Raju

Internal Audit – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Internal Audit – CA Final Audit Question Bank

Question 1.
JKH Pvt. Ltd. who is into the business of imparting coaching to CA students did not appoint any internal auditor for the year ended 31st March, 2021. As on 31st March, 2020, the company had paid up capital of ₹ 50 lakhs and reserves of ₹ 10 crores. Its turnover for the 3 years preceding the year ended 31st March, 2021 was ₹ 75 crores, ₹ 145 crores and ₹ 260 crores respectively. As an auditor of the company for the year ended 31st March, 2021, how would you deal with the above? [Nov. 17 (4 Marks)]
Answer:
Applicability of Provisions of Internal Audit:
As per section 138 of the Companies Act, 2013, read with rule 13 of Companies (Audit and Auditors) Rules, 2014 every private company shall be required to appoint an internal auditor or a firm of internal auditors, having-

1. turnover of two hundred crore rupees or more during the preceding financial year; or
2. outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crore rupees or more at any point of time during the preceding financial year:

As per Para 3(xiv) of CARO, 2020, auditor is required to report (a) whether the company has an internal audit system commensurate with the size and nature of its business; (b) whether the reports of the Internal Auditors for the period under audit were considered by the statutory auditor.

In the instant case, JKH Pvt. Ltd. is having turnover of ₹ 260 crores during the preceding financial year which is more than two hundred crore rupees.

Conclusion: Company has the statutory liability to appoint an Internal Auditor and mandatorily conduct internal audit.

If the company does not have an internal audit system, statutory auditor is required to state the facts in his report under CARO, 2020.

Question 2.
WWF Ltd. is a public company having ₹ 40 lacs paid up capital in previous financial year which raised to ₹ 60 lacs in current financial year under audit. The company had turnover of previous three consecutive financial years being ₹ 49 crores, ₹ 145 crores and ₹ 150 crores. During the previous year, WWF Ltd. borrowed a loan from a public financial institution of ₹ 110 crores but squared up ₹ 20 crores by the year end. The company does not have any internal audit system. In view of the management, internal audit system is not mandatory. Comment. [MTP-April 18]
Answer:
Applicability of Internal Audit:
As per Section 138 of Companies Act 2013, such class or classes of companies as may be prescribed shall be required to appoint an internal auditor. As per Rule 13 of Companies [Accounts] Rules, 2014, following companies must have internal auditor:

1. every listed company;
2. every unlisted public company having-
   1. paid up share capital of ₹ 50 Cr. or more during the preceding financial year; or
   2. turnover of ₹ 200 Cr. or more during the preceding financial year; or
   3. outstanding loans or borrowings from banks or public financial institutions exceeding ₹ 100 Cr. or more at any point of time during the preceding financial year; or
   4. outstanding deposits of ₹ 25 Cr. or more at any point of time during the preceding financial year; and
3. every private company having-
   1. turnover of ₹ 200 Cr. or more during the preceding financial year; or
   2. outstanding loans or borrowings from banks or public financial institutions exceeding ₹ 100 Cr. or more at any point of time during the preceding financial year.

As per Para 3(xiv) of CARO, 2020, auditor is required to report (a) whether the company has an internal audit system commensurate with the size and nature of its business; (b) whether the reports of the Internal Auditors for the period under audit were considered by the statutory
auditor.

In the present case, WWF Ltd. had borrowed a loan from a public financial institution for ₹ 110 Cr. hence the company must have an internal audit system.

Conclusion: Management contention that internal audit system is not mandatory is not correct.

If the company does not have an internal audit system, statutory auditor is required to state the facts in his report under CARO, 2020.

Question 3.
Interior Pvt. Ltd. is a manufacturing company having turnover of ₹ 210 crore but having maximum outstanding loan from public financial institution of ₹ 90 crore only during the preceding financial year. You are required to state whether the company is liable for internal audit as per the provisions of the Companies Act, 2013
Answer:
Applicability of Internal Audit:
As per Section 138 of Companies Act, 2013, such class or classes of companies as may be prescribed shall be required to appoint an internal auditor. As per Rule 13 of Companies (Accounts] rules, 2014, following companies must have internal auditor:

(a) every listed company;
(b) every unlisted public company having-

1. paid up share capital of ₹ 50 Cr. or more during the preceding financial year; or
2. turnover of ₹ 200 Cr. or more during the preceding financial year; or
3. outstanding loans or borrowings from banks or public financial institutions exceeding ₹ 100 Cr. or more at any point of time during the preceding financial year; or
4. outstanding deposits of ₹ 25 Cr. or more at any point of time during the preceding financial year; and

(c) every private company having-

1. turnover of ₹ 200 Cr. or more during the preceding financial year; or
2. outstanding loans or borrowings from banks or public financial institutions exceeding ₹ 100 Cr. or more at any point of time during the preceding financial year.

As per Para 3(xiv) of CARO, 2020, auditor is required to report (a) whether the company has an internal audit system commensurate with the size and nature of its business; (b) whether the reports of the Internal Auditors for the period under audit were considered by the statutory auditor.

In the present case, turnover of Interior Pvt. Ltd. for the immediate preceding financial year was ₹ 210 Cr. which is more than the prescribed limit.

Conclusion: Interior Pvt. Ltd. is liable for the internal audit. Statutory auditor will have to mention in his report the fact of not having internal audit system by the Company.

If the company does not have an internal audit system, statutory auditor is required to state the facts in his report under CARO, 2020.

Question 4.
PQR Ltd., a listed company and having an average annual turnover of more than ₹ 5 crores have no Internal Audit System. Give your views. [Nov. 10 (5 Marks)]
Answer:
Applicability of Internal Audit:
As per Section 138 of Companies Act, 2013, such class or classes of companies as may be prescribed shall be required to appoint an internal auditor. As per Rule 13 of Companies (Accounts) Rules, 2014, following companies must have internal auditor:

(a) every listed company;
(b) every unlisted public company having-

1. paid up share capital of ₹ 50 Cr. or more during the preceding financial year; or
2. turnover of ₹ 200 Cr. or more during the preceding financial year; or
3. outstanding loans or borrowings from banks or public financial institutions exceeding ₹ 100 Cr. or more at any point of time during the preceding financial year; or
4. outstanding deposits of ₹ 25 Cr. or more at any point of time during the preceding financial year; and

(c) every private company having-

1. turnover of ₹ 200 Cr. or more during the preceding financial year; or
2. outstanding loans or borrowings from banks or public financial institutions exceeding ₹ 100 Cr. or more at any point of time during the preceding financial year.

As per Para 3(xiv) of CARO, 2020, auditor is required to report (a) whether the company has an internal audit system commensurate with the size and nature of its business; (b) whether the reports of the Internal Auditors for the period under audit were considered by the statutory auditor.

In the present case, PQR Ltd. is a listed entity which is covered under Rule 13 irrespective of its turnover.

Conclusion: PQR Ltd. is liable for the internal audit.

If the company does not have an internal audit system, statutory auditor is required to state the facts in his report under CARO, 2020.

Question 5.
AB Pvt. Ltd. company having outstanding loans or borrowings from banks exceeding one hundred crore rupees wants to appoint internal auditor. Please guide him who can be appointed as internal auditor and what would be reviewed by him. [May 15 (4 Marks)]
Answer:
Who can be appointed as Internal Auditor:
As per Section 138 of the Companies Act, 2013, every private limited company is required to have internal audit system if its outstanding loans or borrowings from banks or public financial institutions exceed ₹ 100 Cr. at any point of time during the preceding financial year. In present case, AB Pvt. Ltd. is under compulsion to conduct internal audit, as its loans or borrowings exceed ₹ 100 Cr.

As per Section 138, the internal auditor shall either be a chartered accountant, whether engaged in practice or not, or a cost accountant, or such other professional as may be decided by the Board to conduct internal audit of the functions and activities of the companies. The internal auditor may or may not-be an employee of the company.

Work to be reviewed by Internal Auditor:
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 may be 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.

“ICAI Examiner Comments”
Many candidates could not mention either who can be appointed as an internal auditor or the work to be reviewed by internal auditor.

Question 6.
XYZ Yarns Ltd. is a manufacturing company engaged in manufacturing of different types of yarns. Its. annual turnover is ₹ 100 Crores and net profit ₹ 10 crores. It has two manufacturing units. Company is facing difficulties in maintaining adequate system of internal control. Company wants to appoint Internal Auditor who would help in the above task and also various other functions including compliance. In view of above, you are required to explain the main responsibility of Internal Auditors. [MTP-Oct. 18]
Answer:
Responsibilities of Internal Auditor:

1. To maintain adequate system of internal control by a continuous examination of accounting procedures, receipts and disbursements and to provide adequate safeguards against misappropriation of assets.
2. To operate independently of the accounting staff and must not in any way divest himself of any of the responsibilities placed upon him.
3. To observe unusual facts and circumstances and bring them to notice of management.
4. To appraise policies and procedures prevailing in the entity and bring to the notice of management any deficiencies, wherever these require to be corrected.
5. To perform his work with independence. He need to associate closely with management and his knowledge must be kept up to date by his being kept informed about all important occurrences and events affecting the business, as well as the changes that are made in business policies.

Question 7.
The internal auditor must be regarded as part of the management and not merely as an assistant thereto. He must have authority to investigate from the financial angles every phase of the organisational activity under any circumstances. Explain.
Answer:
Role and Responsibilities of Internal Auditor:
Rule 13 of Companies (Accounts) Rules, 2014 provides that the scope, functioning, periodicity and methodology for conducting the internal audit shall be formulated by the Audit Committee of the company or the Board shall, in consultation with the Internal Auditor.

Over a period of time, scope of internal auditing has been widened so as to cover all operations besides accounting and financial operations. To be effective, the Internal Auditor must be regarded as part of the management and not merely as an assistant thereto. He must have authority to investigate from the financial angles, every phase of the organisational activity under any circumstances.

Major responsibilities that are entrusted to Internal Auditor are listed as below:

1. To maintain adequate system of internal control by a continuous examination of accounting procedures, receipts and disbursements and to provide adequate safeguards against misappropriation of assets.
2. To operate independently of the accounting staff and must not in any way divest himself of any of the responsibilities placed upon him.
3. To observe unusual facts and circumstances and bring them to notice of management.
4. To appraise policies and procedures prevailing in the entity and bring to the notice of management any deficiencies, wherever these require to be corrected.
5. To perform his work with independence. He need to associate closely with management and his knowledge must be kept up to date by his being kept informed about all important occurrences and events affecting the business, as well as the changes that are made in business policies.

Question 8.
M/s ME Ltd. is a manufacturing Company of M/s Bars and Rods. The turnover of the company for financial year 2019-20 was ₹ 870 crores. The audit committee has appointed M/s MK Associates, Chartered Accountants as an internal auditor of the company for the financial year 2020-21. As an auditor of ME Ltd., draw out the internal audit plan specifying coverage of area. [May 16 (4 Marks)]
Answer:
Internal Audit Plan specifying the coverage of Area:
While drawing internal audit plan, following specific areas may be covered:

1. Terms of audit engagement and scope of internal audit as determined by audit committee.
2. Nature and timing of reports and other communications.
3. Legal or statutory requirements.
4. Accounting policies adopted by the client and changes made therein.
5. New accounting or auditing pronouncements and their impact on the entity.
6. Identification of significant audit areas.
7. Setting up of materiality levels for purpose of audit.
8. Circumstances requiring special attention, such as the possibility of material error or fraud or related party transactions.
9. Degree of reliance to be placed on accounting system and internal control.
10. Nature, form and extent of audit evidence to be obtained.
11. Nature, timing and extent of procedures to be performed.
12. Use of expert’s work.
13. Establishing and coordinating staffing requirements.
14. Attending the inventory count
15. Method of physical verification of cash and investment.
16. Verification of Assets and Liabilities.
17. Compliance of laws and Regulations.

“ICAI Examiner Comments”
Candidates, in general, failed to explain the areas to be covered in drawing an internal audit plan and rather discussed about role of internal auditor, internal control & internal check.

Question 9.
ABC Ltd. is engaged in manufacturing of Yarns and Towels. It sells its product in both domestic as well as in International Market. It has achieved turnover of ₹ 200 crores in the F.Y. 2019-20. Directors of the company realized that they are not managing the company professionally and thereby request your firm of Internal Auditors for appraisal of its organizational structure to ascertain : whether it is in harmony with the objectives of ABC (P) Ltd. Comment. [MTP-Aug. 18]
Or
Internal Auditor makes an appraisal of organization structure to ensure that it is in harmony with the objectives of the entity, besides checking of financial truncations and operational activities of the entity. Elaborate. [Nov. 18 – New Syllabus (4 Marks)]
Answer:
Appraisal of Organisational Structure by Internal Auditor:
The Internal Auditor should conduct an appraisal of the organisation structure to ascertain:

• whether it is in harmony with the objectives of the enterprise and
• whether the assignment of responsibilities is in consonance therewith.

For this purpose. Internal Auditor should:
(a) Review the manner in which the activities of the enterprise are grouped for managerial control so as to find out whether responsibility and authority are in harmony with the grouping pattern.

(b) Examine the organisation chart to find out whether the structure is simple and economical and that no function enjoys an undue dominance over the others.

(c) Ensure that the responsibilities of managerial staff at headquarters do not overlap with those of chief executives at operating units.

(d) Examine the reasonableness of the span of control of each executive (the number of subordinates that an executive controls). He should examine whether there is a unity of command i.e., whether each person reports only to one superior.

(e) Evaluate the process of managerial development in the enterprise.

Question 10.
“Review of the internal audit function has become statutory responsibility for the statutory auditor.” [May 15 (4 Marks)]
Answer:
Review of internal audit Function by Statutory Auditor:
It is obligatory for a statutory auditor to examine the scope and effectiveness of the work carried out by the internal auditor.

For this purpose, statutory auditor should examine the Internal Audit function of the organisation, the strength of the internal audit staff, their qualification and powers.

Besides statutory auditor should have studied the procedures adopted by internal auditor, refer audit programmes, reports submitted, points raised in audit and ascertain how these had been dealt with subsequently.

The extent of independence exhibited by the internal auditor in the discharge of his duties and his status in the organisation are important factors for determining the effectiveness of his audit.

In a large business, it has been increasingly recognised that, if function of internal auditor and those of statutory auditors could be integrated, it might not be necessary for the statutory auditors to go over the same facts and figure as have been previously examined by a competent and trustworthy internal audit staff.

“ICAI Examiner Comments”
Many candidates wrote about evaluation of internal control instead,of need for review of internal audit function. They also failed to explain the factors that should be considered by statutory auditor while reviewing the work of internal auditor.

Question 11.
ABC Ltd appointed CA Mr. X, for conducting internal audit for the financial year 2020-21. Mr. X seeks your advice in drafting a good quality internal audit report. You are, therefore, required to guide him by elaborating essential features of a good internal audit report.
Or
Webcom Ltd., a public company with a paid up share capital of ₹ 20 crores has a turnover for the financial year 2019-20 of ₹ 220 crores. X, a recently qualified Chartered Accountant, has been appointed for conducting internal audit. He seeks your advice in drafting a good quality internal audit report. Please guide him by elaborating (in brief) the essential features of good internal audit report. [May 19 – Old Syllabus (5 Marks)]
Answer:
Essential Features of Internal Audit Report
1. Objectivity: Comments and opinions expressed in the report should be as objective and unbiased as possible.
2. Clarity: The language used should be simple and straight-forward.
3. Accuracy: The information contained in the report, whether quantified or otherwise, should be accurate.
4. Conciseness: Important information should not be omitted.
5. Constructiveness: Destructive criticism should carefully be avoided in the report.

6. Readability: The reader’s interest should be captured and retained throughout. For this, appropriate paragraph heading may be used.

7. Timeliness: The report should be submitted promptly because if the time lag between the occurrence of an event and its reporting is considerable, the opportunity for taking action may be lost or a wrong decision may be taken in the absence of the information.

8. Findings and conclusions: These may be given either department-wise or in the order of importance. Each conclusion and opinion should normally follow the findings.

9. Recommendations: An internal audit report usually includes recommendations for potential improvements.

10. Auditee’s views: The auditee’s views about audit conclusions or recommendations may also be included in the audit report in appropriate circumstances.

11. Summary: A summary of conclusions and recommendations may be given at the end. This is particularly useful in long reports.

12. Supporting information: The internal auditor should supplement his report by such documents and data which adequately and convincingly support the conclusions. Supporting information may include the relevant standards or regulations.

13. Draft Report: Before writing the final report, the internal auditor should prepare a draft report. This would help him in finding out the most effective manner of presenting his reports.

14. Writing and issuing the Final Report: The final report should be written only when the auditor is completely satisfied with the draft report. The head of the internal auditing department, may review and approve the final report. Before issuing the final report, the auditor should discuss conclusions and recommendations appropriate levels of management. The report should be duly signed.

Liabilities of Auditors – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Liabilities of Auditors – CA Final Audit Question Bank

Professional Negligence

Question 1.
Write a short note on: Professional Negligence.
Answer:
Professional Negligence:
It connotes any failure to perform a duty according to accepted professional standards, which has resulted in some loss, damage or detriment to the party who had engaged a professional.

It is an act or omission which gives rise to a civil liability to compensate.

Elements of Professional Negligence
(a) Existence of duty or responsibility: One party is owed to another party to perform some act with due care, skill and competency.
(b) Occurrence of Breach: A breach occurs while performing the duty.
(c) Loss or damages: Loss or detriment being served by the party to whom the duty was owed as a result of breach. To establish a liability in respect of a third party, it is necessary that such third party should have suffered a loss or damage on account of the professional negligence.

Coverage: Professional negligence is necessarily restricted to the duties in a professional capacity.

Civil and Criminal Liabilities under Companies Act, 2013

Question 2.
Explain the liability of the auditor under the Companies Act, 2013, for making an untrue statement in the report (as an expert forming a part of the prospectus). [May 10 (5 Marks)]
Or
Indicate the precise nature of auditor’s liability for a misstatement that had occurred in the prospectus issued by the company. [MTP-Oct. 18]
Answer:
Liability of auditor for making untrue statements:
Criminal liability for misstatement in prospectus: Sec. 34 of Companies Act, 2013 provides that where any prospectus is issued or circulated or distributed, which includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, then every person who authorises the issue of such prospectus shall be liable u/s 447 (fraud).

Civil liability for misstatement in prospectus: Sec. 35 of Companies Act, 2013 provides that where a person has subscribed for securities of a company acting on any statement included, or the inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or damage as a consequence thereof, the company and every person who is a director of the company at the time of the issue of the prospectus; has authorised himself to be named and is named in the prospectus as a director of the company, or has agreed to become such director, either immediately or after an interval of time; is a promoter of the company; has authorised the issue of the prospectus; and is an expert, shall, be liable to pay compensation to every person who has sustained such loss or damage.

Punishment for Fraud: Sec. 447 of Companies Act 2013, provides that, any person who is found to be guilty of fraud, involving an amount of at least ₹ 10 lakh or 1% of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud.

Where the fraud involves an amount less than ₹ 10 lakh or 1% of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to 5 years or with fine which may extend to ₹ 50 lakh or with both”.

It is also provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than 3 years.

Question 3.
Mr. X, a young chartered accountant, wants to start practice and he required your advice, among other things, on criminal liabilities of an auditor under the Companies Act, 2013. Kindly guide him. [Nov. 13 (4 marks)]
Or
Mr. Arjun, a newly qualified Chartered Accountant started his practice wants to specialize in Audits of corporate and required your advice on criminal liabilities of an auditor under the Companies Act, 2013. Kindly guide him. [May 16 (4 Marks)]
Answer:
Criminal Liabilities under Companies Act, 2013:
Criminal liability for misstatement in prospectus:Sec. 34 of Companies Act, 2013 provides that where any prospectus is issued or circulated or distributed, which includes any statement which is untrue or misleading in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead, then every person who authorises the issue of such prospectus shall be liable u/s 447 (fraud).

Punishment for false statement: Sec. 448 of Companies Act, 2013 provides that if in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act or the rules made thereunder, any person makes a statement,(a) which is false in any material particulars, knowing it to be false; or (b) which omits any material fact, knowing it to be material, he shall be liable under section 447.

Punishment for fraud: Sec. 447 of Companies Act, 2013 provides that, any person who is found to be guilty of fraud, involving an amount of at least ₹ 10 lakh or 1% of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud.

Where the fraud involves an amount less than ₹ 10 lakh or 1% of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to 5 years or with fine which may extend to ₹ 50 lakh or with both”.

It is also provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than 3 years.

ICAI Examiner Comments
Candidates lacked knowledge of the sections 447 and 448 of the Companies Act, 2013 and mainly discussed about quantum of punishment and the amount of fine rather than the provisions leading to arising of criminal liability.

Question 4.
A Chartered Accountant in practice has been appointed as ail auditor of a company which raised finance from the capital market on the basis of a prospectus issued a few years back. The main ) object for raising the finance was specified to be setting up a project on information technology. The company advanced the sum so raised to various firms and private companies in which the I directors of the company were a partner or a director respectively.

These parties had no standing whatsoever with information technology. the Balance Sheet, these advances appeared as a current asset under the head “Short-term Loans and Advances – unsecured, considered good”. There was no mention to the notes to accounts about nature and purpose of such advances; and the auditor has issued routine audit report without any qualifications. On the very next day to the issuance of audit report, the directors and their related parties gone disappeared. The company, in which the auditor was conducting audit, has just vanished. You are required to state whether the auditor will be held guilty for professional misconduct? Is there any liability subsists under any law?
Answer:
Auditor’s negligence in performance of duties:
Clause 7 of Part I of Second Schedule to the CA Act, 1949 provides that a CA in practice will be deemed to be guilty of professional misconduct if he does not exercise due diligence in performance of his duties or is grossly negligent while performing his duties.

Schedule III to the Companies Act, 2013 requires specific disclosure of loans and advances due by directors or other officers of the company or any of them either severally or jointly with any other person or amounts due by firms or private companies respectively in which any director is a partner or a director or a member.

As per Section 188 of the Companies Act, 2013, no company shall enter into any contract or arrangement with a related party with respeet to sale, purchase or supply of any goods or materials, except with the consent of the Board of Directors given by a resolution at a Board Meeting. Section 184 requires disclosure of interest by director and also lays down the procedure to be followed in this regard. Section 189 of the Companies Act, 2013 requires that every company shall keep one or more registers in which particulars of all contracts or arrangements, to which Section 184 or Section 188 applies, shall be entered separately.

In the given case, the company has advanced the sum to the parties that are related to the Directors of the company and showed the same under the head “Short-term Loans and Advances – unsecured, considered good” rather than specific disclosure under the notes to accounts. The auditor of the company also issued clean audit report without any qualifications. It appears that the auditor did not perform his duties properly.

Conclusion: Auditor is guilty of professional misconduct under Clause 7 of part I of Second Schedule to CA Act, 1949 and is also liable to be’ punished u/s 147 of Companies Act, 2013, due to nonobservance of compliance of Schedule III and Sections 184,188 and 189 of Companies Act, 2013.

Question 5.
Indicate the precise nature of auditor’s liability in the following situation: Certain weaknesses in the internal control procedure in the payment of wages in a large construction company were noticed by the statutory auditor who in turn brought the same to the knowledge of the Managing Director of the company. In the subsequent year huge defalcation came to the notice of the management. The origin of the same was traced to the earlier year. The management wants to sue the auditor for negligence and also plans to file a complaint with the Institute.
Answer:
Liabilities of auditor:
SA 265 on “Communicating Deficiencies in Internal Control to TCWG and Management” requires the auditor to determine whether, on the basis of the audit work performed, he has identified one or more deficiencies in internal control. If one or more deficiencies in internal control has been identified, he shall determine whether, such deficiencies individually or in combination constitute significant deficiencies. Significant deficiencies are required to be communicated in writing to TCWG and management on a timely basis.

In the given case, certain weaknesses in the internal control procedure in the payment of wages in a large construction company were noticed by the statutory auditor and brought the same to the knowledge of the Managing Director of the company. In the subsequent year, a huge defalcation took place, the ramification of which stretched to the earlier year. The management of the company desires to sue the statutory auditor for negligence.

The precise nature of auditor’s liability in the case can be ascertained on the basis of the following considerations:
(a) Whether the defalcation emanated from the weaknesses noticed by the statutory auditor, the information regarding which was passed on to the management; and
(b) Whether the statutory auditor properly and adequately extended the audit programme of the previous year having regard to the weaknesses noticed.

If circumstances indicate the possible existence of fraud or error, the auditor should consider the potential effect of the suspected fraud or error on the financial information. If the auditor believes the suspected fraud or error could have a material effect on the financial information, he should perform such modified or additional procedures as he determines to be appropriate. Thus, normally speaking, as long as the auditor took due care in performing the audit work, he cannot be held liable.

The fact that the matter was brought to the notice of the managing director may be a good defence for the auditor as well. In Kingston Cotton Mills Ltd., it was held that it is the duty of the auditor to probe into the depth only when his suspicion is aroused. The statutory auditor, by bringing the weakness to the notice of the managing director had alerted the management which is judicially held to be primarily responsible for protection of the assets of the company and can put forth this as defence against any claim arising subsequent to, passing of the information to the management.

Question 6.
Indicate the precise nature of auditor’s duties in the following situation: Based upon the legal opinion of a leading advocate, X Ltd. made a provision of ₹ 5 crores towards Income Tax liability. The assessing authority has worked out the liability at ₹ 15 crores. It is observed that the opinion of the advocate was inconsistent with legal position with regard to certain revenue items.
Answer:
Auditor’s liabilities in case of short provisions:
SA 500 on “Audit Evidence” requires that auditor to perform appropriate procedures while using the work of management expert as audit evidence. Before relying on expert’s opinion, the auditor should have seen that opinion given by the expert is prima facie appropriate and acceptable.

In the present case, opinion of the management expert was inconsistent with legal position with regard to certain items. It is, perhaps, quite possible that auditor did not seek reasonable assurance as to the appropriateness of the source data, assumptions and methods used by the expert properly.

SA 500 requires that auditor to resolve the inconsistency by discussion with the management and the expert. In case, the experts’ work does not support the related representation in the financial information, the inconsistency in legal opinions could have been detected by the auditor if he had gone through the same. This seems apparent having regard to wide difference in the liability worked out by the assessing authority.

