Standards on Auditing – CA Inter Audit Notes

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

Standards on Auditing – CA Inter Auditing Notes

Question 1.
Comment on the following in relation to SAs: “Management is responsible for compliance with Laws and Regulations”. [May 11 (5 Marks)]
Answer:
Management Responsibility for compliance with laws and regulations:
SA 250 “Consideration of Laws and Regulations in an audit of Financial Statements” states that it is the responsibility of management, with the oversight of TCWG, to ensure that the entity’s operations are conducted in accordance with the provisions of laws and regulations.
For this purpose, management may apply the following procedures:
(a) Monitoring legal requirements and ensuring that operating procedures are designed to meet these requirements.
(b) Instituting and operating appropriate systems of internal control.
(c) Developing, publicising and following a code of conduct.
(d) Ensuring employees are properly trained and understand the code of conduct.
(e) Monitoring compliance with the code of conduct and acting appropriately to discipline employees who fail to comply with it.
(f) Engaging legal advisors to assist in monitoring legal requirements.
(g) Maintaining a register of significant laws and regulations with which the entity has to comply within its particular industry and a record of complaints.

Question 2
What are the roles and responsibilities of the statutory auditor in relation to compliance with the laws and regulations by the entity?
Answer:
Role & Responsibilities of Statutory Auditor in relation to compliance of Laws and Regulations:
The auditor shall obtain a general understanding of:
(a) The legal and regulatory framework applicable to the entity and the industry or sector in which the entity operates; and
(b) How the entity is complying with that framework?

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

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

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

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

Question 3.
State briefly the reporting requirements as per SA 250 on non-compliance with laws and regulations.
Answer:
Reporting requirements as per SA 250 on Non-Compliance with laws and regulations:
(a) Reporting to TCWG:

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

(b) Reporting in Auditor’s Report:

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

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

Question 4.
With reference to SA 250 give some example or matters indicating to the auditor about non-compliance of laws and regulations by management. [Nov. 13 (8 Marks)]
Or
As an auditor what are the indicators you would consider while verifying compliance with laws and regulations?
Answer:
Indicators to be considered for verifying compliance with laws and regulations:
SA 250 “Consideration of Laws and Regulations in an audit of Financial Statements” deals with the auditor’s responsibilities to consider laws and regulations when performing an audit. To verify the compliance of laws and regulations, auditor is required to consider the following indicators:

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

Question 5.
Compare and explain the following: Reporting to Shareholders vs. Reporting to TCWG.
Answer:
Reporting to Shareholders vs. Reporting to those charged with Governance:

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

Question 6.
Explain the various matters that are required to be communicated by the auditor to TCWG.
Answer:
Matters to be communicated to TCWG:
SA-260 “Communication with Those Charged with Governance” provides that the auditor shall communicate with TCWG the followings:

(a) Auditor’s Responsibilities in relation to the Financial Statement Audit: The auditor shall communicate with TCWG that:

The auditor is responsible for forming and expressing an opinion on the F.S.; and
The audit of the F.S, does not relieve management or TCWG of their responsibilities.

(b) Planned Scope and timing of Audit: It may include:
How the auditor proposes to address the significant risks of material misstatements, whether due to fraud or error?

How the auditor plans to address areas of higher assessed RMM?
Auditor’s approach to internal control.
Application of concept of materiality.

(c) Significant Findings from the audit: The auditor shall communicate with TCWG:
The auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and F.S. disclosures.

Significant difficulties, if any, encountered during the audit;
Circumstances that affect the form and content of the auditor’s report, if any; and
Any other significant matter that in the auditor’s professional judgment, are significant to the oversight of the financial reporting process.

(d) Auditor’s Independence: required in case of listed entities.

