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Auditing and Assurance

Q-1

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

As the audit manager had dealt with Wisdom Ltd. for so many years, the other partners have decided to leave the audit of Wisdom Ltd. in his capable hands. Comment on the situation outlines above.

A-1

Quality Control Issues on an engagement: Several quality control issues are raised in the scenario:

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

The lack of an audit engagement partner also means that several of the requirements of SA 220 on “Quality Control for an Audit of Financial Statement”, about ensuring that engagements in relation to independence and directing, supervising and reviewing the audit are not in place.

Conflicting Views: In this scenario the audit manager and senior have conflicting views about the valuation of inventory. This does not appear to have been handled well, with the manager refusing to discuss the issue with the senior.

SA 220 on “Quality Control for an Audit of Financial Statement”, requires that the audit engagement partner takes responsibility for settling disputes in accordance with the firm’s policy in respect of resolution of difference of opinion required by SQC 1” Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements”. In this case, the lack of engagement partner may have contributed to this failure to resolve the disputes. In any event, at best, the failure to resolve the difference of opinion is a breach of the firm’s policy under SQC 1. At worst, it indicates that the firm does not have a suitable policy concerning such disputes required by SQC.1 “Quality Control for Firms that Perform Audits and Reviews of Historical Financial Information, and Other Assurance and Related Services Engagements”.

Q-2

Intelligent Ltd. entered into an agreement with Mr. Intellectual on 15th March, 2016, whereby it agreed to pay him ` 2 lakhs per month as retainership fee for consultation in IT department. However, no amount was actually paid and ` 24 lakhs was provided in the Statement of Profit and Loss for the year ending on March 31st, 2016.

Management of the company uttered that need-based consultation was obtained throughout the year. However, on investigation, no documentary or other evidence of receipt of such service was found. As the auditor of Innocent Ltd., what would be your approach?

A-2

Fraud Committed by Management of the Company: As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, fraud can be committed by management overriding controls using such techniques as recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives.

In the given case, Intelligent Ltd. has entered into an agreement with Mr. Intellectual, at year-end, for consultation in IT department. It also charged yearly fee of ` 24 lakhs in the Statement of Profit and Loss, however, no documentary or other evidence of receipt of such service was found, on investigation . It is clear that company has passed fictitious journal entries, near year-end, to manipulate the operating results.

Accordingly, the auditor would adopt the approach which will be based on the result of misstatement on the basis of such fictitious journal entry, i.e. if, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall determine the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities; or the auditor may consider for appropriateness of withdrawal from such engagement, where withdrawal from the engagement is legally permitted.

In addition, the auditor is required to report according to section 143(12) of the Companies Act, 2013. As per Section 143(12), if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the audit committee within 2 days of his knowledge (as amount involved is less than one crore rupees) and after following the prescribed procedure such as reporting on :

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

Q-3

In the course of audit of Zed Ltd, its auditor wants to rely on audit evidence obtained in previous audit in respect of effectiveness of internal controls instead of retesting the same during the current audit. As an advisor to the auditor kindly caution him about the factors that may warrant a re-test of controls.

A-3

As per SA 330 on “The Auditor’s Responses to Assessed Risks”, changes may affect the relevance of the audit evidence obtained in previous audits such that there may no longer be a basis for continued reliance.

The auditor’s decision on whether to rely on audit evidence obtained in previous audits for control is a matter of professional judgment. In addition, the length of time between retesting such controls is also a matter of professional judgment.

Factors that may warrant a re-test of controls are-

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

Deficient general IT-controls

Q-5

De-garments Ltd. is a retailer of fashion accessories. It has a turnover of ` 54 million and 150 shops throughout the India. It also has six regional warehouses from which the shops are supplied with goods.

The company has an internal audit department which is based at the company’s head office in Delhi. Internal auditors make regular visits to the shops and warehouses.

This is the first year that your firm has acted as auditor for De-garments Ltd. The partner in charge of the audit has expressed his opinion that the internal audit department might be able to assist the external audit team in carrying out its work.

Requirements

(a) State, with reasons, the information that you would require to make an assessment of the likely effectiveness and the relevance of the internal audit function.

Describe four typical procedures that might be carried out by the internal auditors during their visits to the shops and warehouses and on which you might wish to rely.

Assuming that you intend to rely on the work of the internal audit department of De-garments Ltd., describe briefly the effect this will have on your audit of company’s financial statements.

A-5

Information	Reason
The organizational status and reporting responsibilities of the internal auditor and any constraints and restrictions thereon	The degree of objectivity is increased when internal audit : - is free to plan and carry out its work and communicate fully with the external auditor - has access to the highest level of management
Areas of responsibility assigned by management to internal audit, such as review of - Accounting systems and internal controls - Implementation of corporate plans	Not all areas in which internal audit may operate will be relevant to the external auditor. - (Relevant - (Not relevant)
Routine tasks carried out by internal audit staff such as authorization of petty cash reimbursements.	In these respects staff are not functioning as internal audit, they are working simply as an internal control.
Internal auditors formal terms of reference	Internal auditor’s role will be most relevant where it: -Has a bearing on the financial statements. - Involves a specialization
Internal audit documentation such as an audit manual and audit plans	It is more likely that due professional care is being exercised where the work of internal audit is properly planned, controlled, recorded and reviewed.
Professional membership and practical experience (including computer auditing skills) of internal audit staff.	Unless internal audit is technically competent it is inappropriate to place reliance on it.
Internal audit reports generated and feedback thereon.	How the company responds to internal audit findings may be regarded as a measure of the department’s effectiveness.
Number of staff, computer facilities and any other resources available to internal audit.	The effectiveness of internal audit (and hence the reliance placed thereon) will be limited if the department is under resourced

(b)Typical procedures

Inspection of tangible non-current assets: Assets seen at the warehouses (e.g. delivery vehicle fleet) should be noted and subsequently agreed to the fixed asset register maintained at head office (HO). Assets recorded in the register (e.g. shop fixtures and fittings) should be selected for inspection prior to visits to ensure their existence.
Attendance at inventory counts: Periodic counts (eg monthly) should be attended on a rotational basis at warehouses and larger shops to ensure adherence to the company’s procedures. Test counts should be made to confirm the accuracy and completeness of the inventory counts
Cash: Cash counts should be carried out on each register takings (and petty cash floats) whenever shops (and warehouses) are visited on a ‘surprise’ basis.
Goods despatch: Internal control procedures should be observed to be in operation, for example to ensure that all dispatches are documented and destined for the company’s retail outlets.
Employee verification: Payroll procedures are likely to be carried out at HO, warehouses and shops informing HO on a weekly basis of hours worked by employees, illness and holiday etc. However, new employees, especially in the shops (and probably also in the warehouses) will be recruited locally and their details notified to HO.

Internal audit will be able to select a sample of employees from HO records and ensure on the visits to shops and warehouses’ that these represent bona fide employees.

(c)Effect on audit

Systems documentation: The accuracy of systems documentation which has been prepared by internal audit need only be confirmed using ‘walk-through tests’. This saves time (if the systems documentation is correct) since only copies will be required for the audit file.
Tests of controls: The level of independent testing (i.e. by the external auditor) can be reduced where controls have been satisfactorily tested by internal audit, especially if error rates are found to be similar. In particular, attendance at stocktaking at the year end may be limited to those locations with the highest stockholdings.
Substantive procedures: Internal audit’s evidence (e.g. concerning the existence of tangible non-concern assets), will reduce sample sizes for year end verification work. Substantive procedures may also be reduced where the internal audit checks reconciliations’ (e.g. of supplier’s statements to ledger balances, receivable and payables control accounts and bank reconciliations.)

Q-6

You are a member of an audit team of RKP Associates, auditors of a Multinational Company YB Co. Ltd. The company is working in CIS environment. The partner in charge of RKP Associates asked you to draw out the audit plan for evaluating the reliability of controls.

A-6

Audit Plan for Evaluating the Reliability of Controls in CIS Environment: In evaluating the effects of a control, the auditor needs to assess the reliability by considering the various attributes of a control. Some of the attributes for example are that the control is in place and is functioning as desired, generality versus specificity of the control with respect to the various types of errors and irregularities that might occur, general control inhibit the effect of a wide variety of errors and irregularities as they are more robust to change controls in the application sub-system which tend to be specific control because component in these sub-system execute activities having less variety, that whether the control acts to prevent, detect or correct errors etc.

The auditor focuses here on-

Preventive controls: Controls which stop errors or irregularities from occurring.
Detective controls: Controls which identify errors and irregularities after they occur.
Corrective controls: Controls which remove the effects of errors and irregularities after they have been identified.

The auditors are expected to see a higher density of preventive controls at the early stages of processing or conversely they expect to see more detective and corrective controls later in system processing.

Further, while evaluating the reliability of controls, the auditor should:

Ensure that authorized, correct and complete data is made available for processing;
Provide for timely detection and correction of errors.
Ensure that the case of interruption in the work of the CIS environment due to power, mechanical or processing failures, the system restarts without distorting the completion of the entries and records;
Ensure that accuracy and completeness of output;
Provide adequate data security against fire and other calamities, wrong processing, frauds etc.,
Prevent unauthorized amendments to the program;
Provide for safe custody of source code of application software and data files.

Q-7

The method of collecting Audit evidence and evaluating the same changes drastically under CIS Environment”. – Comment.

A-7

Auditor must provide a competent, independent opinion as to whether the financial statements records and report a true and fair view of the state of affairs of an entity. However, computer systems have affected how auditors need to collect and evaluate evidence. These aspects are discussed below:

i) Changes to Evidence Collection - Collecting evidence on the reliability of a computer system is often more complex than collecting evidence on the reliability of a manual system. Auditors have to face a diverse and complex range of internal control technology that did not exist in manual system, like:

accurate and complete operations of a disk drive may require a set of hardware controls not required in manual system,
system development control include procedures for testing programs that again are not necessary in manual control.

Since, Hardware and Software develop quite rapidly, understanding the control technology is not easy. With increasing use of data communication for data transfer, research is focussed an cryptographic controls to project the privacy of data. Unless auditor's keep up with these developments, it will become difficult to evaluate the reliability of communication network competently.

The continuing and rapid development of control technology also makes it more difficult for auditors to collect evidence on the reliability of controls. Even collection of audit evidence through manual means is not possible. Hence, auditors have to run through computer system themselves if they are to collect the necessary evidence. Though generalized audit softwares are available the development of these tools cannot be relied upon due to lack of information. Often auditors are forced to compromise in some way when performing the evidence collection

ii) Changes to Evidence Evaluation - With increasing complexity of computer systems and control technology, it is becoming more and more difficult for the auditors to evaluate the consequences of strength and weaknesses of control mechanism for placing overall reliability on the system.

Auditors need to understand:

whether a control is functioning reliably or multi functioning,
traceability of control strength and weakness through the system. In a shared data environment a single input transaction may update multiple data item used by diverse, physically disparate user, which may be difficult to understand.

Consequences of errors in a computer system are a serious matter as errors in computer system tend to be deterministic, i.e., an erroneous program will always execute data incorrectly. Moreover, the errors are generated at high speed and the cost and effort to correct and rerun program may be high. Errors in computer program can involve extensive redesign and reprogramming. Thus, internal controls that ensure high quality computer systems should be designed implemented and operated upon. The auditors must ensure that these control are sufficient to maintain assets safeguarding, data integrity, system effectiveness and system efficiency and that they are in position and functioning.

