availability of security or net worth of borrower/guarantor is not to be taken into account for purpose of treating an advance as NPA or otherwise,

Asset classification would be borrower-wise and not facility-wise. All facilities including investments in securities would be termed as NPA.

Audit of Different Types of Entities – CA Inter Auditing Notes is designed strictly as per the latest syllabus and exam pattern.

Audit of Different Types of Entities – CA Inter Auditing Notes

Question 1.
Explain in detail the duties of Comptroller and Auditor General of India.
[May 03 (8 Marks), Nov. 12 (10 Marks), RTP-May 19, Nov. 19]
Answer:
Duties of Comptroller and Auditor General:
1. Compilation and submission of Accounts: The C & AG should compile the accounts pertaining to annual receipts and disbursements of the Union or State or Union Territory, and submit these to the President or Governor or Administrator.

2. Rendering Assistance in Accounts Maintenance: The C & AG should provide such information to the Union or State or Union Territory, as they may require from time to time and render such assistance for preparing annual F.S. as they reasonably ask for.

3. Auditing and Reporting: The C & AG should audit and report on:

• All the expenditures from Consolidated Fund of India/State/Union Territory having a Legislative Assembly and to determine whether the monies disbursed were legally available for and applicable to the purpose for which they are applied.
• All the transactions of Union or State pertaining to Contingency Funds and Public Accounts.
• All Trading, Manufacturing, Profit & Loss A/cs & Balance Sheets & other subsidiary accounts kept in any department of a Union or State.

4. Audit of Receipts and Expenditure of substantially financed entities: Where any body or authority is substantially financed by grant or loans from the Consolidated Fund of India/State/ Union Territory, the CAG shall audit and report on all receipts and expenditure of that body or authority.

5. Audit of Grants or Loans: Where any grant or loan is given for any specific purpose from the Consolidated Fund of India/State/Union Territory to any authority or body, not being a foreign State or international organisation, the CAG shall scrutinise the procedures by which the sanctioning authority satisfies itself as to the fulfillment of the conditions subject to which such grants or loans were given.

6. Audit of Receipts of Union or States: CAG shall audit all receipts which are payable into the Consolidated Fund of India/State/Union Territory and satisfy himself that the rules and procedures in that behalf are designed to secure an effective check on the assessment, collection & proper allocation of revenue and are being duly observed.

7. Audit of Accounts of Stores and Stock: The CAG shall have authority to audit and report on the accounts of stores and stock kept in any office or department of the Union/State.

8. Audit of Govt. Companies and Corporations: The duties and powers of the CAG in relation to the audit of the accounts of government companies shall be performed and exercised by him in accordance with the provisions of the Companies Act, 2013.

Question 2.
Write short note on: Audit of Expenditure in Government Audit. [May 07 (5 Marks), May 11 (4 Marks)]
Or
Write short note on: Basic Standards set for audit of Government Expenditure. [Nov. 13 (4 Marks)]
Or
An audit of Expenditure is one of the major components of Government Audit. In the context of ‘Government Expenditure Audit’, write in brief, what do you understand by:
(i) Audit against Rules and Orders
(ii) Audit of Sanctions
(iii) Audit against Provision of Funds
(iv) Propriety Audit
(v) Performance Audit. [RTP-May 18]
Or
Write basis standards set for Expenditure Audit of Government. [Nov. 18 (5 Marks)]
Or
Audit of government expenditure is one of the major components of government audit conducted by the office of C&AG. The basic standards set for audit of expenditure are to ensure that there is provision of funds authorised by competent authority fixing the limits within which expenditure can be incurred. Explain those standards. [RTP-Nov. 19]
Answer:
Basic Standards for audit of government expenditure:
Expenditure audit is conducted to observe the following standards:
1. Expenditure incurred conforms to the relevant provisions of the statutory enactments and is also in accordance with the financial rule and regulation. This is called audit against rules and orders.

2. There is proper sanction either special or general accorded by the competent authority for all expenditure. This is known as audit of sanctions.

3. There are provisions or budget of funds out of which expenditure can be met. This is called audit against provisions of fund.

4. The expenditure is incurred with due regard to broad and general principle of propriety. This is called propriety audit.

5. That the programmes, schemes and projects where large expenditure has been incurred are being run economically and yielding results. This is known as performance audit.

Question 3.
What are the focus points in doing propriety audits by C & AG as regards government expenditure? [Nov. 11 (8 Marks)]
Or
Write short note on: Propriety Audit. [Nov. 17 (4 Marks)]
Or
Audit against the propriety seeks to ensure that expenditure confirms to certain principles. Explain. [MTP-Oct. 19]
Answer:
Propriety Audit: Propriety Audit stands for verification of transactions on the tests of public interest, commonly accepted customs and standards of conduct.

Emphasis/Scope: Instead of too much dependence on documents, vouchers and evidence, it shifts the emphasis to the substance of the transactions and looks into the appropriateness thereof on a consideration of financial prudence, public interest and prevention of wasteful expenditure.

Thus, propriety audit is concerned with scrutiny of executive actions and decisions bearing on financial and profit and loss situation of the company with special regard to public interest and commonly accepted customs, and standards of conduct.

Principles (Focus Points) of Propriety Audit:

• Expenditure is not prima facie more than the occasion demands.
• Every official exercise the same degree of vigilance in respect of expenditure as a person of ordinary prudence would exercise in respect of his own money.
• The authority exercises its power of sanctioning expenditure to pass an order which will not directly or indirectly accrue to its own advantage.
• Funds are not utilised for benefit of a particular person/group of persons.
• Apart from the agreed remuneration, no other avenue is kept open to indirectly benefit the management personnel, employees and others.
• Wastages are avoided in expenditure.
• The expenditure should bring out optimum, enduring benefits instead of mere frittering away the public money on meeting day to day needs repeatedly.

Question 4.
With reference to Government Audit, what do you understand by “Audit of Commercial Accounts”? [May 05 (8 Marks)]
Answer:
Audit of Commercial Accounts:
Entities engaged in commercial activities can be classified as:

• Departmental enterprises engaged in commercial and trading operations, which are governed by the same regulations as other Government departments such as defence factories, mines, etc.
• Statutory corporations created by specific statutes such as LIC, Air India, etc.
• Government companies, set up under the Companies Act, 2013.

Auditing aspects
1. Departmental enterprises: The audit of departmental entities is done in the same manner as any Government department, where commercial accounts are kept,

2. Statutory Corporations: Audit of statutory corporations depends on the nature of the statute governing the corporation.

3. Government Companies: In respect of government companies, the provisions of Companies Act, 2013 are applicable.

• As per Sec. 139(7) and 139(5) of the Companies Act, 2013 the statutory auditor of a Government company shall be appointed or re-appointed by the GAG.
• The audit is done by qualified Chartered Accountants and the audit is done on similar lines with the audits of limited companies.
• In addition to report under section 143, the auditors have to give report on the specific matters as contained in the directives of the C&AG.
• The auditor aforesaid shall submit a copy of his audit report to the CAG who shall have the right to comment upon, or supplement, the audit report in such manner as he may think fit.

Question 5.
What are the powers of C&AG in relation to the accounts of Government Companies audited by the statutory auditors? [Nov 05 (8 Marks)]
or
In case of government companies, CAG has a right to issue directions to auditor and do supplemen¬tary audit. Explain. [May 07 (8 Marks)]
or
Write short notes on the following: Power of CAG u/s 143(6) & 143(7) in relation to audit of Gov¬ernment Company. [Nov 07 (5 Marks)]
Answer:
Powers of CAG in the Audit of a Government company:
Role of C&AG is prescribed under sub-sections (5), (6) and (7) of section 143 of the Companies Act, 2013.
(a) Directions to Auditor – Sec. 143(5): In the case of a Government company, the CAG shall appoint the auditor and direct such auditor the manner in which the accounts of the Government company are required to be audited.

(b) Supplementary Audit – Sec. 143(6): The CAG shall within 60 days from the date of receipt of the audit report have a right to,

• conduct a supplementary audit of the financial statement of the company by such person or persons as he may authorize in this behalf; and
• Comment upon or supplement such audit report:

(c) Test Audit – Sec. 143(7): The CAG may, in case of government company, if he considers necessary, by an order, cause test audit to be conducted of the accounts of such company and the provisions of section 19A of the CAG (Duties, Powers and Conditions of Service) Act, 1971, shall apply to the report of such test audit.

Question 6.
Write short note on: Powers of C & AG in connection with the performance of his duties. [Nov. 09 (5 Marks), Nov. 14 (4 Marks)]
Or
Discuss the power of C & AG in Government audit. [May 19 (3 Marks)]
Or
The C&AG Act gives powers to the C&AG in connection with the performance of his duties. Explain. [MTP-May 20]
Answer:
Powers of C & AG in connection with the performance of his duties:
The Comptroller and Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 gives
the following powers to the C&AG in connection with the performance of his duties:

• Inspection: To inspect any office of accounts under the control of the Union/State including office responsible for the creation of the initial or subsidiary accounts.
• Transmission: To require that any accounts, books, papers and other documents which deal with or are otherwise relevant to the transactions under audit, be sent to specified places.
• Inquiry: To put such questions or make such observations as he may consider necessary to the preparation of any account or report which it is his duty to prepare.

Question 7.
Audit of the accounts of stores and inventories has been developed as a part of expenditure audit with reference to the duties and responsibilities entrusted to C&AG. Discuss.
Answer:
Audit of Stores and inventories:
Audit of the accounts of stores and inventories has been developed as a part of expenditure audit with reference to the duties and responsibilities entrusted to C&AG. Audit procedure of stores include the followings:

• Regulations governing purchase, receipts, issues, custody, sales, write-off and stock taking etc. are reviewed.
• Purchases are audited according to the rules prescribed for audit of expenditure.
• Ensure that prices paid are reasonable. Cases of uneconomical purchases of stores should be brought to the notice of concerned authority.
• The system of accounting for stores should also be reviewed and sure that the balance of stocks and stores in hand is within reasonable limits.
• Valuation of stocks should be seen carefully so that value accounts tally with the physical accounts.
• The sanction for write-offs is to be scrutinised.