Question 7.
The auditor evaluated, in respect of T Ltd., whether the financial statements are prepared in accor¬dance with the requirements of the applicable financial reporting framework.
Auditor’s evaluation included consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s judgments.
Advise the qualitative aspects of the entity’s accounting practices. [MTP-MarcK 18, RTP-May 18, MTP-March 19]
Answer:
Qualitative Aspects of entity’s accounting practices:
SA 260 “Communication with those charged with Governance” requires the auditor to communicate with the TCWG various matters, including therein is the auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and F.S. disclosures. In this reference, SA 260 explains the following:

When applicable, the auditor shall explain to TCWG why the auditor considers a significant accounting practice, that is acceptable under the applicable FRF, not to be most appropriate to the particular circumstances of the entity.
FRF ordinarily allow the entity to make accounting estimates, and judgments about accounting policies and financial statement disclosures, for example, in relation to the use of key assumptions in the development of accounting estimates for which there is significant measurement uncertainty.
In considering the qualitative aspects of the entity’s accounting practices, the auditor may become aware of possible bias in management’s judgments.
The auditor may conclude that lack of neutrality together with uncorrected misstatements causes the financial statements to be materially misstated. Indicators of a lack of neutrality include the following:
- The selective correction of misstatements brought to management’s attention during the audit
- Possible management bias in the making of accounting estimates.
  SA 540 addresses possible management bias in making accounting estimates. Indicators of possible management bias do not constitute misstatements for purposes of drawing conclusions on the reasonableness of individual accounting estimates. They may, however, affect the auditor’s evaluation of whether the financial statements as a whole are free from material misstatement.

Question 8.
In considering the qualitative aspects of the entity’s accounting practices, the auditor may become aware of possible bias in management’s judgments. The auditor may conclude that lack of neutrality together with uncorrected misstatements causes the financial statements to be materially misstated. Explain and analyse the indicators of lack of neutrality with examples, wherever required. [RTP-May 20]
Answer:
Qualitative Aspects of entity’s accounting practices:
In considering the qualitative aspects of the entity’s accounting practices, the auditor may become aware of possible bias in management’s judgments. The auditor may conclude that lack of neutrality together with uncorrected misstatements causes the financial statements to be materially misstated. Indicators of a lack of neutrality include the following:
(i) The selective correction of misstatements brought to management’s attention during the audit.
Example
(a) Correcting misstatements with the effect of increasing reported earnings, but not correcting misstatements that have the effect of decreasing reported earnings.
(b) The combination of several deficiencies affecting the same significant account or disclosure (or the same internal control component) could amount to a significant deficiency (or material weakness if required to be communicated in the jurisdiction). This evaluation requires judgment and involvement of audit executives.

(ii) Possible management bias in the making of accounting estimates.

Question 9.
Discuss with reference to SAs: The auditor shall communicate all significant findings with those charged with Governance. [May 13 (5 Marks)]
Answer:
Communicating Significant Finding to TCWG:
SA 260 “Communication with those charged with Governance” deals with auditor’s responsibilities to communicate with TCWG in an audit of financial statements.
As per SA 260, auditor should communicate all significant findings with the TCWG, stated as below:

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

Question 10.
State the significant difficulties encountered during audit with reference to SA 260. [May 15 (6 Marks)]
Answer:
Significant difficulties encountered during audit:
SA 260 “Communication with those charged with Governance” deals with auditor’s responsibilities to communicate with TCWG in an audit of financial statements.
As per SA 260 among other things auditor should communicate significant difficulties to the TCWG. Examples of significant difficulties to be communicated are:

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

Question 11.
Write short note on: Factors governing modes of communication of auditor with those charged with governance. [Nov. 10 (4 Marks)]
Or
“As per SA 260, auditor is required to communicate with TCWG various matters significant to audit1’. In this reference explain various forms of communication and factors affecting mode of communication.
Answer:
Forms of Communication and Factors governing mode of communication:
SA 260 deals with the auditor’s responsibility to communicate with those charged with governance in relation to an audit of financial statements. Accordingly, various forms of communication may be classified as:

Oral or written;
Detail or summarized;
Structured or unstructured.

The auditor shall communicate in writing with TCWG regarding significant matters, from the audit when, in the auditor’s professional judgment, oral communication would not be adequate.