Q-8

Fine Ltd. is engaged in the production of Jute. In January, 2012, the management of the company decided to expand its business and started manufacturing jute bags. For such expansion, it required fund of ` 80 lakhs which was financed from Good Bank. The loan was repayable in 10 equal yearly instalments (including interest) of ` 20 lakhs beginning from 31st March, 2012 onwards. The company was regular in payment of instalments till 31st March, 2015. Due to improvement in financial condition of the company, it decided for onetime settlement for its outstanding loan. Subsequently, Good Bank rescheduled the loan to ` 50 lakhs to be repaid in August, 2015.

The accountant of the company has disclosed the said loan under the head “Long- term Borrowings” in the Balance Sheet of the company for the financial year 2014- 15

As the auditor of Fine Ltd., kindly guide the management with regard to disclosure of such liabilities in accordance with Schedule III of the Companies Act, 2013?

A-8

required to be disclosed under the head “Other Current Liabilities” in the notes to accounts.

It may be noted that “Current Maturities of Long-Term Debt” refers to that portion of liabilities of a company that are becoming due in next 12 months. Since, these obligations are repayable in next 12 months, they are shifted from Long- Term Liabilities section of the Balance Sheet to Current Liabilities section.

In the given case, Fine Ltd. has taken a loan, from Good bank, of ` 80 lakhs, repayable in 10 equal yearly instalments (including interest) of ` 20 lakhs. The company has repaid its four instalments upto 31st March, 2015. Further, due to good financial condition of the company, it decided for its entire outstanding loan as on 31st March, 2015, to be repaid in August, 2015.

Thus, it is clear that the outstanding loan of ` 50 lakhs, taken from Good Bank, is repayable in next 12 months. However, the accountant of the company has disclosed the said loan under the head “Long-term Borrowings”. Therefore, the management of the company is advised to show the amount of outstanding loan under the head “Other Current Liabilities” and further classify it under sub- heading “Current Maturities of Long-Term Debt” of heading “Other Current Liabilities” in the notes to accounts.

Q-9

Amudha Ltd. is a Mumbai based company. The total turnover of the company is ` 10 crores for the year 2015-16. The company has a branch office at an area which was recently affected by flood. The transportation services are not available due to destruction caused by flood. The branch office recorded turnover of ` 1,50,000 in the Financial Year 2015-16. No audit of branch has been carried out. The statutory auditor of the company has made no reference of the above branch in his report. Comment

A-9

Branch Audit: As per section 143(8) of the Companies Act, 2013 if a company has a branch office, the accounts of that office shall be audited either by the auditor appointed for the company (herein referred to as the company's auditor) under this Act or by any other person qualified for appointment as an auditor of the company under this Act and appointed as such under section 139, or where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company's auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country.

In the given situation, Amudha Ltd. is a Mumbai based company, having total turnover of ` 10 Crore. The company is having a branch office at an area which is recently affected by flood.

Therefore, the company has to get its branch audited. In case no branch audit has been carried out, company’s auditor is required to mention this fact in the audit report and deal appropriately. Thus, no reference of above branch in statutory auditor’s report is not correct.

Q-10

R and H Associates, Chartered Accountants in practice have been appointed as Statutory Auditor of Krishna Ltd. for the accounting year 2015-2016. Mr. H, a partner of the R and H Associates, holds 100 equity shares of Shiva Ltd., a subsidiary company of Krishna Ltd.

A-10

Auditor Holding Securities of a Company : As per sub-section (3)(d)(i) of Section 141 of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. Provided that the relative may hold security or interest in the company of face value not exceeding rupees one lakh.

Also, as per sub-section (4) of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. H, Chartered Accountant, a partner of M/s R and H Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd. Therefore, the firm, M/s R and H Associates would be disqualified to be appointed as statutory auditor of Krishna Ltd. as per section 141(3)(d)(i), which is the holding company of Shiva Ltd., because Mr. H one of the partner is holding equity shares of its subsidiary.

Q-11

Rick Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by Central Government, 25% by Uttar Pradesh Government and 10% by Madhya Pradesh Government. Rick Ltd. appointed Mr. Remo as statutory auditor for the year

A-11

According to Section 139(7) of the Companies Act, 2013, the auditors of a government company shall be appointed or re-appointed by the Comptroller and

Auditor General of India. As per section 2(45), a Government company is defined as any company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company as thus defined”.

In the given case Ajanta Ltd is a government company as its 20% shares have been held by Central Government, 25% by U.P. State Government and 10% by M.P. State Government. Total 55% shares have been held by Central and State governments. Therefore, it is a Government company.

Rick Ltd. is a subsidiary company of Ajanta Ltd. Hence Rick Ltd. is covered in the definition of a government company. Therefore, the Auditor of Rick Ltd. can be appointed only by C & AG.

Consequently, appointment of Mr. Remo is invalid and he should not give acceptance to the Directors of Rick Ltd.

Q-12

Futura Ltd. appointed CA Innocent as an auditor for the company for the current financial year. Further the company offered him the services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors

A-12

Services not to be Rendered by the Auditor: Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:

accounting and book keeping services;
internal audit;
design and implementation of any financial information system;
actuarial services;
investment advisory services;
investment banking services;
rendering of outsourced financial services;
management services; and
any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualifies a person for appointment as an auditor of a company who is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

In the given case, CA Innocent was appointed as an auditor of Futura Ltd. He was offered additional services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors. The auditor is advised not to accept the services as these services are specifically notified in the services not to be rendered by him as an auditor as per section 144 of the Act.

Q-13

Mr. Abhar, a Chartered Accountant, bought a car financed at ` 7,00,000 by Chaudhary Finance Ltd., which is a holding company of Charan Ltd. and Das Ltd. He has been the statutory auditor of Das Ltd. and continues to be even after taking the loan.

A-13

According to section 141(3)(d)(ii) of the Companies Act, 2013, a person is not eligible for appointment as auditor of any company, If he is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of rupees five lakh.

In the given case Mr. Abhar is disqualified to act as an auditor under section 141(3)(d)(ii) as he is indebted to M/s Chaudhary Finance Ltd. for more than 5,00,000. Also, according to section 141(3)(d)(ii) he cannot act as an auditor of any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das Ltd. Therefore he has to vacate his office in Das Ltd. Even though it is a subsidiary of Chaudhary Finance Ltd.

Hence audit work performed by Mr. Abhar as an auditor is invalid, he should vacate his office immediately and Das Ltd should appoint another auditor for the company.

Q-14

CA Jack, a recently qualified practicing Chartered Accountant got his first audit assignment of Futura (P) Ltd. for the financial year 2014-15. He obtained all the relevant appropriate audit evidence for the items related to Statement of Profit and Loss. However, while auditing the Balance Sheet items, CA Jack left out obtaining appropriate audit evidence, say, confirmations, from the outstanding Accounts Receivable amounting ` 150 lakhs, continued as it is from the last year, on the affirmation of the management that there is no receipts and further credits during the year. CA Jack, therefore, excluded from the audit programme, the audit of accounts receivable on the understanding that it pertains to the preceding year which was already audited by predecessor auditor. Comment.

A-14

Verification of Accounts Receivable: As per SA 510 “Initial Audit Engagements – Opening Balances”, while conducting an initial audit engagement, the objective of the auditor with respect to opening balances is to obtain sufficient appropriate audit evidence about whether-
Opening balances contain misstatements that materially affect the current period’s financial statements; and
Appropriate accounting policies reflected in the opening balances have been consistently applied in the current period’s financial statements, or changes thereto are properly accounted for and adequately presented and disclosed in accordance with the applicable financial reporting framework.

When the financial statements for the preceding period were audited by another auditor, the current auditor may be able to obtain sufficient appropriate audit evidence regarding opening balances by perusing the copies of the audited financial statements.

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

For current assets and liabilities, some audit evidence about opening balances may be obtained as part of the current period’s audit procedures, say, the collection of opening accounts receivable during the current period will provide some audit evidence of their existence, rights and obligations, completeness and valuation at the beginning of the period.

In addition, according to SA 580 “Written Representations”, the auditor may consider it necessary to request management to provide written representations about specific assertions in the financial statements; in particular, to support an understanding that the auditor has obtained from other audit evidence of management’s judgment or intent in relation to, or the completeness of, a specific assertion. Although such written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own for that assertion.

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

Thus, CA Jack should have requested the management to provide written representation for their views and expressions; and he should also not exclude the audit procedure of closing balances of Accounts Receivable from his audit programme. Consequently, CA Jack shall also be held guilty for professional misconduct for not exercising due diligence, or grossly negligence in the conduct of his professional duties as per the Code of Ethics.

Q-15

M/s Sureshchandra & Co. has been appointed as an auditor of SC Ltd. for the financial year 2014-15. CA Suresh, one of the partners of M/s Sureshchandra & Co., completed entire routine audit work by 29th May, 2015. Unfortunately, on the very next morning, while roving towards office of SC Ltd. to sign final audit report, he met with a road accident and died. CA Chandra, another partner of M/s Sureshchandra & Co., therefore, signed the accounts of SC Ltd., without reviewing the work performed by CA Suresh. State with reasons whether CA Chandra is right in expressing an opinion on financial statements the audit of which is performed by another auditor.

A-15

Relying on Work Performed by Another Auditor: As per SA 220 “Quality Control for an Audit of Financial Statements”, an engagement partner taking over an audit during the engagement may apply the review procedures such as the work has been performed in accordance with professional standards and regulatory and legal requirements; significant matters have been raised for further consideration; appropriate consultations have taken place and the resulting conclusions have been documented and implemented; there is a need to revise the nature, timing and extent of work performed; the work performed supports the conclusions reached and is appropriately documented; the evidence obtained is sufficient and appropriate to support the auditor’s report; and the objectives of the engagement procedures have been achieved.

Further, one of the basic principles, which govern the auditor’s professional responsibilities and which should be complied with wherever an audit is carried, is that when the auditor delegates work to assistants or uses work performed by other auditor and experts, he will continue to be responsible for forming and expressing his opinion on the financial information. However, he will be entitled to rely on work performed by others, provided he exercises adequate skill and care and is not aware of any reason to believe that he should not have so relied. This is the fundamental principle which is ethically required as per Code of Ethics.

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

In the given case, all the auditing procedures before the moment of signing of final report have been performed by CA Suresh. However, the report could not be signed by him due to his unfortunate death. Later on, CA Chandra signed the report relying on the work performed by CA Suresh. Here, CA Chandra is allowed to sign the audit report, though, will be responsible for expressing the opinion. He may rely on the work performed by CA Suresh provided he further exercises adequate skill and due care and review the work performed by him.

Q-16

CA Ashutosh has been appointed as an auditor of Awesome Health Ltd. for the financial year 2013-14 which was audited by CA Amrawati in 2012-13. As the Auditor of Awesome Health Ltd., state the steps that CA Ashutosh would take to ensure that the Closing Balances of the financial year 2012-13 have been brought to account in 2013-14 as Opening Balances and the Opening Balances do not contain any misstatements

A-16

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

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

Being a new assignment, audit evidence regarding opening balances can be obtained by perusing the copies of the audited financial statements.

For current assets and liabilities, some audit evidence about opening balances may be obtained as part of the current period’s audit procedures. For example, the collection/ payment of opening accounts receivable/ accounts payable during the current period will provide some audit evidence of their existence, rights and obligations, completeness and valuation at the beginning of the period.

In respect of other assets and liabilities such as property plant and equipment, investments, long term debts, the auditor will examine the records relating to opening balances. The auditor may also be able to get the confirmation from third parties (e.g., balances of long term loan obtained from banks can be confirmed from the Bank Loan statement).

Q-17

A Company outsourced the activity of accounting data maintainance to the Service Organisation to achieve cost reduction. As a Statutory Auditor of such company, what are the precautions/checks that you would consider for conducting the audit?