Conclusion: Auditor should reject the opinion and insisted upon making proper provision.

Question 7.
State the nature of liability as provided in the Companies Act, 2013 of an auditor for not appropriately dealing with a misstatement appearing in audited Financial statements or a false statement in Audit Report. [Nov. 18-Old Syllabus (4 Marks)]
Answer:
Auditor’s Liability for not appropriately dealing with a misstatement appearing in audited financial statements or a false statement in Audit Report:

Sec. 448 of Companies Act, 2013 provides that if in any return, report, certificate, financial statement, prospectus, statement or other document required by, or for, the purposes of any of the provisions of this Act or the rules made thereunder, any person makes a statement,—
(a) which is false in any material particulars, knowing it to be false; or
(b) which omits any material fact, knowing it to be material, he shall be liable under section 447.

Punishment for fraud: Sec. 447 of Companies Act, 2013 provides that, any person who is found to be guilty of fraud, involving an amount of at least ₹ 10 lakh or 1% of the turnover of the company, whichever is lower shall be punishable with imprisonment for a term which shall not be less than 6 months but which may extend to 10 years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to 3 times the amount involved in the fraud.

Where the fraud involves an amount less than ₹ 10 lakh or 1% of the turnover of the company, whichever is lower, and does not involve public interest, any person guilty of such fraud shall be punishable with imprisonment for a term which may extend to 5 years or with fine which may extend to ₹ 50 lakh or with both.”.

Liabilities under Income-tax Act, 1961

Question 8.
In assessment procedure of M/s Cloud Ltd., Income Tax Officer observed some irregularities. Therefore, he started investigation of Books of Account audited and signed by Mr. Old, a practicing Chartered Accountant. While going through books he found that M/s Cloud Ltd. used to maintain two sets of Books of Account, one is the official set and other is covering all the transactions. Income Tax Department filed a complaint with the Institute of Chartered Accountants of India saying Mr. Old had negligently performed his duties. Comment. [May 14 (4 Marks)]
Answer:
Liabilities of Auditor:
It is the auditor’s responsibility to audit the statement of accounts and prepare tax returns on the basis of books of account produced before him. After being satisfied with the books and documents produced to him, he can give his opinion on the basis of those documents only by exercising requisite skill and care.

In the present case, Income tax Officer observed some irregularities during the assessment proceeding of M/s Cloud Ltd. Therefore, he started investigation of books of account audited and signed by Mr. Old, a practicing Chartered Accountant. While going through the books, he found that M/s Cloud Ltd. Used to maintain two sets of Books of Account, one is the official set and other is covering all the transactions. Income Tax Department filed a complaint with the ICAI saying Mr. Old had negligently performed his duties.

Mr. Old, the auditor was not under a duty to prepare books of account of assessee and he should, of course, neither suggest nor assist in the preparations of false accounts. He is responsible for the books produced before him for audit. He completed his audit work with official set of books only.

Conclusion: As Mr. Old, performed the auditing with due skill and diligence; and, therefore, no question of negligence arises. It is the duty of the Department to himself investigate the truth and correctness of the accounts of the assessee.

Question 9.
Write a short note on – Auditor’s liability in case of unlawful acts or defaults by clients.
Answer:
Auditor’s liability in case of unlawful acts of the client:
The Institute has recommended following course of action for a member when he is not directly involved in tax frauds committed by his clients, but he discovers such fraud in the course of his professional work:
(a) Member is under no obligation to inform income tax authorities about taxation frauds.

(b) If the fraud relates to accounts or tax matters of the client for past years for which the client was not represented by the member, client should be advised to-disclose. The member may however continue to act for the client in respect of current matters, but at the same time he is also required to ensure that the past fraud does not in any way affect the current tax matters.

(c) If the fraud relates to past years accounts examined and reported by the member himself, on the basis of which the tax assessment in the past has been made, he should advise the client for a disclosure. In case the client refuses, he should disassociate himself from the case and make a report to authorities that the accounts examined by him previously are unreliable on account of some information obtained later. (Details of information should not be communicated)

(d) In case of suppression of current accounts, the client should be advised to make a full disclosure. If he refuses, the accountant should make a complete reservation is his report and disassociate himself with return.

(e) If the services are dispensed with before completion of the assignment, there is no further duty to disclose.

Question 10.
Mr. Ram, a Chartered Accountant has appeared before the Income Tax Authorities as the authorized representative of his client and delivers to the income tax authorities a false declaration. What are the liabilities of Mr. Ram under Income-tax Act, 1961? [May 17 (4 Marks), MTP-Aug. 18)
Answer:
Liabilities under Income-tax Act, 1961:
Section 278 of Income-tax Act, 1961 (Liability for submission of false information): Any person who acts or induces, in any manner another person to make and deliver to the Income Tax Authorities a false account, statement, or declaration relating to any income chargeable to tax which he knows to be false or does not believe to be true is punishable

(i) in a case where the amount of tax, penalty or interest which would have been evaded, if the declaration, account or statement had been accepted as true, or which is wilfully attempted to be evaded, exceeds ₹ 25 Lacs, with rigorous imprisonment for a term which shall not be less than 6 months but which may extend to 7 years and with fine;

(ii) in any other case, with rigorous imprisonment for a term which shall not be less than 3 months but which may extend to 2 years and with fine.

ICAI Examiner Comments
Candidates showed lack of knowledge on liability of Chartered Accountants acting as authorised representative and delivering false information u/s 278 of the Income-tax Act, 1961 and most of them mistakenly related with professional misconduct under the Chartered , Accountants Act, 1949

Question 11.
What are the liabilities of a Chartered Accountant under Income-tax Act, 1961 for furnishing an incorrect statement in any report or certificate required to be submitted by him under the Act? [Nov. 18-New Syllabus (4 Marks)]
Answer:
Liabilities of a Chartered Accountant under Income-tax Act, 1961 for furnishing an incorrect statement in any report or certificate:
Liabilities u/s 271]: Sec. 271J of the Income-tax Act, 1961 provides that where the Assessing Officer op the Commissioner (Appeals), in the course of any proceedings under this Act, finds that an accountant or a merchant banker or a registered valuer has furnished incorrect information in any report or certificate furnished under any provision of this Act or the rules made thereunder, the Assessing Officer or the Commissioner (Appeals) may direct that person to pay a penalty of ₹ 10,000 for each such report or certificate.

Liabilities u/s 278;
Section 278 of Income-tax Act, 1961 (Liability for submission of false information): Any person who acts or induces, in any manner another person to make and deliver to the Income Tax Authorities a false account, statement, or declaration relating to any income chargeable to tax which he knows to be false or does not believe to be true is punishable

(i) in a case where the amount of tax, penalty or interest which would have been evaded, if the declaration, account or statement had been accepted as true, or which is wilfully attempted to be evaded, exceeds ₹ 25 Lacs, with rigorous imprisonment for a term which shall not be less than 6 months but which may extend to 7 years and with fine;

(ii) in any other case, with rigorous imprisonment for a term which shall not be less than 3 months but which may extend to 2 years and with fine.

Audit Committee and Corporate Governance – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Audit Committee and Corporate Governance – CA Final Audit Question Bank

Corporate Governance

Question 1.
Answer:
Corporate Governance:
Corporate Governance is the system by which companies are directed and governed by the management in the best interests of the stakeholders and others ensuring better management, greater transparency and timely financial reporting.

Responsibility to ensure corporate Governance rests with the Board of Directors.

In India, the legal framework of Corporate Governance is contained in Sec. 177 of the Companies Act, 2013 (relating to Audit Committee) and Chapter IV (Regulation 17 to Regulation 27) of SEBI (LODR) Regulations, 2015.

SEBI (LODR) Regulations,2015,issuedbySEBIwiththeobjectiveofstreamliningandconsolidating the provisions of various listing agreements in operation for different segments of the capital markets, such as equity shares, preference shares, debt instruments, units of mutual funds, Indian depository receipts, securitised debt instruments and any other securities that the SEBI may specify.

These Regulations are divided into 2 parts – the substantive provisions are incorporated in the main body while the procedural requirements are incorporated in the form of schedules.

It may be noted that the LODR Regulations deal with only post-listing requirements and exclude all pre-listing requirements.

Question 2.
Write short note on: Matters addressed in SEBI (LODR) Regulations, 2015 regarding Corporate Governance. [Nov. 15 (4 Marks)]
Or
Enumerate the issues addressed in the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 regarding Corporate Governance.
Answer:
Corporate Governance:

• Corporate Governance can be defined as “the formal system of accountability and control for ethical and socially responsible organisational decisions and use of resources”.
• Corporate Governance is the system by which companies are directed and governed by the management in the best interests of the stakeholders and others ensuring better management, greater transparency and timely financial reporting.
• Responsibility to ensure corporate Governance rests with the Board of Directors.
• In India, the legal framework of Corporate Governance is contained in Sec. 177 of the Companies Act, 2013 (relatingto Audit Committee) and Chapter IV (Regulation 17 to Regulation 27) of SEBI (LODR) Regulations, 2015.
• Chapter IV of SEBI (LODR) Regulations, 2015 deals with the below mentioned matters so as to ensure corporate governance framework more effective –
  (a) Board of Director including its composition, independent director, non-executive director etc.;
  (b) Provisions regarding composition and functioning of Audit Committee (Regulation 18).
  (c) Provisions regarding setting ug and role of Nomination and Remuneration Committee.
  (d) Provisions regarding setting up and-role of Stakeholder Relationship Committee.
  (e) Provisions regarding setting up and role of Risk Management Committee.
  (f) Vigil Mechanism.
  (g) Related party Transaction;
  (h) Management of subsidiary companies; Obligations w.r.t. Independent Directors.
  (i) Obligations w.r.t. directors and senior management.
  (j) Others as specified in Part E of Schedule II (Discretionary).

ICAI Examiner Comments
Most of the examinees did not highlight the matters addressed in Clause 49 (Now SEBI (LODR) Regulations regarding Corporate Governance, instead they wrote general answers on Corporate Governance. Also some examinees explained about audit committee.

Audit Committee (Sec. 177 of Companies Act, 2013)

Question 3.
Explain the Constitution and Functions of Audit Committee u/s 177 of Companies Act, 2013.
Or
Write short note on: Requirement for Audit Committee as per Companies Act, 2013. [Nov. 17 (4 Marks)]
Answer:
Constitution of Audit Committee:
Section 177(1) of Companies Act, 2013 read with Rule 6 of Companies (Meetings of Board and its Powers) Rules, 2014 requires Board of Directors of every listed Public company and below mentioned class of companies to constitute an Audit Committee —

1. all public companies with a paid-up capital of ₹ 10 Cr. or more;
2. all public companies having turnover of ₹ 100 Cr. or more;
3. all public companies, having in aggregate, outstanding loans and debentures and deposits exceeding fifty crore rupees or more.

Explanation to Rule 6 provides that the paid-up share capital or turnover or outstanding loans, debentures and deposits, as the case may be, as existing on the date of last audited Financial Statements shall be taken into account.

Functions of Audit Committee:
Every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board which shall, inter alia, include:

1. the recommendation for appointment, remuneration and terms of appointment of auditors;
2. review and monitor the auditor’s independence and performance, and effectiveness of audit process;
3. examination of the financial statement and the auditors’ report thereon;
4. approval or any subsequent modification of transactions of the company with related parties;
5. scrutiny of inter-corporate loans and investments;
6. valuation of undertakings or assets of the company, wherever it is necessary;
7. evaluation of internal financial controls and risk management systems;
8. monitoring the end use of funds raised through public offers and related matters.

Audit Committee (Regulation of SFBl (LODR) Regulations, 2015)

Question 4.
Slate the main features of the qualified and independent Audit Committee set up under regulation 18 of SEBI (LODR) Regulations, 2015. [Nov. 08 (4 Marks), MTP-April 18)
Or
Every listed company shall constitute a qualified & Independent audit committee in accordance with the terms of reference subject to a few conditions. Explain. [MTP-Aug. 18]
Answer:
Features of Qualified and Independent Audit Committee:
(a) The audit committee shall have minimum 3 directors as members. Two-thirds of the members of audit committee shall be independent directors.

In case of a listed entity having outstanding Superior Rights (SR) equity shares, the audit committee shall only comprise of independent directors.

(b) All members of audit committee shall be financially literate and at least one member shall have accounting or related financial management expertise. –
(c) The Chairperson of the Audit Committee shall be an independent director.
(d) The Chairperson of the Audit Committee shall be present at AGM to answer shareholder queries.

(e) The audit committee at its discretion shall invite the finance director or head of the finance function, head of internal audit and a representative of the statutory auditor and any other such executives, to be present at the meetings of the committee.

(f) The Company Secretary shall act as the secretary to the committee.

Question 5.
The audit committee has been granted several roles under SEBI (LODR) regulations, 2015. Oversight of the company’s financial reporting process; recommendation for appointment of auditors; approval of payment to statutory auditors etc. are some of the roles that an audit committee perform. State the role of Audit Committee as provided under SEBI (LODR) Regulations.
Answer:
Role of Audit Committee under SEBI (LODR) Regulations, 2015:
1. Oversight of the company’s financial reporting process and the disclosure of its financial information to ensure that the financial statement is correct, sufficient and credible;

2. Recommendation for appointment, remuneration and terms of appointment of auditors;

3. Approval of payment to statutory auditors for any other services rendered by them;

4. Reviewing with management the annual financial statements before submission to the Board, focusing primarily on:
(a) Matters required to be included in the Director’s Responsibility Statement to be included in the Board’s report in terms of Sec. 134(3)(c) of the Companies Act, 2013.
(b) Changes, if any, in accounting policies and practices and reasons for the same.
(c) Major accounting entries involving estimates based on the exercise of judgment by management.
(d) Significant adjustments made in the financial statements arising out of audit findings.
(e) Compliance with listing and other legal requirements relating to financial statements.
(f) Disclosure of any related party transactions.
(g) Qualifications in the draft audit report.

5. Reviewing, with the management, the quarterly financial statements before submission to the board for approval;

6. Reviewing, with the management, the-statement of uses/application of funds raised through an issue (public issue, rights issue, preferential issue, etc.), the statement of funds utilized for purposes other than those stated in the offer document/prospectus/notice and the report submitted by the monitoring agency monitoring the utilisation of proceeds of a public or rights issue, and making appropriate recommendations to the Board to take up steps in this matter;

7. Review and monitor the auditor’s independence and performance, and effectiveness of audit process;
8. Approval or any subsequent modification of transactions of the company with related parties;
9. Scrutiny of inter-corporate loans and investments; ,
10. Valuation of undertakings or assets of the company, wherever it is necessary;
11. Evaluation of internal financial controls and risk management systems;
12. Reviewing, with the management, performance of statutory and internal auditors, adequacy of the internal control systems;
13. Reviewing the adequacy of internal audit function;
14. Discussion with internal auditors of any significant findings and follow up there on;

15. Reviewing the findings of any internal investigations by the internal auditors into matters where there is suspected fraud or irregularity or a failure of internal control systems of a material nature and reporting the matter to the board;

16. Discussion with statutory auditors before the audit commences, about the nature and scope of audit as well as post-audit discussion to ascertain any area of concern;

17. To look into the reasons for substantial defaults in the payment to the depositors, debenture holders, shareholders (in case of non-payment of declared dividends) and creditors;

18. To review the functioning of the Whistle Blower mechanism;
19. Approval of appointment of CFO after assessing the qualifications, experience and background, etc. of the candidate;
20. Carrying out any other function as is mentioned in the terms of reference of the Audit Committee

21. Reviewing the utilization of loans and/or advances from/investment by the holding company in the subsidiary exceeding rupees 100 crore or 10% of the asset size of the subsidiary, whichever is lower including existing loans/advances/investments existing as on 01.04.2019.

Question 6.
State the mandatory Review areas of the audit committee. [May 12 (4 Marks), RTP-May 20]
Or
List few documents that require mandatory review by Audit Committee. [Nov. 18-New Syllabus (5 Marks)]
Answer:
Mandatory Review Area of Audit Committee:

1. Management discussion and analysis of financial condition and results of operations.
2. Statement of significant related party transactions submitted by management.
3. Management letters/letters of internal control weaknesses issued by the statutory auditors.
4. Internal audit reports relating to internal control weaknesses; and
5. The appointment, removal and terms of remuneration of the Chief Internal Auditor.
6. Statement of deviations:
   (a) Quarterly statement of deviation (s) including report of monitoring agency, if applicable submitted to stock exchange.
   (b) Annual statement of funds utilised for purposes other than those stated in offer document/ prospectus.

Question 7.
D Ltd., a company incorporated in India has six members in its Audit Committee. Due to recessionary conditions in India the revenue of the company is going down and there is slow down in other activities of the company. Therefore, it is expected that there would not be significant work for members of the Audit Committee.

Considering the overall recession in the company and the economy, the members of the Committee decided unanimously to meet only once at the year end. They reviewed monthly information system of the company and found no errors.

As an auditor of D Limited would you consider the decision taken by the Audit Committee to hold the meeting once in a year, is complying with Listing Obligation and Disclosure Requirements (LODR)? Also state the quorum requirements for such meetings. [Nov. 13 (4 Marks), RTP-Nov. 18., Nov. 19 – New Syllabus (5 Marks)]
Answer:
Validity of Audit committee decisions w.r.t. meetings and review area:
Regulation 18 of SEBI (LODR) Regulations, 2015, among other things, requires the followings:

1. The audit committee should meet at least 4 times in a year and not more than 120 days shall elapse between two meetings.
2. Audit committee should mandatorily review certain areas like management discussion and analysis, statement of significant related party transactions, letters of internal control weaknesses, internal audit reports etc.

In the present case, members of audit committee decided to meet only once in a year and review only the monthly information system which does not meet the requirement of regulation 18 of SEBI (LODR) Regulations, 2015 as stated above.

Conclusion: Decision taken by audit committee to conduct meeting once in a year and review of only monthly information system is not in line with the requirements of Regulation 18 of SEBI (LODR) Regulations, 2015.

Quorum requirements of meetings of audit committee: The quorum shall be either 2 members or 1 /3 of the members of the audit committee whichever is greater, but there should be a minimum of two independent members present.

Question 8.
Mr. ‘U’, a respectable Chartered Accountant of international repute was requested by one of the major corporate in India to join its Board and also as a Chairman of Audit Committee. He expressed his apprehensions that he is not having the requisite experience. Mr. ‘U’ seeks your view on the responsibility of Audit Committees vis-a-vis the review of Financial Statements. [May 14 (4 Marks)]
Answer:
Responsibility of Audit Committee vis-a-vis the review of Financial statement:
As per Regulation 18 of SEBI [LODR] Regulations, 2015, audit committee is required to review with management the annual financial statements before submission to the Board, focusing primarily on:

1. Matters required to be included in the Director’s Responsibility Statement to be included in the Board’s report in terms of Sec. 134(3)(c) of the Companies Act, 2013.
2. Changes, if any, in accounting policies and practices and reasons for the same.
3. Major accounting entries involving estimates based on the exercise of judgment by management.
4. Significant adjustments made in the financial statements arising out of audit findings.
5. Compliance with listing and other legal requirements relating to financial statements.
6. Disclosure of any related party transactions.
7. Qualifications in the draft audit report.

Question 9.
Write short notes on: Power of Audit Committee as stipulated under SEBI (Listing Obligations and Disclosure Requirements) Regulations.
Answer:
Power of Audit Committee:
As per SEBI (LODR) Regulations, 2015, the audit committee may exercise following powers, in addition to others:

1. To investigate any activity within its terms of reference.
2. To seek information from any employee.
3. To obtain outside legal or other professional advice.
4. To secure attendance of outsiders with relevant expertise.

Question 10.
Comment on the following in the light of certificate of compliance of conditions of Corporate Governance to be issued for a listed company where the Board consists of 10 directors including a non-executive director as its chairman and further:

1. There were 5 audit committee meetings held during the year as follows: 01/04/2020, 01/06/2020,01/09/2020, 03/01/2021, 25/03/2021.
2. There are 4 independent directors. One of them resigned on 25/05/2020. A new independent director was appointed on 01/09/2020.
3. The Chairman of Audit Committee did not attend the Annual General meeting held on 14/09/2020.
4. The internal audit reports were obtained by Audit Committee on quarterly basis. Quarter 1 internal audit report commented on certain serious irregularities as regards electronic online auction of scrap. The agenda of Audit Committee did not deliberate or take note of the issue. [Nov. 18-Old Syllabus (4 Marks), RTP-Nov. 19]

Answer:
Compliance of conditions as to Corporate Governance:
Regulation 18 of SEBI (LODR) Regulations, 2018, among other things provides the followings:
(a) The Audit Committee shall have minimum 3 directors as members. Two-thirds of the members of Audit Committee shall be independent directors.

(b) The Chairperson of the Audit Committee shall be an independent director. The Chairperson of the Audit Committee shall be present at AGM to answer shareholder queries.

(c) The Audit Committee should meet at least 4 times in a year and not more than 120 days shall elapse between two meetings.

(d) Audit Committee must mandatorily review certain aspects including therein is the Internal audit reports relating to internal control weaknesses.

Regulation 17(1) of the SEBI (LODR) Regulations, 2015 provides the following:
(a) The Board of Directors of the company shall have an optimum combination of executive and non-executive directors with at least one woman director and not less than 50% of the Board of Directors comprising non-executive directors.

(b) Where the Chairperson of the Board is a non-executive director, at least 1/3rd of the Board should comprise independent directors and in case the company does not have a regular non-executive Chairman, at least half of the Board should comprise independent directors.

Further Sec. 149(4) of the Companies Act, 2013 read with Rule 4 of Companies (Appointment and Qualifications of Directors) Rules, 2014 provides that any intermittent vacancy of an independent director shall be filled-up by the Board at the earliest but not later than immediate next Board meeting or 3 months from the date of such vacancy, whichever is later.

Accordingly, while issuing certificate of Corporate Governance, auditor is required to make the following modifications:

1. Gap between meetings held on 01.09.2020 and 03.01.2021 is more than 120 days; .
2. Casual vacancy in the office is independent director was filled up after the period prescribed u/s 149 (4) read with Rule 4 of Companies (Appointment and Qualifications of Directors) Rules, 2014;
3. Chairman was mandatorily required to attend AGM, which he did not;
4. Internal audit report was not reviewed by the Audit Committee.

Question 11.
Section 177 of the Companies Act, 2013 provides that every listed company and other class of companies as prescribed shall constitute a committee of the Board known as “audit Committee”. Briefly discuss the additional requirements as per Sec. 177 which are silent in Regulation 18 of SEBI (LODR) Regulations, 2015.
Answer:
Additional requirement of Sec. 177 which are silent in Regulation 18:
(a) Every Audit Committee shall act in accordance with terms of reference to be specified in writing by the Board.

(b) The Board’s report u/s 134(3) shall disclose the composition of an Audit Committee and where the Board had not accepted any recommendation of the Audit Committee, the same shall be disclosed in such report along with the reasons therefor.

(c) The auditors of a company and the key managerial personnel shall have a right to be heard in the meetings of the Audit Committee when it considers the auditor’s report but shall not have the right to vote.

Question 12.
Briefly explain the role of auditor in audit committee and certification of compliance of conditions of Corporate Governance.
Answer:
Role of Auditor in Audit Committee and certification of compliance of conditions of corporate governance:
Regulation 18 of SEBI (LODR) Regulations, 2015 requires a representative of the statutory auditor, when required, shall be invited to the meetings of the Audit Committee.

Sec. 177 of Companies Act, 2013 requires that auditors of a company and the key managerial personnel has a right to be heard in the meetings of the Audit Committee when it considers the auditor’s report but they shall not have the right to vote.

In relation to audit committee and certification of compliance of conditions of corporate governance, auditor is required:
(a) To ensure that he communicates frequently with the Audit Committee on key accounting or auditing issues that, in his judgment, give rise to a greater risk of material misstatement of the financial statements.

(b) To ensure that he addresses any questions or concerns voiced by the Audit Committee.

(c) To assist and advise the Audit Committee on improving corporate governance, oversight of financial reporting process, implementation of accounting policies and practices, compliance with accounting standards, strengthening of the internal control systems in regard to financial reporting and reporting processes.

(d) To assist the management and the Audit Committee to enable them to discharge their functions effectively and in certification of the requirements of corporate governance.

Note: Auditor role is not to drive corporate governance directly. It is the management’s responsibility to do so and in the process, auditor may play a significant role in assisting management to ensure better standards of corporate governance.

Matters covered by SEBI (LODR) Regulations, 2015

Question 13.
Elaborate under SEBI (LODR) Regulations, 2015, who is an independent director.
Answer:
Independent Director under SEBI (LODR) Regulations, 2015:
As per Regulation 16(1) ofSEBI (LODR) Regulations, 2015, independent director shall mean a non-executive director, other than a nominee director of the company:
a. who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;

b. who is or was not a promoter of the company or its holding, subsidiary or associate company; and not related to promoters or directors in the company, its holding, subsidiary or associate company or member of the promoter group of the listed entity;

c. apart from receiving director’s remuneration, has or had no material pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;

d. none of whose relatives has or had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to 2% or more of its gross turnover or total income or ? 50 Lacs or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;

e. who, neither himself nor any of his relatives
1. holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;

2. is or has been an employee or proprietor or a partner, in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed, of;

• a firm of auditors or CS in practice or cost auditors of the company or its holding, subsidiary or associate company; or
• any legal or a consulting firm that has or had any transaction with the company, its holding, subsidiary or associate company amounting to 10% or more of the gross turnover of such firm;

3. holds together with his relatives 2% or more of the total voting power of the company; or

4. is a Chief Executive or director, by whatever name called, of any non-profit organisation that . receives 25% or more of its receipts from the company, any of its promoters, directors or its holding, subsidiary or associate company or that holds 2% or more of the total voting power of the company;

5. is a material supplier, service provider or customer or a lessor or lessee of the company.

f. who is not less than 21 years of age.

g. who is not a non-independent director of another company on the board of which any non-independent director of the listed entity is an independent director.