Factors affecting mode of Communication:

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

Question 12.
What do you mean by deficiencies in Internal Control? Explain various indicators of Significant deficiencies.
Answer:
Deficiencies in Internal Control:
SA 265 “Communicating Deficiencies in internal control to those charged with Governance and Management” states that deficiency in internal control exists when:
(a) A control is designed, implemented or operated in such a way that it is unable to prevent, or detect and correct, misstatements in the financial statements on a timely basis; or
(b) A control necessary to prevent, or detect and correct, misstatements in the financial statements on a timely basis is missing.

Indicators of Significant Deficiencies:

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

Question 13.
Write short note on: Written communication in respect of deficiencies of internal control. [Nov. 16 (4 Marks)]
Answer:
Written communication in respect of deficiencies of internal control:
The auditor shall communicate material weaknesses in internal control identified during the audit on a timely basis to management at an appropriate level of responsibility, and, as required by SA 260 “Communication with those charged with Governance”. This communication should be, preferably, in writing through a letter of weakness. Important points with regard to such a letter are as follows:
(a) It lists down the area of weaknesses in the internal control system and recommends suggestions for improvement.
(b) It should clearly indicate that this letter covers only weaknesses which have come to the attention of the auditor during his evaluation of internal control for the purpose of determining nature, timing and extent of further audit procedures.
(c) Letter should dearly indicate that his examination of internal control has not been designed to determine the adequacy of internal control for management.
(d) This letter serves as a significant means for management and governing body for the purpose of improving the system and its strict implementation.
(e) The letter may also serve to minimize legal liability in the event of a major defalcation or other loss resulting from a weakness in internal control.

Question 14.
“As per SA 402, the user auditor shall obtain an understanding of how user entity uses the services of a service organization in the user entity operations”. Explain the various matters of which understanding is required.
Answer:
Matters of which understanding is required by user auditor w.r.t. services of a services organization:
As per SA 402 “Audit Considerations relating to an entity using service organization” the user auditor is required to obtain an understanding of how user entity uses the services of a service organization in the user entity operation, including:
(a) Nature of service provided by the service organization and the significance of those services to the user entity.
(b) The nature and materiality of the transactions processed or financial reporting processes affected by service organizations.
(c) The degree of interaction between activities of service organizations and those of the user entity,
(d) The nature of relationship between user entity and the service organization.

Question 15.
In the course of audit of R Ltd. the audit manager of ABC & Co. observed that R Ltd. has outsourced certain activities to an outsourcing agency. As the engagement partner guide the audit manager in the assessment of services provided by the outsourcing agency in relation to the audit.
Answer:
Assessment of services provided by the outsourcing Agencies:
SA 402 “Audit Considerations relating to an entity using service organization”deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organisations. The auditor responsibility in this regard as per SA 402 includes the following:
1. Evaluate the design and implementation of relevant controls of user entity that relate to the services provided by service organization.

2. Determine whether a sufficient understanding of nature and significance of services provided by service organization and their effect on the user entity internal control relevant to the audit has been obtained, to provide basis for identification and assessment of risk of Material Misstatement.

3. If user auditor is unable to obtain a sufficient understanding from the user entity, the user auditor shall obtain that understanding from one or more of following procedures:
(a) Obtaining a Type 1 or Type 2 Report, if available.
(b) Contacting the service organization, through the user entity, to obtain the sufficient information.
(c) Visiting the service organization.
(d) Using another auditor to perform procedures that will provide the necessary information about the relevant controls at the service organization.

Question 16.
Explain the various causes of misstatement.
or
In the course of audit of T Ltd., the audit team is not sure of the possible source of misstatements in the financial statements. As the audit manager identify the sources of misstatements.
Answer:
Causes of Misstatement:
SA 450 “Evaluation of Misstatements identified during the Audit” deals with the auditor’s responsibilities to evaluate the effect of identified misstatements on the audit.

Misstatement may be defined as a difference between the amounts, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be in accordance with the applicable financial reporting framework. Misstatements can arise from error or fraud.