A-17

Precautions to be taken by auditor in case Accounting Data Processed by Service Organisation: A client may use a service organisation such as one that executes transactions and maintains related accountability or records transactions and processes related data (e.g., a computer systems service organisation). If a client uses a service organisation, certain policies, procedures and records maintained by the service organisation might be relevant to the audit of the financial statements of the client. Consequently, the auditor would consider the nature and extent of activities undertaken by service organisations so as to determine whether those activities are relevant to the audit and, if so, to assess their effect on audit risk.

SA 402 on “Audit Considerations relating to an Entity Using a Service Organisation” deals with the user auditor’s responsibility to obtain sufficient appropriate audit evidence when a user entity uses the services of one or more service organisations.

While planning the audit, the auditor of the client should determine the significance of the activities of the service organisation to the client and their relevance to the audit. In doing so, the auditor of the client would need to consider the following, as appropriate:

The nature of the services provided by the service organisation and the significance of those services to the user entity, including the effect thereof on the user entity’s internal control.
The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organisation.
The degree of interaction between the activities of the service organisation and those of the user entity.
The nature of the relationship between the user entity and the service organisation, including the relevant contractual terms for the activities undertaken by the service organisation.

Q-18

You are the auditor of Vishakha Steel Pressing Limited, which manufactures small pressing from sheet-steel. The process generates scrap steel which is placed daily by the work force into a bin kept for that purpose in the yard. Every Friday a lorry arrives from a small local scrap merchant. The bin is loaded on to the lorry and replaced by an empty bin. The weight is obtained by the gatekeeper using the company weighbridge. He notes the weight in a book kept for that purpose in the gate office. Each month a cheque is received through the post from the scrap merchant accompanied by a remittance advice stating the weight of scrap collected, the price and the amount of the cheque. The cheque is banked by the cashier and the remittance advice is filed. There are no other procedures in this area:

You are required to:

a) Suggest major improvements to be made in the internal control in this area.

b) Suggest key audit procedures under these circumstances to mitigate audit risk

A-18

(a) Improvements to be made in the internal control in this area:

Ensure that all scrap is put into the bin by the work force. This can be achieved by documenting the scrap generated in every production lot/shift/day.
Check should be available that the merchant is paying the best prices for the scrap. This can be achieved by getting a quote periodically from few dealers or getting market price and validation.
Ensure that quantity collected is paid for this can be achieved by company quantity lifted with the amount paid/quantity for which payment is received.
An independent official should attend the weighing and the enter in the book.

(b) Key audit procedures under these circumstances to mitigate audit risk:

Budget figures should be prepared for waste and compared to actual waste and variance being investigated.
Compare remittance advices/related quantity and reconcile with the quantity in gate keeper’s book.
Ensure all entries in the weight book is paid for.
Ensure all remittance matching entries in the cash book.
Review the reasonableness of total scarp sold during the period by comparing with manufacturing records of steel used in processing.

Q-19

Zantacs, a limited company having turnover of approximately ` 80 crores uses a tailor made accounting software package. In the said package, all transactions are recorded, processed and the final accounts generated from the system. The management tells you that in view of the voluminous nature of day books, there is no need to print them and that audit can be conducted on the computer itself. The management further assures you that any 'query based reports' as required can be generated and printed. As a statutory auditor of the company, enumerate the procedures you would adopt to conduct the audit.

“The auditor must evaluate major clauses of control used in a Computerised Information system to enhance its reliability” – Comment.

A-19

A key feature of the accounting software package used by the company definitely involves the absence of a clear audit trail. In other words, transactions cannot be easily traced or co-related from the individual supporting documents of those transactions. Moreover, the management does not wish to print the daybooks in view of the voluminous nature since it may involve extensive costs. This has naturally led to extensive dependence by management upon the "exception reporting" principle.

From the auditor's point of view, it must also be conceded, the exception reports in the form of 'query-based reports' which isolate the above data provide him with the very material that he requires for most of his verification work. The only problem which it raises, and it is a serious one, is that he cannot simply assume that the programmes which produce the exception reports are reliable in respect of the following factors:

operating accurately;
printing out all the exceptions which exist; and
bound by programmed control parameters which meet the company's genuine internal control requirements.

In view of the above, whether management relies upon exception reports, it effectively eliminated the audit trail between input and output and the auditor is forced to test the invisible processes which purport to embody the controls, and produce the output such as it is. These tests, which invariably involve the use by the auditor of the computer itself, are known as tests through the machine. In the 'through the machine' approach, the auditor starts by proving the accuracy of the input data, and then thoroughly examines (by applying tests) the processing procedures with a view to establishing the following that:

all input is actually entered into the computer.
neither the computer nor the operators can cause undetected irregularities in the final reports.
the programmes appear, on the evidence of rejection and exception routines, to be functioning correctly.
all operator intervention during processing is logged and scrutinised by the DP manager.

The auditor in such circumstances will have to first evaluate the existing controls. For the same, he has to do the following:

Evaluate the internal control system especially the controls and checks existing for recording the transactions, i.e., he has to verify at what level transactions can be entered into the system and what checks are available to prevent any unauthorised data entry and for rectifying errors/omissions in the transactions entered.
Evaluate at what level there authority is given for modification of transactions already entered. Is there any authority given only to a senior employee to carry out modifications? Or is it that once transactions are entered and validated, no further modifications are possible thereto.
Whether there is a provision in the software for carrying out an on line audit of transactions, i.e. whether there a separate module in the package, where a separate password given to the auditor and once he has seen and approved a particular transaction/set of transactions, the same would be locked and no modifications would be possible by anyone (including the senior most employee) in the company.
Whether there are proper procedures for backup of data on a regular basis and whether the said procedures are being strictly followed.
In case of any loss of data whether there is a clear defined recovery procedure to minimize the loss of data due to power failures or any human errors.
The auditor may introduce some dummy data into the system and see the results obtained.

After the auditor has evaluated the above procedures, he has to prepare an audit plan depending on the results obtained from his earlier evaluation. Since the daybooks are not being printed, the plan can contain procedures wherein data is verified directly on the computer from the vouchers/invoices, etc. The audit plan will also require a lot of analytical procedures to be performed. Depending on the importance of various expense heads and other important account heads, the auditor will also obtain various reports from the system depending on various queries that he would have to identify. Some illustrative reports can be:

To check whether proper classification is done for revenue/capital - a report can be obtained of all purchases (not being raw materials or other routine purchases) exceeding ` one lakh.
To check whether all freight outward bills are accounted for a report containing a month-wise co-relation between goods despatched and freight amount paid. The same can be further co-related with the freight rates obtained from the bills.

Once the auditor has performed the above procedures, he would be able to form an opinion whether reliance can be placed on the accounting systems and the data recorded. If the auditor finds that reliance cannot be placed on the systems he can inform the management about the fact and also that the daybooks, etc., will need to printed to allow him to conduct the audit. The finalisation procedures to be followed even under this system would remain more or less similar to other accounting systems. The auditor can obtain reports of depreciation on fixed assets, inventory valuation and using the normal procedures find out whether reliance can be placed on them, e.g., if while valuing stocks the system is using the LIFO method, the same would not be acceptable and will need to be modified. Similarly depreciation calculations will have to verify on a random basis to find out its reliability.

b) The reliability of a component is a function of control that acts on the component. In a computer system the following are the major types of controls and used to enhance component reliability which the auditor must evaluate:

Authenticity Control: They are exercised to verify the identity of the individuals or process involved in a system. (Pass word, digital signature etc.)
Accuracy Control: These attempts to ensure the correctness of the data and processes in a system (Programme validation check).
Completeness Control: This ensures that no data is missing and all processing is carried through to its proper conclusion.
Privacy Control: This ensures the protection of data from inadvertent or unauthorised disclosure.
Audit Trail Controls: This ensures the traceability of all events occurred in a system.
Redundancy Control: It ensures that processing of data is done only once.
Existence Control: It attempts to ensure the on going availability of all system resources.
Asset safeguarding controls: It attempts to ensure that all resources within a system are protected from destruction or corruption.
Effectiveness Control: It attempts to ensure that the system achieves its goals.
Efficiency Control: It attempts to ensure that a system uses minimum resources to achieve its goals.

Q-20

Ram and Hanuman Associates, Chartered Accountants in practice have been appointed as Statutory Auditor of Krishna Ltd. for the accounting year 2013-2014. Mr. Hanuman, a partner of the Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd., a subsidiary company of Krishna Ltd.

A-20

Auditor holding securities of a company : As per sub-section (3)(d)(i) of Section 141 of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company. Provided that the relative may hold security or interest in the company of face value not exceeding rupees one lakh.

Also, as per sub- section 4 of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub- section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and Hanuman Associates, holds 100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd. Therefore, the firm, M/s Ram and Hanuman Associates would be disqualified to be appointed as statutory auditor of Krishna Ltd. as per section 141 (3)(d)(i), which is the holding company of Shiva Ltd., because Mr. Hanuman one of the partner is holding equity shares of its subsidiary

Q-21

Nick Ltd. is a subsidiary of Ajanta Ltd., whose 20% shares have been held by Central Government, 25% by Uttar Pradesh Government and 10% by Madhya Pradesh Government. Nick Ltd. appointed Mr. Prem as statutory auditor for the year

A-21

According to Section 139 (7) of the Companies Act, 2013, the auditors of a government company shall be appointed or re-appointed by the Comptroller and Auditor General of India. As per section 2(45), a Government company is defined as any company in which not less than 51% of the paid-up share capital is held by the Central Government or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments and includes a company which is a subsidiary of a Government Company as thus defined”.

Nick Ltd. is a subsidiary company of Ajanta Ltd. Hence Nick Ltd. is covered in the definition of a government company. Therefore, the Auditor of Nick Ltd. can be appointed only by C & AG.

Consequently, appointment of Mr. Prem is invalid and he should not give acceptance to the Directors of Nick Ltd.

Q-22

Contravene Ltd. appointed CA Innocent as an auditor for the company for the current financial year. Further the company offered him the services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors.

A-22

Services not to be Rendered by the Auditor: Section 144 of the Companies Act, 2013 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely:

accounting and book keeping services;
internal audit;
design and implementation of any financial information system;
actuarial services;
investment advisory services;
investment banking services;
rendering of outsourced financial services;
management services; and
any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualify a person for appointment as an auditor of a company who is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

In the given case, CA Innocent was appointed as an auditor of Contravene Ltd. He was offered additional services of actuarial, investment advisory and investment banking which was also approved by the Board of Directors. The auditor is advised not to accept the services as these services are specifically notified in the services not to be rendered by him as an auditor as per section 144 of the Act.

Q-23

Mr. Amar, a Chartered Accountant, bought a car financed at ` 7,00,000 by Chaudhary Finance Ltd., which is a holding company of Charan Ltd. and Das Ltd. He has been the statutory auditor of Das Ltd. and continues to be even after taking the loan.

A-23

According to section 141 (3)(d) (ii) of the Companies Act, 2013, a person is not eligible for appointment as auditor of any company, If he is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of rupees five lakh.

In the given case Mr. Amar is disqualified to act as an auditor under section141 (3)(d)

(ii) as he is indebted to M/s Chaudhary Finance Ltd. for more than 5’00’000 ` Also according to Section141 (3)(d) (ii) he cannot act as an auditor of any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan Ltd. & Das

Ltd. Therefore he has to vacate his office in Das Ltd. Even though it is a subsidiary of Chaudhary Finance Ltd.

Hence audit work performed by Mr. Amar as an auditor is invalid, he should vacate his office immediately and Das Ltd should appoint another auditor for the company

Q-24

M/s XYZ & Co., auditors of Goodwill Education Foundation, a recognised nonprofit organisation feels that the standards on auditing need not to be applied as Goodwill Education Foundation is a non-profit making concern.