Question 8.
The Comptroller and Auditor General shall be responsible for compiling the accounts of the Union and of each State from the initial and subsidiary accounts rendered to the audit and accounts offices under his control by treasuries, offices or departments responsible for the keeping of such account. Explain. [MTP-Oct. 20]
Answer:
C&AG responsibility for compiling the accounts of the Union and State:
The C&AG shall be responsible for compiling the accounts of the Union and of each State from the initial and subsidiary accounts rendered to the audit and accounts offices under his control by treasuries, offices or departments responsible for the keeping of such account.

The C&AG shall, from the accounts compiled by him prepare in each accounts, showing under the respective heads, the annual receipts and disbursements for the purpose of the Union, of each State and of each Union Territory having a Legislative Assembly, and shall submit those accounts to the President or the Governor of a State or Administrator of the Union Territory having a Legislative Assembly, as the case may be, on or before such dates as he may, with the concurrence of the Government concerned, determine.

The C&AG Act of 1971 has provisions for relieving him of this responsibility to give information and render assistance to the Union and States. The C&AG shall, insofar as the accounts, for the compilation or keeping of which he is responsible, enable him so to do, give to the Union Government, to the State Government or to the Governments of Union Territories having Legislative Assemblies, as the case may be, such information as they may, from time to time, require and render such assistance in the preparation of the annual financial statements as they may reasonably ask for.

Question 9.
Audit against rules and orders aims to ensure that the expenditure conforms to the relevant pro¬visions of the Constitution and of the laws and rules made thereunder. The job of audit is to see that these rules, regulations and orders are applied properly by the subordinate authorities. It is, however, not the function of audit to prescribe what such rules, regulations and orders shall be. Analyse and Explain [RTP-Nov. 20]
Or
What is the function of audit while examining various rules, regulations and orders with regard to Audit against Rules & Orders by C&AG? [Nov. 20 (3 Marks)]
Answer:
Audit against Rules and orders:
Auditor is required to carry out examination of the various rules, regulations and orders issued by the executive authorities to see that:
(a) they are not inconsistent with any provisions of the Constitution or any laws made thereunder;
(b) they are consistent with the essential requirements of audit and accounts as determined by the CAG.
(c) they do not come in conflict with the orders of, or rules made by, any higher authority; and
(d) in case they have not been separately approved by competent authority, the issuing authority possesses the necessary rule-making power.

Question 10.
The auditor of a Govt. Company has to ensure that each item of expenditure is covered by a sanction, either general or special, of the competent authority. Explain. [RTP-Nov. 20]
Answer:
Audit of Sanctions:
The auditor has to ensure that each item of expenditure is covered by sanction, either general or special from the competent authority. The audit of sanction is directed both in respect of ensuring that:
(a) The expenditure is properly covered by a sanction and
(b) To satisfy that the authority sanctioning it, is competent for the purpose by virtue of powers vested by constitution.

Question 11.
The audit of receipts of government is not as old as audit of expenditure but with the rapid growth of public enterprises audit of receipts tax or non-tax has come to stay. Discuss audit of receipts with respect to Government Audit. [Nov. 20 (4 Marks)]
Answer:
Audit of Receipts:
Basic principle of audit of receipts is to look at the general than on the particular, though individual cases of assessment, demand, collection, refund, etc. are important within the area of test check.

Audit of receipts includes checking:

• whether all revenues due to government have been correctly assessed, realised and credited to government account by the designated authorities;
• whether adequate regulations and procedures have been framed by the concerned department/ agency to secure an effective check on assessment and collection;
• whether regulations and procedures are actually being carried out;
• whether adequate checks are imposed to ensure the prompt detection and investigation of irregularities, double refunds, forged refund vouchers or other loss of revenue through fraud or wilful Omission or negligence to levy or collect taxes or to issue refunds; and
• review of systems and procedures to see that the internal procedures adequately secure correct and regular accounting of demand collections and refunds and to suggest improvement.

Question 12.
Describe the salient features of Financial Administration of Local Bodies. [Nov. 04 (8 marks)]
Answer:
Salient Features of Financial administration of Local Bodies:
Financial administration of local bodies comprises of following:
1. Budgetary Procedure: The objective of local bodies budgetary procedure are

• financial accountability,
• control of expenditure, and
• to ensure that funds are raised and money is spent in accordance with the rules and regulations.

2. Expenditure Control

• In the local body legislative powers are vested in the Council whereas executive powers are delegated to the officers, e.g., Commissioners.
• All matters of regular revenue and expenditures are generally delegated to the executive wing.
• For special situations like, reduction in property taxes, refund of security deposits, etc., sanction from the legislative wing is necessary.

3. Accounting System: The accounting system is characterised by
(a) accounts are usually kept under Cash System.
(b) subsidiary and statistical registers for taxes, assets, cheques etc.,
(c) separate vouchers for each type of transaction,
(d) compulsory monthly bank reconciliation,
(e) submission of summary reports on periodical basis to authorities at regional & state level.

Question 13.
Draft an Audit programme for conducting audit of accounts of a local body. [May 10 (5 Marks), May 16 (6 Marks)]
Or
State the background of “Local Bodies”. Draft an audit programme for audit of local bodies. [May 14 (8 Marks)]
Answer:
Audit Programme for conducting audit of accounts of local bodies:
(a) Ensure validity of appointment.

(b) Determine Objectives of Audit w.r.t.

• Reporting on True and fairness of financial statements.
• Strengths and weakness of Financial Control.
• Adherence to legal and administrative requirements.

(c) Perform Audit w.r.t. following:

• Audit against Rules and Orders
• Audit against Sanctions.
• Audit against provision of funds.
• Propriety Audit and performance audit.
• Audit of Receipts and Revenue.

(d) Frame the conclusion and Issue the Report

Question 14.
State the important objectives of local body’s audit. [May 15, May 17, May 18 (4 Marks)]
Answer:
Important Objectives of local body’s audit:
(a) Reporting on the fairness of the content and presentation of financial statements;
(b) Reporting upon the strengths and weaknesses of systems of financial control;
(c) Reporting on the adherence to legal and/or administrative requirements; .
(d) Reporting upon whether value is being fully received on money spent; and detection and prevention of error, fraud and misuse of resources

Question 15.
Explain the different types of revenue grants which local bodies may receive. [Nov. 20 (3 Marks)]
Answer:
Different types of revenue grants:
Local bodies may receive different types of grants from the State administration as well. Broadly,
the revenue grants are of three categories:
(a) General purpose grants: These are primarily intended to substantially bridge the gap between the needs and resources of the local bodies.
(b) Specific purpose grants: These grants which are tied to the provision of certain services or
performance of certain tasks.
(c) Statutory and compensatory grants: These grants, under various enactments, are given to local bodies as compensation on account of loss of any revenue on taking over a tax by State government from local government.

Question 16.
State any five special points which you, as an auditor, would look into while examining the income and collection of fund by an NGO engaged in providing relief work for flood victims. [Nov. 07 (5 Marks)]
Answer:
Examination of Income and collection of fund of NGO:
1. Grants, donations and other contributions: Grants, donations and Contributions received should be properly checked with reference to donors letter, bank statements etc. and ensure that they are properly accounted and banked.

2. Foreign Contributions: In respect of Foreign contribution, ensure that all such contributions are as per RBI Guidelines and be kept in separate bank account.

3. Receipts from fund raising programs: In the case of fund raising programs, verify the internal control system, mode of receipt and the authority accountable.

4. Membership Fees: Check the membership fees received from the membership register and ensure proper classification into entrance fees, annual fees and life membership fees.

5. Subscriptions: Check the subscriptions from the subscription register and receipts issued.

6. Interest and Dividend: Check the interests and dividends received and receivable with investments held during the year.

Question 17.
What important points should an auditor keep in mind while checking receipt of income of a Non-Governmental Organization (N.G.O.)? * [Nov. 10 (4 Marks)]
Answer:
Examination of Income and collection of fund of NGO:
(i) Grants, donations and other contributions: Grants, donations and Contributions received should be properly checked with reference to donors letter, bank statements etc. and ensure that they are properly accounted and banked.

(ii) Foreign Contributions: In respect of Foreign contribution, ensure that all such contributions are as per RBI Guidelines and be kept in separate bank account.

(iii) Receipts from fund raising programs: In the case of fund raising programs, verify the internal control system, mode of receipt and the authority accountable.

(iv) Membership Fees: Check the membership fees received from the membership register and ensure proper classification into entrance fees, annual fees and life membership fees.

(v) Subscriptions: Check the subscriptions from the subscription register and receipts issued.

(vi) interest and Dividend: Check the interests and dividends received and receivable with investments held during the year.

Question 18.
What are the points on which an auditor should concentrate while planning audit of an N.G.O.? [May 13 (8 Marks)]
Or
You have been appointed as an auditor of an NGO, briefly state the points on which you would concentrate while planning the audit of such an organisation? [RTP-Nov. 18]
Answer:
Points to be concentrated while planning an audit of an NGO:

• Knowledge of the NGO’s work, its mission and vision, areas of operations & environment in which it operates.
• Reviewing its legal form and its MOA, AOA, rules and Regulations.
• Reviewing the Organisation chart, Manuals relating to financial and administrative matters.
• Examination of minutes of meetings of the Managing Committee/Governing Body to ascertain the impact of decisions on the financial records.
• Study the accounting system, procedures, internal controls and internal checks existing for the % NGO and verify their applicability.
• Updating knowledge of relevant statutes especially with regard to recent amendments, circulars, judicial decisions viz. Foreign Contribution (Regulation) Act, 1976, Societies Registration Act, 1860, Income Tax Act, 1961 etc. and the Rules related to the statutes.
• Setting of materiality levels for audit purposes.
• The nature and timing of reports or other communications.

Question 19.
An NGO operating in Delhi had collected large scale donations for Tsunami victims. The donations so collected were sent to different NGOs operating in Tamil Nadu for relief operations. This NGO operating in Delhi has appointed you to audit its accounts for the year in which it collected and remitted donations for Tsunami victims. Draft audit programme for audit of receipts of donations and remittance of the collected amount to different NGOs. Mention six points each, peculiar to the situation, which you will like to incorporate in your audit programme for audit of said receipts and remittances of donations. [MTP-March 18, Oct. 18, March 19]
Answer:
Audit of Donation Receipts:
(i) Internal Control System: Examine internal control system particularly with reference to division of responsibilities in respect of authorised collection of donations, custody of receipt books and safe custody of money.