Causes of Misstatement: Misstatements may result from:

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

Question 17.
Discuss the impact of uncorrected misstatements identified during the audit and the auditor’s response to the same
Answer:
Impact of uncorrected misstatements identified during the audit:
SA 450 “Evaluation of Misstatements identified during the audit” deals with the auditor’s responsibility to evaluate the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements.

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

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

Prior to evaluating the effect of uncorrected misstatements, the auditor shall reassess materiality determined in accordance with SA 320, to confirm whether it remains appropriate in the context of the entity’s actual financial results.

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

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

Question 18.
What are accounting estimates according to SA 540? Give Examples.
Or
“Accounting estimate means an approximation of a monetary amount in the absence of a precise means of measurement”. Discuss explaining the accounting estimates according to SA-540.
Answer:
Accounting Estimates:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and related disclosures” defines an accounting estimate as “an approximation of a monetary amount in the absence of a precise means of measurement”. This term is used for an amount measured at fair value where there is estimation uncertainty. The degree of estimation uncertainty affects the risks of material misstatement of accounting estimates.

Examples of Accounting Estimates:

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

Examples of Fair Value Accounting Estimates:

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

Question 19.
“Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements whereas for some accounting estimates there may be rela¬tively high estimation uncertainty particularly where they are based on significant assumptions”. Explain by giving examples.
Or
With reference to the Standards on Auditing state the example of accounting estimates that may have a high estimation uncertainty.
Answer:
Examples of Accounting estimates having high estimation uncertainty:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and related disclosures” defines an accounting estimate as “an approximation of a monetary amount in the absence of a precise means of measurement”. This term is used for an amount measured at fair value where there is estimation uncertainty. The degree of estimation uncertainty affects the risks of material misstatement of accounting estimates.

Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements. For some accounting estimates, however, there maybe relatively high estimation uncertainty, particularly where they are based on significant assumptions, for example:

Accounting estimates relating to the outcome of litigation.
Fair value accounting estimates for derivative financial instruments not publicly traded.
Fair value accounting estimates for which a highly specialised entity-developed model is used or for which there are assumptions or inputs that cannot be observed in the marketplace.

Additional Examples of Fair Value Accounting Estimates are:

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

Question 20.
While auditing X Ltd, you observe certain material financial statement assertions have been based on estimates made by the management. As an auditor how do you identify and assess risk of material misstatement?
Answer:
Identification and assessment of Risk of Material Misstatement when financial statement assertions are based on estimates made by management:

SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and related disclosures deals with auditor’s responsibilities regarding accounting estimates.

In order to identify and assess risk of material misstatements for accounting estimates, the auditor
shall obtain an understanding of the following:

(a) The requirements of the applicable financial reporting framework.

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

The method, including where applicable the model used in making the accounting estimates.
Relevant controls
Where management has used an expert?
Where there has been or ought to have been a change from the prior period in the methods for making the accounting estimates, and if so why? and
Whether and if so, how the management has assessed the effect of estimation uncertainty?

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

Question 21.
What are the factors that may influence the degree of estimation uncertainty associated with an accounting estimate?
Answer:
Factors Influencing Degree of Estimation Uncertainty:
SA 540 “Auditing Accounting Estimates, including Fair Value Accounting Estimates and related disclosures deals with auditor’s responsibilities regarding accounting estimates. Accordingly. The degree of estimation uncertainty associated with an accounting estimate may be influenced by factors such as-

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

Question 22.
Discuss the following: Relationship between Statutory Auditor and Internal Auditor. [Nov. 16 (4 Marks)]
Answer:
Relationship between Statutory Auditor and Internal Auditor:
SA 610 “Using the work of Internal auditors” deals with the external auditor’s responsibilities regarding the work of internal auditors when the external auditor has determined, in accordance with SA 315 that the internal audit function is likely to be relevant to the audit.
With respect to relationship between statutory auditor and internal auditor, SA 610 provides the following:

(a) The role and objectives of the internal audit function are determined by management and, where applicable, those charged with governance. While the objectives of the internal audit function and the external auditor are different, some of the ways in which the internal audit function and the external auditor achieve their respective objectives may be similar.