A-24

Compliance with Standards on Auditing : As per sub section 9 of section 143 of the Companies Act, 2013, every auditor shall comply with the auditing standards. Further as per sub section 10 of section 143 of the Act, the Central Government may prescribe the standards of auditing or any addendum thereto, as recommended by the Institute of Chartered Accountants of India, constituted under section 3 of the Chartered Accountants Act, 1949, in consultation with and after examination of the recommendations made by the National Financial Reporting Authority.

Provided that until any auditing standards are notified, any standard, or standards of auditing specified by the Institute of Chartered Accountants of India shall be deemed to be the auditing standards.

Further, the Preface to Standards on Auditing gives the scope of the Standards on Auditing. As per the Preface, the SAs will apply whenever an independent audit is carried out; that is, in the independent examination of financial statements/information of any entity; whether profit oriented or not and irrespective of its size, or legal form (unless specified otherwise) when such an examination is conducted with a view to expressing an opinion thereon.

Also while discharging their attest function; it is the duty of the Chartered Accountant to ensure that SAs are followed in the audit of financial information covered by their audit reports.

In the given case, even though the client is a non-profit oriented entity the SAs shall apply and the auditor shall be guilty of professional misconduct for failing to discharge his duty in case of non- compliance with SAs.

Q-25

Rama Pvt. Ltd. is a private company having paid up share capital of rupees twenty-five crore but having public borrowing from nationalized banks and financial institutions of rupees forty crore. The company appointed CA Raman as an auditor in its AGM dated 29th September, 2014.

You are required to state the following provisions as the section 139 of the Companies Act, 2013 in case of an individual auditor or an audit firm, both-

Rotation of auditor;
Cooling off period;
Common partner(s) to the other audit firm whose tenure has expired;
Transitional period for the adoption of new Companies Act;
Right of the company to remove an auditor;
Rotation between partners of audit firm;

A-25

(i) Rotation of Auditor: The provisions related to rotation of auditor are applicable to those companies which are prescribed in Companies (Audit and Auditors) Rules, 2014, which prescribes the following classes of companies excluding one person companies and small companies, namely:-

all unlisted public companies having paid up share capital of rupees ten crore or more;
all private limited companies having paid up share capital of rupees twenty crore or more;
all companies having paid up share capital of below threshold limit mentioned in (a) and (b) above, but having public borrowings from financial institutions, banks or public deposits of rupees fifty crores or more.

As per Section 139(2) of the Companies Act, 2013, no listed company or a company belonging to such class or classes of companies as mentioned above, shall appoint or re-appoint-

an individual as auditor for more than one term of five consecutive years; and
an audit firm as auditor for more than two terms of five consecutive years.

In the given case, Rama Pvt. Ltd. is a private company having paid up share capital of rupees twenty-five crore but having public borrowing from nationalized banks and financial institutions of rupees forty crore. The company appointed CA Raman as an auditor in its AGM dated 29th September, 2014.

The provisions relating to rotation of auditor will be applicable as the paid up share capital exceeds rupees twenty crore. Therefore, Rama Pvt. Ltd. shall appoint CA Raman as an auditor of the company for not more than one term of five consecutive years and CA Raman will hold office of Auditor from the conclusion of this meeting upto conclusion of sixth AGM i.e. AGM to be held in the year 2019.

(ii) Cooling off period: As per the proviso to section 139(2) of the Companies Act, 2013:-

an individual auditor who has completed his term under clause (a) shall not be eligible for re-appointment as auditor in the same company for five years from the completion of his term;
an audit firm which has completed its term under clause (b), shall not be eligible for re-appointment as auditor in the same company for five years from the completion of such term.

Therefore, CA Raman shall not be re-appointed as Auditor in Rama Pvt. Ltd. for further term of five years i.e. he cannot be appointed as Auditor upto year 2024.

(iii) Common partner(s) to the other audit firm whose tenure has expired: As per the second proviso to section 139(2) of the Companies Act, 2013, as on the date of appointment, no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years. For Example, M/s XYZ & Co., is an audit firm having partner Mrs. X, Mr. Y and Mr. Z, whose tenure has expired in the company immediately preceding the financial year. M/s ABZ& Co., is another audit firm in which Mr. Z is a common partner, will also be disqualified for the same company along with M/S XYZ & Co.for the period of five years.

(iv) Transitional period for the adoption of new Companies Act: As per the third proviso to section 139(2) of the Companies Act, 2013, every company, existing on or before the commencement of this Companies Act, 2013 which is required to comply with provisions of this sub-section, shall comply with the requirements of this sub-section within three years from the date of commencement of this Act. For example-

Mr Ram, a Chartered Accountant, is an individual auditor of M/s. Pinaco Ltd by last 5 years as on March, 2013 (i.e. existing on or before the date of Commencement of Companies Act, 2013), here a break in the term for a continuous period of five years will not be considered as fulfilling the requirement of rotation. Thus, Mr Ram can continue the audit of M/s. Pinaco Ltd. for another 3 years due to transitional effect, i.e. aggregate period in the same company will be 8 years.
M/s Ram Associates, a Chartered Accountants Audit Firm, is doing audit of M/s. Pinaco Limited by last 11 years as on March, 2013 (i.e. existing on or before the date of Commencement of Companies Act, 2013), here a break in the term for a continuous period of two terms of five consecutive years will not be considered as fulfilling the requirement of rotation. Thus, M/s Ram Associates can continue the audit of M/s. Pinaco Ltd. for another 3 years due to transitional effect, i.e. aggregate period in the same company will be 14 years.

(v) Right of the company to remove an Auditor: As per the fourth proviso to section 139(2) of the Companies Act, 2013, it has also been provided that right of the company to remove an auditor or the right of the auditor to resign from such office of the company shall not be prejudiced.

(vi) Rotation between partners of audit firm: Under section 139(3) of the Act, subject to the provisions of this Act, members of a company may resolve to provide that-

in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals as may be resolved by members; or
the audit shall be conducted by more than one auditor.

Further, it is important to note that as per the section 139(4) of the Companies Act, 2013, the Central Government may, by rules, prescribe the manner in which the companies shall rotate their auditors in pursuance of section 139(2) of the Act.

Q-26

MSY & Co. is an Audit Firm having partners CA Mukti, CA Shakti and CA Yukti. CA Mukti, CA Shakti and CA Yukti are holding appointment as an Auditor in 4, 6 and 10 Companies respectively.

Provide the maximum number of Audits remaining in the name of MSY & Co.
Provide the maximum number of Audits remaining in the name of individual partner i.e. CA Mukti, CA Shakti, CA Yukti.

A-26

Ceiling Number of Audit: As per section 141(3)(g) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than twenty companies;

As per section 141 (3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company audits.

Sometimes, a chartered accountant is a partner in a number of auditing

firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account.

In the given case, CA Mukti is holding appointment in 4 companies, whereas CA Shakti is having appointment in 6 Companies and CA Yukti is having appointment in 10 Companies. In aggregate all three partners are having 20 audits.

(i) Therefore, MSY & Co. can hold appointment as an auditor of 40 more companies:

Total Number of Audits available to the Firm	= 20*3 =	60
Number of Audits already taken by all the partners
In their individual capacity	= 4+6+10 =	20
Remaining number of Audits available to the Firm	=	40

With reference to above provisions an auditor can hold more appointment as auditor = ceiling limit as per section 141(3)(g)- already holding appointments as an auditor. Hence (1) CA Mukti can hold: 20 - 4 = 16 more audits. (2) CA Shakti can hold 20-6 = 14 more audits and (3) CA Yukti can hold 20-10 = 10 more audits

Q-27

State the provisions relating to filling of casual vacancies as per section 139 (8) of the Companies Act, 2013 and casual vacancy due to resignation.

A-27

As per Section 139(8), any casual vacancy in the office of an auditor shall-

(i) In the case of a company other than a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within thirty days.

If such casual vacancy is as a result of the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within three months of the recommendation of the Board and he shall hold the office till the conclusion of the next annual general meeting;

(ii) In the case of a company whose accounts are subject to audit by an auditor appointed by the Comptroller and Auditor-General of India, be filled by the Comptroller and Auditor-General of India within thirty days:

It may be noted that in case the Comptroller and Auditor-General of India does not fill the vacancy within the said period the Board of Directors shall fill the vacancy within next thirty days.

Casual Vacancy by Resignation: As per section 140 (2) the auditor who has resigned from the company shall file within a period of thirty days from the date of resignation, a statement in the prescribed form ADT–3 (as per Rule 8 of CAAR) with the company and the Registrar, and in case of the companies referred to in section 139(5) i.e. subsequent auditor of Government company, the auditor shall also file such statement with the Comptroller and Auditor-General of India, indicating the reasons and other facts as may be relevant with regard to his resignation. In case of failure the auditor shall be punishable with fine which shall not be less than fifty thousand rupees but which may extend to five lakh rupees as per section 140 (3).

Q-28

In the course of audit of Raja and Rank Ltd., the audit manager of Sharma & Co. observed that Raja and Rank Ltd. has outsourced certain activities to an outsourcing agency.

a) As the engagement partner, guide the audit manager in the assessment of services provided by the outsourcing agency in relation to the audit.

b) Discuss the procedure to be applied in case the user auditor is unable to obtain a sufficient understanding from the user entity?

A-28

a) As per SA 402 “Audit Considerations relating to an Entity Using a Service Organisation”, for obtaining understanding of the user entity in accordance with SA 315, the user auditor shall obtain an understanding of how a user entity uses the services of a service organization in the user entity’s operation including:

The nature of services provided by the service organisation and the significance of such services to the user entity, including its effect on the internal control of user entity.
The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organisation.
The degree of interaction between the activities of the service organization and those of user entity and
The nature of the relationship between the user entity and the service organization including the relevant contractual terms for the activities undertaken by the service organisation.

When obtaining an understanding of internal control relevant to the audit in accordance with SA 315 “Identifying and Assessing the Risks of Material Mis- statement through Understanding the Entity and its Environment”, the user auditor shall evaluate the design and implementation of relevant controls at the user entity that relate to the services provided by the service organisation, including those that are applied to the transactions processed by the service organisation.

(b) The user auditor shall determine whether a sufficient understanding of the nature and significance of the services provided by the service organisation and their effect on the user entity’s internal control relevant to the audit has been obtained to provide a basis for the identification and assessment of risks of material misstatement.

If the 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 the following procedures:

Obtaining a Type 1 or Type 2 report, if available;
Contacting the service organisation, through the user entity, to obtain specific information;
Visiting the service organisation and performing procedures that will provide the necessary information about the relevant controls at the service organisation; or
Using another auditor to perform procedures that will provide the necessary information about the relevant controls at the service organisation.

Q-29

Briefly discuss the following statements in view of SA 300 “Planning an Audit of Financial Statements”:

a)For an initial audit, the auditor may need to expand the planning activities.

b) Audit planning is not a discrete phase but a continuous phase.

A-29

a) Additional Considerations in Initial Audit Engagements: As per SA 300, Planning an Audit of Financial Statements, the purpose and objective of planning the audit are the same whether the audit is an initial or recurring engagement. However, for an initial audit, the auditor may need to expand the planning activities because the auditor does not ordinarily have the previous experience with the entity that is considered when planning recurring engagements.