(ii) Custody of Receipt Books: Examine the existence of system regarding issue of receipt books, whether unused receipt books are returned and the same are verified physically including checking of number of receipt books and sequence of numbering therein.

(iii) Receipt of Cheques: Receipt Book should have carbon copy for duplicate receipt and signed by a responsible official. All details relating to date of cheque, bank’s name, date, amount, etc. should be clearly stated.

(iv) Bank Reconciliation: Reconciliation of bank statements with reference to all cash deposits not only with reference to date and amount but also with reference to receipt book.

(v) Cash Receipts: Register of cash donations to be vouched more extensively. If addresses are available of donors who had given cash, the same may be cross-checked by asking entity to post thank you letters mentioning amount, date and receipt number.

(vi) Foreign Contributions, if any, to receive special attention to compliance with applicable laws and regulations.

Remittance of Donations to Different NGOs:

• Mode of Sending Remittance: Ensure that all remittances are made through account payee cheques. Remittances through Demand Draft need to be scrutinised thoroughly with reference to recipient.
• Confirming Receipt of Remittance: Ensure that all remittances are supported by receipts and acknowledgements.
• Identity: Verify address, Registration Number, etc. of recipient NGO.
• Direct Confirmation Procedure: Send confirmation letters to entities to whom donations have been paid.
• Donation Utilisation: Ensure that amount of donation is utilised for providing relief to Tsunami victims.
• NGOs’ Selection: Check system for selecting NGO to whom donations have been sent.

Question 20.
How the audit is advantageous to Sole Trader? [May 06 (8 Marks)]
Answer:
Advantages of Audit to Sole Traders:
Sole traders are not required to have their accounts audited under any law. But still some of the sole traders who have vast and varied expenditures, get their private accounts audited. In most of such cases the accountant prepares and finalizes the accounts as well as checks the accuracy of accounts.

Benefits of audit to Sole Trader:

• The accounts department will become more efficient as they know that their work is to be checked by an independent person. In this way extent of fraud or misappropriation is reduced to a minimum.
• Audited accounts are generally accepted as correct by the Income Tax Department. It will help the individual to get an early assessment of his accounts.
• Audited accounts help the administrators and executors.
• The audited accounts can be presented, as an evidence, in the courts.
• It will help to secure compensation from insurance companies in the event of loss by fire, etc.
• It helps in borrowing money from banks.

Question 21.
You are approached by a partnership firm to list out the advantages that will accrue to them, if the accounts are audited. State five important advantages. [May 07 (5 Marks)]
Or
What are the advantages of the audit of the accounts of partnership firm. [May 15 (6 Marks), MTP-April 19]
Answer:
Advantages of Audit of Partnership Firms:
The partnerships firms a re governed by the Indian Partnership Act, 1932. This Act does not contemplate audit of the partnership firm. However, it is in the interest of the partners that the accounts of the firm are regularly audited by an independent auditor. The provision for the same may be made in the partnership deed itself.

Advantages of Audit of Partnership Firms:

• Audited accounts help in settling accounts between the partners reliably.
• Audited accounts provide a reliable evidence for computing the amount due to the retiring partner or representative of deceased partner.
• Acceptance of Audited accounts by the Government agencies for various purposes like Income tax authorities for computing the assessable income.
• Audited accounts are relied upon by banks for advancing loan.
• Audited accounts can be helpful in the negotiation for sale or admission of a new partner.
• It is an effective safeguard against any undue advantage being taken by a working partner as against the non-working partners

Question 22.
Mention important points which auditors will consider while conducting audit of accounts of a partnership firm. [May 13 (8 Marks), May 16 (6 Marks), RTP-May 19]
Or
There are certain points which are required to consider specially in the audit of accounts of a partnership. Discuss any three points briefly. [Nov. 19 (3 Marks)]
Answer:
Points to be considered in Audit of Partnership Firms:
1. Confirming that the letter of appointment, signed by a partner, duly authorised, clearly states nature & scope of audit contemplated by the partners, specially limitation, if any.

2. Examine the partnership deed to ensure that it had been signed by all partners & registered with the registrar of firms. Ascertain from the partnership deed about capital contribution, profit sharing ratios, interest on capital contribution, powers and responsibilities of the partners, etc.

3. Study the minute book, if any, maintained to record the policy decision taken by partners specially the minutes relating to authorisation of extraordinary and capital expenditure, raising of loans, purchase of assets and other such matters which are not of a routine nature.

4. Verifying that the business in which the partnership is engaged is authorised by the partnership agreement.

5. Examining whether books of account appear to be reasonable and are considered adequate-in relation to the nature of the business of the partnership.

6. Verifying that the profits/losses have been divided among partners in agreed profit-sharing ratio.

7. Confirming that a provision for the firm’s tax payable by the partnership has been made in the accounts before arriving at the amount of profit divisible among the partners.

8. Ensure that various requirements of legislations applicable to the partnership firm like Section 44AB of the Income-tax Act, 1961 have been complied with.

Question 23.
Write a short note on: Books of Account to be maintained by a Limited Liability Partnership.
Answer:
Books of Account to be maintained by a LLP:
As per Sec. 34 of LLP Act, 2008, LLP shall maintain such proper books of account as may be prescribed relating to its affairs for each year of its existence. Books may be maintained on cash basis or accrual basis and according to double entry system of accounting. Books shall be maintained at registered office for such period as may be prescribed.

As per Rule 24 of LLP Rules, 2009, the books of account shall contain:
(a) particulars of all sums of money received and expended by the LLP and the matters in respect of which the receipt and expenditure takes place;
(b) a record of the assets and liabilities of the LLP;
(c) statements of cost of goods purchased, inventories, WIP, finished goods and cost of goods sold; and
(d) any other particulars which the partners may decide.

The books of account which a LLP is required to keep shall be preserved for eight years from the date on which they are made.

Question 24.
Write a short note on: Statutory provisions as to Audit of Limited Liability partnerships.
Answer:
Statutory Provisions as to Audit of LLP:
As per Sec. 34 of LLP Act, 2008, accounts of LLP shall be audited in accordance with such rules as may be prescribed.
Rule 24 of LLP Rules, 2009 provides the following in relation to audit:

Requirement of Audit: A LLP whose turnover does not exceed, in any financial year, ? 40 Lacs, or whose contribution does not exceed ? 2 5 Lacs shall not be required to get its accounts audited. If partners of such LLP decide to get the accounts of such LLP audited, the accounts shall be audited in accordance with these rules.

Eligibility for auditor: A person shall not be qualified for appointment as an auditor of a LLP unless he is a Chartered Accountant in practice.

Period of Appointment: Auditor of a LLP shall be appointed for each financial year of the LLP for auditing its accounts.

Appointment of auditor by designated partner: The designated partners may appoint an auditor:
(a) at any time for the first financial year but before the end of the first financial year,
(b) at least 30 days prior to the end of each financial year (other than the first financial year),
(c) to fill a casual vacancy in the office of auditor, including in the case when the turnover or contribution of a LLP exceeds the limits, or
(d) to fill up the vacancy caused by removal of an auditor.

Appointment of auditor by partner: Partners may appoint an auditor where the designated partners have power to appoint and have failed to appoint.

Tenure of Auditor: Auditor shall hold office in accordance with the terms of his or their
appointment and shall continue to hold such office till the period the new auditors are appointed, or they are re-appointed.

Question 25.
List the benefits that arise to LLP from getting the accounts audited.
Answer:
Benefits that arise to LLP from getting the accounts audited:
(a) Detection of errors & frauds
(b) Verification of financial statements
(c) Resolving disputed among the partners in relation to accounting matters.
(d) Arranging finance from banks & financial institutions.
(e) Improved management of the LLP
(f) Settlement of accounts between partners at the time of admission, death, retirement, insolvency, insanity, etc.

Question 26.
Briefly describe the auditor’s duty regarding audit of LLP.
Answer:
Auditor’s duty regarding Audit of LLP:
(a) Auditor should obtain instructions in writing as to the work to be performed by him.

(b) Auditor should read the LLP agreement & note the following provisions

• Nature of the business of LLP
• Capital contributed by each partner
• Interest in respect of capital contributions
• Duration of partnership
• Drawings allowed to the partners
• Salaries, commission etc. payable to partners
• Rights & duties of partners
• Method of settlement of accounts between partners at the time of admission, retirement, admission etc.
• Any loans advanced by the partners
• Profit sharing ratio

(c) Auditor should report
(a] Whether the records reflects true and fair view
(b) Whether he obtains all information & explanation
(c) whether any restriction/limitation imposed upon him.

(d) If minute book is being maintained, auditor shall refer it for any resolution passed regarding the accounts.

Question 27.
Mention any six points to be considered for good internal control for collection of tuition fees from students of college. [May 09 (6 Marks)
Answer:
Internal control points for collection of tuition fees:
(a) There must be a clear-cut tuition fee structure approved by the college council.
(b) The challan or paying in slip should contain necessary fields for identifying the roll number of the student, class, and period for which fees is paid etc. The slips should have such number of counterfoils to cross check the remittance.
(c) The paying in slip when filled by the students, should be checked for its correctness as to applicable amount etc. by one clerk and the amount should be entered in a scroll. He must initial the slip which authorises the cashier to accept the fees as per slip.
(d) The cashier scroll and the authorising officer/s scroll should be checked by an officer daily.
(e) All remittance should be banked each day. No amount should be allowed to be spared for meeting any type of expense.
(f) Alternatively, the fees may be directly remitted into bank and banker’s daily remittance slip should be scrutinised by college officers.
(g) Arrears list should be periodically prepared from the students rolls. Any concession, remission of tuition fees should have approval of competent authority.
(h) Delayed remittance should carry fines or compensating charges for delay.
(i) When students are readmitted after removal for non-payment of fees, the admission should carry the permission of competent authority.