(b) Irrespective of the degree of autonomy and objectivity of the internal audit function, such function is not independent of the entity as is required of the external auditor when expressing an opinion on financial statements.

(c) Therefore, the external auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the external auditor’s use of the work of the internal auditors.

Question 23.
Explain the activities of Internal Audit Function,
Answer:
Activities of Internal Audit Function:
As per SA 610 “Using the work of Internal Auditor” the activities of the internal audit function may
include one or more of the following:
1. Activities Relating to Governance: Internal audit function may assess the governance process in its accomplishment of objectives on ethics and values, accountability and communicating risk to appropriate areas of the organization.

2. Activities Relating to Risk Management: Internal audit function may assist the entity by identifying and evaluating significant exposures to risk and contributing to the improvement of risk management and internal control (including effectiveness of the financial reporting process).

3. Evaluation of internal control: Internal audit function may be assigned specific responsibility for reviewing controls, evaluating their operation and recommending improvements thereto.

4. Examination of financial and operating information: Internal audit function maybe assigned to review the means used to identify, recognize, measure, classify and report financial and operating information, and to make specific inquiry into individual items, including detailed testing of transactions, balances and procedures.

5. Review of operating activities: The internal audit function may be assigned to review the economy, efficiency and effectiveness of operating activities, including non-financial activities of an entity.

6. Review of compliance with laws and regulations: Internal audit function may be assigned to review compliance with laws, regulations and other external requirements, and with management policies and directives and other internal requirements.

Question 24.
You have been appointed auditor of a large Industrial Company which has an established Internal Audit Department. You are required to state the main aspects that would be considered to find out effectiveness of the department.
or
Can the external auditor rely on the work of internal auditor?
or
Discuss with reference to SAs: “The degree of reliance that a Statutory Auditor can place on the work of the Internal Auditor is a matter of individual judgment”. [Nov. 14 (8 Marks)]
Answer:
Aspects to be considered to evaluate the effectiveness of Internal Audit Department:
SA 610 ” Using the work of Internal auditors” deals with the external auditor’s responsibilities regarding the work of internal auditors when the external auditor has determined, in accordance with SA 315 that the internal audit function is likely to be relevant to the audit.
For this purpose, external auditor is required to evaluate the following:

(a) Objectivity of Internal Auditor: Objectivity refers to the ability to perform without allowing bias to override professional judgments. Factors that may affect the external auditor’s evaluation include the following:

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

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

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

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

Existence, adequacy and use of documented internal audit procedures.
Existence of appropriate quality control policies and procedures for internal audit function.
The degree of reliance that a statutory auditor can place on the work done by the internal auditor is a matter of individual judgment in a given set of circumstances. The ultimate responsibility for reporting on the financial statements is that of the statutory auditor. It must be clearly understood that the statutory auditor’s responsibility is absolute and any reliance he places upon the internal audit system is part of his audit approach or technique and does not reduce his sole responsibility.

Question 25.
Mr. A was appointed as statutory auditor of X Ltd. X Ltd. has an internal audit system and Mr. A is of the opinion that internal auditors can be used to provide direct assistance for the purpose of statutory audit. Advise Mr. A whether he can take direct assistance of internal auditor and if yes, what are the precautions he need to take.
Answer:
Using direct assistance of internal auditor:
As per SA 610 “Using the Work of Internal Auditor” statutory auditor can take direct assistance of internal auditor subject to following conditions:

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

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

2. Prior to using internal auditors to provide direct assistance for purposes of the audit, the external auditor shall:
(a) Obtain written agreement from an authorized representative of the entity that the internal auditors will be allowed to follow the external auditor’s instructions, and that the entity will not intervene in the work the internal auditor performs for the external auditor; and
(b) Obtain written agreement from the internal auditors that they will keep confidential specific matters as instructed by the external auditor and inform the external auditor of any threat to their objectivity.