For initial audits, additional matters the auditor may consider in establishing the overall audit strategy and audit plan include the following:

Unless prohibited by law or regulation, arrangements to be made with the predecessor auditor, for example, to review the predecessor auditor’s working papers.
Any major issues (including the application of accounting principles or of auditing and reporting standards) discussed with management in connection with the initial selection as auditor, the communication of these matters to those charged with governance and how these matters affect the overall audit strategy and audit plan.
The audit procedures necessary to obtain sufficient appropriate audit evidence regarding opening balances (as per SA 510 “Initial Audit Engagements– Opening Balances”).
Other procedures required by the firm’s system of quality control for initial audit engagements (for example, the firm’s system of quality control may require the involvement of another partner or senior individual to review the overall audit strategy prior to commencing significant audit procedures or to review reports prior to their issuance).

b) Audit Planning – a Continuous Process: As per SA 300, Planning an Audit of Financial Statements, planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins shortly after (or in connection with) the completion of the previous audit and continues until the completion of the current audit engagement. Planning, however, includes consideration of the timing of certain activities and audit procedures that need to be completed prior to the performance of further audit procedures. For example, planning includes the need to consider, prior to the auditor’s identification and assessment of the risks of material misstatement, such matters as-

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

♦The determination of materiality.

♦The involvement of experts.

The performance of other risk assessment procedures.

The auditor may decide to discuss elements of planning with the entity’s management to facilitate the conduct and management of the audit engagement (for example, to coordinate some of the planned audit procedures with the work of the entity's personnel). Although these discussions often occur, the overall audit strategy and the audit plan remain the auditor's responsibility. When discussing matters included in the overall audit strategy or audit plan, care is required in order not to compromise the effectiveness of the audit. For example, discussing the nature and timing of detailed audit procedures with management may compromise the effectiveness of the audit by making the audit procedures too predictable.

Q-30

While commencing the statutory audit of Alex Co. Ltd., what would you consider as an auditor to assess risk of material misstatement and responses to such risks?

A- 30

Considerations of Auditor for Assessing the Risk of Material Misstatement: As per SA 315 “Identifying and Assessing the Risk of Material Misstatement through understanding the Entity and its Environment”, the auditor shall identify and assess the risks of material misstatement at the financial statement level; and the assertion level for classes of transactions, account balances, and disclosures to provide a basis for designing and performing further audit procedures. For this purpose, the auditor shall:

Identify risks throughout the process of obtaining an understanding of the entity and its environment, including relevant controls that relate to the risks, and by considering the classes of transactions, account balances, and disclosures in the financial statements;
Assess the identified risks, and evaluate whether they relate more pervasively to the financial statements as a whole and potentially affect many assertions;
Relate the identified risks to what can go wrong at the assertion level, taking account of relevant controls that the auditor intends to test; and
Consider the likelihood of misstatement, including the possibility of multiple misstatements, and whether the potential misstatement is of a magnitude that could result in a material misstatement.

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

i) Consider the reasons for the assessment given to the risk of material misstatement at the assertion level for each class of transactions, account balance, and disclosure, including:

The likelihood of material misstatement due to the particular characteristics of the relevant class of transactions, account balance, or disclosure; and
Whether the risk assessment takes into account the relevant controls, thereby requiring the auditor to obtain audit evidence to determine whether the controls are operating effectively; and

ii) Obtain more persuasive audit evidence the higher the auditor’s assessment of risk.

Q-31

Pasta Ltd., a manufacturing concern want to develop internal control system. You are an expert in developing the internal control system, hereby called to brief about the same. In view of above, you are required to brief about internal control system and inherent limitations of the internal control?

A-31

Internal Control System and its Inherent Limitations: As per Guidance Note on Audit of Internal Financial Control over Financial Reporting, internal controls are a system consisting of specific policies and procedures designed to provide management with reasonable assurance that the goals and objectives it believes important to the entity will be met.

"Internal Control System" means all the policies and procedures (internal controls) adopted by the management of an entity to assist in achieving management's objective of ensuring, as far as practicable, the orderly and efficient conduct of its business, including adherence to management policies, the safeguarding of assets, the prevention and detection of fraud and error, the accuracy and completeness of the accounting records, and the timely preparation of reliable financial information.

To state whether a set of financial statements presents a true and fair view, it is essential to benchmark and check the financial statements for compliance with the framework. The Accounting Standards specified under the Companies Act, 2013 (which are deemed to be applicable as per Section 133 of the 2013 Act, read with Rule 7 of Companies (Accounts) Rules, 2014) is one of the criteria constituting the financial reporting framework on which companies prepare and present their financial statements under the Act and against which the auditors evaluate if the financial statements present a true and fair view of the state of affairs and the results of operations of the company in an audit of the financial statements carried out under the Act.

The fundamental therefore is that effective internal control is a process effected by people that supports the organization in several ways, enabling it to provide reasonable assurance regarding risk and to assist in the achievement of objectives.

Fundamental to a system of internal control is that it is integral to the activities of the company, and not something practiced in isolation.

An internal control system:

Facilitates the effectiveness and efficiency of operations.
Helps ensure the reliability of internal and external financial reporting.
Assists compliance with laws and regulations.
Helps safeguarding the assets of the entity.

Limitations of Internal Control - Internal control, no matter how effective, can provide an entity with only reasonable assurance and not absolute assurance about achieving the entity’s operational, financial reporting and compliance objectives.

Internal control systems are subject to certain inherent limitations, such as:

Management's consideration that the cost of an internal control does not exceed the expected benefits to be derived.
The fact that most internal controls do not tend to be directed at transactions of unusual nature. The potential for human error, such as, due to carelessness, distraction, mistakes of judgement and misunderstanding of instructions.
The possibility of circumvention of internal controls through collusion with employees or with parties outside the entity.
The possibility that a person responsible for exercising an internal control could abuse that responsibility, for example, a member of management overriding an internal control.
Manipulations by management with respect to transactions or estimates and judgements required in the preparation of financial statements.

Q-32

ZZZ Ltd. used to spend huge resources and time to maintain large data of accounts management. Not only the maintenance of data, but the transfer of files from one department to another took months. Most of the time, accounts department of the company could not co-ordinate between data transferred from one department to another.

Due to this complexity of data maintenance in the form of files, the management opted switching to customised accounting software package. Now, in the said package, all transactions are recorded, processed and the final accounts generated from the system. The management tells you that in view of the voluminous nature of day books and the motto of ‘save nature’, there is no need to take printouts and that audit can be conducted on the computer itself. The management further assures you that any 'query based reports' as required can be generated and printed.

As a statutory auditor of the company, enumerate the procedures you would adopt to conduct the audit in such environment.

A-32

Audit under CIS Environment: A key feature of the accounting software package used by the company definitely involves the absence of a clear audit trail. In other words, transactions cannot be easily traced or co-related from the individual supporting documents of those transactions. Moreover, the management does not wish to print the daybooks in view of the voluminous nature since it may involve extensive costs. This has naturally led to extensive dependence by management upon the "exception reporting" principle.

operating accurately;
printing out all the exceptions which exist; and
bound by programmed control parameters which meet the company's genuine internal control requirements.

all input is actually entered into the computer.
neither the computer nor the operators can cause undetected irregularities in the final reports.
the programmes appear, on the evidence of rejection and exception routines, to be functioning correctly.
all operator intervention during processing is logged and scrutinised by the DP manager.

The auditor in such circumstances will have to first evaluate the existing controls. For the same, he has to do the following:

Evaluate the internal control system especially the controls and checks existing for recording the transactions, i.e., he has to verify at what level transactions can be entered into the system and what checks are available to prevent any unauthorised data entry and for rectifying errors/omissions in the transactions entered.
Evaluate at what level there is authority given for modification of transactions already entered. Is there any authority given only to a senior employee to carry out modifications? Or is it that once transactions are entered and validated no further modifications are possible thereto.
Whether there is a provision in the software for carrying out an online audit of transactions, i.e. whether there a separate module in the package, where a separate password given to the auditor and once he has seen and approved a particular transaction/set of transactions, the same would be locked and no modifications would be possible by anyone (including the senior most employee) in the company.
Whether there are proper procedures for backup of data on a regular basis and whether the said procedures are being strictly followed.
In case of any loss of data whether there is a clear defined recovery procedure to minimize the loss of data due to power failures or any human errors.
The auditor may introduce some dummy data into the system and see the results obtained.

The audit plan will also require a lot of analytical procedures to be performed. Depending on the importance of various expense heads and other important account heads, the auditor will also obtain various reports from the system depending on various queries that he would have to identify. Some illustrative reports can be:

To check whether proper classification is done for revenue/capital - a report can be obtained of all purchases (not being raw materials or other routine purchases) exceeding ` one lakh.
To check whether all freight outward bills are accounted for a report containing a month-wise co-relation between goods dispatched and freight amount paid. The same can be further co-related with the freight rates obtained from the bills.

Once the auditor has performed the above procedures, he would be able to form an opinion whether reliance can be placed on the accounting systems and the data recorded. If the auditor finds that reliance cannot be placed on the systems he can inform the management about the fact and also that the daybooks, etc., will need to printed to allow him to conduct the audit. The finalisation procedures to be followed even under this system would remain more or less similar to other accounting systems. The auditor can obtain reports of depreciation on fixed assets, inventory valuation and using the normal procedures find out whether reliance can be placed on them, e.g., if while valuing inventories the system is using the LIFO method, the same would not be acceptable and will need to be modified. Similarly depreciation calculations will have to be verified on a random basis to find out its reliability.

Q-33

LN Ltd., a well reputed manufacturing public limited company has made a contribution of ` 2.5 lacs during the financial year ended 31.3.16 to a political party for running a school, situated in the village, where most of the workers of the company reside. It is admitted that the benefit of the school is mostly for the children of the workers of the company. The company has not made any profits in the last four years. Comment.

A-33

Restrictions Regarding Political Contribution: Section 182 of the Companies Act, 2013 deals with prohibitions and restrictions regarding political contributions. According to this section, a government company or any other company which has been in existence for less than three financial years cannot contribute any amount directly or indirectly to any political party. In other cases, contribution in any financial year should not exceed 7½ % of average net profits during the three immediately preceding financial years.

In the given case, LN Ltd. has not made any profit in last four years and contributed ` 2.5 lacs during the year to a political party for running a school. This is violation of the provisions of section 182 of the said Act although the children of its workers are benefited. The auditor would have to qualify his report stating the contravention of the provisions of the Companies Act.

Q-34

Mr. XXX, a practicing Chartered Accountant, has been offered for appointment as an auditor of Z Ltd., a leading company. Later on, Mr. YYY, the step-brother of Mr. XXX, purchased securities of the company having face value of ` 89,000. Comment, whether Mr. XXX may accept the offer of appointment as an auditor?

A-34

Holding of Securities by Relative: According to section 141(3)(d)(i) of the Companies Act, 2013 read with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

However, as per the proviso to this section, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.

Further, the term “relative” as defined under the Companies Act, 2013 includes step- brother.

In the present situation, Mr. YYY, the step-brother of Mr. XXX, is holding the securities having face value of ` 89,000 in Z Ltd. It may be noted that step-brother is included in the definition of the term “relative” as per the Companies Act, 2013.

However, the proviso to section 141(3)(d)(i) of the said Act allows a relative of the auditor to hold securities in the company of face value not exceeding of ` 1,00,000.

Here, holding securities by the relative of Mr. XXX is below the limit as prescribed under the said proviso.

Therefore, Mr. XXX may accept the offer of appointment as an auditor of Z Ltd.

Q-35

KM Pvt. Ltd., engaged in the manufacturing business of Silk Shirts, is a newly incorporated company dated 01.09.2016. On 28.09.2016, the members of KM Pvt. Ltd. themselves appointed CA Raj, a renowned practitioner, as the first auditor of the company opposing that Board is not authorised to appoint the auditor. You are required to comment on the action of the Members.

A-35

Appointment of First Auditor in the case of a company, other than a Government Company: As per the provisions of section 139(6) of the Companies Act, 2013, the first auditor of a company shall be appointed by the Board of Directors within 30 days from the date of registration of the company.

In the case of failure of the Board to appoint the auditor, it shall inform the members of the company.