Question 14.
P Limited is a listed Company in which no code of conduct is laid down for its board members and senior members. As an auditor of P Limited:
(a) Briefly explain the compliance requirements with respect to Code of Conduct as per Listing Order Disclosure Requirement (LODR) Regulations.
(b) What will be your role in compliance of above-mentioned Code of Conduct as per LODR Regulations?
Answer:
Requirements of Code of Conduct in SEBI (LODR) Regulations, 2015:
(a) Compliance Requirements w.r.t. Code of Conduct:

1. Regulation 17(5): The board of directors shall lay down a code of conduct for all members of board of directors and senior management of the listed entity. The code of conduct shall suitably incorporate the duties of independent directors as laid down in the Companies Act, 2013.
2. Regulation 26(3): All members of the Board and senior management shall affirm compliance with the code of conduct on an annual basis.
3. Regulation 46(2): Listed entity shall disseminate code of conduct on its website.
4. Part D of Schedule V: Annual Report of the company shall contain a declaration signed by the CEO stating that the members of board and senior management have affirmed compliance with the code of conduct.

(b) Role of auditor in compliance of code of conduct requirements:

1. As certain whether the Board has laid down a Code of Conduct for all Board members and senior personnel of the company.
2. Obtain a copy of the code of conduct.
3. Verify whether all Board members and senior management have affirmed compliance with the code on an annual basis.
4. Verify whether the code has been posted on company’s website.

Question 15.
Write short note on: CEO/CFO Certification to the Board.
Answer:
CEO/CFO Certification to the Board:
Regulation 17(8) of SEBI (LODR) Regulations, 2015 requires that the CEO and CFO shall provide the compliance certificate to the Board that:

(a) They have reviewed financial statements and the cash flow statement for the year and that to the best of their knowledge and belief:

• These statements do not contain any materially untrue statement or omit any material fact or contain statements that might be misleading.
• These statements together present a true and fair view of the company’s affairs and are in compliance with existing accounting standards, applicable laws and regulations,

(b) There are no transactions entered that are fraudulent, illegal and violative of the company’s code of conduct.
(c) They accept responsibility for establishing and maintaining internal controls w.r.t. financial reporting.
(d) They have indicated to the auditors and the audit committee:

• Significant changes in internal control during the year.
• Significant changes in accounting policies during the year.
• Instances of significant fraud.

Question 16.
Write short note on: Content of Management Discussion and Analysis. [Nov. 13 (4 Marks)]
Answer:
Management Discussion and Analysis:
Schedule V of SEBI (LODR) regulations, 2015 requires that a Management Discussion and Analysis should form part of the Annual Report to the shareholders. This Management Discussion & Analysis should include discussion on the following matters within the limits set by the company’s competitive position:

1. Industry structure and developments.
2. Opportunities and Threats.
3. Segment-wise or product-wise performance.
4. Outlook
5. Risks and concerns.
6. Internal control systems and their adequacy.
7. Discussion on financial performance with respect to operational performance.
8. Material developments in Human Resources/Industrial Relations front, including number of people employed.
9. Details of significant changes (i.e. change of 2 5% or more as compared to the immediately previous financial year) in key financial ratios, along with detailed explanations therefor, including:
   • Debtors Turnover
   • Inventory Turnover
   • Interest Coverage Ratio
   • Current Ratio
   • Debt Equity Ratio
   • Operating Profit Margin (%)
   • Net Profit Margin (%)
   • or sector-specific equivalent ratios, as applicable.
10. Details of any change in Return on Net Worth as compared to the immediately previous financial year along with a detailed explanation thereof.

Question 17.
The auditor of Mould Limited made an adverse statement in his certificate as the Audit Committee of the company did not meet four times a year. Discuss few circumstances which require an adverse or qualified statement in the auditor’s certificate in respect of compliance of the requirements of Corporate Governance. [Nov. 16 (4 Marks)]
Or
Discuss any eight (8) adverse or qualified statement or disclosure, which you would like to make in respect of non-compliance with requirements Corporate Governance of a company. [May 18 – Old Syllabus (4 Marks)]
Or
Some situations may require an adverse or qualified statement or a disclosure without necessarily making it a subject matter of qualification in»the Auditors’ Certificate, in respect of compliance of requirements of corporate governance. Give four examples of such situations. [MTP-Oct. 18]
Or
A listed entity has to obtain a compliance certificate from either the statutory auditors or practicing company secretaries regarding compliance of conditions of corporate governance and annex it to the Directors’ Report. Discuss some situations which may require an adverse or qualified statement in respect of the above certificate. [Nov. 19 – Old Syllabus [5 Marks)]
Answer:
Circumstances requiring adverse or qualified statement in Auditor’s certificate in respect of compliance of requirements of corporate governance:

1. The number of non-executive directors is less than 50% of the strength of Board of directors.
2. A qualified and independent audit committee is not set up.
3. The chairman of the audit committee is not an independent director.
4. The audit committee does not meet four times a year.
5. The necessary powers in terms of SEBI (LODR) Regulations, 2015 have not been vested by the Board in the audit committee.
6. The time gap between two Board meetings is more than four months.
7. A director is a member of more than ten committees across all companies in which he is a director.
8. The information of quarterly results is neither put on the company’s website nor sent in a form so as to enable the Stock Exchange on which the entity’s securities are listed to enable such Stock Exchange to put it on its own website.
9. The power of share transfer is not delegated to an officer or a committee or to the registrar and share transfer agents.

Question 18.
M/s All-in-one limited is a large – sized listed Indian company with focus on design and delivery of custom made information Technology applications for various business entities in India and abroad. The management wants to know whether they are required to constitute Risk Management committee as per SEBI (LODR) Regulations, 2015 and if so, required, what should be its composition? Advise. [May 18 – New Syllabus (4 Marks)]
Answer:
Requirement and Composition of Risk Management Committee:
As per Regulation 21 of SEBI (LODR) Regulations, 2015 requires the board of directors of companies to constitute a Risk Management Committee.

Composition of Risk Management Committee:
(a) The majority of members of Risk Management Committee shall consist of members of the board of directors.

(b) The majority of members of Risk Management Committee shall consist of members of the board of directors and in case of a listed entity having outstanding SR equity shares, at least 2/3rd of the Risk Management Committee shall comprise of independent directors.

(c) The Chairperson of the Risk management committee shall be a member of the board of directors and senior executives of the listed entity may be members of the committee. ………..

(d) The board of directors shall define the role and responsibility of the Risk Management Committee and may delegate monitoring and reviewing of the risk management plan to the committee and such other functions as it may deem fit.

(e) The risk management committee*shall meet atleast once in a year.

(f) The provisions of this regulation shall be applicable to top 100 listed entities, determined on the basis of market capitalisation, as at the end of the immediate previous financial year.

Question 19.
The Directors and senior management of a listed company of which you are the statutory auditor, want to know their obligations under the SEBI Regulations in regard to Board or Non-Executivc Directors, (mention any Five). [May 19 – Old Syllabus (5 Marks)]
Answer:
Obligations of Directors and Senior Management under SEBI (LODR) Regulations, 2015:
(1) Regulation 17(2): The Board shall meet at least 4 times a year, with a maximum time gap of 120 days between any two meetings.

(2) Regulation 17(3): The Board shall periodically review compliance reports pertaining to all laws applicable to the listed entity, prepared by the listed entity as well as steps taken by the listed entity to rectify instances of non-compliances.

(3) Regulation 17(3): The Board shall satisfy itself that plans are in place for orderly succession for appointment to the Board and senior management.

(4) Regulation 17A: A person shall not be a director in more than 8 listed entities with effect from April 1, 2019 and in not more than 7 listed entities with effect from April 1, 2020:
Provided that a person shall not serve as an independent director in more than 7 listed entities.

(5) Regulation 25: An independent director shall be held liable, only in respect of such acts of omission or commission by the listed entity which had occurred with his knowledge and with his consent or where he had not acted diligently with respect to the provisions contained in these regulations.

(6) Regulation 26(1): A director shall not be a member in more than 10 committees or act as chairperson of more than 5 committees across all listed entities in which he is a director.

(7) Regulation 26(2): Every director shall inform the listed entity about the committee positions he or she occupies in other listed entities and notify changes as and when they take place.

(8) Regulation 26(4): Non-executive directors shall disclose their shareholding in the listed entity in which they are proposed to be appointed as directors, in the notice to the general meeting called for appointment of such director.

(9) Regulation 26(5): Senior management shall make disclosures to the board relating to all material, financial and commercial transactions, where they have personal interest that may have a potential conflict with the interest of the listed entity at large.

Question 20.
You have been appointed as an auditor of M/s Real Ltd. in which total number of directors in the board is 9. As an auditor, state the points to be considered in verification of composition of Board under Regulation 17 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. [May 19 – New Syllabus (6 Marks)]
Answer:
Verification regarding composition of Board of Directors:
(i) Ascertain whether, the Board comprises an optimum combination of executive and non-executive directors, with at least one woman director and not less than 50% of members of Board,comprising non-executive directors.
The minutes ofthe Board meetings may be verified to ascertain whether a director is an executive director or a non-executive director.

(ii) Verify that no listed entity shall appoint a person or continue the directorship of any person as a non-executive director who has attained the age of 75 years unless a special resolution is passed to that effect, in which case the explanatory statement annexed to the notice for such motion shall indicate the justification for appointing such a person.

(iii) Verify that where the Chairperson of the Board is a non-executive director and at least 1/3rd of the Board comprise of independent directors.
In case the listed entity does not have a regular non-executive Chairperson, at least 1/2 of the Board should comprise of independent directors.

(iv) Verify that the board of directors of the top 1000 listed entities (with effect from April 1, 2019) and the top 2000 listed entities (with effect from April 1, 2020) shall comprise of not less than six directors.

(v) In case of listed company having outstanding SR equity shares, the auditor shall check that at least half of the board of directors comprises of independent directors.

(vi) Ensure that the Chairperson of the board of the top 500 listed entities is – (a) a non-executive director; (ft) not related to the Managing Director or the CEO as per the definition of the term “relative” defined under the Companies Act, 2013.

(vii) Auditor may also examine the annual disclosure submitted by the directors to the Board.

(viii) Auditor should also verify that independent non-executive director, apart from receiving remuneration, should not have any material pecuniary relationship with the listed entity, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year.

Question 21.
M/s FCA & Associates, Chartered Accountants is one of the leading auditing firms in Guwahati. The firm received an assignment to examine the compliance conditions [as stated in SEBI (LODR) Regulations] of corporate governance by ABC Ltd., a listed entity with no outstanding SR equity shares. The firm had made the following observations:

Observation No. 1: Mr. Fine, one of the Director of the Company, also the Chairman of the Stakeholder Relationship Committee, was acting
Observation No. 2: The Nomination & Remuneration Committee consisted of 6 members, which regularly met biannually.
Observation No. 3: The Risk Management Committee consisted of 9 directors, out of which, the number of independent directors is the majority, but it was less than two thirds of the total strength.
Which among the above three observations made by the auditor of ABC Ltd. should be reported by M/s.FCA& Associates? [RTP-Nov. 20]
Answer:
Reporting on Corporate Governance Requirements:
Observation No. 1:
As per Regulation 26 of SEBI (LODR) Regulations, a Director cannot be a Chairman in more than 5 committees across all listed entities. However, for the purpose of reckoning the limit under this Regulation, chairmanship of committees in a private company shall be excluded.

In this case, since Mr. Fine is the Chairman of audit committee in ABC Ltd. and Chairman in 4 other listed companies, there is no violation of the limit specified under the Regulation 26. Accordingly, this observation need not be reported by the auditor.

Observation No. 2:
As per Regulation 19, Part D of Schedule II of SEBI (LODR) Regulations, every listed company should have a Nomination & Remuneration Committee, which shall meet at least once in a year.

In the given case the committee met biannually (i.e. once in 2 years). Accordingly, this observation needs to be reported by the auditor.

Observation No. 3:
As per Regulation 21 of SEBI (LODR) Regulations, in case of a listed entity having outstanding SR equity shares, atleast two thirds of Risk Management Committee shall comprise of independent directors.

In the given case, ABC Ltd. does not have outstanding SR equity shares. Accordingly, this observation need not be reported by the auditor.

Conclusion: Only observation 2 will be reported.

Question 22.
Mr. S has been appointed as a director of CAC Ltd. You are required to state the information to be provided to the shareholders of the company in accordance with Regulation 36 of the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015.
Answer:
Information to be provided to Shareholders under Regulation 36 of SEBI (LODR) Regulations:
The listed entity shall send annual report to the holders of securities, not less than 21 days before the AGM.

In case of the appointment of a new director or re-appointment of a director the shareholders must be provided with the following information:

(a) a brief resume of the director;
(b) nature of his expertise in specific functional areas;
(c) disclosure of relationships between directors inter se;
(d) names of listed entities in which the person also holds the directorship and the membership of Committees of the board; and
(e) shareholding of non-executive directors.

Securitization – CA Final SFM Study Material is designed strictly as per the latest syllabus and exam pattern.

Securitization – CA Final SFM Study Material

Question 1.
Discuss briefly the steps involved in the Securitization mechanism. [May 2018] [4 Marks]
Answer:
The process of securitization typically involves the creation of pool of assets from the illiquid financial assets, such as receivables or loans which are marketable.

The following steps are taken in securitization mechanism:

Step 1	Creation of Pool of Assets	The process of securitization begins with creation of pool of assets by segregation of assets backed by similar type of mortgages in terms of interest rate, risk, maturity and con­centration units.
Step 2	Transfers to SPV	One assets have been pooled, they are transferred to Special Purpose Vehicle (SPV) especially created for this purpose.
Step 3	Sale of Secu­ritized Papers	SPV designs the instruments based on nature of interest, risk, tenure etc. based on pool of assets. These instruments can be Pass Through Security or Pay Through Certificates.
Step 4	Administra­tion of assets	The administration of assets in subcontracted back to origi­nator which collects principal and interest from underlying assets and transfer it to SPV, which works as a conduct.
Step 5	Recourse to Originator	Performance of securitized papers depends on the perfor­mance of underlying assets and unless specified in case of default they go back to originator from SPV.
Step 6	Repayment of funds	SPV will repay the funds in form of interest and principal that arises from the assets pooled.
Step 7	Credit Rating to Instru­ments	Sometime before the sale of securitized instruments credit rating can be done to assess the risk of the issuer.

Question 2.
Explain the benefits of Securitization from the perspective of both originator as well as the investor. [May 2018] [Nov. 2019] [4 Marks]
Answer:
The Originator is that entity which sells assets collectively to Special Purpose Vehicle and the “Investors” are the buyers of securitized papers which may be an individual or institutional investors such as mutual funds, provident funds, insurance companies, etc. The following are the benefits of securitization to these parties involved in securitization:
(A) From the angle of originator:
Originator (entity which sells assets collectively to Special Purpose Vehicle) achieves the following benefits from securitization.

• Off – Balance Sheet Financing: When loan/receivables are securitized it release a portion of capital tied up in these assets resulting in off Balance Sheet financing leading to improved liquidity position which helps expanding the business of the company.
• More specialization in main business: By transferring the assets the entity could concentrate more on core business as servicing of loan is transferred to SPV. Further, in case of non-recourse arrangement even the burden of default is shifted.
• Flelps to improve financial ratios: Especially in case of Financial Institutions and Banks, it helps to manage Capital-To-Weighted Asset Ratio effectively.
• Reduced borrowing Cost: Since securitized papers are rated due to credit enhancement even they can also be issued at reduced rate as of debts and hence the originator earns a spread, resulting in reduced cost of borrowings.

(B) From the angle of investor:
Following benefits accrues to the investors of securitized securities.

• Diversification of Risk: Purchase of securities backed by different types of assets provides the diversification of portfolio resulting in reduction of risk.
• Regulatory requirement: Acquisition of asset backed belonging to a particular industry say micro industry helps banks to meet regulatory requirement of investment of fund in industry specific.
• Protection against default: In case of recourse arrangement if there is any default by any third party then originator shall make good the least amount. Moreover, there can be insurance arrangement for compensation for any such default.

Question 3.
Explain the features of ‘Securitization’. [ICAI Mock Test Aug. 2018] [4 Marks]
Answer:
The securitization has the following features:

• Creation of Financial Instruments – The process of securities can be viewed as process of creation of additional financial product of securities in market backed by collaterals.
• Bundling and Unbundling – When all the assets are combined in one pool it is bundling and when these are broken into instruments of fixed denomination it is unbundling.
• Tool of Risk Management -In case of assets are securitized on non-recourse basis, then securitization process acts as risk management as the risk of default is shifted.
• Structured Finance – In the process of securitization, financial instruments are tailor structured to meet the risk return trade of profile of investor, and hence, these securitized instruments are considered as best examples of structured finance.
• Trenching – Portfolio of different receivable or loan or asset are split into several parts based on risk and return they carry called ‘Tranche’. Each Trench carries a different level of risk and return.
• Homogeneity – Under each trench the securities are issued of homogenous nature and even meant for small investors the who can afford to invest in small amounts.

Question 4.
Discuss briefly the primary participants in the process of Securitization. [Mock Test Aug. 2018] [4 Marks]
Answer:
The participants in the process of securitization are Primary Participants and Secondary Participants. The primary participants in the process of securitization are as follows:

• Originator: It is the initiator of deal or can be termed as securitizer. It is an entity which sells the assets lying in its books and receives the funds generated through the sale of such assets. The originator transfers both legal as well as beneficial interest to the Special Purpose Vehicle (SPV).
• Special Purpose Vehicle / Also, called SPV is created for the purpose of executing the deal. Since issuer originator transfers all rights in assets to SPV, it holds the legal title of these assets. It is created especially for the purpose of securitization only and normally could be in form of a company, a firm, a society or a trust. The main objective of creating SPV to remove the asset from the Balance Sheet of Originator. Since, SPV makes an upfront payment to the originator, it holds the key position in the overall process of securitization. Further, it also issues the securities (called Asset Based Securities or Mortgage Based Securities) to the inves-tors.
• The Investors: Investors are the buyers of securitized papers which may be an individual, an institutional investor such as mutual funds, provident funds, insurance companies, mutual funds, Financial Institutions etc. Since, they acquire a participating in the total pool of assets/receivable, they receive their money back in the form of interest and principal as per the terms agree.

Question 5.
Distinguish between Primary participants and secondary participants in securitization [RTP May 2018]
Answer:

Primary Participants	Secondary Participants
Primary Participants are main parties to this process. The primary participants in the process of securitization are as follows: (i)  Originator: It is the initiator of deal or can be termed as securitizer. It is an entity which sells the assets lying in its books and receives the funds generated through the sale of such assets.	Besides, the primary participants, other parties involved into the securitization process are as follows: (i) Obligors: Actually they are the main source of the whole securitization process. They are the parties who owe money to the firm and are assets in the Balance Sheet of Originator.
(ii) Special Purpose Vehicle: Also, called SPV is created for the purpose of executing the deal. Since issuer . originator transfers all rights in assets to SPV, it holds the legal title of these assets. It is created especially for the purpose of securitization only and normally could be in form of a company, a firm, a society or a trust.	(ii) Rating Agency: Since the securitization is based on the pools of assets rather than the originators, the as¬sets have to be assessed in terms of its credit quality and credit support available and that is where the credit rating agencies come.
(iii) The Investors: Investors are the buyers of securitized papers which may be an individual, an institutional investor such as mutual funds, provident funds, insurance companies, mutual funds, Financial Institutions etc.	(iii) Receiving and Paying Agent (RPA): Also, called Servicer or Administrator, it collects the payment due from obligor(s) and passes it to SPV. It also follow up with defaulting borrower and if required initiate appropriate legal action against them.
	(iv) Agent or Trustee: Trustees are ap-pointed to oversee that all parties to the deal perform in the true spirit of terms of agreement. Normally, it takes care of interest of investors who acquires the securities.
	(v) Credit Enhancer: Since investors in securitized instruments are directly exposed to performance of the underlying and sometime may have limited or no recourse to the originator, they seek additional comfort in the form of credit enhancement. In other words, they require credit rating of issued securities which also empowers marketability of the securities. Originator itself or a third party say a bank may provide an additional comfort called Credit Enhancer. While originator provides his comfort in the form of over collateralization or cash collateral, the third party provides it in form of letter of credit or surety bonds.
	(vi) Structurer: It brings together the originator, investors, credit enhancers and other parties to the deal of securitization. Normally, these are investment bankers also called arranger of the deal. It ensures that deal meets all legal, regulatory, ac-counting and tax laws requirements.

Question 6.
What are the main problems faced in securitization especially in Indian context? [Nov. 2019] [4 Marks]
Answer:
The main problems faced in growth of Securitization of instruments especially in Indian context are the following:
1. Stamp Duty : Stamp Duty is one of the obstacle in India. Under Transfer of Property Act, 1882, a mortgage debt stamp duty which even goes upto 12% in some States of India and this impeded the growth of securitization in India. It should be noted that since pass through certificate does not evidence any debt only able to receivable, they are exempted from stamp duty.
Moreover, in India, recognizing the special nature of securitized instruments in some States has reduced the stamp duty on them.

2. Taxation : Taxation is another area of concern in India. In the absence of any specific provision relating to securitized instruments in Income Tax Act experts’ opinion differ a lot. Some are of opinion that in SPV as a trustee is liable to be taxed in a representative capacity then other are of view that instead of SPV, investors will be taxed on their share of income. Clarity is also required on the issues of capital gain implications on passing payments to the investors.

3. Accounting: Accounting and reporting of securitized assets in the books of originator is another area of concern. Although securitization is slated to an off-balance sheet instrument but in true sense receivables are removed from originator’s balance sheet. Problem arises especially when assets are transferred without recourse.

4. Lack of standardization : Every originator follows own format for docu-mentation and administration have lack of standardization is another obstacle in growth of securitization.

5. Inadequate Debt Market: Lack of existence of a well-developed debt market in India is another obstacle that hinders the growth of secondary market of securitized or asset backed securities.

6. Ineffective Foreclosure laws:For last many years there are efforts are going on for effective foreclosure but still foreclosure laws are not supportive to lending institutions and this makes securitized instruments especially mortgaged backed securities less attractive as lenders face difficulty in transfer of property in event of default by the borrower.

Audit of Dividend – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Audit of Dividend – CA Final Audit Question Bank

Question 1.
Write short note on: Investor Education and protection Fund.
Answer:
Investor Education and Protection Fund
Sec. 125 of the Companies Act, 2013 empowers the Central Government to establish a fund known as Investor Education and Protection Fund. The purpose of this fund is to utilize the money for the promotion of investor awareness and protection to the interests of the investors.

The amount that are required to be credited in this fund are:
(a) Amount given by the C.G. by way of grants after due appropriation made by Parliament by law in this behalf;
(b) Donations given to the Fund by the C.G., State Governments, companies or any other institution;
(c) Amount in the Unpaid Dividend Account of companies;
(d) Amount in the general revenue account of the C.G. which had been transferred to that account u/s 205A(5] of the Companies Act, 1956, as it stood immediately before the commencement of the Companies (Amendment] Act, 1999, and remaining unpaid or unclaimed on the commencement of this Act;
(e) the amount lying in the Investor Education and Protection Fund u/s 205C of the Companies Act, 1956;
(f) the interest or other income received out of investments made from the Fund;
(g) the amount received under sub-section [4] of section 38;
(h) the application money received by companies for allotment of any securities and due for refund;
(i) matured deposits with companies other than banking companies;
(j) matured debentures with companies;
(k) interest accrued on the amounts referred to in clauses (h) to (i);
(l) sale proceeds of fractional shares arising out of issuance of bonus shares, merger and amalgamation for seven or more years;
(m) redemption amount of preference shares remaining unpaid or unclaimed for seven or more years; and
(n) such other amount as may be prescribed:
Provided that no such amount referred to in clauses (h) to (j) shall form part of the Fund unless such amount has remained unclaimed and unpaid for a period of seven years from the date it became due for payment.

Question 2.
While adopting the accounts for the year, the Board of Directors of Prima Ltd., decided to consider the Interim Dividend declared @ 12% as final dividend and did not consider transfer of profit to Reserves. As a statutory auditor, how would you deal with this? [Nov. 16 (4 Marks)]
Answer:
Declaration of Interim Dividend:
As per Sec. 2(35) of Companies Act, 2013 dividend includes interim dividend. Therefore, the procedures which are applicable to final dividend also applies to any interim dividend.

As per Sec. 123(3) of Companies Act, 2013 the Board of Directors of a company may declare interim dividend during any financial year or any time during the period from closure of financial year till holding of AGM
(a) out of the surplus in the profit and loss account or
(b) out of profits of the financial year in vvhich such interim dividend is sought to be declared or
(c) out of profits generated in the financial year till the quarter preceding the date of declaration of the interim dividend.

In case the company has incurred loss during the current financial year up to the end of the quarter immediately preceding the date of declaration of interim dividend, such interim dividend shall not be declared at a rate higher than the average dividends declared by the company during the immediately preceding three financial years.

As per Sec. 123(4) of Companies Act, 2013 amount of dividend including interim dividend shall be deposited in a separate bank account within five days from the date of declaration of such dividend.

The provisions contained in sections 123, 124,125,126 and 127 shall, as far as may be, also apply to any interim dividend.

First proviso to Section 123(1) provides that a company may, before the declaration of any dividend in any financial year, transfer such percentage of its profit for that financial year as it may consider appropriate to the reserves of the company. Therefore, company is not mandatorily required to transfer the profit to the reserves, it is an option available to the company to transfer a percentage of profit to reserves.

Conclusion: Assuming that the company has complied with the depreciation requirement, the interim dividend can be declared without transferring profits to reserves.

Question 3.
A company has paid interim dividend at 10% based on its half-yearly performance while at the end of the year suffered a net loss. How you will deal with the matter in your audit report as a statutory auditor?
Answer:
Payment of Interim Dividend:
As per Sec. 2(35) of Companies Act, 2013 dividend includes interim dividend. Therefore, the procedures which are applicable to final dividend also applies to any interim dividend.

Section 123(1) of the Companies Act, 2013 provides that dividend cannot be declared or paid by a company for any financial year except out of profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Section 123(2), or out of the profits or the company for any previous financial year or years arrived at after providing for depreciation in the manner aforementioned and remaining undistributed, or out of both.

In the present case, the company has suffered a net loss at the end of the year, which signifies that the directors have not calculated the performance of the company about the second half of the year accurately.

Hence, if the company had a sufficient balance in the P & L Account as at the beginning of the year, the interim dividend paid may be adjusted against the same. In this situation, auditor need not report anything.