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

Question 26.
While doing audit, Ram, the Auditor requires reports from experts for the purpose of audit evi¬dence. What types of reports/opinions he can obtain and to what extent he can rely upon the same?
Or
List the matters in respect of which auditor’s can use the work of auditor’s expert.
Answer:
Matters where auditor can use the work of Auditor’s Expert:
SA 620 “Using the work of an Auditor’s Expert” the matters where the auditor can use the expert work are listed below:
(a) The valuation of complex financial instruments, land and buildings, plant and machinery, jewellery, works of art, antiques, intangible assets, assets acquired and liabilities assumed in business combinations and assets that may have been impaired.
(b) The actuarial calculation of liabilities associated with insurance contracts or employee benefit plans.
(c) The estimation of oil and gas reserves.
(d) The valuation of environmental liabilities, and site clean-up costs.
(e) The interpretation of contracts, laws and regulations.
(f) The analysis of complex or unusual tax compliance issues.

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

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

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

Question 27.
What are the factors that may influence the auditor’s decision on whether to use an auditor’s expert, when management has used a management’s expert in preparing the financial statements?
Answer:
Factors influencing the auditor’s decision w.r.t. use of AE when management had used a management expert:

SA 620 “Using the work of Auditor’s Expert” deals with the auditor’s responsibilities regarding the
use of an auditor’s expert. Accordingly, factors influencing the auditor’s decision w.r.t. use of AE
when management had used a management expert are:

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

Question 28.
What are the procedures to be followed by a statutory auditor for verifying the provisions for accrued liability for retirement benefits which is based on a certificate of a reputed actuary engaged by the auditor for the purpose?
Or
Explain the procedures to be performed for evaluating the work of auditor’s expert.
Answer:
Procedures to be followed for evaluating the work of Auditor’s Expert:
SA 620 “Using the work of Auditor’s Expert” deals with the auditor’s responsibilities regarding the use of an auditor’s expert, The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including:
(a) The relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence;
(b) If that expert’s work involves use of significant assumptions and methods, the relevance and reasonableness of those assumptions and methods in the circumstances; and
(c] If that expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data.

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

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

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

Question 29.
State your views on reference to an expert in the Auditor’s report.
Answer:
Reference of Expert in Auditor’s Report:
(a) SA 620 “Using the work of an Auditor’s Expert” deals with the auditor’s responsibilities regarding the use of an individual or organisation’s work in a field of expertise other than accounting or auditing, when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence.

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

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

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

Question 30.
SA 720 requires the auditor to read and consider the other information because other information that is materially inconsistent with the F.S. or the auditor’s knowledge obtained in the audit may indicate that there is a material misstatement of the F.S. or that a material misstatement of the other information exists, either of which may undermine the credibility of the F.S. and the auditor’s report thereon. Explain the meaning of the term Other Information and state the requirements of SA 720 as to obtaining and considering the other information.
Answer:
Other Information and Requirements of SA 720:
SA 720 “The Auditor’s Responsibilities relating to Other Information” deals with the auditor’s responsibilities relating to Other Information, whether financial or non-financial information included in an entity’s annual report. SA 720 defines the term other information as Financial or non-financial information (other than F.S. and the auditor’s report thereon) included in an entity’s annual report.

Requirements of SA 720 as to obtaining the other information:
The auditor shall:
(a) Determine, through discussion with management, which documents comprises the annual report, and the entity’s planned manner and timing of the issuance of such documents;

(b) Make appropriate arrangements with management to obtain in a timely manner and, if possible, prior to the date of the auditor’s report, the final version of the documents comprising the annual report; and

(c) When some or all of the documents determined above will not be available until after the date of the auditor’s report, request management to provide a written representation that the final version of the documents will be provided to the auditor when available, and prior to its issuance by the entity, such that the auditor can complete the procedures required by this SA.

Requirements of SA 720 as to considering the Other information:
The auditor shall read the other information and, in doing so shall:
(a) Consider whether there is a material inconsistency between the other information and the financial statements. As the basis for this consideration, the auditor shall, to evaluate their consistency, compare selected amounts or other items in the other information (that are intended to be the same as, to summarize, or to provide greater detail about, the amounts or other items in the financial statements) with such amounts or other items in the financial statements; and

(b) Consider whether there is a material inconsistency between the other information and the auditor’s knowledge obtained in the audit, in the context of audit evidence obtained and conclusions reached in the audit.
While reading the other information, the auditor shall remain alert for indications that the other information not related to the financial statements or the auditor’s knowledge obtained in the audit appears to be materially misstated.