The members of the company shall within 90 days at an extraordinary general meeting appoint the auditor. Appointed auditor shall hold office till the conclusion of the first annual general meeting.

As per the facts given in the case, the appointment of CA Raj as first auditor by the Members of KM Pvt. Ltd. by themselves is in violation of section 139(6) of the Companies Act, 2013, which authorizes the Board of Directors to appoint the first auditor of the company within one month of registration of the company. It may be noted that, only in the case of failure by the Board to appoint the auditor, the members of the company may appoint the auditor at an extraordinary general meeting.

Thus, the appointment of CA Raj by the Members of the company is not in order.

Q-36

Elucidate the power of tribunal to change the auditor of a company if found acted in a fraudulent manner as provided under sub-section (5) of section 140 of the Companies Act, 2013.

A-36

Power of Tribunal in case Auditor acted in a Fraudulent Manner: As per sub-section (5) of the section 140 of the Companies Act, 2013, the Tribunal either suo motu or on an application made to it by the Central Government or by any person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or officers, it may, by order, direct the company to change its auditors.

However, if the application is made by the Central Government and the Tribunal is satisfied that any change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that he shall not function as an auditor and the Central Government may appoint another auditor in his place.

It may be noted that an auditor, whether individual or firm, against whom final order has been passed by the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a period of five years from the date of passing of the order and the auditor shall also be liable for action under section 447 of the said Act.

It is hereby clarified that the case of a firm, the liability shall be of the firm and that of every partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its director or officers.

Q-37

Fraud can be committed by management overriding controls using such techniques as engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity.

In view of the above-mentioned circumstances of management fraud, explain briefly duties and responsibilities of an auditor in case of material misstatement resulting from such Management Fraud

A-37

Duties & Responsibilities of an Auditor in case of Material Misstatement resulting from Management Fraud: Misstatement in the financial statements can arise from fraud or error. The term fraud refers to an ‘Intentional Act’ by one or more individuals among management, those charged with governance. The auditor is concerned with fraudulent acts that cause a material misstatement in the financial statements.

As per SA 240 on “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, fraud can be committed by management overriding controls using such techniques as engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity.

Fraud involving one or more members of management or those charged with the governance is referred to as “management fraud”. The primary responsibility for the prevention and detection of fraud rests with those charged with the governance and the management of the entity.

Further, an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with the SAs.

The risk of the auditor not detecting a material misstatement resulting from management fraud is greater than for employee fraud, because management is frequently in a position to directly or indirectly manipulate accounting records, present fraudulent financial information or override control procedures designed to prevent similar frauds by other employees

Auditor’s opinion on the financial statements is based on the concept of obtaining reasonable assurance, hence in an audit, the auditor does not guarantee that material misstatements will be detected.

Further, as per section 143(12) of the Companies Act, 2013, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government (in case amount of fraud is ` 1 crore or above) or Audit Committee or Board in other cases (in case the amount of fraud involved is less than `1 crore) within such time and in such manner as may be prescribed.

The auditor is also required to report as per Clause (x) of Paragraph 3 of CARO, 2016, whether any fraud by the company or any fraud on the company by its officers or employees has been noticed or reported during the year. If yes, the nature and the amount involved is to be indicated.

If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:

Determine the professional and legal responsibilities applicable in the circumstances, including whether there is a requirement for the auditor to report to the person or persons who made the audit appointment or, in some cases, to regulatory authorities;
Consider whether it is appropriate to withdraw from the engagement, where withdrawal from the engagement is legally permitted; and
If the auditor withdraws:

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

Q-38

Gama Ltd. is a mobile phone operating company. Barring the marketing function it had outsourced the entire operations like maintenance of mobile infrastructure, customer billing, payroll, accounting functions, etc. Assist the auditor of Gama Ltd. as to how he can obtain an understanding of how Gama Ltd. uses the services of the outsourced agency in its operations.

A-38

Understanding How User Entity Uses the Services of Service Organisation: As per SA 402 on “Audit Considerations Relating to an Entity Using a Service Organisation”, when obtaining an understanding of the user entity in accordance with SA 315

“Identifying and Assessing the Risks of Material Misstatement throughUnderstanding the Entity and its Environment”, the user auditor shall obtain an understanding of how a user entity uses the services of a service organisation in the user entity’s operations, including:

The nature of the services provided by the service organisation and the significance of those services to the user entity, including the effect thereof on the user entity’s internal control;
The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organisation;
The degree of interaction between the activities of the service organisation and those of the user entity; and
The nature of the relationship between the user entity and the service organisation, including the relevant contractual terms for the activities undertaken by the service organisation.

Q-39

While verifying the employee records in a company, it was found that a major portion of the labour employed was child labour. On questioning the management, the auditor was told that it was outside his scope of the financial audit to look into the compliance with other laws. Comment.

A-39

Compliance with Other Laws: As per SA 250, “Consideration of Laws and Regulations in an Audit of Financial Statements”, the auditor shall 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 including tax and labour laws.

Further, non-compliance with other laws and regulations may result in fines, litigation or other consequences for the entity, the costs of which may need to be provided for in the financial statements, but are not considered to have a direct effect on the financial statements.

If the auditor suspects there may be non-compliance, the auditor shall discuss the matter with management. If management does not provide sufficient information that supports that the entity is in compliance with laws and regulations and, in the auditor’s judgment, the effect of the suspected non-compliance may be material to the financial statements, the auditor shall consider the need to obtain legal advice.

If the auditor is precluded by management from obtaining sufficient appropriate audit evidence to evaluate whether non-compliance that may be material to the financial statements has, or is likely to have, occurred, the auditor shall express a qualified opinion or disclaim an opinion on the financial statements on the basis of a limitation on the scope of the audit.

In the instant case, major portion of the labour employed in the company was child labour. While questioning by auditor, reply of the management that it was outside his scope of financial audit to look into the compliance with other laws is not acceptable as it may have a material effect on financial statements.

Thus, auditor should ensure the disclosure of above fact and provision for the cost of fines, litigation or other consequences for the entity. In case, the auditor concludes that 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 statement.

Q-40

Lakshya Ltd. has a branch office located outside India. Company is in the process of appointment of non-Chartered Accountant as an auditor but otherwise qualified person from country where the branch office is situated. Statutory auditor is of the opinion that non-Chartered Accountant cannot be appointed as branch auditor. Comment.

You are also required to discuss the applicability of SA 600 using the work of another auditor by the head office auditor in regard to branch located outside India, if non-Chartered Accountant is appointed

A-40

Non-Chartered Accountant as Branch Auditor: As per section 143(8) of the Companies Act, 2013, where a company has a branch office, the accounts of that office shall be audited either by the auditor appointed for the company under this Act or by any other person qualified for appointment as an auditor of the company. Where the branch office is situated in a country outside India, the accounts of the branch office shall be audited either by the company’s auditor or by an accountant or by any other person duly qualified to act as an auditor of the accounts of the branch office in accordance with the laws of that country and the duties and powers of the company’s auditor with reference to the audit of the branch and the branch auditor, if any, shall be such as may be prescribed.

Thus, a non- Chartered Accountant can be appointed as an auditor of branch office located outside India provided he is qualified for appointment as an auditor in that country.

Using the Work of Another Auditor: When the accounts of the branch are audited by a person other than the company’s auditors, there is need for a clear understanding of the role of such auditor and the company’s auditor in relation to the audit of accounts of the branch and the audit of the company as a whole. Also, there is great necessity for a proper rapport between these two auditors for the purpose of an effective audit. In recognition of these needs, the Council of the Institute of Chartered Accountants of India has dealt with these issues in SA 600, “Using the Work of another auditor”. It makes clear that in certain situations, the statute governing the entity may confer the right on the principal auditor to visit a component and examine the books of accounts and other records of the said component, if he thinks it necessary to do so. Where another auditor has been appointed for the component, the principal auditor would normally be entitled to rely upon the work of such auditor unless there are special circumstances to make it necessary for him to visit the component and/or to examine the books of accounts and other records of the said component. Further, it requires that the principal auditor should perform procedures to obtain sufficient appropriate audit evidence, that the work of the other auditor is adequate for the principal auditors’ purpose, in context of the specific assignment.

Q-41

As an internal auditor for a large manufacturing concern, you are asked to verify whether there are adequate records for identification and value of Plant and Machinery, tools and dies and whether any of these items have become obsolescent and not in use. Draft a suitable audit programme for the above.

A-41

The Internal Audit Programme in connection with Plant and Machinery, Tools and Dies may be on the following lines:

Internal Control Aspects - The following may be incorporated in the audit programme to check the internal control aspects:

Maintaining separate register for hired assets, leased asset and jointly owned assets.
Maintaining register of fixed asset and reconciling to physical inspection of fixed asset and to nominal ledger.
All movements of assets are accurately recorded.
Authorisation be obtained for –

a declaring a fixed asset scrapped.

selling a fixed asset.

Check whether additions to fixed asset register are verified and checked by authorised person. Proper recording of all additions and disposal.
Examining procedure for the purchase of new fixed assets, including written authority, work order, voucher and other relevant evidence.
Regular review of adequate security arrangements.
Periodic inspection of assets is done or not.
Regular review of insurance cover requirements over fixed assets.

Assets Register: To review the registers and records of plant, machinery, etc. showing clearly the date of purchase of assets, cost price, location, depreciation charged, etc.

Cost Report and Journal Register: To review the cost relating to each plant and machinery and to verify items which have been capitalised.

Code Register: To see that each item of plant and machinery has been given a distinct code number to facilitate identification and verify the maintenance of Code Register.

Physical Verification: To see physical verification has been conducted at frequent intervals.

Movement Register: To verify (a) whether a Movement Register for movable equipments and (b) log books in case of vehicles, etc. are being maintained properly.

Assets Disposal Register: To review whether assets have been disposed off after proper technical and financial advice and sales/disposal/retirement, etc. of these assets are governed by authorisation, sales memos or other appropriate documents.

Spare Parts Register: To examine the maintenance of a separate register of tools, spare parts for each plant and machinery.

Review of Maintenance: To scrutinise the programme for an actual periodical servicing and overhauling of machines and to examine the extent of utilisation of maintenance department services.

Review of Obsolescence: To scrutinise whether expert’s opinion have been obtained from time to time to ensure purchase of technically most useful efficient and advanced machinery after a thorough study.

Review of R&D: To review R&D activity and ascertain the extent of its relevance to the operations of the organisation, maintenance of machinery efficiency and prevention of early obsolescence.

Q-42

M/s Abu & Co. was appointed as auditor of Grand Airways Ltd. As the audit partner, what factors shall be considered in the development of overall audit plan?

A-42

Development of an Overall Plan: Overall plan is basically intended to provide direction for audit work programming and includes the determination of timing, manpower development and co-ordination of work with the client, other auditors and other experts. The auditor should consider the following matters in developing his overall plan for the expected scope and conduct of the audit-

Terms of his engagement and any statutory responsibilities.
Nature and timing of reports or other communications.
Applicable Legal or Statutory requirements.
Accounting policies adopted by the clients and changes, if any, in those policies.
The effects of new accounting and auditing pronouncement on the audit.
Identification of significant audit areas.
Setting of materiality levels for the audit purpose.
Conditions requiring special attention such as the possibility of material error or fraud or involvement of parties in whom directors or persons who are substantial owners of the entity are interested and with whom transactions are likely.
Degree of reliance to be placed on the accounting system and internal control.
Possible rotation of emphasis on specific audit areas.
Nature and extent of audit evidence to be obtained.
Work of the internal auditors and the extent of reliance on their work, if any in the audit.
Involvement of other auditors in the audit of subsidiaries or branches of the client and involvement of experts.
Allocation of works to be undertaken between joint auditors and the procedures for its control and review.
Establishing and coordinating staffing requirements.