However, if balance in P & L A/c was not available, the dividend may also be paid out of reserves, subject to compliance of conditions as prescribed in Companies (Declaration and Payment of Dividend) Rules, 2014. If, however, there is no balance in the profit and loss account nor any reserves were available, the dividend would be clearly paid out of capital.

Conclusion: Assuming that there is no balance in the profit & loss account nor any reserves were available. Auditor need to qualify his report mentioning the fact that the dividend having been paid out of capital.

Question 4.
For the year ended on 31st March, 2021, P Ltd. proposed to pay a dividend of 25% on its equity shares and it further proposed to transfer 20% of Net profit for that year after tax to its reserves. Its auditor objected to the same stating that 10% is the maximum permissible limit to transfer to reserves. [May 14 (4 Mark)]
Answer:
Transfer to Reserve:
Section 123(1) of the Companies Act, 2013 provides that dividend cannot be declared or paid by a company for any financial year except out of profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Section 123(2), or out of the profits or the company for any previous financial year or years arrived at after providing for depreciation in the manner aforementioned and remaining undistributed, or out of both.

First proviso to Section 123(1) provides that a company may, before the declaration of any dividend in any financial year, transfer such percentage of its profit for that financial year as it may consider appropriate to the reserves of the company. Therefore, company is not mandatorily required to transfer the profit to the reserves, it is an option available to the company to transfer a percentage of profit to reserves.

In the present case, P Ltd. has proposed to pay a dividend of 25% on its equity shares and a transfer of 20% of Net profit to its reserves.

Conclusion: Assuming that the company has complied with the depreciation requirement, the dividend can be declared by transferring any amount of profits to reserves.

Question 5.
As a statutory auditor, how would you deal with the following: ABC Ltd. having a paid-up capital of ₹ 1 crore earned as total net profit of ₹ 1 crore for the years 2017-18 to 2019-20. The Company did not declare any dividend nor transferred any amount to Reserves for these years. The entire profit was retained in the Profit & Loss Account.

In 2020-21, the company made a profit of ₹ 20 lacs. The company also proposed in 2020-21 to declare dividend @25% of capital out of accumulated profits.
Answer:
Declaration of Dividends:
Section 123(1) of the Companies Act, 2013 provides that dividend cannot be declared or paid by a company for any financial year except out of profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of Section 123(2), or out of the profits or the company for any previous financial year or years arrived at after providing for depreciation in the manner aforementioned and remaining undistributed, or out of both.

First proviso to Sectionl23(1) provides that a company may, before the declaration of any dividend in any financial year, transfer such percentage of its profit for that financial year as it may consider appropriate to the reserves of the company. Therefore, company is not mandate rily required to transfer the profit to the reserves, it is an option available to the company to transfer a percentage of profit to reserves.

In the present case company earns a profit of ₹ 20 Lacs, but wants to declare dividend @ 25%, of capital that amounts to ₹ 25 Lacs. The deficiency of ₹ 5 Lacs may be paid out of accumulated profits.

Conclusion: The company is well within its power and right to declare the dividend of ₹ 25 lacs for the year 2020-21.

Question 6.
As Auditor of Act Fast Ltd. what steps will you take to ensure that the dividend has been paid only out of profit? ‘ [Nov. 08 (8 Marks)]
Or
AARK Ltd is a large-sized listed company having annual turnover of INR 4000 crores. The company also has a plan to get listed on New York Stock Exchange next year. The company has paid good amount of dividend during the year to its shareholders which is significantly higher as compared to earlier years. The statutory auditors would like to focus on this aspect at the time of their statutory audit.
Please advise the relevant procedures that the statutory auditors should perform in respect of this area. [RTP-May 19]
Answer:
Steps for verification of dividend:
To ensure that dividend is paid out of profits, auditor should take the following steps:
(i) Ensure that all the rules and regulations concerning the declaration or payment of dividends have been complied with.

(ii) Ensure that the dividends have been declared or paid only out of distributable profit z.e. profits for the current year for which dividend is declared, or accumulated profits of the previous years, or money provided by the Central or State Government as per Sec. 123(1) of the Companies Act, 2013.

(iii) In case of inadequacy or absence of profits in any financial years, if dividend has been paid out of accumulated profits, earned by it in previous years and transferred to the reserves, verify that the rules related to such distribution has been complied.

(iv) Verify that the dividend recommended by the Board has been approved by the members at the AGM.

(v) Verify that the dividend has been transferred to the separate scheduled bank account within 5 days from the declaration of such dividend as required by Sec. 123(4) of the Companies Act, 2013.

(vi) Verily that the dividend has been paid within 3 0 days from the declaration. If in case the dividend has not been claimed or paid within 30 days from the declaration, verify that the unpaid or unclaimed dividend amount has been transferred to a special account called unpaid dividend account as per Sec. 124(1) of the Companies Act, 2013.

(vii) Verify that the company has prepared a statement within a period of 90 days of making any transfer of an amount to the Unpaid Dividend Account containing the specified particulars, and have placed it on the website of the company, if any, and also on any other website approved by the C.G. for this purpose as required under Sec. 124(2) of the Companies Act, 2013.

(viii) Verify that, if any money transferred to Unpaid Dividend Account has remained unpaid or unclaimed for a period of 7 years from the date of such transfer then, whether it has been transferred by the company along with interest accrued, if any, thereon to the Investor Education and Protection Fund established u/s 125(1) of the Companies Act, 2013 and a statement regarding such transfer has also been sent to the authority which administers such fund.

(ix) In case the company has outsourced the activity to the Service Organisation, check that all the compliances with laws, regulations, accounting and disclosure related to the dividends have been made appropriately.

Question 7.
The management of limited company states that proposed dividend does not represent a liability and hence no provision need to be made. Comment.
Or
As a statutory auditor of the company, comment on the following: For the year ended 31st March 2021, the financial statements of A (Pvt) Ltd. were adopted on 30th April, 2021. At this meeting, the directors proposed a dividend for the year 2020-21 of 25% on the equity share capital amounting to ₹ 10 Lacs. No entry was passed for the proposed dividend in the books of the company, since in the view of the directors the same was not required as per Schedule 111. [Nov. 12 (5 Marks)]
Answer:
Non-Provisions for proposed dividends;
Schedule III requires disclosure of the amount of dividend proposed to be distributed to equity and preference shareholders for the period and the related amount per share to be disclosed separately. It also requires separate disclosure of the arrears of fixed cumulative dividends on preference shares.

As per AS-4, “Contingencies and Events Occurring after the Balance Sheet Date” there are events which, although they take place after the balance sheet date, are sometimes reflected in the financial statements because of statutory requirements or because of their special nature. For example, if dividends are declared after the balance sheet date but before the financial statements are approved for issue, the dividends are not recognised as a liability at the balance sheet date because no obligation exists at that time unless a statute requires otherwise. Such dividends are disclosed in the notes.

In the present case, no entry was passed for proposed dividend.

Conclusion; Contention of the management not to provide dividend is correct.

Question 8.
The Board of Directors of ACP Ltd. has recommended the dividend of 15% on paid up share capital of ₹ 450 crores for the year ended 31st March, 2020, at their meeting held on 1st of May, 2020 when the accounts for the financial year 2019-20 were approved. The Board of Directors when they met on 7th July, 2020 for the review of first Quarter accounts, the Board has decided to rescind their decision to recommend dividend.
The notice for AGM to be held on 14.08.2020 was sent on 15th July, 2020 without any recommendation of dividend.
At the AGM the members asked the management how they can rescind the declaration of dividend once recommended. Comment. [May 16 (4 Marks), MTP-Aug. 18]
Answer:
Revocation of recommended Dividend:
As per Regulation 80 of Table F of schedule I of the Companies Act, 2013, the company in general meeting may declare dividends, but no dividend shall exceed the amount recommended by the Board.

Section 123 of the Companies Act, 2013, provides that the dividend shall be declared or paid by a company for any financial year out of the profits of the company for that year arrived at after providing for depreciation in prescribed manner.

As per Sec. 127 of Companies Act, 2013, dividend after declaration has to be paid or warrant in respect thereof has to be posted within 30 days from the date of declaration.

Dividend once declared, becomes a debt against the company and cannot be revoked except in certain situations.

In the present case, the decision for revocation of dividend arrived before its declaration in General meeting.

Conclusion: Board of directors are well within their powers to rescind the dividend which is recommended earlier, but not yet declared in the

“ICAI Examiner Comments”
Most of the candidates failed to explain the valid reason for rescinding the dividend.

Question 9.
ABC Limited is in the practice of maintaining consistent dividend payment over a minimum of 14%. The Financial year 2020-21 was so very bad for the company that it was not possible for the 1 company to maintain the payment of consistent dividend as above. The Management, being hopeful of recovery of its performance in next year, felt that the depreciation of the year to the extent of 75% alone be charged to the statement of profit and loss and the remaining 25% be kept in a ‘ separate account code in the balance sheet – ‘Debit Balances Adjustable against Revenue Account’, The Management was of the view that it would be in fair practice of accounting if the depreciation for asset is charged before the expiry of the lifes of assets and the amount parked in asset code as above would unfailingly be adjusted to Revenue before the close of next financial year anyway.

Analyse the issues involved and state how the Auditor should decide on this matter. [Nov. 18-New Syllabus (5 Marks), MTP-Oct 20]
Answer:
Declaration of Dividend without providing the depreciation:
Sec. 123(1) of Companies Act, 2013 provides that, no dividend shall be declared or paid by a company for any financial year except out of the profits of the company for that financial year arrived at after providing for depreciation in accordance with the provisions of Sec. 123(2).

Sec. 123(2) provides that depreciation shall be provided to in accordance with the provisions of Schedule II.

As per Schedule II to the Companies Act, 2013 deprecation is to be charged over useful lives of the assets. Useful life of an asset is the period over which an asset is expected to be available for use by an entity or the number of production or similar units expected to be obtained from the asset by the entity. The useful life of an asset shall not be longer that the useful life specified in the Part C of Schedule II. If, however where a company uses a different useful life justification for the difference shall be disclosed in the financial statement with justification supported by technical device.

In the present case, company in order to maintain consistency in payment of dividend is willing to charge 75% of the depreciation to the statement of profit and loss and the remaining 25% be kept in a separate account code in the balance sheet – ‘Debit Balances Adjustable against Revenue Account’.

Conclusion: Management view is not correct as depreciation can be paid only out of profits that is arrived at after providing the depreciation.

Auditor should ensure the compliance of provisions of section 123 and Schedule II. In case the management does not comply with the provisions and does not charge the 100% depreciation the auditor shall suggest the management for the same and if management refuses, the auditor should qualify his report accordingly. ‘

Security Analysis – CA Final SFM Study Material is designed strictly as per the latest syllabus and exam pattern.

Security Analysis – CA Final SFM Study Material

Part – 1 (Theory)

Question 1.
Mention the various techniques used in economic analysis. [May 2011] [4 Marks]
Answer:
While making investment decisions, two approaches can be used. The first is the fundamental Analysis and the second is the technical analysis. In fundamental analysis the intrinsic value of the equity stock is determined by making a forecast of earnings and dividends of stock and discounting them at an appropriate rate considering the risk. One of the key variables that an investor must monitor in order to carry out fundamental analysis is Economic analysis.

Techniques used in Economic analysis :
Some of the techniques used for economic analysis are:
(a) Anticipatory Surveys : They help investors to form an opinion about the future state of the economy. It incorporates expert opinion on construction activities, expenditure on plant and machinery, levels of inventory – all having a definite bearing on economic activities. The future spending habits of consumers are taken into account.

(b) Barometer/Indicator Approach : Various indicators are used to find out how the economy shall perform in the future. The indicators have been classified as under:

• Leading Indicators: They lead the economic activity in terms of their outcome. They relate to the time series data of the variables that reach high/low points in advance of economic activity.
• Roughly Coincidental Indicators: They reach their peaks and troughs at approximately the same time in economy.
• Lagging Indicators: They are time series data of variables that lag behind in their consequences vis-a-vis economy. They reach their turning points after the economy has reached its own already.

(c) Economic Model Building Approach: The steps used are as follows:

• Hypothesize total economic demand by measuring total income (GNP) based on political stability, rate of inflation, changes in eco- „ nomic levels.
• Forecasting the GNP by estimating levels of various components viz. consumption expenditure, gross private domestic investment, government purchases of goods/services, net exports, etc.
• After forecasting individual components of GNP, add them up, to obtain the forecasted GNP.
• Comparison is made of total GNP thus arrived at with that from an independent agency for the forecast of GNP and then the overall forecast is tested for consistency. This is carried out for ensuring that both the total forecast and the component wise forecast fit together in a reasonable manner.

Part – 2 (Numerical Problems)

Question 1.
The closing value of Sensex for the month of October, 2007 is given below:

You are required to test the weak form of efficient market hypothesis by applying the run test at 5% and 10% level of significance.
Following value can be used
Value of t at 5% is 2.101 at 18 degrees of freedom.
Value of t at 10% is 1.734 at 18 degrees of freedom.
Value of t at 5% is 2.086 at 20 degrees of freedom.
Value of t at 10% is 1.725 at 20 degrees of freedom. [Nov. 2008] [8 Marks]
Answer:

Total of sign of price changes (r) = 08
No. of Positive changes = n₁ = 11
No. of Negative changes = n₂ = 08

Since too few runs in the case would indicate that the movement of prices is not random. We employ a two-tailed test for the randomness of prices.
Test at 5% level of significance at t.05 using t – table at 18 degrees of freedom.
The lower limit.
= μ – txσ_r^∧
= 10.26 – 2.101 × 2.06 = 5.932

Upper limit
= μ + t × σ_r
= 10.26 + 2.101 × 2.06
= 14.588

At 10% level of significance at 18 degrees of freedom Lower limit
= 10.26 – 1.734 × 2.06
= 6.688

Upper limit
= 10.26 + 1.734 × 2.06
= 13.832 C
As seen, the value of r lies between these limits. Hence, the market exhibits weak form of efficiency.

Question 2.
Closing values of BSE Sensex from 6th to 17th day of the month of January of the year 200X were as follows:

Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 30 days simple moving average of Sensex can be assumed as 15,000. The value of exponent for 30 days EMA is 0.062. Give detailed analysis on the basis of your calculations. [May 2018] [Nov. 2009] [6 Marks]
Answer:

Conclusion: The market is bullish. The market is likely to remain bullish for short-term to medium term. On the basis of this indicator (EMA), the investors/ brokers can take long position.

Question 3.
Closing Values of BSE Sensex from 6th to 17th day of the month of January of the year 20xx were as follows :

Calculate Exponential Moving Average (EMA) of Sensex during the above period. The 30 days simple moving average of Sensex can be assumed as 35,000. The value of exponent for 30 days EMA is 0.064.

Provide analyzed conclusion on the basis of your calculations.
(Calculations should be up to three decimal points.) [Nov. 2019] [8 Marks] Ans.

Conclusion: The market is bullish. The market is likely to remain bullish for short-term to medium term. On the basis of this indicator (EMA), the investors/ brokers can take long position.

Question 4.
Given the data below: apply an auto-correlation test for finding whether the market is weakly efficient. Use time lag of 10 days: [Practice Question]

Trading days	Closing Sensex	Trading days	Closing Sensex
1	13450	11	13250
2	13440	12	13290
3	13430	13	13330
4	13380	14	13290
5	13370	15	13300
6	13340	16	13320
7	13330	17	13330
8	13335	18	13340
9	13310	19	13320
10	13270	20	13340

Answer:
Calculation of changes in index values (with time lag of 10 Days)

Calculation of coefficient of correlation:


As r does not tend to zero, the market is not weak.

Audit of Consolidated Financial Statements – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Audit of Consolidated Financial Statements – CA Final Audit Question Bank

Question 1.
ANC Ltd., having two subsidiaries but did not have any holding company, is a company whose securities are not listed on any stock exchange, whether in India or outside India. The CEO of the ANC Ltd. says that since it is an unlisted company therefore consolidation of financial statement is not applicable. Comment on the contention of the CEO.
Answer:
Preparation of Consolidated Financial Statement:
As per section 129(3) of the Companies Act, 2013, where a company has one or more subsidiaries or associate companies, it shall, in addition to its own financial statements prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with the applicable accounting standards.

However, by virtue of second proviso to Rule 6 of Company (Accounts) Rules, 2014, the requirement related to preparation of consolidated financial statements shall not apply to a company if it meets the following conditions:

(i) it is a wholly-owned subsidiary, or is a partially-owned subsidiary of another company and all its other members, including those not otherwise entitled to vote, having been intimated in writing and for which the proof of delivery of such intimation is available with the company, do not object to the company not presenting consolidated financial statements;

(ii) it is a company whose securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India; and

(iii) its ultimate or any intermediate holding company files consolidated financial statements with the Registrar which are in compliance with the applicable Accounting Standards.

In the given case, ANC Ltd. is a holding company of two subsidiaries and not a subsidiary company.

Conclusion: Contention of the CEO of the company is not tenable and the company needs to prepare consolidated financial statements.

Question 2.
Write short note on: Responsibility of holding company for preparation of Consolidated Financial Statements. [Nov. 12 (4 Marks)]
Answer:
Responsibility of holding company for preparation of Consolidated Financial Statements:
As per section 129(3) of the Companies Act, 2013, where a company has one or more subsidiaries or associate companies, it shall, in addition to its own financial statements prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with the applicable accounting standards.

The responsibility for the preparation and presentation of consolidated financial statements, among other things, is that of the management of the parent. This includes:

(a) identifying components, and including the financial information of the components to be included in the consolidated financial statements;
(b) where appropriate, identifying reportable segments for segmental reporting;
(c) identifying related parties and related party transactions for reporting;
(d) obtaining accurate and complete financial information from components;
(e) making appropriate consolidation adjustments;
(f) Harmonisation of accounting policies and accounting framework; and
(g) GAAP conversion, where applicable.

Apart from the above, the parent ordinarily issues instructions to the management of the component specifying the parent’s requirements relating to financial information of the components to be included in the consolidated financial statements.

The instructions ordinarily cover the accounting policies to be applied, statutory & other disclosure requirements applicable to the parent, including the identification of and reporting on reportable segments, and related parties & related party transactions, and a reporting timetable.

Question 3.
Deluxe Ltd. holds the ownership of 51% of voting power and control over Executive Ltd. Holding company have prepared the consolidated financial statement as required by Sec. 129 of the Companies Act, 2013. What will be your objective, as an Auditor, in the audit of such Consolidated Financial Statement? [May 18 – Old Syllabus (4 Marks)]
Or
Write a short note on: Auditor’s objectives in an audit of consolidated financial statements. [RTP-Nov. 19]
Answer:
Objectives of Auditor while auditing the Consolidating Financial Statements:
The auditor of the CFS is responsible for expressing an opinion on whether the CFS are prepared, in all material respects, in accordance with the FRF under which the parent prepares the CFS.

Therefore, the auditor’s objectives in an audit of CFS are:

(a) to satisfy himself that the consolidated financial statements have been prepared in accordance with the requirements of applicable financial reporting framework;
(b) to enable himself to express an opinion on the true and fair view presented by the consolidated financial statements;
(c) to enquire into the matters as specified in section 143(1) of the Companies Act, 2013;
(d) to report on the matters given in the clauses (a) to (i) of section 143(3) of the Companies Act, 2013; for other matters under section 143(3)(j) read with rule 11 of the Companies (Audit and Auditors) Rules, 2014; and
(e) The auditor should also validate the requirement of preparation of CFS for the company as per applicable FRF.

Question 4.
While doing the audit of consolidated financial statements, which current period consolidation adjustments are to be taken into account. [May 09 (8 Marks)]
Or
X Limited is the holding company of Y Limited and Z Limited. Explain the nature of current period consolidation adjustments which will be taken into account for the preparation of Consolidated Financial Statements. [May 14 (6 Marks)]
Or
You have been appointed to audit consolidated financial statements of Xerna Ltd. for the financial year 2020-21 while vouching, you observed that Intra Group Transactions have not been eliminated
You are, therefore, required to guide the management by explaining what are current period adjustments and list out the same.
Answer:
Current Period Consolidation Adjustment
These are those adjustments which are made in the accounting period for which Consolidated Financial Statements are prepared.

These adjustments primarily relate to elimination of intra-group transactions and account balances including:
(a) intra-group interest paid and received or management fees, etc;
(b) unrealised intra-group profits on assets acquired/transferred from/to other subsidiaries;
(c) intra-group indebtedness;
(d) adjustments relating to harmonising the different accounting policies being followed by the parent and its components;

(e) adjustments to the F.S. (of the parent and the components being consolidated) for recognized subsequent events or transactions that occur between the balance sheet date and the date of the auditor’s report on the consolidated F.S. of the group.

(f) adjustments for the effects of significant transactions or other events that occur between date of components balance sheet and not already recognised in its F.S. and the date of the auditor’s report on the group’s consolidated F.S. when the financial statements of the component to be used for consolidation are not drawn upto the same balance sheet date as that of the parent;

(g) In case of a foreign component, adjustments to convert a component’s audited F.S. prepared under the component’s local GAAP to the GAAP under which the consolidated F.S. are prepared.

(h) determination of movement in equity attributable to the minorities interest since the date of acquisition of the subsidiary.

(f) adjustments of deferred tax on account of temporary differences arising out of elimination of profit and losses resulting from intra-group transactions and undistributed profits of the component in case of consolidated F.S. prepared under Ind AS.

Question 5.
Write short note on: Permanent Consolidation adjustments. [May 13, Nov. 15 (4 Marks)]
Answer:
Permanent Consolidation Adjustments:
Permanent consolidation adjustments are those adjustments that are made only on the first occasion or subsequent occasions in which there is a change in the shareholding of a particular entity which is consolidated. These adjustments are:

1. Determination of Goodwill or Capital Reserve as per applicable AS.
2. Determination of the amount of equity attributable to minority.

Verification Points

• Auditor should verify that the adjustment of goodwill or capital reserve and minority interest have been made appropriately.
• The auditor should pay particular attention to the determination of pre-acquisition reserves of the components. Date(s) of investment in components assumes importance in this regard.
• Examine whether the pre-acquisition reserves have been allocated appropriately between the parent and the minority of the subsidiary.
• Verify the changes that might have taken place in permanent consolidation adjustments on account of subsequent acquisition of shares in the components, disposal of the components in the subsequent years.

“ICAI Examiner Comments”
Most of the examinees referred to irrelevant points on AS-21 and temporary adjustment.

Question 6.
H Limited, a company registered with SEBI, has three subsidiaries and one associate. While doing the audit of Consolidated Financial Statement (CFS) of H Limited you have come to know that the associate entity had made a provision dividend in its financial statement. H Limited computed its share of the results of operations of the associate after taking into account the proposed dividend. Comment. [Nov. 13 (4 Marks)]
Answer:
Adjustment of dividend provisions made by associate in consolidated financial statements:
Explanation (b) to Para 6 of AS 2i-“Accounting for Investments in Associates in Consolidated Financial Statements” requires that in case an associate has made a provision for proposed dividend in its financial statements, the investor’s share of the results of operations of the associate is computed without taking in to consideration the proposed dividend.

In the present case, the consolidated financial statements are prepared in violation of AS-23 to the extent that share of result of operations of associate is computed after taking into account the proposed dividend.

Conclusion: Auditor is required to state the matter and quality the report accordingly.

Question 7.
A Ltd. holds the ownership of 10% of voting power and control over the composition of Board of Directors of B Ltd. While planning the statutory audit of A Ltd., what factors would be considered by you for audit of financial statements? [May 15 (6 Marks)]
Answer:
Special considerations in case of entities controlling the composition of Board of Directors of others:
Ownership of voting power is not necessary to control the other enterprise. Control may be exercised by controlling the composition of the Board of Directors (in the case of a company) or corresponding governing body (in the case of any other enterprise) with a view to obtain economic benefits.

For example, an entity holds only 10 per cent of the share capital of another entity but it has control over the composition of the Board of Directors/governing body of the second entity. In such a case, the first entity would be considered as a parent of the second entity and, therefore, it would consolidate the second entity in the consolidated financial statements as subsidiary.

The auditor, therefore, apart from carrying out general procedures, should verify whether the parent controls the composition of the Board of Directors or corresponding governing body of any entity.

In this regard, the auditor may verify the Board’s minutes, shareholder agreements entered into by the parent, agreements with the entities to which the parent might have provided any technology or know-how, enforcement of statute, as the case may be, etc.

The auditor would have to use his professional judgment to determine whether the parent controls the composition of the Board of Directors of any other entity. If yes, whether that entity has been consolidated as a subsidiary in the consolidated financial statements.

“ICAI Examiner Comments”
Most of the candidates discussed SA 550 on Related Parties but did not mention about audit procedures. Many candidates could not identify holding subsidiary relationship thereby they did not refer to consolidation of Holding and Subsidiary company accounts. Candidates could not narrate the opinion to be made where related party transactions are not properly accounted and disclosed.

Question 8.
Parent Ltd. acquired 51% shares of Child Ltd. during the year ending 31.03.2020. During the financial year 2020-21 the 20% shares of Child Ltd. were sold by parent Ltd Parent Ltd. while preparing the financial statement for the year ending 31.03.2020 and 31.03.2021 did not consider the financial statements of Child Ltd. for consolidation. As statutory auditor how would you deal with it? [May 15 (6 Marks)]
Or
Moon Ltd. acquired 65% shares of Sun Ltd. on 28th October 2020. On 25th April 2021 they sold 25% shares of Sun Ltd. While preparing consolidated financial statements for the year ended 31st March, 2021, accountant of Moon Ltd. did not consider financial statements of Sun Ltd. for consolidation. Comment. [May 17 (5 Marks)]
Answer:
Auditor’s duties in case of exclusion of subsidiaries/associates in consolidation:
As per section 129(3) ofthe Companies Act, 2013, where a company has one or more subsidiaries or associate companies, itshall, in addition to its own financial statements prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with the applicable accounting standards.

As per Rule 6 of Companies (Accounts) Rules, 2014, the consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III to the Act and the applicable AS. However, a company which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial statements provided in Schedule III of the Act.

As per AS 21 “Consolidated Financial Statements” consolidation of a subsidiary is not required if the relationship of parent with the subsidiary is intended to be temporary or subsidiary operate under sever long term restrictions which significantly impair its ability to transfer funds to the parent.