Question 28.
Mention the eight important points which an auditor will consider while conducting the audit of educational institutions. [May 12 (8 Marks)]
Or
Mention any eight important points which an auditor will consider while conducting the audit of a school. [Nov. 14 (8 Marks)]
Answer:
Special Points in audit of Educational Institutions (School):
1. Examine the charters, trust deed, applicable Act etc. containing the rules and regulations. Particular attention should be given to those rules and regulations that have a bearing on the accounts.
2. The system of keeping the accounts should be ascertained and go through the proceedings of the minutes of the governing body, especially those relating to the accounts.
3. The auditor should obtain a copy of the budget sanctioned or the financial statement. This would enable him to acquaint himself with the different heads of income and expenditures of the institution.
4. The auditor should vouch all the receipts through students’ monthly fees with the help of students’ fees register or the carbon copies of the fees receipts along with the entries in the cash book and bank book.
5. The auditor should see that the fees received in advance have been properly dealt with.
6. Verify the grants received from the government.
7. Check whether the money has been utilised for the purpose for which it was received.
8. Examine whether the concessions granted to the students are duly authorised.
9. Donations received from different charitable bodies have been duly acknowledged and recorded properly in the accounts.
10. The auditor should vouch the incomes from the properties, buildings which sometimes are given on rent for public functions etc.
11. If the institution also provides hostel facilities, the hostel fees and deposits received from the students should be vouched with the counter foils of the receipts.
12. All the establishment expenses should be carefully vouched in detail and the capital expenses should be given particular attention.
13. The auditor should examine the stocks of furniture, equipments, stationery etc. very carefully.
14. The amount of salary paid to staff should be vouched thoroughly through the Salary Register. Check that the salary is given after taking the signatures of the personnel receiving the salary.
15. The auditor should see that all the assets and liabilities are brought into account. Physically verify the fixed assets.
16. The auditor should check the payments made on account of scholarships with reference to the Scholarship Register.
17. Verify the annual statements of accounts and while doing so see that separate statements of account have been prepared as regards different funds, for example, PF to the Staff, Building Fund etc.

Question 29.
Mention any 8 special points which you as an auditor would look into while auditing the books of account of Hospital. [May 11, Nov. 12, May 14 (8 Marks) MTP-March 18, Aug. 18, Oct. 18, March 19, RTP-May 19]
Or
You have been appointed auditor of M/s. Divine Children Hospital. Discuss any four important points that would attract your attention while audit. [Nov. 19 [4 Marks)]
Answer:
Special Points in Audit of books of account of Hospital:

• Examine the letter of appointment to ascertain the scope of responsibilities.
• Study the Charter or Trust Deed under which the hospital has been set up and take a special note of the provisions affecting the accounts.
• Examine and evaluate the system of internal check and internal control and determine the nature, timing and the extent of audit procedures.
• Vouch the entries in the Patients’ Bill Register with the copies of bill issued. Test check the selected bills to see that these have been correctly prepared taking into account the period of stay of each patient as recorded in the Attendance Schedule.
• Vouch the collection from patients with copies of bills and entries in Bills Register. Arrears of dues should be properly carried forward and where these are deemed to be irrecoverable, they should be written off under due authorisations.
• Interest and/or dividend income should be vouched with reference to the Investment Register and Interest and Dividend warrants.
• In case of legacies and donations which are received for specific purposes, it should be ensured that any income therefrom is not applied for any other purposes.
• Where receipts of subscriptions show significant deviations from budgeted figures, it should be thoroughly inquired into and the matter be brought to the notice of the trustees or the Managing Committee.
• Governments grants or grants from local bodies should be verified with reference to the correspondence with the concerned authorities.
• Clear distinction should be made between the items of capital and revenue nature.
• The capital expenditure should be incurred under proper authorisation by a valid resolution of the trustees or the Managing Committee.
• Check the system of internal check as regards purchases and issue of stores, medicines etc.
• Examine that the appointment of the staff, payment of salaries etc. are duly authorised.
• Physically verify the investments, fixed assets and inventories.
• Check that adequate depreciation has been provided on all the depreciable assets.

Question 30.
What steps would you take into consideration in auditing the receipts from patients of a Hospital? [Nov. 17 (6 Marks)]
Answer:
Steps to be considered while auditing the receipts from patients of a hospital:
(a) Examine and evaluate the system of internal control w.r.t. raising bills, maintaining records of patients, etc.
(b) Vouch the Register of patients with copies of bills issued to them.
(c) Verify bills for a selected period with the patients’ attendance record to see that the bills have been correctly prepared.
(d) Ensure that bills have been issued to all patients from whom an amount was recoverable according to the rules of the hospital.
(e) Vouch the collection from patients with copies of bills and entries in Bills Register.
(f) Arrears of dues should be properly carried forward and where these are deemed to be irrecoverable, they should be written off under due authorisations.

Question 31.
In the case of audit of a charitable institution, what attentions should be paid by auditor regarding audit of expenditure items? [Nov. 19 (4 Marks)]
Answer:
Audit of Expenditure items in case of Charitable Institution:
1. If any grant is being allowed to any person, verify whether the grant have been paid only for a charitable purpose or purposes falling within the purview of the objects for which the charitable institution has been set up and that no trustee, director or member of the Managing Committee has benefited there from either directly or indirectly.

2. Verify the schedules of securities held, as well as inventories of properties both movable and immovable by inspecting the securities and title deeds of property and by physical verification of the movable properties on a test basis.

3. Verifying the cash and bank balances.

4. Ascertaining that any funds contributed for a special purpose have been utilised for the purpose.

Question 32.
How will you vouch/verify the following investments income in the case of charitable institution. [RTP-Nov. 20]
Answer:
Investment Income in the case of Charitable Institution:

• Vouching the amounts received with the dividend and interest counterfoils.
• Checking the calculations of interest received on securities bearing fixed.
• Checking that the appropriate dividend has been received where any investment has been sold ex-dividend or purchased cum-dividend.
• Comparing the amounts of dividend received with schedule of investments making special enquiries into any investments held for which no dividend has been received.

Question 33.
Mention any 8 special points which you as an auditor would look into while auditing the books of account of Cinema. [May 11 (8 Marks)]
Answer:
Steps involved in audit of Cinema Hall:
1. Preliminary Engagement activities

• Study carefully the documents relating to the setting up of the organisation such as MOA and AOA, etc. and note down the provisions relating to accounts.
• Examine the letter of appointment to ascertain the scope of responsibilities.
• Obtain an Understanding of Entity and its environment and determine the risk of material misstatements.
• Determine the responses to assessed risk of material misstatements.

2. Evaluation of Internal Control: to verify

• that entrance to the cinema hall is only through printed tickets;
• tickets are serially numbered and bound into books;
• that the number of tickets issues for each show and class are different;
• that for advance booking a separate series of tickets is issued and
• stock of tickets is kept in proper custody.
• that Cash collected is deposited in banks partly on the same day and rest on the next day – depending upon the banking facility available

3. Substantive Procedures (Vouching and Verification)

• Verify the income from advertisements and slides showed before the show.
• Vouch the expenditure incurred on publicity of picture, maintenance of hall, electricity expenses etc.
• Vouch recoveries of advertisement expenses etc. from film distributors.
• Vouch payment of film hire with reference to agreement with distributor or producer.
• Verify the basis of other incomes earned like restaurant, vehicle parking and display windows etc.
• Confirm that depreciation on machinery and furniture has been charged at an appropriate rate.

4. Others (System Audit)

• If tickets are issued through computer-audit the system to ensure its reliability and authenticity of data generated by it.
• System should provide that at the end of each show a proper statement should be prepared and cash collected be tallied.

Question 34.
Mention any eight important points which an auditor will consider while conducting audit of club? [Nov. 13 (8 Marks)]
Answer:
Steps in auditing the accounts of a club:
1. Preliminary Engagement Activities

• Study carefully the documents relating to the setting up of the organisation such as MOA and AOA, etc. and note down the provisions relating to accounts.
• Examine the letter of appointment to ascertain the scope of responsibilities.
• Obtain an Understanding of Entity and its environment and determine the risk of material misstatements.
• Determine the responses to assessed risk of material misstatements.

2. Substantive Procedures (Tests of Details)
A. Receipts

• Vouch the receipt on account of entrance fees with members’ applications, counterfoils issued/minutes of the Managing Committee.
• Vouch member’s subscriptions with the counterfoils of receipt issued to them.
• Reconcile the amount of total subscriptions due with the amount collected and that outstanding.
• Ensure that arrears of subscriptions for the previous year have been correctly brought over and arrears for the year under audit and subscriptions received in advance have been correctly adjusted.
• Verify the internal check as regards members being charged with the price of foodstuffs and drinks provided to them and their guests, as well as, with the fees chargeable for the special services rendered, such as billiards, tennis, etc.
• Trace debits for a selected period from subsidiary registers maintained in respect of supplies and services, to members to confirm that the account of every member has been debited with amounts recoverable from him.

B. Payments

• Vouch purchase of sports items, furniture, crockery, etc. and trace their entries into the respective stock registers.
• Vouch purchases of foodstuffs, cigars, wines, etc., and test their sale price so as to confirm that the normal rates of gross profit have been earned on their sales. The stock of unsold provisions and stores, at the end of year, should be verified physically and its valuation checked.

C. Assets

• Check the stock of furniture, sports material and other assets physically with the respective stock registers or inventories prepared at the end of the year.
• Inspect the share scrips and bonds in respect of investments, check their current values for disclosure in final accounts; also ascertain that the arrangements for their safe custody are satisfactory.

D. Others
Examine the financial powers of the secretary and, if these have been exceeded, report specific care for confirmation by the Managing Committee.

Question 35.
Cine Screen Multiplex Ltd. is operating cinemas in different locations in Mumbai and has appointed you as an internal auditor. What are the areas that need to be verified in relation to receipts from sale of Tickets? [MTP-May 20]
Answer:
Verification points in receipts from sale of tickets:

• Verify that entrance to the cinema-hall during show is only through printed tickets;
• Verify that they are serially numbered and bound into books;
• Verify that the number of tickets issued for each show and class, are different though the numbers of the same class for the show on the same day, each week, run serially;
• Verify that for advance booking a separate series of tickets is issued;
• Verify that the inventory of tickets is kept in the custody of a responsible official.
• Confirm that at the end of show, a statement of tickets sold is prepared and cash collected is agreed with it.
• Verify that a record is kept of the ’free passes’ and that these are issued under proper authority.
• Reconcile the amount of Entertainment Tax collected with the total number of tickets issued for each class.
• Vouch the entries in the Cash Book in respect of cash collected on sale of tickets for different shows on a reference to Daily Statements which have been test checked as aforementioned with record of tickets issued for the different shows held.