Q-43

Yex Ltd. has five entertainment centers to provide frivolous facilities for public especially for children and youngsters at 5 different locations in the peripheral of 200 kms. Collections are made in cash. Specify the adequate control system towards collection of money.

A-43

i) Control System over Selling and Collection of Tickets: In order to achieve proper internal control over the sale of tickets and its collection by the Y Co. Ltd., following system should be adopted -

Printing of tickets: Serially numbered pre-printed tickets should be used and designed in such a way that any type of ticket used cannot be duplicated by others in order to avoid forgery. Serial numbers should not be repeated during a reasonable period, say a month or year depending on the turnover. The separate series of the serial should be used for such denomination.
Ticket sales: The sale of tickets should take place from the Central ticket office at each of the 5 centres, preferably through machines. There should be proper control over the keys of the machines.

Daily cash reconciliation: Cash collection at each office and machine should be reconciled with the number of tickets sold. Serial number of tickets for each entertainment activity/denomination will facilitate the reconciliation.

Daily banking: Each day’s collection should be deposited in the bank on next working day of the bank. Till that time, the cash should be in the custody of properly authorized person preferably in joint custody for which the daily cash in hand report should be signed by the authorized persons.

Entrance ticket: Entrance tickets should be cancelled at the entrance gate when public enters the centre.

Advance booking: If advance booking of facility is made available, the system should ensure that all advance booked tickets are paid for.

Discounts and free pass: The discount policy of the Y Co. Ltd. should be such that the concessional rates, say, for group booking should be properly authorized and signed forms for such authorization should be preserved.

Surprise checks: Internal audit system should carry out periodic surprise checks for cash counts, daily banking, reconciliation and stock of unsold tickets etc.

Q-44

Saras, a limited company having turnover of approximately ` 80 crores uses a tailor made accounting software package. In the said package, all transactions are recorded, processed and the final accounts generated from the system. The management tells you that in view of the voluminous nature of day books, there is no need to print them and that audit can be conducted on the computer itself. The management further assures you that any 'query based reports' as required can be generated and printed. As a statutory auditor of the company, enumerate the procedures you would adopt to conduct the audit.

A-44

From the auditor's point of view, it must also be conceded, the exception reports in the form of 'query-based reports' which isolate the above data provide him with the

very material that he requires for most of his verification work. The only problem which it raises, and it is a serious one, is that he cannot simply assume that the programmes which produce the exception reports are reliable in respect of the following factors:

operating accurately;
printing out all the exceptions which exist; and
bound by programmed control parameters which meet the company's genuine internal control requirements.

all input is actually entered into the computer.
neither the computer nor the operators can cause undetected irregularities in the final reports.
the programmes appear, on the evidence of rejection and exception routines, to be functioning correctly.
all operator intervention during processing is logged and scrutinised by the DP manager.

The auditor in such circumstances will have to first evaluate the existing controls.

For the same, he has to do the following:

Evaluate the internal control system especially the controls and checks existing for recording the transactions, i.e., he has to verify at what level transactions can be entered into the system and what checks are available to prevent any unauthorised data entry and for rectifying errors/omissions in the transactions entered.
Evaluate at what level there authority is given for modification of transactions already entered. Is there any authority given only to a senior employee to carry out modifications? Or is it that once transactions are entered and validated, no further modifications are possible thereto.
Whether there is a provision in the software for carrying out an on line audit of transactions, i.e. whether there a separate module in the package, where a separate password given to the auditor and once he has seen and approved a particular transaction/set of transactions, the same would be locked and no modifications would be possible by anyone (including the senior most employee) in the company.

` Whether there are proper procedures for backup of data on a regular basis and whether the said procedures are being strictly followed.

` In case of any loss of data whether there is a clear defined recovery procedure to minimize the loss of data due to power failures or any human errors.

` The auditor may introduce some dummy data into the system and see the results obtained.

To check whether proper classification is done for revenue/capital - a report can be obtained of all purchases (not being raw materials or other routine purchases) exceeding ` 1 lakh.
To check whether all freight outward bills are accounted for a report containing a month-wise co-relation between goods despatched and freight amount paid. The same can be further co-related with the freight rates obtained from the bills.

Q-45

“The auditor must evaluate major clauses of control used in a Computerised Information system to enhance its reliability” – Comment.

A-45

The reliability of a component is a function of control that acts on the component. In a computer system the following are the major types of controls and used to enhance component reliability which the auditor must evaluate:

Authenticity Control: They are exercised to verify the identity of the individuals or process involved in a system. (Pass word, digital signature etc.)
Accuracy Control: These attempts to ensure the correctness of the data and processes in a system (Programme validation check).
Completeness Control: This ensures that no data is missing and all processing is carried through to its proper conclusion.
Privacy Control: This ensures the protection of data from inadvertent or unauthorised disclosure.
Audit Trail Controls: This ensures the traceability of all events occurred in a system.
Redundancy Control: It ensures that processing of data is done only once.
Existence Control: It attempts to ensure the on going availability of all system resources.
Asset safeguarding controls: It attempts to ensure that all resources within a system are protected from destruction or corruption.
Effectiveness Control: It attempts to ensure that the system achieves its goals.
Efficiency Control: It attempts to ensure that a system uses minimum resources to achieve its goals.

Q-46

1 M/s SSS & Co. is an audit firm having partners CA. Satyam, CA. Shivam and CA. Sundaram. CA. Satyam, CA. Shivam and CA. Sundaram are holding appointment as an auditor in 4, 6 and 10 companies respectively.

Provide the maximum number of audits remaining in the name of M/s SSS & Co.
Provide the maximum number of audits remaining in the name of individual partner i.e. CA. Satyam, CA. Shivam and CA. Sundaram.
Can M/s SSS & Co. accept the appointment as an auditor in 60 private companies having paid-up share capital less than `100 crore, 2 small companies and 1 dormant company?

(b) Would your answer be different, if out of those 60 private companies, 45 companies are having paid-up share capital of ` 110 crore each?

A-46

Ceiling on Number of Audit: As per section 141(3)(g) of the Companies Act, 2013, a person shall not be eligible for appointment as an auditor if he is in full time employment elsewhere or a person or a partner of a firm holding appointment as its auditor, if such person or partner is at the date of such appointment or reappointment holding appointment as auditor of more than 20 companies other than one person companies, dormant companies, small companies and private companies having paid- up share capital less than ` 100 crore.

As per section 141(3)(g), this limit of 20 company audits is per person. In the case of an audit firm having 3 partners, the overall ceiling will be 3 × 20 = 60 company audits. Sometimes, a chartered accountant is a partner in a number of auditing firms. In such a case, all the firms in which he is partner or proprietor will be together entitled to 20 company audits on his account.

In the given case, CA. Satyam is holding appointment in 4 companies, whereas CA. Shivam is having appointment in 6 Companies and CA. Sundaram is having appointment in 10 Companies. In aggregate all three partners are having 20 audits.

Therefore, M/s SSS & Co. can hold appointment as an auditor of 40 more companies:

Total Number of Audits available to the Firm

= 20*3 =

Number of Audits already taken by all the

partners in their individual capacity

= 4+6+10 =

Remaining number of Audits available to the Firm

With reference to above provisions an auditor can hold more appointment as auditor = ceiling limit as per section 141(3)(g) - already holding appointments as an auditor Hence (1) CA. Satyam can hold: 20 - 4 = 16 more audits. (2) CA. Shivam can hold 20 - 6 = 14 more audits and (3) CA. Sundaram can hold 20 -10 = 10 more audits.

In view of above disussed provisions M/s SSS & Co. can hold appointment as an auditor in all the 60 private companies having paid-up share capital less than ` 100 crore, 2 small companies and 1 dormant company as these are excluded from the ceiling limit of company audits given under section 141(3)(g) of the Companies Act, 2013.
As per fact of the case, M/s SSS & Co. is already having 20 company audits and they can also accept 40 more company audits. In addition, they can also conduct the audit of one person companies, small companies, dormant companies and private companies having paid up share capital less than ` 100 crores. In the given case, out of the 60 private companies, M/s SSS & Co. is offered 45 companies having paid-up share capital of ` 110 crore each.

Therefore, M/s SSS & Co. can also accept the appointment as an auditor for 2 small companies, 1 dormant company, 15 private companies having paid-up share capital less than ` 100 crore and 40 private companies having paid-up share capital of ` 110 crore each in addition to above 20 company audits already holding.

Q-47

CA. Rock is a partner in M/s Ajay & Associates and M/s Vijay & Associates simultaneously. M/s Ajay & Associates has completed its tenure of 10 years as an auditor in Sanjay Ltd. immediately preceding the current financial year. It may be noted that the provisions for applicability of rotation of auditors are applicable to Sanjay Ltd. Now, the company wants to appoint M/s Vijay & Associates as auditor for 5 years.

a)Whether M/s Vijay & Associates is allowed to accept the appointment as auditor of Sanjay Ltd.?

b) Would your answer be different from above if CA. Rock, being in-charge of M/s Ajay & Associates and certifying authority of financial statements of Sanjay Ltd., retires from the partnership in M/s Ajay & Associates and joins M/s Vijay & Associates?

A-47

(a) Audit Firm having Common Partner: Section 139(2) of the Companies Act, 2013 provides that as on the date of appointment, no audit firm having a common partner or partners to the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall be appointed as auditor of the same company for a period of five years.

In the given case, CA. Rock is a common partner in M/s Ajay & Associates and M/s Vijay & Associates. The tenure of 10 years of M/s Ajay & Associates as an auditor has been expired in Sanjay Ltd. immediately preceding the current financial year

i.e. the firm shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.

Therefore, M/s Vijay & Associates will also be disqualified to be appointed as auditor of Sanjay Ltd. for next 5 financial years as CA. Rock was the common partner of M/s Vijay & Associates whose tenure in Sanjay Ltd. has expired.

(b) Retiring Partner being In-charge in Previous Audit Firm: As per 139(2) of the Companies Act, 2013 read with the explanation given under Companies (Audit and Auditors) Rules, 2014 for the purpose of rotation of auditors, if a partner, who is in-charge of an audit firm and also certifies the financial statements of the company, retires from the said firm and joins another firm of chartered accountants, such other firm shall also be ineligible to be appointed for a period of 5 years.

In the given case, CA. Rock was in-charge of M/s Ajay & Associates and certifying authority of financial statements of Sanjay Ltd. who retires from the said firm and joins M/s Vijay & Associates. The tenure of 10 years of M/s Ajay & Associates as an auditor has been expired in Sanjay Ltd. immediately preceding the current financial year i.e. the firm shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.

Therefore, M/s Vijay & Associates will also be disqualified to be appointed as auditor of Sanjay Ltd. for next 5 financial years as newly joined partner CA. Rock has retired from M/s Ajay & Associates immediately preceding the current financial year whose tenure in Sanjay Ltd. has expired.

Q-48

FX Ltd. is engaged in the business of newspaper and radio broadcasting. It operates through different brand names. During the Financial Year 15-16, it incurred substantial amounts on external trade, business communication and branding expenses by participation in various corporate social responsibility initiatives. The company expects to benefits by this expenditure by attracting new customers over a period of time and accordingly it has capitalised the same under ‘brand development expenses’ and intends to amortise the same over the period in which it expects the benefits to flow. As the statutory auditor of the company, do you concur with this treatment? Give reasons.

A-48

Capitalisation of Expenses: As per Accounting Standard 26 on “Intangible Assets”, expenditure on an intangible item should be recognised as an expense when it is incurred unless it forms part of the cost of an intangible asset that meets the recognition criteria.