Where an enterprise owns majority of voting power by virtue of ownership of the shares of another enterprise and all the shares are acquired & held exclusively with a view to their subsequent disposal in the near future, the control by the first mentioned enterprise would be considered temporary and the investments in such subsidiaries should be accounted for in accordance with AS 13 “Accounting for Investments”.

The auditor should satisfy himself that the exclusion made by the management falls within these two categories.

As per Ind AS 110, there is no such exemption for ‘temporary control’, or “for operation under severe long-term funds transfer restrictions” and consolidation is mandatory for Ind AS compliant financial statement in this case.

In the given case, Parent Ltd. has acquired 51% shares of Child Ltd. during the year ending 31.03.2020 and sold 20% shares during the year 2020-21. Parent Ltd. did not consolidate the financial statements of Child Ltd. for the year ending 31.03.2020 and 31.03.2021.

Conclusion: The intention of Parent Ltd. is quite clear that the control in Child Ltd. is temporary as the former company disposed off the acquired shares in the next year of its purchase.

Parent Ltd. is not required to prepare consolidated F.S. as per AS 21. However, for compliance of Sec. 129(3), Parent Ltd. is required to made disclosures in the F.S. as per the provisions provided in Schedule III to the Companies Act 2013.

If the Parent Ltd. is required to prepare its financial statements under Ind AS, it shall have to prepare Consolidated F.S. in accordance with Ind AS 110 as exemption for ‘temporary control’, or “for operation under severe long-term funds transfer restrictions” is not available under Ind AS 110.

“ICAI Examiner Comments”
Most of the candidates mentioned that as per Sec, 129(3) of the Companies Act, 2013 where a company having subsidiary, which is not required to prepare consolidated F.S. under the accounting standards, it shall be sufficient if the company complies with the provisions on consolidated F.S. provided in Schedule III to the Act. Only few candidates referred to AS 21 and AS 13.

Question 9.
H Ltd. owns 55% voting power in S Ltd. It however holds and discloses all the shares as “Stock-in-trade” in its accounts. The shares are held exclusively with a view to their subsequent disposal in the near future. H Ltd. represents that while preparing Consolidated Financial Statements, S Ltd. can be excluded from the consolidation. As a Statutory Auditor, how would you deal?
Answer:
Consolidation of Financial Statement:
As per section 129(3) of the Companies Act, 2013, where a company has one or more subsidiaries or associate companies, it shall, in addition to its own financial statements prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with the applicable accounting standards.

As per Rule 6 of Companies (Accounts) Rules, 2014, the consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III to the Act and the applicable AS. However, a company which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial statements provided in Schedule III of the Act.

There could be two reasons for exclusion of a subsidiary, associate or jointly controlled entity
(a) The relationship of parent with the subsidiary, associate or jointly controlled entity is intended to be temporary, or
(b) The subsidiary, associate or joint venture operates under several long-term restrictions which significantly impair its ability to transfer funds to the parent.
The auditor should satisfy himself that the exclusion made by the management falls within these two categories.

In the present case, H Ltd’s intention is to dispose off the shares in the near future as shares are being held as stock in trade and it is quite clear that the control is temporary.

Conclusion: H Ltd. is not required to consolidate as per requirement of AS 21, However, for the compliance of provisions related to consolidation of financial statements given under Section 129(3) of the Companies Act, 2013 read with Companies (Accounts) Rules, 2014, H Ltd. is required to consolidate the financial statements as per the provisions on consolidated financial statements provided in Schedule III to the Act.

Question 10.
B Ltd. is the Subsidiary company of A Ltd. ABC & Associates has been appointed as auditor of A Ltd. for the Financial year 2020-2021 and XYZ & Associates has been appointed as auditor of B Ltd. for the year 2020-21. Explain the role of ABC & Associates and XYZ & Associates as auditors of the parent company and subsidiary respectively. [Nov. 16 (4 Marks) MTP-Oct 20]
Answer:
Role of Auditor of Parent Company and Subsidiary company:
SA 600 “Using the work of Another Auditor” establishes the standard when an auditor, reporting on the financial statements of a group (consolidated financial statements), uses the work of another auditor on the financial information of one or more components included in the financial statements of the entity. Accordingly, role of auditor of parent company and subsidiary are as follows:

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

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

Question 11.
You are appointed as an auditor of Nawab Limited, a listed company which is a main supplier to the UK building and construction market. With a turnover of ₹ 2.9 billion, the company operates through 11 business units and has nearly 180 branches across the countries.
As an auditor, how will you draft the report in case:
(a) When the Parent’s Auditor is also the Auditor of all its Components?
(b) When the Parent’s Auditor is not the Auditor of all its Components?
(c) When the Component(s) Auditor Reports on Financial Statements under an Accounting Framework Different than that of the Parent?
(d) When the Component(s) Auditor Reports under an Auditing Framework Different than that of the Parent?
(e) Where the financial statements of one or more components are not audited? [MTP-April 18]
Or
You are appointed as an auditor of Najib Limited, a listed company which is a main supplier to the USA building and construction market. With a turnover of Rs. 1.9 billion, the company operates L through 11 business units and has nearly 170 branches across the countries.
As an auditor, how will you draft the report in case:
(i) When the Component(s) Auditor Reports on Financial Statements under an Accounting Framework different than that of the Parent?
(ii When the Component(s) Auditor Reports under an Auditing Framework different than that of the Parent? [RTP – Nov. 18]
Or
You are appointed as an auditor of Azad Limited, a listed company which is a main supplier to the USA building and construction market. With a turnover of? 1.6 billion, the company operates through 9 business units and has nearly 135 branches across the countries. As an auditor, how will you draft the report in case (i) When the Parent’s Auditor is also the Auditor of all its Components? and (ii) When the Parent’s Auditor is not the Auditor of all its Components? [MTP-May 20]
Answer:
Reporting Considerations
(a) Parent Auditor is also the auditor of all of its components
Auditor should issue an audit report expressing opinion whether the consolidated financial statements give a true and fair view of the state of affairs of the Group as on balance sheet date and as to whether consolidated profit and loss statement gives true and fair view of the results of consolidated profit or losses of the Group for the period under audit.

Where the consolidated financial statements also include a cash flow statement, the auditor should also give his opinion on the true and fair view of the cash flows presented by the consolidated cash flow statements.

Auditor of Parent should report whether principles and procedures for preparation and presentation of consolidated F.S. as laid down in the relevant AS [s] have been followed. In case of any deviation, the auditor should make adequate disclosure in the audit report so that users of the consolidated F.S. are aware of such deviation.

(b) Parent’s Auditor is not the Auditor of all of its components
If the parent’s auditor is not the auditor of the components included in the consolidated F.S., the auditor of the consolidated F.S. should also consider the requirement of SA 600.

If the parent’s auditor decides that he will make reference to the audit of the other auditors in the report as required by SA 706, he should disclose clearly the portion of the F.S. audited by the other auditor (s]. This may be done by stating the amount or %age of total assets and total revenue of subsidiary(s] included in consolidated F.S. not audited by him.

It is to be noted that reference in the report of the auditor of consolidated F.S. to the fact that part of the audit of the group was made by other auditor is not to be construed as a qualification of the opinion but rather as an indication of the divided responsibility between the auditors of the parent and its subsidiaries.

(c) Component Auditor Reports on F.S. under an Accounting Framework different than that of the Parent
When a component’s F.S. are prepared under an accounting framework that is different than that of the framework used by the parent in preparing group’s consolidated F.S., the parent’s management perform a conversion of the components’ audited F.S. from the framework used by the component to the framework under which the consolidated F.S. are prepared.

The conversion adjustments are audited by the principal auditor to ensure that the financial information of the components] is suitable and appropriate for the purposes of consolidation.

Alternatively, component may prepare financial statements on the basis of the parent’s accounting policies, as outlined in the group accounting manual. The local component auditor can then audit and issue an audit report on the components F.S. prepared in accordance with “group accounting policies”.

The Principal auditor can then decide whether or not to rely on the components’ audit report and make reference to it in the auditor’s report on the consolidated financial statements.

(d) Component Auditor Reports under an Auditing Framework Different than that of the Parent
Audits of F.S., including consolidated F.S., are performed under auditing standards generally accepted in India.

In order to maintain consistency of the auditing framework and to enable the parent auditor to rely and refer to the other auditor’s audit report in their audit report on the consolidated F.S., the components’ F.S. should also be audited under a framework that corresponds to Indian Auditing Standards.

(e) Components Not Audited
F.S. of all components included in consolidated F.S. should be audited or subjected to audit procedures. Such audits and audit procedures can be performed by the auditor reporting on the consolidated F.S. or by the components’ auditor.

Where the F.S. of one or more components continues to remain unaudited, the auditor reporting on the consolidated RS. should consider unaudited components in evaluating a possible modification to his report on the consolidated F.S.

The evaluation is necessary because the auditor has not been able to obtain sufficient appropriate audit evidence in relation to such consolidated amounts/balances.

Auditor should evaluate both qualitative and quantitative factors on the possible effect of such amounts remaining unaudited when reporting on the consolidated F.S. using the guidance provided in SA 70S, “Modifications to the Opinion in the Independent Auditor’s Report”.

Question 12.
C Ltd. is holding 55% shares of D Ltd. M/s. AB & Associates are statutory auditors of C Ltd. Whereas for D Ltd. there is another firm appointed as statutory auditors. What are the reporting responsibilities of M/s. AB & Associates for audit of consolidated financial statements?[May 17 (5 Marks)]
Answer:
Reporting Responsibilities of auditor of Holding Company if auditor of subsidiary company is different:
If the parent’s auditor is not the auditor of the components included in the consolidated F.S., the auditor of the consolidated F.S. should also consider the requirement of SA 600.

If the parent‘s auditor decides that he will make reference to the audit of the other auditors in the report, he should disclose clearly the portion of the F.S. audited by the other auditor(s). This may be done by stating the amount or %age of total assets and total revenue of subsidiary(s) included in consolidated F.S. not audited by him.

It is to be noted that reference in the report of the auditor of consolidated F.S. to the fact that part of the audit of the group was made by other auditor (s) is not to be construed as a qualification of the opinion but rather as an indication of the divided responsibility between the auditors of the parent and its subsidiaries.

Requirements of SA 600:
When the principal auditor concludes, based on his procedures, that the work of the other auditor cannot be used and the principal auditor has not been able to perform sufficient additional procedures regarding the financial information of the component audited by the other auditor, the principal auditor should express a qualified opinion or disclaimer of opinion because there is a limitation on the scope of audit.

When the principal auditor has to base his opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity, e.g., the number of divisions/branches/ subsidiaries or other components audited by other auditors.

Question 13.
H Co. Ltd., is a holding company with two subsidiaries R Co. Ltd. and S Co. Ltd., The H Co. Ltd., adopts straight line method of depreciation for its assets whereas S Co. Ltd., follows written down value or diminishing value method. Though R Co. Ltd., follows straight line method of depreciation, it does not give effect to component accounting of depreciation in respect of high value assets, while consolidating the financials of the R Co. Ltd., and S Co. Ltd., with those of H Co. Ltd., determine the possible issue that you have to ensure for compliance in the light of above facts. [May 18 – New Syllabus (5 Marks)]
Answer:
Consolidated Financial Statements:
In preparing consolidated financial-statements, the financial statements of the parent and its subsidiaries are combined on a line by line basis by adding together like items of assets, liabilities, income and expenses.

Consolidated financial statements are prepared using uniform accounting policies for like transactions. If a member of the group uses different accounting policies, appropriate adjustments are made to its financial statements when they are used in preparing the consolidated financial statements.

If it is not practicable to use uniform accounting policies in preparing the consolidated financial statements, that fact should be disclosed together with the proportions of the items in the consolidated financial statements to which the different accounting policies have been applied.

As per paras 60 and 61 of Ind AS 16, ‘Property, Plant and Equipment’, a change in the method of depreciation shall be accounted for as a change in an accounting estimate as per Ind AS 8, ‘Accounting Policies, Changes in Accounting Estimates and Errors’. Therefore, the selection of the method of depreciation is an accounting estimate and not an accounting policy.

Therefore, there can be different methods of estimating depreciation for property, plant and equipment, if their expected pattern of consumption is different. The method once selected in the individual financial statements of the subsidiary should not be changed while preparing the consolidated financial statements.

Accordingly, in the given case, the property, plant and equipment of S Co. Ltd. (subsidiary company) may be depreciated using WDV method and property, plant and equipment of parent company may be depreciated using SLM, if such method closely reflects the expected pattern of consumption of future economic benefits embodied in the respective assets.

However, under the provisions of Companies Act, 2013 and as per requirement of AS 10, component accounting of depreciation is mandatory. Auditor should insist the parent company to ask R Co. Ltd. (subsidiary company) to give effect to component accounting of depreciation before consolidation of financial statements.

Question 14.
H Limited is an investment company preparing its Financial Statements in accordance with Ind AS. The company obtains funds from various investors and commits its performance for fair return and capital appreciation to its investors. During the year under audit, it had been observed that the company had invested 25% in SI Ltd., 50% in S2 Ltd. and 60% in S3 Ltd. of the respective share capitals of the Investee Companies. When checking the investment schedule of the company, an issue cropped as to whether there would arise any need to consolidate accounts of any such investee companies with those of H Limited in accordance with Section 129(3) of the companies Act, 2013 which contains no exclusion from consolidation. Analyse the issues involved and give your views. [Nov. 18-New Syllabus (5 Marks)]
Answer:
Auditor’s duties in case of exclusion of subsidiaries/associates in consolidation:
As per section 129(3) of the Companies Act, 2013, where a company has one or more subsidiaries or associate companies, it shall, in addition to its own financial statements prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with the applicable accounting standards.

As per Rule 6 of Companies (Accounts) Rules, 2014, the consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III to the Act and the applicable AS. However, a company which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial statements provided in Schedule III of the Act.

As per Para 31 of Ind-AS 110, an investment entity shall not consolidate its subsidiaries. Instead, an investment entity shall measure an investment in a subsidiary at fair value through profit or loss in accordance with Ind AS 109 (Financial Instruments). As per Para 33, parent of an investment entity shall consolidate all entities that it controls, including those controlled through an investment entity subsidiary, unless the parent itself is an investment entity.

In the given case H Limited is an investment company preparing its Financial Statements in accordance with Ind AS. Company had invested 25% in SI Ltd., 50% in S2 Ltd. and 60% in S3 Ltd. of the respective share capitals of the Investee Companies.

Conclusion: H Ltd. is not required to consolidate accounts of investee companies as provided under Para 31 of Ind-AS 110. However, company is required to comply with the provisions on consolidated financial statements as provided in Schedule III.

Question 15.
What is meant by “Group financial statements”? Give reference of relevant Auditing Standard and issues addressed concerning the audit of Group financial statements. . [Nov. 18 – Old Syllabus (4 Marks)]
Answer:
Meaning of Group Financial Statements:

• Group Financial Statements also known as Consolidated financial statements are the financial statements of a group presented as those of a single entity.
• Group financial statements are presented for a Group of entities under the control of a Parent.
• A group comprises a parent and its subsidiaries. A parent is an entity that has one or more subsidiaries. Group financial statements are presented, to the extent possible, in the same format as adopted by the parent for its separate Financial Statements.
• AS-21 and Ind AS-110 lays down principles and procedures for preparation and presentation of Consolidated Financial Statements.

Question 16.
R Ltd. owns 51% voting power in S Ltd. It however, holds and discloses all the shares as “Stock-intrade” in its financial statements since the shares are held exclusively with a view to their subsequent disposal in the near future. R Ltd. represents that while preparing Consolidated Financial Statements, S Ltd. can be excluded from the consolidation. As the Statutory Auditor of R Ltd., how would you deal when the consolidated financial statements are to be drawn up in compliance with Ind AS.
[May 19 – Old Syllabus (4 Marks)]
Or
M Ltd. acquired 51% shares of S Ltd. on 01.04.2020 and sold 25% of these shares during the financial year 2020-21. M Ltd. did not prepare Consolidated Financial Statements for the financial year 2020-21 on the plea that the control was only temporary. Do you agree with the view of M Ltd.? Decide, assuming that M Ltd. is required to prepare its financial statements under Ind As. [Nov. 19 – Old Syllabus (4 Marks)]
Answer:
Consolidation of financial statements:
As per section 129(3) of the Companies Act, 2013, where a company has one or more subsidiaries or associate companies, it shall, in addition to its own financial statements prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with the applicable accounting standards.

As per Rule 6 of Companies (Accounts) Rules, 2014, the consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III to the Act and the applicable AS. However, a company which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial statements provided in Schedule III of the Act.

As per AS 21 “Consolidated Financial Statements” consolidation of a subsidiary is not required if the relationship of parent with the subsidiary is intended to be temporary or subsidiary operate under sever long term restrictions which significantly impair its ability to transfer funds to the parent.

There is no exemption for ‘temporary control’, or “for operation under severe long-term funds transfer restrictions” in Ind AS 110 and consolidation is mandatory for Ind AS compliant financial statement in this case.

Conclusion: Auditor should ask the management for the consolidation of S Ltd. If Consolidation not made, auditor should modify the audit report on Consolidated Financial Statements.

Question 17.
ALM Associates has been appointed as auditor of M/s Harry Ltd. which acquired 55% shares in M/s Sam Ltd. on 15th October, 2020. During audit of Harry Ltd. the auditors found that the company have not prepared consolidated financial statements because on the date of acquisition the fair value of certain assets & liabilities has not been ascertained which is significant and are accounted for on estimated basis only. Help ALM Associates in framing opinion paragraph of audit report. [May 19 – New Syllabus (4 Marks)]
Answer:
Consolidation of financial statements:
As per section 129(3) ofthe Companies Act, 2013, where a company has one or more subsidiaries or associate companies, it shall, in addition to its own financial statements prepare a consolidated financial statement of the company and of all the subsidiaries and associate companies in the same form and manner as that of its own and in accordance with the applicable accounting standards.

As per Rule 6 of Companies (Accounts] Rules, 2014, the consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III to the Act and the applicable AS. However, a company which is not required to prepare consolidated financial statements under the Accounting Standards, it shall be sufficient if the company complies with provisions on consolidated financial statements provided in Schedule III of the Act.

In the present case, during audit, auditors found that the company have not prepared consolidated financial statements because on the date of acquisition the fair value of certain assets and liabilities has not been ascertained which is significant and are accounted for on estimated basis only.

Conclusion: Consolidation is mandatory, auditor is required to state the fact in auditor report on standalone financial statements.

Note: Answer given in the Suggested answer oflCAI is entirely different covering therein the draft of Adverse opinion and Basis for Adverse opinion.

Author’s view: It is not necessary that auditor of standalone financial statements should be appointed as auditor of consolidated financial statements, so while auditing standalone financial statements, auditor is not required to modify the opinion on standalone financial statements on the ground of non-consolidation.

Further, when consolidated F.S. are not available, how the auditor is issuing report on consolidated financial statements (It is specified in the suggested answer – Opinion Section – the accompanying consolidated financial statements do not give a true and fair view)

Risk Management – CA Final SFM Study Material is designed strictly as per the latest syllabus and exam pattern.

Risk Management – CA Final SFM Study Material

Part 1 (Theory)

Question 1.
Discuss how the risk associated with securities is affected by Government policy. [May 2011] [4 Marks]
Answer:
The Government policy may change from time to time and thus influence various industries and their securities in a number of ways, thereby affecting the risks and returns associated with them. The risk from government policies may come due to following changes, having impact on securities:

• If there is change in Foreign Trade Policy (FTP), it will impact the Indian industries and securities issued by them.
• Restrictions on shareholding in different industry sectors.
• Licensing policy
• Changes in FDI and FII rules
• Restrictions on commodity and stock trading in exchanges.
• Changes in various corporate and other laws having direct and indirect impact on securities.

Question 2.
What are the Various types of risk faced by an organisation? [Practice Question]
Answer:
The various types of risk faced by an organization are :
1. Strategic Risk:-
A comprehensive, detailed and well thought out business plan is a pre-requisite for any successful business. These plans should be constantly updated. These strategic management decisions are pervasive in the whole organization and do not affect an isolated part. These plans and decisions are taken for the better future and success of organization. However, future being uncertain, the best laid out plans may even fail. This is known as strategic risk.

Strategic risk can be defined as the uncertainties and untapped opportunities embedded in strategic intent and how well the strategies are executed. If the organization responds well to the uncertainties and opportunities, the strategic risk is well managed. If strategic risk is to be managed, there should be a clear corporate strategy and complete understanding of risks associated with adopting and executing it.

2. Compliance Risk:
Every business needs to comply with rules and regulations. Many rules and regulations are imposed on organizations by the government and other regulatory authorities to ensure that organizations work ethically and fairly. They work for a better society, whether by sharing profits, or conserving the environment. These objectives can be achieved through rules and regulations.

• If the laws are not complied, there are heavy penalties. This could be in the form of payment for damages, fines, imprisonment and cancellation of contracts.
• An organization may face material loss if it does not adhere to the laws and regulations. This is called as compliance risk.
• In case some new product is launched or new territorial areas are explored, the compliance risks may increase as one is venturing into unknown and unforeseen territory.
• Further, with debacles and frauds in the organizations, the compliance laws increase in number as well as severity in consequences due to non-compliance. Compliance risk may cause severe damage to the reputation of an organization.

3. Operational Risk:
It is also called as internal risk. It is defined as a risk incurred by an or-ganizations internal activities.
The Basel II regulations defines operational risk as the risk of loss resulting from inadequate or failed internal process, people and systems, or from external events. It is the risk an organization undertakes when it attempts to operate within a given field or industry. This risk is not inherent in financial, systematic or market-wide risk. It is the risk remaining after determining financing and systematic risk, and includes risk resulting from break downs in internal procedures, people and systems. It includes internal frauds or external threats like theft, natural disasters etc. or poor management decisions.

4. Financial Risk:
The financial risk is the variability in earnings or cash flows and market values, caused by unpredictable changes in commodity prices, security prices, interest rates and exchange rates or it could be due to non fulfilment of obligations by counter parts in financial transactions. Though, political risk is not a financial risk in direct sense but same can be included, as any unexpected political change in any foreign country may lead to country risk which may ultimately result in financial loss.

The financial risk may be further divided into:
(a) Counterparty risk:- When the opposite party in a financial transac¬tions fails to honour their obligations, it is termed as counterparty risk. It is majorly default risk.

(b) Political Risk:- It is faced by those who have overseas financial transactions. If the government of another country makes some policy changes, it may cause huge loss. These policy changes could be

• Confiscation or destruction of properties
• Restrictions on borrowings
• Price control of products
• Invalidation of patents etc.

(c) Interest rate risk:-
This risk occurs due to change in interest rate resulting in change in assets and liabilities. This risk has more significance for banking companies and entities dealing in financial instruments.

(d) Currency Risk:
Also, known as exchange rate risk, it effects organizations dealing with foreign exchange. For example if an organization in India has debtors to the extent of $1,00,000 in its Balance sheet, the organiza¬tion will lose, if depreciates against Indian currency.

Question 3.
Discuss the evaluation of Financial risk from the perspective of
(a) Stakeholders
(b) Company
(c) Government [May 2019] [4 Marks]
Answer:
The financial risk can be evaluated from different point of views as follows:
(a) From stakeholder’s point of view:- The main stakeholder is any business is the equity shareholders or owners. For them, the financial risk can be evaluated by calculating the debt ratios or the total debt in its capital structure. Higher debt indicates more risk, as equity will always be paid after the payments are made to the lenders, while paying interest or at the time of repayment of loan.
A creditor or lender may evaluate his risk by finding the debt service coverage ratio and its debt ratio.

(b) From Company’s point of view:- A company may face financial risk if the company lends, or borrows excessively, especially, where there are chances of default in respect of payment of interest or principal.

(c) From Government’s point of view:- When a government is unable to honour its bonds or bills (i.e. sovereign debt crisis) or the leading financial institutions in the country (non-sovereign debt) defaulting in repayment, it leads to spread of distrust among the society.

Question 4.
What is Value at Risk (VAR) ? What are its features and applications [May 2019] (Modified) [4 Marks]
Answer:
Value at Risk is a measure of risk of investment. Barry Schachter de-scribes value at Risk as “an estimate of the level of loss, which is expected to be equaled or exceeded with a given small probability.” It is a statistical measure calculated over a specific investment horizon and measures the expected loss arising due to normal market movements in variables which are responsible for risk.

VAR answers two basic questions:

• What is worst case Scenario?
• What will be the loss?

It was first applied in 1922 in New York Stock Exchange, entered the financial world in 1990’s and became world’s most widely used measure of financial risk.

Features of VAR:
The following are the features of VAR

• The calculation of VAR is based on three components:
  (a) Standard deviation, or % loss or loss in amount
  (b) Time period
  (c) Confidence level which is generally taken as 95% or 99%.
• It is a statistical tool based on standard deviation.
• It is possible to apply VAR for different time horizons from 1 day and upwards.
• It is assumed that the values are normally distributed and this helps in calculating the maximum loss.
• It helps in controlling risk by setting limits for maximum loss.
• Z score is calculated while calculating VAR i.e. it indicates how much standard deviation is the value away from mean value. When Z score is multiplied by standard deviation, it gives VAR.
• It is different from other measures of risk as it distinguishes between downside movements and upside movements and focuses only on down side movement.

Applications of VAR
The concept of VAR is used to quantify the risk arising out of individual assets and liabilities. This can help in laying down the policy of managing risk. Thus, VAR can be applied :
(a) to measure maximum possible loss on a portfolio for a period and for a trading position.
(h) to enable the management to decide and formulate strategies.
(c) to fix limits for individuals dealing in front office of a treasury department.
(d) as a tool for Assets and liabilities management, especially in banks.
(e) as a benchmark for performance measurement of any operation or trading.

Part – 2 (Numerical Problems)

Question 1.
Neel holds Rs. 1 crore shares of XY Ltd. whose market price standard deviation is 2% per day. Assuming 252 trading days in a year, determine maximum loss level over the period of 1 trading day and 10 trading days with 99% confidence level. Assuming share prices are normally distributed and for level 99%, the equivalent Z score from Normal table of Cumulative area shall be 2.33. [May 2018][4 Marks]
Answer:
Value of the Shares = Rs. 1,00,00,000
Standard deviation per day = 2% of Rs. 1,00,00,000 = Rs. 2 lakhs
(i) Therefore, Standard deviation in 1 day = 2 × √1 = Rs. 2 lakhs.
At 99% confidence level the value of one tailed (as cumulative area is given) Z table is 2.33.
So, the value at risk = 2.33 × 2 = Rs. 4.66 lakhs.