Question 36.
What procedure may be adopted by an auditor, while auditing leasing transactions entered into by the leasing company? [Nov. 13 (8 Marks)]
Answer:
Audit procedure for examination of hire purchase transactions:
1. Examine the MOA and AOA of the hire purchasing company to see whether is it is one of the object and within its powers to let the goods on hire.

2. Examine the letter of appointment to ascertain the scope of responsibilities.

3. Ensure that adequate resolution has been passed authorizing a particular director to execute the hire purchase agreement.

4. The hire purchase agreement should be in writing and be signed by all the parties viz. the owner, the hirer.

5. Hire purchase agreement should clearly specify the following:

• the hire purchase price of the goods;
• the cash price of the goods;
• the date of commencement of the hire purchase agreement;
• the number of instalments by which the hire purchase price is to be paid, the amount of those instalments, the due date etc.;
• the description of goods involved in the hire purchase agreement;
• procedures to be followed in case of default by the hire purchaser.

6. Check whether the payments are being received regularly as per the agreement. Where the payments are received in cash check the counterfoils issued to the hirer. In most of the cases, post dated cheques are taken from the hire purchaser. In such cases, the auditor should see that these cheques are kept in proper custody, are marked as account payee, and duly presented on the due dates.

Question 37.
Define the different types of lease agreements as per Accounting Standard/Ind-AS. [May 19 (4 Marks)]
Answer:
Different Types of Lease Agreements:
As per AS-19/Ind-AS 17 lease arrangements could be of 2 types i.e.
1. Finance Lease and
2. Operating Lease.
(a) Finance Lease: An arrangement with the following attributes qualifies as a Finance Lease:

• The lease arrangement transfers ownership of the asset to the lessee at the end of the lease term;
• The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised;
• The lease term is for the major part of the economic life of the asset even if title is not transferred;
• At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and
• The leased assets are of such a specialized nature that only the lessee can use them without major modifications.

(b) Operating Lease: An arrangement that does not transfer substantially all the risks and rewards incidental to ownership qualifies as an Operating Lease. In other words, an operating lease is a lease arrangement “Other than finance lease”.

Question 38.
What special steps will you take into consideration in auditing the accounts of a hotel. [May 05 (10 Marks)]
Or
What are the six important points that will attract your attention in the case of audit of a hotel. [Nov. 09 (5 Marks)]
Answer:
Steps in Auditing the accounts of a hotel:
A. Preliminary Engagement activities

• Study carefully the documents relating to the setting up of the organisation such as MOA and AOA, etc. and note down the provisions relating to accounts.
• Examine the letter of appointment to ascertain the scope of responsibilities.
• Obtain an Understanding of Entity and its environment and determine the risk of material misstatements.
• Determine the responses to assessed risk of material misstatements.

B. Substantive Procedures (Tests of Details)
1. Revenue Receipts (Income)

• Vouch the receipts from sale of foodstuffs, cold drinks etc. from the copies of cash memos and the summary of daily takings prepared by the cashier.
• Examine the Visitors Ledger and the daily totals thereof should be vouched with the Cash Book and Impersonal Ledger.
• Receipts on account of boarding and lodging should be checked with individual customer’s accounts as also the number of days the rooms were occupied.
• Receipts on account of holding of marriages, receptions, conferences, seminars etc. should be checked with the agreements and correspondence with the parties concerned and the counterfoils of money receipts.
• Check the adequacy of internal check as regards charging the members for foodstuffs, etc. supplied to them and their guests.

2. Revenue Payments (Expenses)

• Where commission is paid to travel agents or booking agents, the same should be verified with reference to the agreement entered into on this behalf.
• Examine the procedures relating to purchases and issue of foodstuffs, crockery etc. All the purchases should be properly authorised and be accounted for in the Stock Registers.
• Vouch the expenditure on purchase of magazines and journals with the bills supplied by the vendors.
• Salaries and yearly increments to staff should be verified by reference to service contracts, salary registers, etc.
• Expenditure on repairs and maintenance should be vouched with the bills or receipts submitted by the people involved for the work.

3. Capital Items (Assets and Liabilities)

• Physically verify the investments, fixed assets and inventories.
• Check that adequate depreciation has been provided on all the depreciable assets.

4. Others
Where the hotel also operates a booth to facilitate conversion of foreign currency into Indian rupees the auditor should ensure the compliance with the provision of FEMA, 1999.

Question 39.
Write short note on: Restriction on shareholding in a Co-operative Society.
Answer:
Restrictions on shareholdings:
Section 5 of the Co-operative Societies Act, 1912 provides that in the case of a society where the liability of a member of the society is limited, no member of a society other than a registered society can hold such portion of the share capital of the society as would exceed a maximum of twenty per cent of the total number of shares or of the value of shareholding to ₹ 1,000.

The auditor of a co-operative society will be concerned with this provision so as to watch any breach relating to holding of shares.

Question 40.
Write short note on: Restrictions on investments of funds of a central co-operative society.
Answer:
Investment of funds:
According to Section 32 of the Central Act the modes of investment of funds of a society may be stated as follows. A society may invest its funds in any one or more of the following:
(a) In the Central or State Co-operative Bank.
(b) In any of the securities specified in Section 20 of the Indian Trusts Act, 1882.
(c) In the shares, securities, bonds or debentures of any other society with limited liability.
(d) In any co-operative bank, other than a Central or State co-operative bank, as approved by the Registrar on specified terms and conditions.
(e) In any other moneys permitted by the Central or State Government.

Question 41.
Mention the duties of Auditor of Co-operative Societies in regard to the following:
(i) Overdue interest.
(ii) Compliance with provisions of Co-operative Act and Rules thereunder.
(iii) Special Report to Registrar of Co-operative Societies.
Answer:
Duties of Auditor of Co-operative Societies:
1. Overdue Interest: Overdue interest should be excluded from interest outstanding and accrued due while calculating profit.

2. Adherence to Co-operative Principles: The auditor will have to ascertain in general, how far the objects, for which the co-operative organisation is set up, have been achieved in the course of its working. The assessment is not necessarily in terms of profits, but in terms of extending benefits to members who have formed the society. While auditing the expenses, the auditor should see that they are economically incurred and there is no wastage of funds. The principles of propriety audit should be followed for the purpose.

3. Special report to the Registrar: During the course of audit, if the auditor notices that there are some serious irregularities in the working of the society, he may report these special matters to the Registrar, drawing his specific attention to the points. The Registrar on receipt of such a special report may take necessary action against the society.

Circumstances in which special report is required:

• If any grant is being allowed to any person, verify whether the grant have been paid only for a charitable purpose or purposes falling within the purview of the objects for which the charitable institution has been set up and that no trustee, director or member of the Managing Committee has benefited there from either directly or indirectly.
• Verify the schedules of securities held, as well as inventories of properties both movable and immovable by inspecting the securities and title deeds of property and by physical verification of the movable properties on a test basis.
• Verifying the cash and bank balances.
• Ascertaining that any funds contributed for a special purpose have been utilised for the purpose.

Question 42.
Under what circumstances, an auditor is required to submit a special report to the registrar of Co-operative Societies?
Answer:
Special report to the Registrar:
During the course of audit, if the auditor notices that there are some serious irregularities in the working of the society, he may report these special matters to the Registrar. The Registrar on receipt of such a special report may take necessary action against the society.

Circumstances in which special report is required:

• Personal profiteering by members of managing committee in transactions of the society, which are detrimental to the interest of the society.
• Detection of fraud relating to expenses, purchases, property and stores of the society.
• Mis-management (decisions of management against co-operative principles).
• In the case of urban co-operative banks, disproportionate advances to vested interest groups, such as relatives of management, and deliberate negligence about the recovery thereof. Cases of reckless advancing, where the management is negligent about taking adequate security and proper safeguards for judging the creditworthiness of the party.

Question 43.
“Examination of overdue debts, audit classification of society, and reporting the infringements of provisions of the Act are the special features of audit of a co-operative society.” Do you agree?
Answer:
Special Features of Audit of a co-operative society:
1. Examination of Overdue debts:
Overdue debts for a period from six months to five years and more than five years will have to be classified and shall have to be reported by an auditor. A further analysis of these overdue debts from the viewpoint of chances of recovery will have to be made, and they will have to be classified as good or bad. The auditor will have to ascertain whether proper provisions for doubtful debts is made and whether the same is satisfactory.

2. Audit Classification of the Society:
After a judgment of an overall performance of the society, the auditor has to award a class to the society. This judgment is to be based on the criteria specified by the Registrar. It may be noted here that if the management of the society is not satisfied about the award of audit class, it can make an appeal to the Registrar, and the Registrar may direct to review the audit classification.

3. Reporting on Infringements of provisions of the Act:
Auditor of a cooperative society is required to point out the infringement with the provisions of Cooperative Societies Act and Rules and bye-laws. The financial implications of such infringements should be properly assessed by the auditor and they should be reported.

Question 44.
Auditor of a cooperative society has to submit his audit report in the prescribed form specified by the Registrar or as given in the related Rules. State the matters to be covered in the audit report.
Answer:
Matters to be reported in Audit Report:
The audit report has to be submitted in the prescribed form specified by the Registrar or as given in the related Rules. According to the present prescribed form in some of the States, the auditor has to state:
(a) Whether he has obtained all the necessary information and explanations which to the best of his knowledge and belief were necessary for the purpose of audit.
(b) Whether in his opinion and to the best of his information and according to the explanations given to him, the said accounts give all the information required by the Act.
(c) Whether the Profit and Loss Account of the society gives a true and fair view of the Profit and Loss made by the society.
(d) Whether the Balance Sheet drawn up as at the end of the year gives a true and fair view of the state of affairs of the society as on the given date.
(e) Whether in his opinion, proper books of account as required by the Act, the Rules and the bye¬laws of the society have been properly maintained.
(f) Whether the Balance Sheet and the Profit and Loss Account examined by him are in agreement with the books of account and returns of the society.
The auditor will have to give qualifying observations, if any of the answers to the above mentioned
matters are negative.