Question 31.
Comment on the following: While reading the other information, auditor finds certain misstatement of other information. Explain the requirement of relevant SA w.r.t. Auditor’s responses in such a situation.
Answer:
Auditor’s responses on a material misstatement in the Other Information:
SA 720 “The Auditor’s Responsibilities relating to Other Information” deals with the auditor’s responsibilities relating to Other Information, whether financial or non-financial information included in an entity’s annual report.

If the auditor concludes that a material misstatement of the other information exists, the auditor shall request management to correct the other information. If management:
(a) Agrees to make the correction, the auditor shall determine that the correction has been made; or
(b) Refuses to make the correction, the auditor shall communicate the matter with TCWG and request that the correction be made.

If the auditor concludes that a material misstatement exists in other information obtained prior to the date of the auditor’s report, and the other information is not corrected after communicating with TCWG, the auditor shall take appropriate action, including:
(a] Considering the implications for the auditor’s report and communicating with TCWG about how the auditor plans to address the material misstatement in the auditor’s report,
(b) Withdrawing from the engagement, where withdrawal is possible under applicable law or regulation.

If the auditor concludes that a material misstatement exists in other information obtained after the date of the auditor’s report, the auditor shall:
(a) If the other information is corrected, perform the procedures necessary in the circumstances; or
(b) If the other information is not corrected after communicating with TCWG, take appropriate action considering the auditor’s legal rights and obligations, to seek to have the uncorrected material misstatement appropriately broughtto the attention ofusers for whom the auditor’s report is prepared.

Objective Questions (Correct/Incorrect – True/False)

Question 1.
The scope of work of an internal auditor may extend even beyond the financial accounting.
Answer:
Statement is correct.
As per SA 610 “Using the Work of Internal Auditor” the scope of internal audit function may include:

Monitoring of internal control
Examination of financial & operating information
Review of operating activities
Review of compliance with laws & regulations
Risk management
Governance

Question 2.
AAS-24 (SA 402) deals with responsibility of the auditor of the service organisation. [May 08 (2 Marks)]
Answer:
Statement is Incorrect, SA402 “Audit Considerations relating to an entity using Service Organisation” deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organisations.

Question 3.
An expert for the purpose of AAS-9 (SA 620) is a person, firm or association of persons possessing special skill, knowledge and experience in auditing. [May 08 (2 Marks)]
Answer:
Statement is incorrect, an expert for the purpose of SA 620 “Using the work of Auditor’s Expert” an expert is an individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence.

Question 4.
AAS-9 (SA 620) is applicable when an auditor seeks legal opinion from an advocate. [Nov. 07 (2 Marks)]
Answer:
Statement is correct, SA 62 0 “Using the work of Auditor’s Expert” deals with the auditor’s responsibilities regarding the use of an individual or organisation’s work in a field of expertise other than accounting or auditing, when that work is used to assist the auditor in obtaining sufficient appropriate audit evidence.

Question 5.
The auditor, in the interest of the users, while explaining the nature of his reservation, can describe the work of the expert with his name, in the audit report without obtaining prior consent of the expert. [Nov. 09(2 Marks)]
Answer:
Statement is incorrect.
As per SA 620 “Using the work of Auditor’s Expert” it maybe appropriate in some circumstances to refer to the auditor’s expert in an auditor’s report containing a modified opinion, to explain the nature of the modification. In such circumstances, the auditor may need the permission of the auditor’s expert before making such a reference.

Question 6.
An Auditor’s external expert is not subjected to quality control policies and procedures of an audit firm. [Nov. 14 (2 Marks)]
Answer:
Statement is correct.
SA 620 “Using the work of an Auditor’s expert” states that an auditor’s external expert is not a member of the engagement team and is not subject to quality control policies and procedures.

Standards on Auditing – CA Inter Auditing Notes

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