(ii) Standard deviation in 10 days = 2 × √10
= Rs. 2 lakhs × 3.162 = 6.324 lakhs
So, the value at risk = 2.33 × 6.324 = Rs. 14.735 lakhs.

Question 2.
Following is the information about Mr. J’s portfolio :

Investment in shares of ABC Ltd.	Rs. 200 lakhs
Investment in shares of XYZ Ltd.	Rs. 200 lakhs
Daily standard deviation of both shares	1%
Co-efficient of correlation between both shares	0.3

Required:
Determine the 10 days 99% Value at Risk (VAR) for Mr. J’s portfolio. Given: The Z score from the Normal Table at 99% confidence level is 2.33. (Show your calculations up to four decimal points) [Nov. 2019] [8 Marks]
Answer:
The standard deviation ol both the shares is tv and the investment in both the shares is Rs. 2,00,00,000. Therefore, the daily change in the value of investment of each share will be 1% of Rs. 2,00,00,000 i.e. Rs. 2,00,000. The correlation coefficient between the two securities is 0.3. The daily change in the value of the portfolio will be: Portfolio Variance (σ_xA²)
σ = W_xσ_x² + W_Aσ_A² + 2W_xW_Aσ_xσ_Ar
= (0.50)² (1) + (0.50)² (1) + 2(0.50) (0.50) (1)(1) (0.3)
= 0.65%
σ_xy = \(\sqrt{0.65}\) = 0.80623%
Value of the portfolio = Rs. 4,00,00,000
Standard deviation per day = 0.80623% of Rs. 4,00,00,000 = Rs. 3.22490 lakhs
Therefore, Standard deviation in 10 days = 3.22490 × \(\sqrt{10}\) = Rs. 10.198 lakhs.
At 99% confidence level the value of one tailed Z table is 2.33.
So, the Value at Risk = 2.33 × 10.198 =Rs. 23.76 lakhs.

CARO, 2020 – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

CARO, 2020 – CA Final Audit Question Bank

Applicability of CARO, 2020

Question 1.
ABC Pvt. Ltd. is a holding company of XYZ Ltd. Whether CARO is applicable to ABC Pvt. Ltd.?
Answer:
Applicability of CARO over a Private company (holding of public company):
The Companies (Auditor’s Report] Order, 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:

1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
2. its total borrowings any bank or financial institution are not more than ₹ 1 cr. at any point of time during the financial year; and
3. its total revenue as disclosed in ScheduleIII (including revenue from discontinuing operations] does not exceed ₹ 10 Cr. during the financial year as per the financial statements.

In the present case, ABC Pvt. Ltd. is a holding company of XYZ Ltd., hence reporting under CARO is required.

Conclusion: CARO is applicable.

Question 2.
Astha Pvt. Ltd. has fully paid capital of ₹ 140 lakhs. During the year, the company had borrowed ₹ 15 lakhs each from a bank and a financial institution independently. It has the turnover (Net of excise ₹ 50 lakhs which is credited to a separate account) of ₹ 475 lakhs. Will Companies (Auditor’s Report) Order, 2020 be applicable to Astha Pvt. Ltd.?
Answer:
Applicability of CARO over a Private Company:
The Companies (Auditor’s Report) Order, 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:

1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
2. its total borrowings any bank or financial institution are not more than ₹ 1 cr, at any point of time during the financial year; and
3. its total revenue as disclosed in Schedule III (including revenue from discontinuing operations) does not exceed₹ 10 Cr. during the financial year as per the financial statements,

In the present case, paid up capital of the company exceeds ₹ 1 Cr., hence reporting under CARO is required.

Conclusion: CARO is applicable over the company.

Question 3.
E-Tech Pvt. Ltd., which has an aggregate outstanding loan of ₹ 20 lakhs from Banks and ₹ 30 lakhs from Financial Institutions, defaulted in repayment thereof to the extent of 50%. The company holds that it being a private limited company, the Companies (Auditor’s Report) Order, 2020 is not applicable.

You are required to state the list of companies to which CARO is not applicable and state how would you deal with the given situation as an auditor of the company.
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:
  1. its paid-up capital and reserves are not more than ₹ 1 Cr, as on Balance Sheet date, and
  2. its total borrowings any bank or financial institution are not more than ₹ 1 cr, at any point of time during the financial year; and
  3. its total revenue as disclosed in Schedule III (including revenue from discontinuing operations) does not exceed ₹ 10 Cr. during the financial year as per the financial statements.
• In the instant case the total borrowings do not exceed ₹ 100 lakhs during the year, reporting under CARO is not required.

Conclusion: Contention of the E Tech Pvt. Ltd., is correct that CARO, 2020 will not be applicable on it as outstanding loan from banks and financial institution in aggregate does not exceeds ₹ 1 Cr.

Question 4.
A Pvt. Ltd. is incorporated on 1st july, 2020. During the year ended 31st March, 2021, it had issued shares (fully paid up) of ₹ 80 lakhs, had borrowed ₹ 60 lakhs each from 2 financial institutions and its turnover (Net of excise ₹ 100 lakhs which is credited to a separate account) is ₹ 950 lakhs. Will Companies Auditors Report Order, 2020 (CARO) be applicable to A Pvt. Ltd.?
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:
  1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
  2. its total borrowings any bank or financial institution are not more than ₹ 1 cr. at any point of time during the financial year; and
  3. its total revenue as disclosed in Schedule III (including revenue from discontinuing operations) does not exceed ₹ 10 Cr. during the financial year as per the financial statements.
• In the present case paid-up capital is ₹ 80 lakhs, turnover is less than ₹ 10 Crores but its borrowings from banks and financial institution is ₹ 120 Lakhs.
• While computing revenue, excise duty will not be considered as per the requirements of Schedule III.
• While computing borrowings from banks and financial statements, loans are to be taken cumulatively not individually.

Conclusion: Contention of the A Pvt. Ltd. is not correct as total borrowings exceeds ₹ 1 Cr,, hence reporting under CARO, 2020 will be required.

Question 5.
As an auditor, how would you deal with the following: L Private Ltd., which has outstanding loan of more than ₹ 100 lakhs from Financial Institution defaulted in repayment thereof to the extent of 50%. The company holds that it being a private limited company, the Companies Auditors Report Order (CARO) is not applicable.
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:
  1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
  2. its total borrowings any bank or financial institution are not more than ₹ 1 cr. at any point of time during the financial year; and
  3. its total revenue as disclosed in Schedule III (including revenue from discontinuing operations) does not exceed ₹ 10 Cr. during the financial year as per the financial statements.
• In the instant case the total borrowings exceed ₹ 100 Lakhs out of which company defaults in repayment to the extent of 50%. As borrowings exceeds ₹ 1 Cr. during the year, reporting under CARO is required.
• Para 3 (ix) of CARO, 2020 requires the auditor to comment whether the company has defaulted in repayment of loans or other borrowings or in the payment of interest thereon to any lender, if yes, the period and amount of default to be reported.

Conclusion: Contention of L Pvt. Ltd. is not correct as borrowings from financial institution exceeds ₹ 1 Cr., and auditor is required to report the period and amount of default in repayment of dues under Para 3(viii) of CARO, 2020.

Question 6.
T Pvt. Ltd.’s paid up Capital & Reserves are less than ₹ 1 cr. and it has no outstanding loan exceeding ₹ 1 Cr. from any bank or financial institution. Its sales are ₹ 12 crores before deducting Trade discount ₹ 20 lakhs and Sales returns ₹ 1.90 Cr. The services rendered by the company amounted to ₹ 20 lakhs. The company contends that reporting under Companies Auditor’s Reports Order (CARO) is not applicable. Discuss.
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:
  1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
  2. its total borrowings any bank or financial institution are not more than ₹ 1 cr. at any point of time during the financial year; and
  3. its total revenue as disclosed in Schedule III (including revenue from discontinuing operations) does not exceed ₹ 10 Cr. during the financial year as per the financial statements.
• As per Schedule III, revenue from operations shall consists of revenue from sale of products, sale of services, and other operating revenues.
• While computing total revenue, trade discount as well as sales returns are required to be deducted.
• In the present case the turnover of the company including value of service rendered after deducting trade discount and sales returns amounts to ₹ 10.10 crores (i.e. 12 – 0.20 – 1.90 + 0.20 crore).

Conclusion: Contention of the company that CARO is not applicable is not correct, as Total Revenue exceeds ₹ 10 Cr.

Question 7.
A Private limited company reports the following position as on 31^st March, 2021:
Paid up capital : 60 Lacs
Revaluation reserves : 20 Lacs
Capital reserves : 22 Lacs
P & L A/c (Dr. Balance) : 4 Lacs
The management of the company contends that CARO, 2020 is not applicable to it.
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:
  1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
  2. its total borrowings any bank or financial institution are not more than ₹ 1 cr. at any point of time during the financial year; and
  3. its total revenue as disclosed in Schedule 111 (including revenue from discontinuing operations) does not exceed ₹ 10 Cr. during the financial year as per the financial statements.
• As per Guidance Note on CARO, 2020 issued by ICAI, while computing paid up capital and reserves, capital reserves, revenue reserves, revaluation reserves and credit balance of Profit and loss account are to be considered in aggregate as reduced by debit balance in the profit and loss account, if any.
• In the present case, paid-up capital and reserves after deducting debit balance of Profit & Loss Account amounts to ₹ 98 Lacs (60 + 20 + 22 – 4).

Conclusion: CARO is not applicable as paid-up capital and reserves does not exceed ₹ 1 Cr. (assuming that other conditions as to borrowings and revenue also satisfied).

Question 8.
Under CARO, 2020, how as a statutory auditor would you comment on the following: X Pvt. Ltd. is a subsidiary of a listed entity. The management of the company believes that since X Pvt. Ltd. is a private company and satisfies all conditions under CARO, 2020, reporting under CARO is not applicable.
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, applies to all companies including foreign companies except certain companies which are specifically exempted.
• CARO, 2020 exempts private limited companies not being a subsidiary or holding of a public company, from its application which fulfils certain conditions.
• In the present case M/s X Pvt. Ltd. is a subsidiary of a listed entity and its management believes that the company satisfies all conditions as required under CARO, 2020.

Conclusion: Exemption from CARO is not available to a private company which is a subsidiary of a public company. Hence contention of the management that company being a private limited company and satisfies all the conditions required for exemption, is not correct.

Question 9.
H Private Ltd. (not a small company) had taken overdrafts from two banks with a limit of ₹ 40 lacs each against the security of fixed deposit it had with those banks and an unsecured overdraft from a financial institution of ₹ 36 lacs. The said loans were outstanding as at 31^st March, 2021. The paid-up capital and reserves of the company as at that date was ₹ 80 lacs and its revenue during the financial year ended on 31st March, 2021 was ₹ 6 crores. The management of the company is of the opinion that CARO, 2020 is not applicable to it because turnover and paid-up capital were within the limits prescribed and loans taken against the fixed deposits cannot be considered. The company further contended that loan limit is to be reckoned per bank or financial institution and not cumulatively. Comment.
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:
  1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
  2. its total borrowings any bank or financial institution are not more than ₹ 1 cr. at any point of time during the financial year; and
  3. its total revenue as disclosed in Schedule III (including revenue from discontinuing operations) does not exceed ₹ 10 Cr. during the financial year as per the financial statements.
• In the present case paid-up capital is less than ₹1 Cr., Revenue is less than ₹ 10 Crores but its total borrowings from banks and financial institution is ₹ 1.16 Cr.
• As per Guidance Note of CARO, 2020 issued by ICAI, while computing total borrowings from banks and financial statements, loans against Fixed deposits are to be taken into consideration. Further loans from banks and financial institutions are to be taken cumulatively not individually.

Conclusion: Contention of H Ltd. is not correct as total borrowings exceeds ₹ 1 Cr., hence reporting under CARO, 2020 will be required.

Question 10.
A Private Limited Company reports the following position as on 31^st March, 2021:
Paid up Capital : ₹ 70 Lacs
Revaluation Reserve : ₹ 24 Lacs
Capital Reserve : ₹ 20 Lacs
Profit & Loss (Dr.) Balance : ₹ 24 Lacs
The Management of the Company contends that CARO, 2020 is not applicable to it. Comment.
Answer:
Applicability of CARO, 2020:

• The Companies (Auditor’s Report) Order (CARO), 2020, exempts private limited companies, not being a subsidiary or holding of a public company, from its application which fulfils all the following conditions:
  1. its paid-up capital and reserves are not more than ₹ 1 Cr. as on Balance Sheet date, and
  2. its total borrowings any bank or financial institution are not more than ₹ 1 cr. at any point of time during the financial year; and
  3. its total revenue as disclosed in Schedule III (including revenue from discontinuing operations) does not exceed ₹ 10 Cr. during the financial year as per the financial statements.
• As per Guidance Note on CARO, 2020 issued by ICAI, while computing paid up capital and reserves, capital reserves, revenue reserves, revaluation reserves and credit balance of Profit and loss account are to be considered in aggregate as reduced by debit balance in the profit and loss account, if any.
• In the present case, paid up-capital and reserves after deducting debit balance of Profit & Loss Account amounts to ₹ 90 Lacs (70 + 24 + 20 – 24).

Conclusion: CARO is not applicable as paid-up capital and reserves does not exceed ₹ 1 Cr. (assuming that other conditions as to borrowings and revenue also satisfied).

Matters to be Reported under CARO, 2020

Question 11.
X Ltd. closed its manufacturing operations and sold all its manufacturing fixed assets during the financial year ended 31^st March, 2021. However, it intends continue its operations as a trading : company. In respect of other fixed assets, the company carried out a physical verification as at i the end of 31^st March, 2021 and found a material discrepancy to the tune of ₹ 1 lac, which was written off and is disclosed separately in the profit and loss account. Kindly incorporate the above in your audit report.
Answer:
Reporting w.r.t. Fixed Assets:
Para 3(i) of CARO, 2020 requires the auditor to comment whether the property, plant and equipment have been physically verified by the management at reasonable intervals; whether any material discrepancies were noticed on such verification and if so, whether the same have been properly dealt with in the books of account.

SA 5 70 “Going Concern” requires the auditor to perform appropriate procedures so as to ensure appropriateness of going concern assumption.

In the present case, X Ltd. had closed its manufacturing operations and sold all its manufacturing fixed assets, but it intends continue its operations as a trading company. Hence auditor is required to examine management plans for continuation of the company and appropriateness of going concern assumption by performing appropriate procedures.

Further, in respect of other fixed assets, company has carried out physical verification and found a material discrepancy of ₹ 1 Lacs which was written off and disclosed separately in the profit and loss account. In respect of this, auditor should incorporate the below mentioned para in his report:

“As per AS-1, “Disclosure of Accounting Policies”, “the enterprise is normally viewed as a going concern, that is as continuing its operation for the foreseeable future. It is assumed thatthe enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations.” Although the company has disposed off its manufacturing fixed assets during the financial year ending on 31-3-2021, it is still a going concern in the form of a trading company.

We also report that on physical verification of other fixed assets, a material discrepancy to the tune of ₹ 1 Lac was noticed and that the same has been properly dealt with in the books of account”.

Question 12.
Under CARO, 2020, as a statutory auditor, how would you report: NSP Limited has its factory building, appearing as fixed assets in its financial statements in the name of one of its director who was overlooking the manufacturing activities.
Answer:
Audit procedures w.r.t. reporting over title deeds of immovable properties under CARO:
Para 3 (i) (c) of CARO, 2020 requires the auditor to comment whether the title deeds of all the immovable properties (Other than properties where the company is the lessee and the lease agreements are duly executed in favour of the lessee) disclosed in the financial statements are held in the name of the company.

The Order is silent as to what constitutes ‘title deeds’. In general, title deeds mean a legal deed or document constituting evidence of a right, especially to the legal ownership of the immovable property.

Title deeds of the immovable property maybe Registered sale deed/transfer deed/conveyance deed, etc. of land, land & building together, etc. purchased, allotted, transferred by any person including any government, government authority/body/agency/corporation, etc. to the company.

If title deeds are not held in name of the company, details thereof to be provided in the below mentioned format:

Description of Property	Gross carrying value	Held in njme of	Whether promoter, director or their relative or employee	Period held – indicate range, where appropriate	Reason for not being held in name of company*

*Also indicate if in dispute.

Question 13.
ABC Ltd. owns a piece of Land and Building situated at IP road, Mumbai which was purchased before 30 years. The title deeds for the same arc deposited with State Bank of India for obtaining credit facilities by the company.

As the statutory auditor of the company for the year ended 31^st March, 2021, what are the audit procedures to be followed and what is the reporting under CARO, 2020?
Answer:
Audit procedures w.r.t. reporting over title deeds of immovable properties under CARO:
Para 3(i) (c) of CARO, 2020 requires the auditor to comment whether the title deeds of all the immovable properties (Other than properties where the company is the lessee and the lease agreements are duly executed in favour of the lessee) disclosed in the financial statements are held in the name of the company.

The Order is silent as to what constitutes ‘title deeds’. In general, title deeds mean a legal deed or document constituting evidence of a right, especially to the legal ownership of the immovable property.

Title deeds of the immovable property maybe Registered sale deed/transfer deed/conveyance deed, etc. of land, land & building together, etc. purchased, allotted, transferred by any person including any government, government authority/body/agency/corporation, etc. to the company.

Where the title deeds of the immovable property have been mortgaged with the Banks/Financial Institutions, etc., for securing the borrowings and loan raised by the company, a confirmation about the same should be sought from the respective institution to this effect. The auditor may also consider verifying this information from the online records, if available, of the relevant State.

If title deeds are not held in name of the company, details thereof to be provided in the below mentioned format:

Description of Property	Gross carrying value	Held in name of	Whether promoter, director or their relative or employee	Period held – indicate range, where appropriate	Reason for not being held in name of company*

*Also indicate if in dispute.

Question 14.
The Property, Plant and Equipment of Amir Ltd. included ₹ 25.75 crores of earth removing machines of outdated technology which had been retired from active use and had been kept for disposal after knock down. These assets appeared at residual value and had been last inspected ten years back. As an Auditor, what may be your reporting concern in view of CARO, 2020 on matters specified above?
Answer:
Reporting w.r.t. Fixed Assets:
Para 3(i) of CARO, 2020 requires the auditor to comment

• whether the property, plant and equipment assets have been physically verified by the management at reasonable intervals;
• whether any material discrepancies were noticed on such verification and if so,
• whether the same have been properly dealt with in the books of account.

In the present case, the Property, Plant and Equipment of Amir Ltd. included ₹ 25.75 crores of earth removing machines of outdated technology which had been retired from active use and had been kept for disposal after knock down. These assets appeared at residual value and had been last inspected ten years back.

Inspection of above mentioned machine was done 10 years back. Though it is a retired machine, however value is ₹ 25.75 crores which is a significant amount, requires physical verification at regular intervals.

Conclusion: Auditor is required to state the fact about discrepancies in system of physical verification of machineries held for disposal.

Question 15.
What are the reporting requirements for closing stock in the CARO, 2020.
Answer:
Reporting Requirement for Closing Stock under CARO: ,
Para 3(ii) of CARO, 2020 requires the auditor to comment on the following:
(a) whether physical verification of inventory has been conducted at reasonable intervals by the management and whether, in the opinion of the auditor, the coverage and procedure of such verification by the management is appropriate; whether any discrepancies of 10% or more in the aggregate for each class of inventory were noticed and if so, whether they have been properly dealt with in the books of account;

(b) whether during any point of time of the year, the company has been sanctioned working capital limits in excess of ₹ 5 crore, in aggregate, from banks or financial institutions on the basis of security of current assets; whether the quarterly returns or statements filed by the company with such banks or financial institutions are in agreement with the books of account of the Company, if not, give details.

Question 16.
As the statutory auditor of B Ltd. to whom CARO, 2020 is applicable, how would you report in the following situations: Physical verification of only 50% (in value) of items of inventory has been conducted by the company. The balance 50% will be conducted in next year due to lack of time and resources.
Answer:
Physical verification of Inventory:
Para 3 (ii) of CARO, 2020 requires the auditor to state in his report whether physical verification of inventory has been conducted at reasonable interval by the management and whether, in the opinion of the auditor, the coverage and procedure of such verification by the management is appropriate.

Physical verification of inventory is the responsibility of the management which should verify all material items at least once in a year and more often in appropriate cases.

What constitutes “reasonable intervals” depends on circumstances of each case. The periodicity of the physical verification of inventories depends upon the nature of inventories, their location and the feasibility of conducting a physical verification. The management of a company normally determines the periodicity of the physical verification of inventories considering these factors.

Normally, wherever practicable, all the items of inventories should be verified by the management of the company at least once in a year.

The auditor in order to satisfy himself about verification at reasonable intervals should examine the adequacy of evidence and record of verification.

In the given case, physical verification of 50% of the items has not been conducted by the management during the year.

Conclusion: Auditor should point out the fact regarding inadequacies in the physical verification procedures of inventory in his report.

Question 17.
In the course of audit of Y Ltd., as the auditor of the company you observe the following: The company has advanced a loan to a firm in which a director was interested at a rate lower than the prevailing market rate as well as there was no agreement on terms of repayment.
How auditor will report in CARO, 2020?
Answer:
Reporting requirement under CARO, 2020:
Para 3 (ii)(a) of CARO, 2020 requires the auditor to report whether during the year the company has provided loans or advances in the nature of loans, or stood guarantee, or provided security to any other entity, if so, indicate the aggregate amount during the year, and balance outstanding at the balance sheet date with respect to such loans or advances.

Para 3(iii)(b) of CARO, 2020, requires the auditor to report whether the terms and conditions of the grant of all loans and advances in the nature of loans and guarantees provided are not prejudicial to the company’s interest.

In the present case, company has granted a loan to a firm in which a director is interested, the terms and conditions of which are prejudicial to the company interest, hence auditor may report as under:

“According to the information and explanations given to us and based on the audit procedures conducted by us, we are of the opinion that the terms and conditions of loans granted by the company to a firm in which a director of the company is interested, (total loan amount
granted ₹ – – — and balance outstanding as at balance sheet date ₹ ——–) are prejudicial to the company’s interest on account of the fact that the loans have been granted at an interest rate of ____ % per annum which is significantly lower than the cost of funds to the company and also lower than the prevailing yield of government security close to the tenor of the loan”.

Pare 3(iii)(f) of CARO, 2020 requires the auditor to report whether the company has granted any loans or advances in the nature of loans either repayable on demand or without specifying any terms or period of repayment, if so, specify the aggregate amount, percentage thereof to the total loans granted, aggregate amount of loans granted to Promoters, related parties as defined in Sec. 2(76) of the Companies Act, 2013.

Question 18.
H Ltd. granted unsecured loan of ₹ 1 crore @ 15% p.a. to two of its subsidiaries during the Financial Year 2020-21. Before the year end both the companies repaid the loan. The management of H Ltd. is of the opinion that since no balance is outstanding as on 31st March 2021, these loans are not required to be reported in CARO, 2020. Comment and draft a suitable report.
Answer:
Reporting requirement under CARO, 2020:
Para 3 (iiii) (a) of CARO, 2020 requires the auditor to report whether during the year the company has provided loans or advances in the nature of loans, or stood guarantee, or provided security to any other entity, if so, indicate the aggregate amount during the year, and balance outstanding at the balance sheet date with respect to such loans or advances.

Para 3(iii)(b) of CARO, 2020, requires the auditor to report whether the terms and conditions of the grant of all loans and advances in the nature of loans and guarantees provided are not prejudicial to the company’s interest.

Guidance Note on CARO, 2020 as issued by ICAI states that it may so happen that a party might have taken a loan/advance in nature of loan from a company and repaid it during the same financial year. Therefore, while examining the loans, the auditor should also take into consideration the loans/advances in nature of loan transactions that have been squared-up during the year and report such transactions under this clause.

In the given case, H Ltd. has granted unsecured loan of ₹ 1 crore @15% p.a. to two of its subsidiaries during the Financial Year 2020-21. During the year, both the companies have repaid its loan. Therefore, the auditor need to consider the transaction and comment as follows:

“The Company has granted loan of ₹ 1 Crore @ 15% p.a. to 2 of its subsidiaries during the Financial Year 2020-21. The maximum amount involved during the year was ₹ 1.00 crore and the year-end balance of such loans was Nil”.

Question 19.
ABC Ltd. has granted a loan of ₹ 20 crores to its associate XYZ (R) Ltd. at the beginning of the financial year and it remain outstanding at the year end. How the auditor should report the fact?
Answer:
Reporting requirement under CARO, 2020:
As per Para 3 (iii) of CARO, 2020 auditor is required to report the following in respect of loans and advances granted during the year by the company to another company, firms, LLPs or any other entities:

aggregate amount during the year, and balance outstanding at the balance sheet date with respect to such loans or advances.

whether the terms and conditions of the grant of all loans and advances in the nature of loans and guarantees provided are not prejudicial to the company’s interest.

in respect of loans and advances in the nature of loans, whether the schedule of repayment of principal and payment of interest has been stipulated and whether the repayments or receipts are regular;

if the amount is overdue, state the total amount overdue for more than 90 days, and whether reasonable steps have been taken by the company for recovery of the principal and interest;

whether any loan or advance in the nature of loan granted which has fallen due during the year, has been renewed or extended or fresh loans granted to settle the overdues of existing loans given to the same parties, if so, specify the aggregate amount of such dues renewed or extended or settled by fresh loans and the percentage of the aggregate to the total loans or advances in the nature of loans granted during the year;

whether the company has granted any loans or advances in the nature of loans either repayable on demand or without specifying any terms or period of repayment, if so, specify the aggregate amount, percentage thereof to the total loans granted, aggregate amount of loans granted to Promoters, related parties as defined in Sec. 2(76) of the Companies Act, 2013.

In the given case, ABC Ltd. has granted a loan of ₹ 20 crores to its associates at the beginning the Financial Year and it remain outstanding at year end.