Question 45.
An auditor of a Co-operative Society governed by Cooperative Societies Act, 1912 is required to attach schedules giving certain information. Please list the information required to be given in the schedules.
Answer:
Schedules forming part of Audit Report:
The form of the audit report to be submitted by the auditor, as prescribed in various states, contains a number of matters which the auditor has to state or comment upon. In addition to that, the auditor will have to attach schedules to the report regarding the following information:

• All transactions which appear to be contrary to the provisions of the Act, the rules and bye-laws of the society.
• All sums, which ought to have been, but have not been brought into account by the society.
• Any material, or property belonging to society which appears to the auditor to be bad or doubtful of recovery.
• Any material irregularity or impropriety in expenditure or in the realisation or monies due to society.
• Any other matters specified by the Registrar in this behalf.
  In the case of nil report in any of the above matters, the auditor will have to give a nil report.

Question 46.
State the requirements regarding the maintenance of books of account with respect to a multi-state co-operative society.
Or
Write short note on: Aspects to be covered in the books of account to be maintained by a multi-co¬operative society.
Answer:
Aspects to be covered in Books of Account:
As per the Multi State Co-operative Society Rules, 2002, every multi state co-operative society shall keep books of account with respect to:
(a) all sum of money received & expended
(b) all sales and purchases of goods.
(c) the assets and liabilities of the society.
(d) in the case of Multi State Co-operative Society engaged in production, processing and manufacturing, particulars relating to utilization of materials or labour or other term of cost as may be specified in the bye laws.

Question 47.
Multi-State Co-operative Societies Act, 2002 states that a person who is a Chartered Accountant within the meaning of the Chartered Accountants Act, 1949 can only be appointed as auditor of Multi-State co-operative society. Explain stating also the persons who are not eligible for appointment as auditors of a Multi-State co-operative society. [MTP-Aug. 18]
Answer:
Qualifications of Auditors of Multi-State Co-operative Societies:
Sec. 72 of Multi-State Co-operative Societies Act, 2002, provides that a person who is a Chartered Accountant can only be appointed as auditor of a multi-state co-operative society. Following persons cannot be appointed as auditor:
(a) Body Corporate
(b) Officer/Employee of Multi State Cooperative society
(c) Partner/Employee of Officer/Employee of Multi State Cooperative society
(d) A person who is indebted to multi state cooperative society or who has given guarantee in connection with a loan of third party to multi state cooperative society for an amount exceeding ₹ 1,000.

Question 48.
Briefly explain the provisions for qualification and appointment of Auditors under the Multi-State Co-operative Societies Act, 2002. [Nov. 18 (5 Marks)]
Answer:
Qualifications of Auditors of Multi-State Co-operative Societies:
Sec. 72 of Multi-State Co-operative Societies Act, 2002, provides that a person who is a Chartered Accountant can only be appointed as auditor of a multi-state co-operative society. Following persons cannot be appointed as auditor:
(a) Body Corporate
(b) Officer/Employee of Multi State Cooperative society
(c) Partner/Employee of Officer/Employee of Multi State Cooperative society
(d) A person who is indebted to multi state cooperative society or who has given guarantee in connection with a loan of third party to multi state cooperative society for an amount exceeding ₹ 1,000.

Appointment of Auditors of Multi-State Co-operative Societies:
Sec. 70 of Multi-State Co-operative Societies Act, 2002, provides the provisions as to appointment of auditors of Multi-State Co-operative Societies. Accordingly,

• First Auditor of Multi-State Co-operative Societies shall be appointed by Board of Directors within one month of registration. If Board fails, company may appoint first auditor at General meeting. Auditor so appointed hold office till conclusion of first Annual General Meeting.
• Subsequent auditors are appointed at each Annual General Meeting. Auditor so appointed hold office till conclusion of next AGM.

Question 49.
Write short notes on: Powers and duties of an auditor of a Multi-State Cooperative Society.
Answer:
Powers and Duties of Auditor of Multi-State Cooperative Society:
Section 73 of the Multi-State Cooperative Societies Act, 2002 provides the provisions relating to powers and duties of auditor.

Powers of Auditor [Sec. 73(1)]:

• Every auditor shall have a right of access at all times to the books, accounts and vouchers of the Multi-State Co-operative Society whether kept at the head office or elsewhere.
• Every auditor shall be entitled to require from the officers or other employees of the Multi-State Co-operative Society such information and explanation as the auditor may think necessary for the performance of the duties as an auditor.

Duties of Auditor [Sec. 73(2)]:
(A) To conduct Inquiry: The auditor shall make the following inquiries:

• Whether loans and advances made by the Multi-State Co-operative Society on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interests of the Multi-State Co-operative or its members;
• Whether transactions of the Multi-State Co-operative Society which are represented merely by book entries are not prejudicial to the interest of the Multi-State Co-operative Society;
• Whether personal expenses have been charged to revenue account; and
• Where it is stated in the books and papers of the Multi-State Co-operative Society that any shares have been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance sheet is correct, regular and not misleading.

(B) Making Report: The auditor shall make a report over the following:

• On the accounts examined by him
• On every Balance Sheet and Profit and Loss Account and
• On every other document required to be part or annexed to the balance-sheet or profit and loss account,
  which are laid before the society in general meeting during his tenure of office.
  The report shall state whether, in his opinion and to the best of his information and according to the explanations given to him, the said accounts give the information required by this Act in the manner
  so required and give a true and fair view-

(a) in the case of the balance-sheet, of the state of the multi-state cooperative society’s affairs as at the end of its financial year; and
(b) in the case of the profit and loss account, of the profit or loss for its financial year.

Question 50.
As per Multi-state Co-operative Societies Act, 2002, the auditor shall make a report to the members of the Multi-State co-operative society on the accounts examined by him and on every balance-sheet and profit and loss account and on every other document required to be part of or annexed to the balance-sheet or profit and loss account. Explain. [RTP-May 20]
Answer:
Auditor’s Duties on Reporting of accounts and financial statements:
As per Sec. 73(3) and 73(4) of Multi- state Co-operative Societies Act, 2002, the auditor shall make a report to the members of the Multi-State co-operative society on the accounts examined by him and on every balance-sheet and profit and loss account and on every other document required to be part of or annexed to the balance-sheet or profit and loss account, which are laid before the Multi-State co-operative society in general meeting during his tenure of office, and the report shall state whether, in his opinion and to the best of his information and according to the explanation given to him, the said account give the information required by this act in the manner so required, and give a true and fair view:
(a) In the case of the balance-sheet, of the state of the Multi-State co-operative society’s affairs as at the end of its financial year; and

(b) In the case of the profit and loss account, of the profit or loss for its financial year. The auditor’s report shall also state:
(i) Whether he has obtained all the information and explanation which to the best of his knowledge and belief were necessary for the purpose of his audit.

(ii) Whether, in his opinion, proper books of account have been kept by the Multi- State co¬operative society so far as appears from his examination of these books and proper returns adequate for the purpose of his audit have been received from branches or offices of the Multi-State co-operative society not visited by him.

(iii) Whether the report on the accounts of any branch office audited by a person other than the Multi-State co-operative society’s auditor has been forwarded to him and how he has dealt with the same in preparing the auditor’s report.

(iv) Whether the Multi-State co-operative society’s balance sheet and profit and loss account dealt with by the report are in agreement with the books of account and return.

(v) Where any of the matters referred to in Sec. 73(3) and 73(4) is answered in the negative or with a qualification, the auditor’s report shall state the reason for the answer.

Question 51.
Under which circumstances can the Central Government appoint the special auditor of a Multi-State Cooperative Society?
Or
Central Govt, hold 55% of the paid up share Capital in Kisan Credit Co-operative Society, which is incurring huge losses. Advise when the Central Government can direct Special Audit under Section 77 of the Multi State Co-operative Society Act. [May 19 (3 Marks)]
Answer:
Circumstances requiring Special Audit:
Sec. 77 of Multi-State Cooperative Societies Act, 2002 empowers Central Government to pass an order for the special audit if they are of opinion

• that the affairs of any Multi-State co-operative society are not being managed in accordance with co-operative principles or prudent commercial practices or with sound business principles; or
• that any Multi-State co-operative society is being managed in a manner likely to cause serious injury or damage to the interests of the trade industry or business to which it pertains; or
• that the financial position of any Multi-State co-operative society is such as to endanger its solvency.

Question 52.
Mr. M, has served as an auditor in the Co-Operative Department of a Government, is appointed as a statutory auditor by a Co-Operative society that has receipts over ₹ 3 crores during the financial year. He is not a chartered accountant. Mr. D, chartered accountant is appointed to conduct tax audit of the society u/s 44AB of the Income-tax Act, 1961. Comment. [May 18 (4 Marks)]
Answer:
Tax Audit Report in case of Co-operative society:
Proviso to Sec. 44AB of Income Tax Act, 1961 lays down that where the accounts of an assessee are required to be audited by or under any other law, it shall be sufficient compliance with the provisions of this section, if such person get the accounts of such organisation audited under such other law before the specified date and furnishes by that date, the report of the audit as required under such other law and a further report by an Accountant in the form prescribed under this section.

The term “accountant” as defined under section 288 under the Income Tax Act, 1961 means a chartered accountant within the meaning of the Chartered Accountants Act, 1949, who holds a valid certificate of practice.

Accordingly, the person who is not a Chartered Accountant as mentioned in the question, is eligible to act as auditor of Cooperative Society under the Cooperative Society Act, 1912. Tax audit u/s 44AB of Income Tax Act, 1961 can be performed only be a Chartered Accountant.

Question 53.
You are appointed as an auditor of co-operative society. State the special features of the co-oper¬ative audit to be borne in mind by the auditor, concerning,
(1) Audit classification of society.
(2) Discussion of draft audit report with the managing committee. [Nov. 20 (4 Marks)]
Answer:
Audit of Co-operative Society:
(i) Audit Classification of Society:

• After a judgment of an overall performance of the society, the auditor has to award a class to the society. This judgment is to be based on the criteria specified by the Registrar.
• It may be noted here that if the management of the society is not satisfied about the award of audit class, it can make an appeal to the Registrar, and the Registrar may direct to review the audit classification.
• The auditor should be very careful, while making a decision about the class of society.

(ii) Discussion of Draft report with the managing committee:

• On conclusion of the audit the auditor should ask the Secretary of the society to convene a meeting of the managing committee to discuss the draft audit report.
• The audit report should never be finalized without discussion with the managing committee.