Conclusion: Auditor is required to report the matters as required under Para 3 (iii) of CARO, 2020.

Question 20.
As a Company auditor you noticed that there is an inter corporate loan granted by the company. What are the reporting requirements as regard the matters concerning terms of interest on the inter-corporate loan?
Answer:
Reporting requirements as to inter corporate loan granted by the company:
As per Para 3 (iv) of CARO, 2 0 2 0, the auditor is required to report, in respect of loans, investments, guarantees, and security whether provisions of Sections 185 and 186 of the Companies Act, 2013 have been complied with. If not, provide details thereof. For this purpose of ensuring compliance of Sec. 186, the auditor should:

Obtain the details of, loans given to any person or other body corporate, guarantee given or security provided in connection with a loan to any other body corporate or person and securities acquired of any other body corporate by way of subscription, purchase or otherwise, made during the year as well as the outstanding balances as at the beginning of the year.

Check whether rate of interest is not lower than the prevailing yield of one year, three-year, five years or ten-year government security closest to the tenor of the loan granted.

Check if the company is in default in the repayment of any deposits accepted or in payment of interest thereon, then the company is not allowed to give any loan or guarantee or any security or an acquisition till such default is subsisting.

Non-compliance of Sec. 186 with respect to interest on the intercorporate loan may be reported incorporating following details:

S. No.	Non-compliance of Section 186				Remarks, if any
		Name of Company/Party	Amount Involved	Balance as at Balance Sheet Date
1	Loan given at rate of interest lower than prescribed
2	Any other default

Question 21.
CARO, 2020 requires the auditor of the company to report whether maintenance of cost records has been specified by the Central Government under section 148 of the Companies Act, 2013 and whether such accounts and records have been so made and maintained.

You are required to briefly explain the audit procedure to be followed by the auditor and suggest the reporting pattern.
Answer:
Reporting requirement under CARO, 2020:
Para 3(vi) of CARO, 2020 requires the auditor to comment “whether maintenance of cost records has been specified by the CG u/s 148(1) of the Companies Act, 2013 and whether such accounts and records have been so made and maintained”

The word “made” applies in respect of cost accounts (or cost statements) and the word “maintained” applies in respect of cost records relating to materials, labour, overheads, etc.

The auditor has to report under the clause irrespective of whether a cost audit has been ordered by the Central Government.

The auditor should obtain a written representation from the management stating:
(a) whether cost records are required to be maintained for any product(s) or services of the company u/s 148 of the Act, and the Companies (Cost Records and Audit) Rules, 2014; and

(b) whether cost accounts and records are being made and maintained regularly.

The auditor should also obtain a list of books/records made and maintained in this regard.

The Order does not require a detailed examination of such records. The auditor should, therefore, conduct a general review of the cost records to ensure that the records as prescribed are made and maintained. He should, of course, make such reference to the records as is necessary for the purposes of his audit.

It is necessary that the extent of the examination made by the auditor is clearly brought out in his report. The following wording is, therefore, suggested:

“We have broadly reviewed the books of account maintained by the company pursuant to the Rules made by the Central Government for the maintenance of cost records under section 148 of the Act, and are of the opinion that prima facie, the prescribed accounts and records have been made and maintained.”

Question 22.
As a statutory auditor, how would you deal with the following case: During the course of audit of ABC Ltd. it is noticed that out of ₹ 12 Lacs of provident fund contribution accounted in the books, only ₹ 2 Lacs has been remitted to the authorities during the year. On enquiry the Chief Accountant informed that due to financial problems they have not remitted but will remit the same as and when the position improves.
Or
During the course of Audit of M/s CT Ltd. for the financial year 2020-21, it has noticed that ₹ 2.00 lakhs of employee contribution and ₹ 9.50 lakhs of employer contribution towards employee state insurance contribution have been accounted in the books of account in respective heads. Whereas, it was found that ₹ 4.00 lakhs only have been deposited with ESIC department during the year ended 31^stst March, 2021. The Finance Manager informed that auditor that due to financial crunch they have not deposited the amount due, but will deposit the amount overdue along with interest as and when financial position improves. Comment as a statutory auditor.
Answer:
Reporting Requirement under CARO w.r.t. payment of statutory dues:
Para 3(vii)(a) of CARO, 2020 requires the auditor to comment whether the company is regular in depositing undisputed statutory dues including GST, Provident Fund, Employees State Insurance (ESI), Income-tax, Sales-tax, Wealth tax, Service tax, Duties ofCustoms, Duty of Excise, Value Added Tax, cess and any other statutory dues with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable shall be indicated.

SA 250 “Consideration of Laws and Regulations in an audit of financial statements, also requires the auditor to obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements”.

A company is required to deposit provident fund and Employees State Insurance dues to appropriate authorities with in the period prescribed under the EPF Act and the Rules governing it.

In the present case company is not regular in depositing the provident Fund/ESI Contributions. The reason put forward by the Chief Accountant that the amount has not been deposited due to financial problems faced by the Company is no excuse for not remitting the PF/ESI Contributions.

Conclusion: Non-payment of PF/ESI contribution needs to be disclosed by the auditor in his audit report as per requirement of Para 3(vii)(a) of CARO, 2020.

Question 23.
As a Statutory Auditor, how would you deal with the following: PQR Ltd. has not deposited Provident Fund contribution of ₹ 10 lakhs with the authorities till the year-end.
Answer:
Reporting Requirement under CARO w.r.t. payment of statutory dues:
Para 3(vii)(a) of CARO, 2020 requires the auditor to comment whether the company is regular in depositing undisputed statutory dues including GST, Provident Fund, Employees State Insurance (ESI), Income-tax, Sales-tax, Wealth tax, Service tax, Duties of Customs, Duty of Excise, Value Added Tax, cess and any other statutory dues with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable shall be indicated.

SA 250 “Consideration of Laws and Regulations in an audit of financial statements, also requires the auditor to obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements.”

A company is required to deposit provident fund and Employees State Insurance dues to appropriate authorities with in the period prescribed under the EPF Act and the Rules governing it.

In the present case company is not regular in depositing the provident Fund.

Conclusion: Non-payment of PF needs to be disclosed by the auditor in his audit report as per requirement of Para 3(vii)(a) of CARO, 2020.

Question 24.
Comment on the following: Is the company regular in depositing undisputed statutory dues including GST, Provident Fund, Employees State Insurance, Income Tax, Sales Tax, Wealth Tax, Customs duty, Excise duty, Value added Tax, Cess and any other statutory dues with the appropriate authorities and if not, the extent of arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable shall be indicated by the auditor.
Answer:
Reporting on Regularity of payment of statutory dues:
Para 3(vii)(a) of CARO, 2020 requires the auditor to comment:
(i) whether the company is regular in depositing undisputed statutory dues including GST, Provident Fund, Employees State Insurance, Income Tax, Sales Tax, Service Tax, Duties of Customs, duty of Excise, Value added Tax, Cess and any other statutory dues with the appropriate authorities; and

(ii) if not, the extent of arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable shall be indicated by the auditor.

Implication of Para 3(vii)(a) are as follows:

1. Auditor is required to comment upon regularity in depositing undisputed statutory dues.
2. Payment includes all statutory dues payable by the company. The amount payable will include the interest/penalty payable under the respective laws.
3. If the company is not regular in depositing the undisputed statutory dues the auditor is required to state the extent of outstanding statutory dues as at the last day of the financial year from a period of more than six months from the date they became payable.
4. The auditor has to get a written representation from the management indicating the details of disputed claims, undisputed but have remained outstanding for more than six months and a statement as to the completeness of the information provided by the management.

Question 25.
Big and Small Ltd. received a show cause notice from GST department intending to levya demand of ₹ 25 lakhs in December 2020. The company replied to the above notice in January 2021 contending that it is not liable for the levy. No further action was initiated by the GST department upto the finalization of the audit for the year ended on 31st March, 2021. As the auditor of the company, what is your role in this?
Answer:
Reporting in case of Statutory dues:
Para 3(vii)(a) of CARO, 2020 requires the auditor to comment whether the company is regular in depositing undisputed statutory dues including GST, Provident Fund, Employees State Insurance [ESI], Income-tax, Sales-tax, Wealth tax, Service tax, Duties of Customs, Duty of Excise, Value Added Tax, cess and any other statutory dues with the appropriate authorities and if pot, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable shall be indicated.

As per Para 3(vii)(b) of CARO, 2020, where statutory dues referred above have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned.”

A mere representation to the Department shall not constitute the dispute.

In the present case issuance of show cause notice by GST department does not tantamount to demand payable by the Company. In as much as the Company has replied to the notice and no further correspondence was received from the department, it has to be construed that there is no demand.

Conclusion: The auditor needs not to report on this.

Question 26.
XYZ Pvt. Ltd. has submitted the financial statements for the year ended 31-3-2021 for audit. The audit assistant observes and brings to your notice that the company’s records show following

• Income Tax relating to Assessment Year 2017-18 ₹ 125 lacs – Appeal is pending before Hon’ble ITAT since 30-09-2016.
• Customs duty ₹ 85 lakhs – Demand notice received on 15-9-2020 but no action has been taken to pay or appeal.

As an auditor, how would you bring this fact to the members?
Answer:
Reporting under CARO w.r.t. Statutory Dues:
Para 3(vii)(a) of CARO, 2020 requires the auditor to comment whether the company is regular in depositing undisputed statutory dues including GST, Provident Fund, Employees State Insurance (ESI), Income-tax, Sales-tax, Wealth tax, Service tax, Duties of Customs, Duty of Excise, Value Added Tax, cess and any other statutory dues with the appropriate authorities and if not, the extent of the arrears of outstanding statutory dues as at the last day of the financial year concerned for a period of more than six months from the date they became payable shall be indicated.

As per Para 3(vii)[b] of CARO, 2020, where statutory dues referred above have not been deposited on account of any dispute, then the amounts involved and the forum where dispute is pending shall be mentioned.

The auditor should also obtain a management representation about the disputed dues, the amounts involved and the forum where the dispute is pending. The auditor should carry out necessary audit procedures to verify the information provided by the management.

In the present case, there is Income Tax demand of ₹ 125 Lacs and the company has gone for an appeal, it should be brought to notice of members by reporting under Para 3(vii)(b) of CARO, 2020 as below:

S. No.	Name of the Statute	Nature of Dues	Amount (in Lacs)	Period to which amount relates	Forum where dispute is pending
1	Income-tax Act, 1961	Income Tax	125.00	AY 2015-16	ITAT

In reference to demand notice received for Custom Duty of ₹ 85 Lacs on 15-9-2020 for which company has not taken any action and is outstanding for more than 6 months, it leads to the irregularity which should be brought to notice of members by reporting under Para 3(vii)(a) of CARO, 2020.

Question 27.
OK Ltd. has taken a term loan from a nationalized bank in 2016 for ₹ 200 lakhs repayable in five equal instalments of ₹ 40 lakhs from 31st March, 2017 onwards. It had repaid the loans due in 2017 & 2018, but defaulted in 2019,2020 & 2021. As the auditor of OK Ltd. what is your responsibility assuming that company has sought re-schedulement of loan?
Answer:
Reporting w.r.t. repayment of dues:
As per Para 3(ix)(a) of CARO, 2020 auditors of a company are required to comment in his report whether the company has defaulted in repayment of loans or other borrowings or in the payment of interest thereon to any lender, if yes, the period and amount of default to be reported as per the format below:

Nature of borrowing, including debt securities	Name of lender*	Amount not paid on due date	Whether principal or interest	No. of days delay or unpaid	Remarks, if any

*Lenderwise details to be provided in case of defaults to banks, financial institutions and Government

As per the general instructions for preparation of Balance Sheet, provided under Schedule III to the Companies Act, 2013, terms of repayment ofterm loans and other loans is required to be disclosed in the notes to accounts. It also requires disclosure of period and amount of continuing default as on the balance sheet date in repayment of loans and interest, separately in each case.

Submission of application for re-schedulement/restruduring does not mean that no default has occurred.

In this case OK Ltd. has defaulted in repayment of dues for three years. Application for rescheduling will not change the default position.

Conclusion: The auditor has to report in his audit report that the Company has defaulted in its repayment of dues to the bank to the extent of ₹ 120 lakhs.

Question 28.
R Ltd. as at 31^st March, 2021 defaulted in the repayment of interest and principal due to a financial institution. The due date was 28l” February, 2021. However, the defaulted amount was paid on 5^th April, 2021. The company’s management is of the opinion that since the default is set right before the audit completion these need not be reported in CARO, 2020. Comment and draft a suitable report. [May 13 (4 Marks)]
Or
C Limited has defaulted in repayments of dues to a financial institution during the financial year 2020-21 and the same remained outstanding as at March 31, 2021. However, the Company settled the total outstanding dues including interest in April, 2020 subsequent to the year end and before completion of the audit. Discuss how you would deal with this matter and draft a suitable Auditor’s Report. [Nov. 14 (4 Marks)]
Answer:
Reporting w.r.t. repayment of dues:
As per Para 3(ix)(a) of CARO, 2020 auditors of a company are required to comment in his report whether the company has defaulted in repayment of loans or other borrowings or in the payment of interest thereon to any lender, if yes, the period and amount of default to be reported as per the format below:

Nature of borrowing, including debt securities	Name of lender*	Amount not paid on due date	Whether principal or interest	No. of days delay or unpaid	Remarks, if any

*Lender wise details to be provided in case of defaults to banks, financial institutions and Government.

As per the general instructions for preparation of Balance Sheet, provided under Schedule III to the Companies Act, 2013, terms of repayment of term loans and other loans is required to be disclosed in the notes to accounts. It also requires disclosure of period and amount of continuing default as on the balance sheet date in repayment of loans and interest, separately in each case.

In the given case, company has defaulted in repayments of dues to a financial institution during the financial year 2020-21 which remain outstanding as at March 31, 2021. However, the company has settled the total outstanding dues including interest in April, 2021 but, the dues were outstanding as at March 31, 2021.

Conclusion: The auditor is required to state in his report the default of the company in respect of repayment of its dues and report as under:

“The company has defaulted in repayment of principal and interest to the financial institution amounted to ₹ …………., that become due on 2 8th Feb, 2021. However, the outstanding sum was settled by the company on 5th April, 2021.

Question 29.
Under CARO how, as a statutory auditor how would you comment on the following: A Term Loan was obtained from a bank for ₹ 75 lakhs for acquiring R&D equipment, out of which ₹ 12 lakhs were used to buy a car for use of the concerned director, who was overlooking the R&D activities. [Nov. 12 (4 Marks)]
Answer:
Utilisation of Term Loans:
Para 3(ix)(c) of CARO, 2020 requires the auditor to comment whether term loans were applied for the purpose for which the loans were obtained; if not, the amount of loan so diverted and the purpose for which it is used may be reported;

For this purpose, auditor should examine the terms and conditions of the term loan with the actual utilisation of the loans. If the auditor finds that the fund has not been utilized for the purpose for which they were obtained, the report should state the fact.

In the instant case, term loan was taken for the purpose of purchase of Research & Development equipment, but a part of it has been utilized for purchase of vehicle for the use of Director.

Purchase of vehicle for use by Director who was incharge of the R&D activities, cannot be considered as purchase of Research & Development equipment.

Conclusion: Auditor is required to report the fact in his audit report. Reporting may be as follows:

In our opinion and according to the information and explanations given to us, the Company has utilized the money raised by the term loans during the year for the purposes for which they were raised, except for:

Nature of the fund Raised	Name of the lender	Amount diverted	Purpose for which amount was sanctioned	Purpose for which amount was utilised	Remarks

Question 30.
As a Statutory Auditor, how would you deal with the following: LM Ltd. had obtained a Term Loan of ₹ 300 lakhs from a bank for the construction of a factory. Since there was a delay in the construction activities, the said funds were temporarily invested in short term deposits.
Answer:
Utilisation of Term Loans:
Para 3 (ix) (c) of CARO, 2020 requires theauditor to comment whether term loans were applied for the purpose for which the loans were obtained; if not, the amount of loan so diverted and the purpose for which it is used may be reported;

For this purpose, auditor should examine the terms and conditions of the term loan with the actual utilisation of the loans. If the auditor finds that the fund has not been utilized for the purpose for which they were obtained, the report should state the fact.

As per Guidance Note on CARO, 2020, during construction phase, companies, generally, temporarily invest the surplus funds to reduce the cost of capital or for other business reasons. However, subsequently the same are utilised for the stated objectives. In such cases, the auditor should mention the fact that pending utilisation of the term loan for the stated purpose, the funds were temporarily used for the purpose other than for which the loan was sanctioned but were ultimately utilised for the stated end-use.

In the instant case, term loan was taken for the purpose of construction of a factory, but said funds were invested in short term deposits due to delay in construction activities.

Conclusion: Auditor is required to report the fact that the pending utilisation of term loan, the funds are temporarily invested in short term deposits, in his audit report as per requirement of paragraph 3 (ix)(c) of CARO, 2020.

Question 31.
During the financial year ended on 31-3-2021, LM Private Limited had borrowed from a Nationalized Bank, a term loan of ₹ 120 lakhs consisting of ₹ 100 lakhs for purchase of a machinery for the new plant and ₹ 20 lakhs for erection expenses. As on the date of 31^st March, 2021, the total of capital and free reserves of the Company was ₹ 50 lakhs and turnover for the year 2020-21 was ₹ 750 lakhs.

The Bank paid ₹ 100 lakhs to the vendor of the Company for the supply of machinery on 31-12-2020. The machinery had reached the yard of the Company. On 28-2-2021, the Company had drawn the balance of loan viz. ₹ 20 lakhs to the credit of its current account maintained with the Bank and utilized the full amount for renovating its administrative office building. The machinery had been kept as capital stock under construction. Comment as to reporting issues, if any, that the Auditor should be concerned with for the financial year ended on 31-3-2021, in this respect.
Answer:
Reporting as to misutilisation of Term Loans:
Reporting under CARO, 2020 is applicable in case of a private limited company if the total borrowings exceed ₹ 1 Cr. from any bank or financial institution at any point of time during the financial year.

Para 3 (ix) (c) of CARO, 2020 requires the auditor to comment whether term loans were applied for the purpose for which the loans were obtained; if not, the amount of loan so diverted and the purpose for which it is used may be reported;

In the present case, LM Private limited had borrowed from a Nationalized Bank, a term loan of ₹ 120 lakhs consisting of ₹ 100 lakhs for purchase of a machinery for the new plant and ₹ 20 lakhs for erection expenses. The Bank paid ₹ 100 lakhs to the vendor of the Company for the supply of machinery on 31-12-2020. The machinery had reached the yard of the Company. On 28-2-2021, the Company had drawn the balance of loan viz. ₹ 20 lakhs to the credit of its current account maintained with the Bank and utilized the full amount for renovating its administrative office building.

Auditor of LM Private Limited is under obligation to report on matters covered under CARO, 2020 as total borrowings exceed ₹ 1 Cr. LM Private Limited had taken term loan for erection purposes, but utilized the funds for renovation of administrative office building.

Conclusion: As per requirement of Para 3(ix)(c) of CARO, 2020, auditor is required to report the fact that out of the term loan obtained for machinery purchase and erection, ₹ 20 Lacs was not utilized for the purpose of erection of machinery.

Question 32.
As a statutory auditor, how would you report on the following under CARO: ABC Pvt. Ltd. is a manufacturer of jewellery. A senior employee of the Company informed you that the Company does not properly disclose the purity of gold used on the jewellery.
Answer:
Reporting under CARO w.r.t. Fraud:
Para 3 (x/) of CARO, 2020 requires the auditor to comment whether any fraud by the company or any fraud on the Company has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.

In the present case if purity of gold is not properly disclosed on the jewellery it amounts to defrauding the customers. It implies that the management is deceiving customers to obtain an illegal advantage.

As per SA 240 “The Auditor’s responsibilities in relation to an audit of Financial Statements” the auditor is concerned with fraudulent acts that cause a material misstatement in financial statements. Hence as long as books of account are not falsified arising out of difference in the purity of gold, i.e., actual cost of the gold and the sale price of gold, it has no implication for the auditor.

Conclusion: From the view point of reporting on frauds under CARO, 2020, there is no implication for misstatement in the financial statements. Hence, no reporting is necessary for non-proper disclosure of purity of gold on the jewellery.

Question 33.
What are the reporting requirements in the audit report under the Companies Act, 2013/CARO, 2020 for the following situations?
(a) A fraud has been committed against the company by an officer of the company.
(b) A fraud has been committed against the company by a vendor of the company.
(c) The company has committed a major fraud on its customer and the case is pending in the court.
(d) A fraud has been reported in the cost audit report but not noticed by statutory auditors in his audit.
Answer:
Reporting under Companies Act, 2013/CARO, 2020 w.r.t. Fraud:
Section 143(12) of Companies Act, 2013 requires that if an auditor of a company in the course of the performance of his duties as auditor, has reason to believe that an offence of fraud involving such amount or amounts as may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report the matter to the Central Government within such time and in such manner as may be prescribed. For this purpose, Rule 13 prescribes the amount of ₹ 1 Cr. or more.

However, in case of a fraud involving lesser than the specified amount, i.e. below ₹ 1 Cr., the auditor shall report the matter to the audit committee constituted u/s 177 or to the Board in other cases within such time and in such manner as may be prescribed:

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

Accordingly, reporting requirements will be:

S. No.	Situation	Reporting under Companies Act, 2013	Reporting under CARO, 2020
1	A fraud has been committed against the company by an officer of the company	Reporting required to C.G. if amount of fraud exceeds ₹ 1 Cr.	Nature of Fraud and amount involved need to be reported under Para 3(xi).
2	A fraud has been committed against the company by a vendor of the company.	No reporting required.	Nature of Fraud and amount involved need to be reported under Para 3 (xi).
3	The company has committed a major fraud on its customer and the case is pending in the court.	Effect of such fraud on financial statements need to be reported.	Nature of Fraud and amount involved need to be reported under Para 3(xi).
4	A fraud has been reported in the cost audit report but not noticed by statutory auditors in his audit.	Effect of such fraud on financial statements need to be reported.	Para 3 (xi) requires reporting of fraud that has been noticed or reported during the year.

Question 34.
CARO, 2020 has made several significant changes and has introduced many new reporting requirements vis-a-vis CARO, 2016.

In view of the above, describe the relevant clause relating to Nidhi Companies – compliance with I net owned funds to deposit requirements and the relevant provisions.
What audit procedures are to.be adopted for verification and reporting on the same? [Nov. 16 (4 Marks)]
Answer:
Clause relating to NIDHI Companies under CARO, 2020:
Clause (xii) of Para 3 of CARO, 2020 requires the auditor to report certain matters relating to Nidhi Companies. The matters on which auditor is required to report are:

• Whether the Nidhi Company has complied with the Net Owned Fund to Deposits in the ratio of 1: 20 to meet out the liability and
• Whether the Nidhi Company is maintaining 10% unencumbered term deposits as specified in the Nidhi Rules, 2014 to meet out the liability.
• Whether there has been any default in payment of interest on deposits or repayment thereof for any period and if so, the details thereof;

Audit Procedures for Verification and Reporting:
Ministry of Corporate Affairs on 31st March 2014, vide its Notification No. GSR 258(E] notified the ‘Nidhi Rules 2014’, which came into force on the first day of April 2014.

As per Rule 3(d) Net Owned Funds are defined as the aggregate of paid-up equity share capital and free reserves as reduced by accumulated losses and intangible assets appearing in the last audited balance sheet. Provided that, the amount representing the proceeds of issue of preference shares, shall not be included for calculating Net Owned Funds.

A Nidhi company can accept fixed deposits, recurring deposits and savings deposits from its members in accordance with the directions notified by the Central Government. The aggregate of such deposits is referred to as “deposit liability”.

The auditor should ask the management to provide the computation of the deposit liability and net owned funds on the basis of the requirements mentioned above. This would enable him to verify that the ratio of deposit liability to net owned funds is in accordance with the requirements prescribed in this regard.

Question 35.
RNT Ltd. has entered into non-cash transactions with Mr. Ram, son of one of the directors of the company, which is an arrangement by which the RNT Ltd. is in process to acquire assets for consideration other than cash. Under CARO, 2020, as a statutory auditor, how would you report? [RTP-Nov. 19]
Answer:
Reporting under CARO, 2020:
Para 3(xv) of CARO, 2020 requires the auditor to comment “whether the company has entered into any non-cash transactions with directors or persons connected with him and if so, whether provisions of Section 192 of Companies Act, 2013 have been complied with”.

Section 192 of the Companies Act, 2013 of the Act deals with restriction on non-cash transactions involving directors or persons connected with them. The section prohibits the company from entering into following types of arrangements unless it meets the conditions laid out in the said section:

1. An arrangement by which a director of the company or its holding, subsidiary or associate company or a person connected with such director acquires or is to acquire assets for consideration other than cash, from the company.
2. An arrangement by which the company acquires or is to acquire assets for consideration other than cash, from such director or person so connected.

The reporting requirements under this clause are in two parts. The first part requires the auditor to report on whether the company has entered into any non-cash transactions with the directors or any persons connected with such director/s. The second part of the clause requires the auditor to report whether the provisions of section 192 of the Act have been complied with. Therefore, the second part of the clause becomes reportable only if the answer to the first part is in affirmative.

Suggested paragraph on reporting:
“According to the information and explanations given to us, the Company has entered into non-cash transactions with one of the directors/person connected with the director during the year, by the acquisition of assets by assuming directly related liabilities, which in our opinion is covered under the provisions of Section 192 of the Act, and for which approval has not yet been obtained in a general meeting of the Company”.

Question 36.
Whilst the Audit team has identified various matters, they need your advice to include the same in your audit report in view of CARO, 2020:
(a) The long-term borrowings from the parent has no agreed terms and neither the interest nor the principal has been repaid so far.
(b) The Company is in the process of selling its office along with the freehold land available at Chandigarh and is actively on the lookout for potential buyers. Whilst the same was purchased at ₹ 25 Lakhs in 2008, the current market value is ₹ 250 Lakhs,

This property is pending to be registered in the name of the Company, due to certain procedural issues associated with the Registration though the Company is having a valid possession and has paid its purchase cost in full. The Company has disclosed this amount under Fixed Assets though no disclosure of non-registration is made in the notes forming part of the accounts.

(c) An amount of ₹ 3.25 Lakhs per month is paid to M/s. WE CARE Associates, a partnership firm, which is a ‘related party’ in accordance with the provisions of the Companies Act, 2013 for the marketing services rendered by them. Based on an independent assessment, the consideration paid is higher than the arm’s length pricing by ₹ 0.2 5 Lakhs per month. Whilst the transaction was accounted in the financial statements based on the amounts’ paid, no separate disclosure has been made in the notes forming part of the accounts highlighting the same as a ‘related party’ transaction. [MTP-Oct. 19]

(d) The Internal Auditor of the Company has identified a fraud in the recruitment of employees by the HR department wherein certain sums were alleged to have been taken as kick-back from the employees for taking them on board with the Company. After due investigation, the concerned HR Manager was sacked. The amount of such kick-backs is expected to be in the range of ₹ 12 Lakhs. [MTP-March 19, RTP-May 19]
Answer:
Reporting under CARO, 2020
(a) Auditor is required to report the matter as per Para 3(xii) of CARO, 2020 which requires him to report “whether all transactions with the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where applicable and the details have been disclosed in the Financial Statements etc., as required by the applicable accounting standards”.

(b) Auditor is required to report the matter as per Para 3(i)(c) of CARO, 2020 which requires him to report, “whether the title deeds of all the immovable properties disclosed in the financial statements are held in the name of the company”. If title deeds are not held in name of the company, details thereof to be provided in the below mentioned format:

Description of Property	Gross carrying value	Held in name of	Whether promoter, director or their relative or employee	Period held – indicate range, where appropriate	Reason for not being held in name of company*

*Also indicate if in dispute.

(c) Auditor is required to report the matter as per Para 3(xiii) of CARO, 2020 which requires him to report “whether all transactions with the related parties are in compliance with sections 177 and 188 of Companies Act, 2013 where applicable and the details have been disclosed in the Financial Statements etc., as required by the applicable accounting standards”.

Reporting is required, as one of related party transaction amounting ₹ 3.25 lakhs per month i.e. in lieu of marketing services has been noticed of which amount ₹ 0.25 lakh per month is exceeding the arm’s length price has not been disclosed highlighting the same as related party transactions as per AS 18.

(d) Auditor is required to report the matter as per Para 3(xi) of CARO, 2020 which requires him to report, “whether any fraud by the company or any fraud on the Company has been noticed or reported during the year; If yes, the nature and the amount involved is to be indicated.”

Reporting is required, as a fraud has been identified in recruitment of employees by the HR Department wherein certain sums were alleged to have been taken as kick-back from the employees of company amounting to ₹ 12 Lakhs, approx.

Audit Reports – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Audit Reports – CA Final Audit Question Bank

Audit Reports

Question 1.
Distinguish between Notes on Accounts and Qualifications.
Answer:
Notes on Accounts vs. Qualifications

Notes on Accounts	Qualifications
Notes represents management’s stand on a matter and assessment on ail matters involving difference of opinion between them and the auditors.	Qualification represents auditor disagreement on the matters with Management.
Notes of a qualificatory nature appear in the ac­counts and forms part of Financial Statements.	Qualifications are stated by auditor in the auditor’s report
Management may insist upon the auditor for not modifying his audit opinion considering the man­agement has disclosed full facts and assessment of the matter through notes on the F.S.	Auditor needs to exercise his professional judg­ment to determine whether the disclosures in the notes alone would suffice ora qualification is needed in audit report.
Notes on accounts includes information which is necessary to make the financial statements under­standable by the users.	Qualification mustbe expressed bythe Auditor in a clear and unambiguous manner.

Report vs Certificate

Question 2.
Write a short note on Certificate for Special Purpose vs. Audit Report.
Or
Differentiate between audit report and audit certificate. [May 17 (4 Marks)]
Answer:
Report and Certificate:
Audit Report: An audit report is a formal statement usually made after an enquiry, examination or review of specified matters under report and includes the reporting auditor’s opinion thereon.

While issuing an audit report, auditor is responsible to ensure that his opinion is in due accordance with facts, and that it is arrived at by the application of due care and skill.

Meaning of Certificate: A certificate is a written confirmation of the accuracy of the facts stated therein and does not involve any estimate or opinion. Such certificates are often required by Government authorities in support of statements or other information prepared by an enterprise. Such certificates represent that the auditor has verified certain figures and is satisfied about their accuracy.

Report	Certificate
It is an expression of opinion on true and fair view of financial statements and books of account.	It is a confirmation of correctness and accuracy of subject matter for which certificate is being issued.
Report is based on practitioner professional judgment.	Certificate is based on actual facts and figures.
Scope of audit is wide and generally covers an opinion on complete set of financial statements.	Scope of certificate is narrow and restricted to subject matter only.
Audit report is generally issued annually as per the requirements of statute.	Certificates are issued as per the specific re­quirements of law.
Auditor’s responsibility in case any misstatement is not being identified, is subject to his negligence in performance of his duties.	In case of wrong certification, auditor is held liable irrespective of due diligence.

Question 3.
What are the contents of reports and certificates for special purposes.
Answer:
Contents of Report and Certificates for Special Purposes:
In some cases, contents of Reports and Certificates are specified by law and cannot be changed. However, in other cases, reporting auditor is free to draft his report or certificate in a manner he likes. While drafting such report or certificate, the auditor should consider the following:

(a) Identification of specific elements, accounts or items covered by the report or certificate.

(b) Stating the manner in which the audit was conducted, e.g., by the application of generally accepted auditing practices, or any other specific tests.

(c) limitation on scope, if any, should be clearly mentioned.
(d) Fundamental Assumptions on which the special purpose statement is based should be clearly indicated.
(e) Information and explanations obtained during the course of work should be included.
(f) The title of the report or certificate should clearly indicate its nature.

(g) Extent to which reliance has been placed on the report of other auditor, who have carried out audit of general purpose financial statements.

(h) Where a report requires the interpretation of statute, the reporting auditor should clearly indicate the fact that he is merely expressing his opinion in the matter.

(i) An audit report or certificate should ordinarily be a self-contained document and should not confine itself to a mere reference to another report or certificate.

(j) Extent of responsibility assumed by the reporting auditor should be clearly indicated.

Question 4.
Draft an audit report under following circumstances:

1. Under the Payment of Bonus Act, 1965, a ‘report’ on the computation of bonus payables.
2. Auditor’s Report in accordance with Regulation 55 of the SEBI (Mutual Fund) Regulation, 1996. [May 15 (4 Marks)]

Answer:
Draft Audit Report under the Payment of Bonus Act, 1965, a ‘report’ on the computation of bonus payables.

“We have reviewed the figures in the above computation in comparison with the books and records produced to us, the audit of which has already been completed by us and report that subject to the notes given on face of the computation in our opinion, and to the best of our knowledge and belief and according to the information and explanation given to us, the above computation is in due accordance therewith and has been made on a basis reasonably consistent with the provisions of the Payment of Bonus Act, 1965.”
Place : ForAB&Co.
Date : Chartered Accountants

Auditor’s Report in accordance with Regulation 55 of the SEBI (Mutual Fund) Regulation, 1996.

AH Mutual funds shall be required to get their accounts audited in terms of a provision to that effect in their trust deeds. The Auditor’s Report shall form a part of the Annual Report.

The auditor shall state whether:

1. He has obtained all information and explanations which, to the best of his knowledge and belief, were necessary for the purpose of His audit.
2. The Balance Sheet and the Revenue Account are in agreement with the books of account of the fund.

The auditor shall give his opinion as to whether:

1. The Balance Sheet gives a true and fair view of the scheme wise state of affairs of the fund as at the balance sheet date, and
2. The Revenue Account gives a true and fair view of the scheme wise surplus/deficit of the fund for the year/period ended at the balance sheet date.

“ICAI Examiner Comments”
Candidates were lacking knowledge in drafting of Auditor’s Report in accordance with Regulation 55 of the SEBI (Mutual fund) Regulations, 1996.

Miscellaneous

Question 5.
Distinguish Reasonable assurance engagement from limited assurance engagement. [May 18 – New Syllabus (4 Marks)]
Or
List out the key differences between “Reasonable Assurance” and “Limited Assurance” engagements. [Nov. 18-Old Syllabus (4 Marks)]
Answer:
Limited and Reasonable Assurance:
Guidance Note on Reports or certificates for special purpose defines the term assurance engagement as “An engagement in which a practitioner aims to obtain sufficient appropriate evidence in order to express an opinion/conclusion, designed to enhance the degree of confidence of the intended users, other than the responsible party about the subject matter information (that is, the outcome of the measurement or evaluation of an underlying subject matter against criteria)”.

Each assurance engagement is classified on two dimensions: either a reasonable assurance engagement or a limited assurance engagement.

Reasonable assurance engagement: An assurance engagement in which the practitioner reduces engagement risk to an acceptably low level in the circumstances of the engagement, as the basis for the practitioner’s opinion. The practitioner’s opinion is expressed in a form that conveys the practitioner’s opinion on the outcome of the measurement or evaluation of the underlying subject matter against the criteria.

Limited assurance engagement: An assurance engagement in which the practitioner reduces engagement risk to a level that is acceptable in the circumstances of the engagement but where that risk is greater than for a reasonable assurance engagement, as the basis for expressing a conclusion in a form that conveys whether, based on the procedures performed and evidence obtained, a matter(s) has(have) come to the practitioner’s attention to cause the practitioner to believe that the subject matter information is materially misstated.

The NTE of procedures performed in a limited assurance engagement is limited compared with that necessary in a reasonable assurance engagement but is planned to obtain a level of assurance that is, in the practitioner’s professional judgment, meaningful.

Question 6.
A professional accountant is often required to give certificates or report for special purposes required by various authorities and statute and he needs to take careful evaluation of such engagement. However, issuing such special purpose certificates or reports has some inherent limitations which could limit his review and evaluation. Enumerate some of the limitations associated with such special purpose report or certificates. [May 19-New Syllabus (4 Marks)]
Answer:
Limitations associated with such special purpose report or certificates:

Whenever a practitioner is required to give a ”certificate” or a “report” for special purpose, the practitioner needs to undertake a careful evaluation of the scope of the engagement, i.e., whether the practitioner would be able to provide reasonable assurance or limited assurance on the subject matter. A practitioner is expected to provide either a reasonable assurance or a limited assurance, since it is difficult to reduce engagement risk to zero due to inherent limitations.

The inherent limitations could arise from:
(a) the nature of financial reporting;
(b) the use of selective testing;
(c) the inherent limitations of internal controls;
(d) the fact that much of the evidence available to the practitioner is persuasive rather than conclusive;
(e) the nature of procedures to be performed in a specific situation;
(f) the use of professional judgment in gathering and evaluating evidence and forming conclusions based on that evidence;
(g) in some cases, the characteristics of the underlying subject matter when evaluated or measured against the criteria; and
(h) the need for the engagement to be conducted within a reasonable period of time and at a reasonable cost.

Question 7.
XYZ Ltd. has significant operations in a foreign country. Due to civil and political unrest in that country physical verification of inventory and fixed assets could not carried out and you are not in a position to obtain audit evidence through other audit procedures also. The value of fixed assets and inventory forms part of 80% of the asset value of the company. As the auditor of XYZ Ltd. what factors do you consider in your reporting responsibility. Also draft a suitable report that will be incorporated in the main audit report (Reporting under CARO need not be considered). [May 13 (8 Marks)]
Answer:
Factors to be considered in Audit reporting;
Auditor is required to consider the following factors:

1. Inventories and the Fixed Assets constitute 80% of the assets and hence having a pervasive effect.
2. Auditor is not being able to attend physical verification of the inventories and fixed assets due to civil and political unrest in the foreign country, where the inventory and fixed assets are located.
3. Auditor failed to obtain proper and sufficient audit evidence, even by alternative audit procedures.

Relevant Draft to be incorporated in the main audit report:
“Our responsibility is to express an opinion on these financial statements based on our audit in accordance with the Standards on Auditing issued by the Institute of Chartered Accountants of India.

Because of the matters 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.

Basis for Disclaimer of Opinion
We were appointed as auditors of the Company and we report that we could not observe the counting of physical inventories and physical verification of fixed assets due to civil and political unrest in foreign country where the company has significant operation. We were also unable to satisfy ourselves by alternative means concerning the inventory quantities and fixed assets of the company held at March 31st 20XX, which are stated in the Balance Sheet at ₹ XXX and ₹ XXX, respectively.

Disclaimer of Opinion
Because of the significance of the matters described in the Basis for Disclaimer of Opinion paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion. Accordingly, we do not express an opinion on the financial statements.

Report on Other Legal and Regulatory Requirements
As required by section 143(3) of the Companies Act, 2013, we report that:

As described in the Basis for Disclaimer of Opinion paragraph, we were unable to obtain all the information and explanations which to the best of our knowledge and belief were necessary for the purpose of our audit.

Special Aspects of Auditing in an Automated Environment – CA Final Audit Question Bank is designed strictly as per the latest syllabus and exam pattern.

Special Aspects of Auditing in an Automated Environment  – CA Final Audit Question Bank

Meaning and Components of Automated Environment  

Question 1.
A real-time environment is a type of automated environment in which business operations and transactions are initiated, processed and recorded immediately as they happen without delay. It has several critical IT components that enable anytime, anywhere transactions to take place. You are required to name the components and its example of real-time environment. [MTP-Oct. 18, May 20; RTP-Nov. 18]
Answer:
Components and Example of Real Time Environment:

• Real Time Environment is a type of automated environment in which business operations and transactions are initiated, processed and recorded on a real-time basis, i.e. immediately on their occurrence.
• Examples of Such environments are Airlines and Railway Reservations, CORE Banking, E-Commerce, ERP etc.
• Real Time Environment facilitates anytime, anywhere transactions to take place. For this purpose, it is essential to have the systems, networks and applications available during all times.

IT Components required in Real Time Environment:

1. Applications like ERP, Core Banking Etc.
2. Middleware like web servers
3. Networks like WAN, Internet hosting.
4. Hardware like Data centres, storage devices, power supply etc.

Auditing in an Automated Environment

Question 2.
SA 315 requires the auditor to obtain an understanding of the entity and its environment as a part of Risk Assessment procedure to identify and assess Risk of Material Misstatements. List the areas of which auditor is required to obtain understating in an automated environment.
Or
Write a short note on: Understanding and documenting automated environment. [RTP-May 20]
Answer:
Understanding of Automated Environment
As required by SA 315, auditor is required to obtain an understanding of the entity and its environment as a part of Risk Assessment procedure to identify and assess Risk of Material Misstatements. In an automated environment, auditor is required to obtain an understating of the following:

1. Applications being used by the entity;
2. IT infrastructure components for each of the application;
3. Organisation structure and governance;
4. Policies, procedures and processes followed;
5. IT risks and controls.

Question 3.
In a controls-based audit, the audit approach can be classified into three broad phases comprising of planning, execution, and completion. In this approach, the considerations of automated environment will be relevant at every phase. Comment. [RTP-May 18, MTP-Aug. 18]
Or
“The audit cycle consists of Planning, Execution and Completion. The automation in processing of business transactions has considerations to b.e weighed by auditor at every phase of this cycle”. – Enumerate the focal points of such considerations when auditing in automated environment. [Nov. 18-New Syllabus (4 Marks)]
Or
In a controls-based audit, the audit approach can be ‘classified into three broad phases comprising of planning, execution, and completion. You are required to briefly explain the relevant considerations for every phase in above audit approach in case of an automated environment. [Nov. 19 – New Syllabus (4 Marks)]
Answer:
Considerations of automated environment in different stages of Audit:

	Stages of Audit	Considerations
A. Planning Stage
	1. Risk Assessment	♦ Consider risk arising from use of IT systems. ♦ Identify significant accounts and disclosures. ♦ Identify likely sources of misstatement.
	2. Understanding of the Business	1 Document understanding of business processes using Flowcharts/Narratives. 2. Prepare Risk and Control Matrices. 3.  Understand design of controls by performing walk­through of end-to-end process. 4. Process wide considerations for Entity Level Controls, Segregation of Duties.
B. Executing Stage
	3. Assessing Entity Level Controls	Consider aspects related to: ♦  understanding and review of IT Governance. ♦ Segregation of duties, ♦ Review of General IT Controls & Application Controls.
	4. Assessing Process Level Controls	Consider aspects relating to Risks and Controls with each process, sub-process and activity.

“ICAI Examiner Comments”
It appeared that the examinees were not aware about the topic consequently they answered in general terms.

Enterprise Risk Management

Question 4.
The volatility, unpredictability and pace of fast changes that exists in the automated environment today is far greater than in the past and consequently it throws more risks to business which requires them to have a need to continuously manage such risks. State various risks which an enterprise may have to fact; and manage. [May 19 (5 Marks)]
Answer:
Risks which an enterprise may face and manage:
Businesses today operate in a dynamic environment. The volatility, unpredictability and pace of changes that exist in the business environment today is far greater than in the past. Some of the reasons for this dynamic environment include globalisation, use of technology, new regulatory requirements, etc. Because of this dynamic environment the associated risks to business have also increased and companies have a need to continuously manage risks.

Examples of risks include: –

1. Market Risks;
2. Regulatory & Compliance Risks;
3. Technology & Security Risks; ‘
4. Financial Reporting Risks;
5. Operational Risks;
6. Credit Risk;
7. Business Partner Risk;
8. Product or Project Risk; and
9. Environmental Risks.

Question 5.
Briefly describe the various stages of a Risk Assessment Process.
Answer:
Stages in a Risk Assessment Process:
Risk Assessment Process is the most critical component of Enterprise Risk Management. The entity’s risk assessment process forms the basis for how management determines the risks to be managed.

Steps involved in Risk Assessment Process
Step 1 – Define Business Objectives and Goals.
Step 2 – Identify events that affect achievement of business objectives.
Step 3 – Assess likelihood and impact.
Step 4 – Respond and mitigate risks.
Step 5 – Assess Residual Risks.

Question 6.
Write short note on: Enterprise Risk Management.
Answer:
Enterprise Risk Management (ERM):
ERM is a formal program that is implemented across an enterprise for enabling risk management. In many countries, companies are required to have a formal ERM Program as a statutory requirement.

In India, Sec. 134(3) of Companies Act, 2013 requires the Board of Directors to include in their report a statement indicating development and implementation of a risk management policy for the company including identification therein of elements of risk, if any, which in the opinion of the Board may threaten the existence of the company.

The most common framework that is suitable for implementing an effective ERM is the COSO Enterprise RiskManagement-Integrated FrameworkdevelopedbytheCommitteeof Sponsoring Organisations (COSO) in 2004 and subsequently updated in 2016 to address the changes in business environment.

Besides COSO framework, another widely available framework is the ISO 31000 Risk Management standard published by the International Organization for Standardization.

Assessing IT related Risks and Controls

Question 7.
Write short note on: General IT Controls.
Answer:
General IT Controls:
General IT-controls are policies and procedures that relate to many applications and support the effective functioning of application controls.

They apply to mainframe, mini frame, and end-user environments. General IT-controls that maintain the integrity of information and security of data commonly include controls over the following:

1. Data centre and network operations.
2. System software acquisition, change and maintenance.
3. Program change.
4. Access security.
5. Application system acquisition, development, and maintenance.

Question 8.
Describe application controls and give three examples of automated application controls.
Answer:
Application Controls:

• Application controls are manual or automated procedures that typically operate at a business process level and apply to the processing of individual applications.
• Application controls can be preventive or detective in nature and are designed to ensure the integrity of the accounting records.
• Accordingly, application controls relate to procedures used to initiate, record, process and report transactions or other financial data. These controls help ensure that transactions occurred, are authorised, and are completely and accurately recorded and processed.
• Examples of Application controls include the following:
  1. Edit checks and Validation of input data,
  2. Sequence Number checks.
  3. Limit Checks.
  4. Reasonable Checks.
  5. Mandatory Data Fields.

Question 9.
Identify the controls which are automated, manual or IT dependent manual for the below mentioned cases?

1. Price master configured in the sales master can only be edited by authorised personnel in the system.
2. Invoice cannot be booked in SAP in case Purchase orders are not approved.
3. Inventory ageing report is pulled out from the system based on which provisioning is calculated after analyzing the future demand by the inventory personnel and approved by the controller.
4. All invoices are signed by warehouse personnel before the goods are dispatched to the customer.
5. Credit limit is assigned to the customer and goods cannot be sold in excess of credit limit configured in the system.
6. All changes to the credit limit is approved manually by sales manager.
7. Ageing report is pulled out from SAP based on which provisioning is calculated by accounting personnel and approved by financial controller.
8. PO, CRN (Good received note) and invoice are matched by the system before it is posted in the financial records. [MTP-April 18]

Answer:
Identification of Controls:

1. Automated control as there is inbuilt control which allows editing in sales master by only authorised personnel.
2. Automated control as there is inbuilt control which doesn’t allow approval of invoice in case of non approval of purchase order. “
3. IT dependent manual control as inventory ageing report is pulled out from the system after which provision for inventory is manually approved. „
4. Manual control as sign off is required to be done for the invoice before the dispatch of the goods.
5. Automated control as there is inbuilt control that doesn’t allow goods to be sold if credit limit assigned to the customer has been crossed.
6. Manual control as sign off is required for every change to the credit limit.
7. IT dependent manual control as ageing report is relied upon for calculation of provisioning for debtors.
8. Automated control as PO, GRN and invoice is matched by the system before recording of the invoice to the vendor account.

Evaluating Controls at Entity Level and Process Level

Question 10.
Distinguish between: Direct Entity Level Controls and Indirect Entity Level Controls.
Or
While evaluating the risks and controls at entity level, the Auditor should take cognizance of the prevalent direct and indirect entity level controls operating in the entity. Explain what they pertain to with few examples. [May 18 (4 Marks)]
Answer:
Direct Entity Level Controls (ELCs) and Indirect Entity Level Controls:

Direct ELCs
Direct ELCs operate at a level of business process to prevent, detect or correct a misstatement in a timely manner. Examples of Direct ELCs are:

• Business performance reviews;
• Monitoring of effectiveness of control by Internal Audit function.

Indirect ELCs
Indirect ELCs do not relate to any specific business process, transaction or account balance and therefore, cannot prevent, detect or correct misstatements.

Indirect ELCs contribute indirectly to the effective operation of direct ELCs. Examples of Indirect ELCs are:

• Company code of conduct;
• Human resource policies;
• Job roles & responsibilities.

“ICAI Examiner Comments”
It seems that examinees were unaware of the topic. Very few examinees could comprehend and explain Direct ELCs and indirect ELCs with examples. Some examinees misunderstood the question and explained wrongly the types of audit Risk viz., Inherent Risk, Control Risk, Detection Risk.

Data Analytics

Question 11.
What is Data Analytics. When auditing in an automated environment, auditors can apply the concepts of data analytics for several aspects of an audit. State those aspects.
Or
In an automated environment, the data stored and processed in systems can be used to get various insights into the way business operates. This data can be useful for preparation of management information system (MIS) reports and electronic dashboards that give a high-level snapshot of business performance. In view of above you are required to briefly discuss the meaning of data analytics and example of circumstances when auditing in an automated environment, auditors can apply the concepts of data analytics. [RTP-May 19]
Answer:
Data Analytics:
Data analytics is an analytical process by which meaning information is generated and prepared from raw system data using processes, tools, and techniques. In an automated environment, various insights can be extracted from operational, financial, and other forms of electronic data internal or external to the organization

The data so extracted is useful for preparation of management information system (MIS) reports and electronic dashboards that give a high-level snapshot of business performance. The data analytics methods used in an audit are known as Computer Assisted Auditing Techniques or CAATs.

Application of Data Analytics
In an automated environment, auditors can apply the concept of data analytics for several aspects of an audit including the following:

1. Preliminary Analytics;
2. Risk Assessment;
3. Control Testing;
4. Non-Standard Journal Analysis;
5. Evaluation of Deficiencies;
6. Fraud Risk assessment.

Question 12.
“Generating and preparing meaningful information from raw system data using processes, tools, and techniques is known as Data Analytics and the data analytics methods used in an audit are known as Computer Assisted Auditing Techniques or CAATs.” You are required to give a suggested approach to get the benefit from the use of CAATs. [RTP-Nov 19, MTP – Oct. 20]
Answer:
Suggested approach to get the benefit from the use of CAATs:
A suggested approach to benefit from the use of CAATs is to follow the steps given below:
Step 1: Understand Business Environment including IT;
Step 2: Define the Objectives and Criteria;
Step 3: Identify Source and Format of Data;
Step 4: Extract Data;
Step 5: Verify the Completeness and Accuracy of Extracted Data;
Step 6: Apply Criteria on Data Obtained;
Step 7: Validate and Confirm Results.

Standards, Guidelines and Procedures – to be adhered to while auditing in an automated environment

Question 13.
When auditing in an automated environment the auditor should be aware, adhere to and be guided by the various standards, guidelines and procedures that may he relevant to both audit and the automated environment. Briefly describe any four such standards.
Answer:
Standards relevant to Audit and Automated Environment:
(i) Standards on Auditing (SA): AASB of ICAI issues various standards which are required to be followed while auditing the financial statements of an entity.

(ii) Sec. 143(3)(i) of Companies Act, 2013: Section 143(3)(T) of Companies Act, 2013 requires statutory auditors to provide an Independent Opinion on the Design and Operating Effectiveness of Internal Financial Controls with reference to financial statements of the company as at Balance Sheet date. For this purpose, ICAI issued a Guidance Note on Audit of Internal Financial Controls Over Financial Reporting which provides the guidelines and procedures for reporting on IFC.

(iii) Section 404 of SOX Act, 2002: Section 404 of Sarbanes Oxley Act of 2002 requires public listed companies to implement, assess and ensure effectiveness of internal controls over financial reporting. Auditors of such companies are required to express an independent opinion on the design and operating effectiveness of internal controls over financial reporting (ICFR).

(iv) CoBIT: Control Objectives for Information and Related Technologies is best practice IT Governance and Management framework published by Information Systems Audit and Control Association. It provides the required tools, resources and guidelines that are relevant to IT governance, risk, compliance and information security.

(v) CSF: Cyber security Framework published by the National Institute of Standards and Technology is one of the most popular framework for improving critical infrastructure cyber security, which provides a set of standards and best practices for companies to manage cyber security risks.