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

Question 1.
Article 150 of the Constitution provides that the accounts of the Union and of the States shall be kept in such form as the Finance Minister may on the advice of the C&AG prescribe. [MTP-May 20]
Answer:
Statement is incorrect.
Article 150 of the Constitution provides that the Accounts of the Union and the states will be maintained as per the description given, by the President on advice of C&AG.

Question 2.
According to ‘propriety audit’, the auditors try to bring out cases of improper, avoidable, or infruc- tuous expenditure even though the expenditure has been incurred in conformity with the existing rules and regulations.
Answer:
Statement is correct.
Instead of too much dependence on documents, vouchers and evidence, propriety audit shifts the emphasis to the substance of the transactions and looks into the appropriateness thereof on a consideration of financial prudence, public interest and prevention of wasteful expenditure.

Question 3.
Expenditure incurred by the municipalities and corporations can be broadly classified under the following heads: (a) general administration and revenue collection,
(b) public health,
(c) public safety,
(d) education,
(e) public works, and
(f) others such as interest payments.
Answer:
Statement is correct.
Expenditure incurred by the municipalities and corporations can be broadly classified under the following heads: (a) general administration and revenue collection,
(b) public health,
(c) public safety,
(d) education,
(e) public works, and
(f) others such as interest payments.

Question 4.
NGOs may be defined as non-profit making organisations which raise funds from members, donors or contributors apart from receiving donation of time, energy and skills for achieving their social objectives.
Answer:
Statement is correct.
NGO’s can be defined as non-profit organisations which raise funds from members or donors apart from receiving donation of time, energy & skills for achieving their social objectives.

Question 5.
Comptroller and Auditor General of India can be removed by the Prime Minister of India on the recommendation of his Council of Ministers. [Nov. 09 (2 Marks)]
Answer:
Statement is incorrect.
The Comptroller and Auditor General of India cannot be removed by the Prime Minister of India on the recommendation of his Council of Ministers.
He can be removed on the ground of proven misbehaviour or incapacity, when each House of Parliament decides to do so by majority of not less than 2/3 of the members of the house present and voting.

Question 6.
The accounts of every LLP shall be audited in accordance with rule 24 of LLP Rules 2009. [May 19 (2 Marks)]
Answer:
Statement is correct.

• Sec. 34 of LLP Act, 2008 states that Accounts of LLP shall be audited in accordance with such rules as may be prescribed.
• Rule 24 of LLP Rules, 2009 provides the detailed provisions in this regard, in accordance with which a LLP whose turnover does not exceed, in any financial year, Rs. 40 Lacs, or whose contribution does not exceed Rs. 25 Lacs shall not be required to get its accounts audited.

Question 7.
LLP need not file a “Statement of Accounts and Solvency”. [MTP-May 20]
Answer:
Statement is incorrect.

• As per Sec. 34 of LLP Act, 2008, Statement of Account and Solvency shall be filed with the Registrar every year in such form and manner and accompanied by prescribed fees.
• As per Rule 24 of LLP Rules, 2009, Statement of Account and Solvency shall be filed in Form 8 with the Registrar, within a period of 30 days from the end of 6 months of the financial year to which the Statement of Account and Solvency relates.

Question 8.
The Constitution of India contains no specific provisions regarding the appointment, salary and duties and powers of the C&AG. Moreover, the constitution does not guarantee the independence of the C&AG of India. [RTP-Nov. 20]
Answer:
Statement is incorrect.
The Constitution of India contains specific provisions regarding the appointment, salary and duties and powers of the C&AG. The constitution guarantees the independence of the C&AG of India by prescribing that he shall be appointed by the President of India and shall not be removed from office except on the ground of proven mis-behaviour or incapacity.

Question 9.
Every LLP is required to submit Statement of Account and Solvency in Form 8, which shall be filed within a period of sixty days from the end of three months of the financial year to which the State¬ment of Account and Solvency relates. [Nov. 20 (2 Marks)]
Answer:
Statement is incorrect.
As per Sec, 34 of LLP Act, 2008, every LLP shall, within a period of six months from the end of each financial year, prepare a Statement of Account and Solvency for the said financial year in prescribed form, and such statement shall be signed by the designated partners of the LLP.

As per Rule 24 of LLP Rules, 2009, Statement of Account and Solvency shall be filed in Form 8 with the Registrar, within a period of 30 days from the end of 6 months of the financial year to which the Statement of Account and Solvency relates.

Standards on Auditing – CA Inter Auditing Notes is designed strictly as per the latest syllabus and exam pattern.

Standards on Auditing – CA Inter Auditing Notes

Question 1.
Comment on the following in relation to SAs: “Management is responsible for compliance with Laws and Regulations”. [May 11 (5 Marks)]
Answer:
Management Responsibility for compliance with laws and regulations:
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:
(a) Monitoring legal requirements and ensuring that operating procedures are designed to meet these requirements.
(b) Instituting and operating appropriate systems of internal control.
(c) Developing, publicising and following a code of conduct.
(d) Ensuring employees are properly trained and understand the code of conduct.
(e) Monitoring compliance with the code of conduct and acting appropriately to discipline employees who fail to comply with it.
(f) Engaging legal advisors to assist in monitoring legal requirements.
(g) 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 2
What are the roles and responsibilities of the statutory auditor in relation to compliance with the laws and regulations by the entity?
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.

Question 3.
State briefly the reporting requirements as per SA 250 on non-compliance with laws and regulations.
Answer:
Reporting requirements as per SA 250 on Non-Compliance with laws and regulations:
(a) Reporting to 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 TCWG, 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.

Question 4.
With reference to SA 250 give some example or matters indicating to the auditor about non-compliance of laws and regulations by management. [Nov. 13 (8 Marks)]
Or
As an auditor what are the indicators you would consider while verifying compliance with laws and regulations?
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 agents 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.

Question 5.
Compare and explain the following: Reporting to Shareholders vs. Reporting to TCWG.
Answer:
Reporting to Shareholders vs. Reporting to those charged with Governance:

Reporting to Shareholders	Reporting to TCWG
1. SA 700, 705 & 706 and Sec. 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.

Question 6.
Explain the various matters that are required to be communicated by the auditor to TCWG.
Answer:
Matters to be communicated to TCWG:
SA-260 “Communication with Those Charged with Governance” provides that the auditor shall communicate with TCWG the followings:

(a) Auditor’s Responsibilities in relation to the Financial Statement Audit: The auditor shall communicate with TCWG that:

• The auditor is responsible for forming and expressing an opinion on the F.S.; and
• The audit of the F.S, does not relieve management or TCWG of their responsibilities.

(b) Planned Scope and timing of Audit: It may include:
How the auditor proposes to address the significant risks of material misstatements, whether due to fraud or error?

• How the auditor plans to address areas of higher assessed RMM?
• Auditor’s approach to internal control.
• Application of concept of materiality.

(c) Significant Findings from the audit: The auditor shall communicate with TCWG:
The auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and F.S. disclosures.

• Significant difficulties, if any, encountered during the audit;
• 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.

(d) Auditor’s Independence: required in case of listed entities.

Question 7.
The auditor evaluated, in respect of T Ltd., whether the financial statements are prepared in accor¬dance with the requirements of the applicable financial reporting framework.
Auditor’s evaluation included consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s judgments.
Advise the qualitative aspects of the entity’s accounting practices. [MTP-MarcK 18, RTP-May 18, MTP-March 19]
Answer:
Qualitative Aspects of entity’s accounting practices:
SA 260 “Communication with those charged with Governance” requires the auditor to communicate with the TCWG various matters, including therein is the auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and F.S. disclosures. In this reference, SA 260 explains the following:

• When applicable, the auditor shall explain to TCWG why the auditor considers a significant accounting practice, that is acceptable under the applicable FRF, not to be most appropriate to the particular circumstances of the entity.
• FRF ordinarily allow the entity to make accounting estimates, and judgments about accounting policies and financial statement disclosures, for example, in relation to the use of key assumptions in the development of accounting estimates for which there is significant measurement uncertainty.
• In considering the qualitative aspects of the entity’s accounting practices, the auditor may become aware of possible bias in management’s judgments.
• The auditor may conclude that lack of neutrality together with uncorrected misstatements causes the financial statements to be materially misstated. Indicators of a lack of neutrality include the following:
  • The selective correction of misstatements brought to management’s attention during the audit
  • Possible management bias in the making of accounting estimates.
    SA 540 addresses possible management bias in making accounting estimates. Indicators of possible management bias do not constitute misstatements for purposes of drawing conclusions on the reasonableness of individual accounting estimates. They may, however, affect the auditor’s evaluation of whether the financial statements as a whole are free from material misstatement.

Question 8.
In considering the qualitative aspects of the entity’s accounting practices, the auditor may become aware of possible bias in management’s judgments. The auditor may conclude that lack of neutrality together with uncorrected misstatements causes the financial statements to be materially misstated. Explain and analyse the indicators of lack of neutrality with examples, wherever required. [RTP-May 20]
Answer:
Qualitative Aspects of entity’s accounting practices:
In considering the qualitative aspects of the entity’s accounting practices, the auditor may become aware of possible bias in management’s judgments. The auditor may conclude that lack of neutrality together with uncorrected misstatements causes the financial statements to be materially misstated. Indicators of a lack of neutrality include the following:
(i) The selective correction of misstatements brought to management’s attention during the audit.
Example
(a) Correcting misstatements with the effect of increasing reported earnings, but not correcting misstatements that have the effect of decreasing reported earnings.
(b) The combination of several deficiencies affecting the same significant account or disclosure (or the same internal control component) could amount to a significant deficiency (or material weakness if required to be communicated in the jurisdiction). This evaluation requires judgment and involvement of audit executives.

(ii) Possible management bias in the making of accounting estimates.

Question 9.
Discuss with reference to SAs: The auditor shall communicate all significant findings with those charged with Governance. [May 13 (5 Marks)]
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 10.
State the significant difficulties encountered during audit with reference to SA 260. [May 15 (6 Marks)]
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 11.
Write short note on: Factors governing modes of communication of auditor with those charged with governance. [Nov. 10 (4 Marks)]
Or
“As per SA 260, auditor is required to communicate with TCWG various matters significant to audit1’. In this reference explain various forms of communication and factors affecting mode of communication.
Answer:
Forms of Communication and Factors governing mode of communication:
SA 260 deals with the auditor’s responsibility to communicate with those charged with governance in relation to an audit of financial statements. Accordingly, various forms of communication may be classified as:

• Oral or written;
• Detail or summarized;
• Structured or unstructured.

The auditor shall communicate in writing with TCWG regarding significant matters, from the audit when, in the auditor’s professional judgment, oral communication would not be adequate.

Factors affecting mode of Communication:

• 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 12.
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 RS. preparation.
• Misstatements detected by the auditor’s procedures were not prevented, or detected and corrected by the entity internal control.

Question 13.
Write short note on: Written communication in respect of deficiencies of internal control. [Nov. 16 (4 Marks)]
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 260 “Communication with those charged with Governance”. 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 dearly 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.

Question 14.
“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.
Answer:
Matters of which understanding is required by user auditor w.r.t. services of a services organization:
As per SA 402 “Audit Considerations relating to an entity using service organization” 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:
(a) Nature of service provided by the service organization and the significance of those services to the user entity.
(b) The nature and materiality of the transactions processed or financial reporting processes affected by service organizations.
(c) The degree of interaction between activities of service organizations and those of the user entity,
(d) The nature of relationship between user entity and the service organization.

Question 15.
In the course of 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.
Answer:
Assessment of services provided by the outsourcing Agencies:
SA 402 “Audit Considerations relating to an entity using service organization”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. The auditor responsibility in this regard as per SA 402 includes the following:
1. Evaluate the design and implementation of relevant controls of user entity that relate to the services provided by service organization.

2. 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.

3. 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 16.
Explain the various causes of misstatement.
or
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.
Answer:
Causes of Misstatement:
SA 450 “Evaluation of Misstatements identified during the Audit” deals with the auditor’s responsibilities to evaluate the effect of identified misstatements on the audit.

Misstatement may be defined 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. Misstatements can arise from error or fraud.

Causes of Misstatement: Misstatements may result from:

• 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.

Question 17.
Discuss the impact of uncorrected misstatements identified during the audit and the auditor’s response to the same
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 correct some or all of the misstatements communicated by the auditor, the auditor shall obtain an understanding of management’s reasons for not making the corrections.

Prior to evaluating the effect of uncorrected misstatements, the auditor shall reassess materiality determined in accordance with SA 320, to confirm whether it remains appropriate in the context of the entity’s actual financial results.

The auditor shall communicate with TCWG, 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.

Question 18.
What are accounting estimates according to SA 540? Give Examples.
Or
“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 good will and intangible assets.
• Transactions involving the exchange of assets or liabilities between independent parties without monetary consideration.

Question 19.
“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 rela¬tively 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.
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.

Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements. For some accounting estimates, however, there maybe relatively high estimation uncertainty, particularly where they are based on significant assumptions, for example:

• Accounting estimates relating to the outcome of litigation.
• Fair value accounting estimates for derivative financial instruments not publicly traded.
• Fair value accounting estimates for which a highly specialised entity-developed model is used or for which there are assumptions or inputs that cannot be observed in the marketplace.

Additional Examples of Fair Value Accounting Estimates are:

• 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 good will and intangible assets.
• Transactions involving the exchange of assets or liabilities between independent parties without monetary consideration.

Question 20.
While auditing X Ltd, you observe certain material financial statement assertions have been based on estimates made by the management. As an auditor how do you identify and assess risk of material misstatement?
Answer:
Identification and assessment of Risk of Material Misstatement when financial statement assertions are based on estimates made by management:

SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and related disclosures deals with auditor’s responsibilities regarding accounting estimates.

In order to identify and assess risk of material misstatements for accounting estimates, the auditor
shall obtain an understanding of the following:

(a) The requirements of the applicable financial reporting framework.

(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:

• The method, including where applicable the model used in making the accounting estimates.
• Relevant controls
• Where management has used an expert?
• Where there has been or ought to have been a change from the prior period in the methods for making the accounting estimates, and if so why? and
• 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 21.
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 deals with auditor’s responsibilities regarding accounting estimates. Accordingly. 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 22.
Discuss the following: Relationship between Statutory Auditor and Internal Auditor. [Nov. 16 (4 Marks)]
Answer:
Relationship between Statutory Auditor and 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.
With respect to relationship between statutory auditor and internal auditor, SA 610 provides the following:

(a) The role and objectives of the internal audit function are determined by management and, where applicable, those charged with governance. While the objectives of the internal audit function and the external auditor are different, some of the ways in which the internal audit function and the external auditor achieve their respective objectives may be similar.

(b) Irrespective of the degree of autonomy and objectivity of the internal audit function, such function is not independent of the entity as is required of the external auditor when expressing an opinion on financial statements.

(c) Therefore, the external auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the external auditor’s use of the work of the internal auditors.

Question 23.
Explain the activities of Internal Audit Function,
Answer:
Activities of Internal Audit Function:
As per SA 610 “Using the work of Internal Auditor” the activities of the internal audit function may
include one or more of the following:
1. Activities Relating to Governance: Internal audit function may assess the governance process in its accomplishment of objectives on ethics and values, accountability and communicating risk to appropriate areas of the organization.

2. Activities Relating to Risk Management: Internal audit function may assist the entity by identifying and evaluating significant exposures to risk and contributing to the improvement of risk management and internal control (including effectiveness of the financial reporting process).

3. Evaluation of internal control: Internal audit function may be assigned specific responsibility for reviewing controls, evaluating their operation and recommending improvements thereto.

4. Examination of financial and operating information: Internal audit function maybe assigned to review the means used to identify, recognize, measure, classify and report financial and operating information, and to make specific inquiry into individual items, including detailed testing of transactions, balances and procedures.

5. Review of operating activities: The internal audit function may be assigned to review the economy, efficiency and effectiveness of operating activities, including non-financial activities of an entity.

6. Review of compliance with laws and regulations: Internal audit function may be assigned to review compliance with laws, regulations and other external requirements, and with management policies and directives and other internal requirements.

Question 24.
You have been appointed auditor of a large Industrial Company which has an established Internal Audit Department. You are required to state the main aspects that would be considered to find out effectiveness of the department.
or
Can the external auditor rely on the work of internal auditor?
or
Discuss with reference to SAs: “The degree of reliance that a Statutory Auditor can place on the work of the Internal Auditor is a matter of individual judgment”. [Nov. 14 (8 Marks)]
Answer:
Aspects to be considered to evaluate the effectiveness of Internal Audit Department:
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.
  The degree of reliance that a statutory auditor can place on the work done by the internal auditor is a matter of individual judgment in a given set of circumstances. The ultimate responsibility for reporting on the financial statements is that of the statutory auditor. It must be clearly understood that the statutory auditor’s responsibility is absolute and any reliance he places upon the internal audit system is part of his audit approach or technique and does not reduce his sole responsibility.

Question 25.
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.
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 26.
While doing audit, Ram, the Auditor requires reports from experts for the purpose of audit evi¬dence. What types of reports/opinions he can obtain and to what extent he can rely upon the same?
Or
List the matters in respect of which auditor’s can use the work of auditor’s expert.
Answer:
Matters where auditor can use the work of Auditor’s Expert:
SA 620 “Using the work of an Auditor’s Expert” the matters where the auditor can use the expert work are listed below:
(a) 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.
(b) The actuarial calculation of liabilities associated with insurance contracts or employee benefit plans.
(c) The estimation of oil and gas reserves.
(d) The valuation of environmental liabilities, and site clean-up costs.
(e) The interpretation of contracts, laws and regulations.
(f) 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 27.
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 AE when management had used a management expert:

SA 620 “Using the work of Auditor’s Expert” deals with the auditor’s responsibilities regarding the
use of an auditor’s expert. Accordingly, factors influencing the auditor’s decision w.r.t. use of AE
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 28.
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:
Procedures to be followed for evaluating the work of Auditor’s Expert:
SA 620 “Using the work of Auditor’s Expert” deals with the auditor’s responsibilities regarding the use 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.

Procedures to evaluate the adequacy of the auditor’s expert’s work:
(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 29.
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 30.
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 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 31.
Comment on the following: While reading the other information, auditor finds certain misstatement of other information. Explain the requirement of relevant SA w.r.t. Auditor’s responses in such a situation.
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 broughtto the attention ofusers for whom the auditor’s report is prepared.

Objective Questions (Correct/Incorrect – True/False)

Question 1.
The scope of work of an internal auditor may extend even beyond the financial accounting.
Answer:
Statement is correct.
As per SA 610 “Using the Work of Internal Auditor” the scope of internal audit function may include:

• Monitoring of internal control
• Examination of financial & operating information
• Review of operating activities
• Review of compliance with laws & regulations
• Risk management
• Governance

Question 2.
AAS-24 (SA 402) deals with responsibility of the auditor of the service organisation. [May 08 (2 Marks)]
Answer:
Statement is Incorrect, SA402 “Audit Considerations relating to an entity using 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.

Question 3.
An expert for the purpose of AAS-9 (SA 620) is a person, firm or association of persons possessing special skill, knowledge and experience in auditing. [May 08 (2 Marks)]
Answer:
Statement is incorrect, an expert for the purpose of SA 620 “Using the work of Auditor’s Expert” an expert is an individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence.

Question 4.
AAS-9 (SA 620) is applicable when an auditor seeks legal opinion from an advocate. [Nov. 07 (2 Marks)]
Answer:
Statement is correct, SA 62 0 “Using the work of 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.

Question 5.
The auditor, in the interest of the users, while explaining the nature of his reservation, can describe the work of the expert with his name, in the audit report without obtaining prior consent of the expert. [Nov. 09(2 Marks)]
Answer:
Statement is incorrect.
As per SA 620 “Using the work of Auditor’s Expert” it maybe appropriate in some circumstances to refer to the auditor’s expert in an auditor’s report containing a modified opinion, to explain the nature of the modification. In such circumstances, the auditor may need the permission of the auditor’s expert before making such a reference.

Question 6.
An Auditor’s external expert is not subjected to quality control policies and procedures of an audit firm. [Nov. 14 (2 Marks)]
Answer:
Statement is correct.
SA 620 “Using the work of an Auditor’s expert” states that an auditor’s external expert is not a member of the engagement team and is not subject to quality control policies and procedures.