In the given case, FX Ltd. incurred substantial amounts on external trade, business communication and branding expenses by participation in various corporate social responsibility initiatives. The company expects to benefits by this expenditure by attracting new customers over a period of time and accordingly it has capitalised the same under brand development expenses. Here, no intangible assets or other asset is acquired or created that can be recognised.

Therefore, the accounting treatment by the company to amortise the entire expenditure over the period in which it expects the benefits to flow is not correct and the same should be debited to the Statement of Profit and Loss in the year of incurring.

Q-49

Dabloo Ltd. is facing financial crunch and has sold significant part of machinery to repay 25% amount of wages overdue. Many workers have also left the company due to non-payment of wages. Dabloo Ltd. is also considering filing for bankruptcy. The financial statements (and notes thereto) do not disclose the fact. As an Auditor, how would you deal with the situation? You are also required to identify the type of opinion you would issue and draft the same.

A-49

Disclosure for Uncertainty about Going Concern: As per SA 570 “Going Concern”, it is the responsibility of the Auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern.

In the given case, Dabloo Ltd. has sold significant part of machinery to repay its wages overdue and also considering filing for bankruptcy. These events indicate a material uncertainty that may cast significant doubt on the company’s ability to continue as a going concern and, therefore, it would be unable to realize its assets and discharge its liabilities in the normal course of business.

Thus, the auditor should ask the management for its adequate disclosure in the financial statement and include the same in his report. However, if the management fails to make adequate disclosure, the auditor should express a qualified or adverse opinion. In view of circumstances mentioned in SA 705 “Modifications to the Opinion in the Independent Auditor’s Report”, the auditor should give adverse opinion in above case as follows -

In our opinion, because of the omission of the information mentioned in the Basis for Adverse Opinion paragraph, the financial statements do not give information required by the Companies Act, 2013 in the manner so required and also do not give a true and fair view in conformity with the accounting principles generally accepted in India:

In the case of the Balance sheet, of the state of affairs of the Company as at March 31,20xx;
In the case of the Profit & Loss account, of the profit/loss for the year ended on that date; and
In the case of the Cash flow statement, of the cash flow for the year ended on that date.

Q-50

OST Limited, a manufacturing company donated ` 45,000 and ` 55,000 to Charitable Societies namely ‘Healthy World Charitable Foundation’ and ‘Learning Kids Foundation’ respectively during the financial year 2015-16. The company has not taken any approval in general meeting for such donation. The average net profits of the company for the last three years were ` 15 lakhs. As an auditor, what will be your comment?

A-50

Donation to Charitable Institutions: Section 181 of the Companies Act, 2013 provides that the Board of Directors of a company may contribute to bona fide charitable and other funds with prior permission of the company in general meeting for such contribution in case any amount the aggregate of which, in any financial year, exceed 5 per cent of its average net profits for the three immediately preceding financial years.

In the instant case, OST Limited has given donation of ` 1,00,000/- (` 45,000/- + 55,000/-) to two charitable organisations. The average profit of the last 3 years is ` 15 lakhs and the 5% of this works out to ` 75,000. Hence the maximum of donation could be ` 75,000 only. For excess of ` 25,000 the company is required to take prior permission in general meeting which is not been taken.

Therefore, by paying donations of ` 1,00,000 which is more than ` 75,000, the Board has contravened the provisions of section 181 of the Companies Act, 2013. Hence, the auditor should qualify his report accordingly

Q-51

KRP Ltd., at its annual general meeting, appointed Mr. X, Mr. Y and Mr. Z as joint auditors to conduct auditing for the financial year 2013-14. For the valuation of gratuity scheme of the company, Mr. X, Mr. Y and Mr. Z wanted to refer their own known Actuaries. Due to difference of opinion, all the joint auditors consulted their respective Actuaries. Subsequently, major difference was found in the actuary reports. However, Mr. X agreed to Mr. Y’s actuary report, though, Mr. Z did not. Mr. X contends that Mr. Y’s actuary report shall be considered in audit report due to majority of votes. Now, Mr. Z is in dilemma.

I) You are required to briefly explain the responsibilities of auditors when they are jointly and severally responsible in respect of audit conducted by them and also guide Mr. Z in such situation.

II) Explain the responsibility of auditors, in case, report made by Mr. Y’s actuary, later on, found faulty.

A-51

(I) Difference of Opinion Among Joint Auditors: SA 299 on, “Responsibility of Joint Auditors” deals with the professional responsibilities, which the auditors undertake in accepting such appointments as joint auditors. In respect of the work divided amongst the joint auditors, each joint auditor is responsible only for the work allocated to him, whether or not he has made a separate report on the work performed by him. On the other hand the joint auditors are jointly and severally responsible in respect of the audit conducted by them as under:

in respect of the audit work which is not divided among the joint auditors and is carried out by all of them;
in respect of decisions taken by all the joint auditors concerning the nature, timing or extent of the audit procedures to be performed by any of the joint auditors;
in respect of matters which are brought to the notice of the joint auditors by any one of them and on which there is an agreement among the joint auditors;
for examining that the financial statements of the entity comply with the disclosure requirements of the relevant statute;
for ensuring that the audit report complies with the requirements of the relevant statute;
it is the separate and specific responsibility of each joint auditor to study and evaluate the prevailing system of internal control relating to the work allocated to him, the extent of enquiries to be made in the course of his audit;
the responsibility of obtaining and evaluating information and explanation from the management is generally a joint responsibility of all the auditors;
each joint auditor is entitled to assure that the other joint auditors have carried out their part of work in accordance with the generally accepted audit procedures and therefore it would not be necessary for joint auditor to review the work performed by other joint auditors.

Normally, the joint auditors are able to arrive at an agreed report. However where the joint auditors are in disagreement with regard to any matters to be covered by the report, each one of them should express their own opinion through a separate report. A joint auditor is not bound by the views of majority of joint auditors regarding matters to be covered in the report and should express his opinion in a separate report in case of a disagreement.

In the instant case, there are three auditors, namely, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd. For the valuation of gratuity scheme of the Company they referred their own known Actuaries. Mr. Z (one of the joint auditor) is not satisfied with the report submitted by Mr. Y’s referred actuary. He is not agreed with the matters to be covered by the report whereas Mr. X agreed with the same. Hence, as per SA 299, Mr. Z is suggested to express his own opinion through a separate report whereas Mr. X and Mr. Y may provide their joint report for the same.

(II) Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”, the expertise of an expert may be required in the actuarial calculation of liabilities associated with insurance contracts or employee benefit plans etc., however, the auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert.

The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence as per SA 500.

Further, in view of SA 620, if the expert’s work involves use of significant assumptions and methods, then the relevance and reasonableness of those assumptions and methods must be ensured by the auditor and if the 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 in the circumstances must be verified by the auditor.

In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as an auditor of KRP Ltd., referred their own known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert as per SA 620. Mr. Y’s referred actuary has provided the gratuity valuation report, which later on found faulty. Further, Mr. Z is not agreed with this report therefore he submitted a separate audit report specifically for such gratuity valuation.

In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation report of Actuary, to ensure the relevance and reasonableness of assumptions and methods used. They were also required to examine the relevance, completeness and accuracy of source data used for such report before expressing their opinion.

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

Q-52

(b) Yummy Ltd., dealing in manufacturing and trading of milk butter, has a benchmark in its product for so many years. Tasty Ltd., a rival company to Yummy Ltd., has introduced its new product, peanut butter. Due to being health conscious, the consumers have shifted from milk butter to peanut butter within few months. This has result into massive loss during the year to Yummy Ltd. due to non-selling of perishable milk products. The company has also started having negative net worth. It's production head, finance head and marketing head have also left the company. The company has no sound action plan to mitigate these situations. Kindly guide the auditor of Yummy Ltd., how he should deal with the situation.

A-52

Inability to Continue as a Going Concern: As per SA 570 on “Going Concern”, it is the responsibility of the Auditor to obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements and to conclude whether there is a material uncertainty about the entity’s ability to continue as a going concern. The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern. In evaluating management’s assessment, the auditor shall consider whether management’s assessment includes all relevant information of which the a(du)ditor is aware as a result of the audit.

In the instant case, Yummy Ltd. has suffered massive loss due to introduction of a substitute of its product by its rival company, Tasty Ltd., and having negative net worth also. Besides this, its production head, finance head and marketing head have also left the company. The company, in addition, has no action plan to mitigate these situations. Thus there are clear indications that there is danger to entity’s ability to continue in future. Considering the fact that there is no sound plan of action from the management to mitigate these factors and to put the company back on the recovery, the going concern assumption does not hold appropriate. (f)

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

If the result of the inappropriate assumption used in the preparation of financial statements is so material and pervasive as to make the financial statements misleading, the auditor should express an adverse opinion

Q-53

LMN Ltd. supplies navy uniforms across the country. The company has 4 warehouses at different locations throughout the India and 5 warehouses at the borders. The major stocks are generally supplied from the borders. LMN Ltd. appointed M/s OPQ & Co. to conduct its audit for the financial year 2013-14. Mr. O, partner of M/s OPQ & Co., attended all the physical inventory counting conducted throughout the India but could not attend the same at borders due to some unavoidable reason.

You are required to advise M/s OPQ & Co.,

i) How sufficient appropriate audit evidence regarding the existence and condition of inventory may be obtained?

ii) How an auditor is supposed to deal when attendance at physical inventory counting is impracticable?

A-53

i) Special Consideration with Regard to Inventory: As per SA 501 “Audit Evidence-Specific Considerations for Selected Items”, when inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by:

Attendance at physical inventory counting, unless impracticable, to:

Evaluate management’s instructions and procedures for recording and controlling the results of the entity’s physical inventory counting;

Observe the performance of management’s count procedures; Inspect the inventory; and

Perform test counts; and

Performing audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory count results.

ii) Attendance at Physical Inventory Counting Not Practicable: In some cases, attendance at physical inventory counting may be impracticable. This may be due to factors such as the nature and location of the inventory, for example, where inventory is held in a location that may pose threats to the safety of the auditor. The matter of general inconvenience to the auditor, however, is not sufficient to support a decision by the auditor that attendance is impracticable. Further, as explained in SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”, the matter of difficulty, time, or cost

involved is not in itself a valid basis for the auditor to omit an audit procedure for which there is no alternative or to be satisfied with audit evidence that is less than persuasive.
Further, where attendance is impracticable, alternative audit procedures, for example, inspection of documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical inventory counting, may provide sufficient appropriate audit
evidence about the existence and condition of inventory.
n some cases, though, it may not be possible to obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by performing alternative audit procedures. In such cases, SA 705 on Modifications to the Opinion in the Independent Auditor’s Report, requires the auditor to modify the opinion in the auditor’s report as a result of the scope limitation

Q-54

Your firm has been appointed as an auditor of YSPPP Ltd. The company operates 30 petrol stations throughout India. You are the senior in-charge of the audit for the year ending 31st March, 2014 and are engaged on the audit planning. The company’s sites are long-established and supplying fuel, oil, air and water.

Over the last few years, due to the intense price competition in petrol trading, the company has expanded its shops into mini-markets with a wide range of motor accessories, food, drinks and household products. The induction of mini-markets has increased the volume of cash transactions. This induction has also lead to scarcity of staff at each and every location. For that reason, part-time staffs are also recruited.

Point-of-sale PCs have been installed at all the petrol stations, linked on-line via a network to the computer at head office. Sales and inventory data are entered directly from the PCs at branches.

The company has an internal auditor, whose principal function is to monitor continuously and test the operation of internal controls throughout the organization. The internal auditor is also responsible for coordinating the year-end inventory count.

Requirements:

Prepare notes for a planning meeting with the audit partner which-

a) Identify, from the situation outlined above, circumstances particular to YSPPP Ltd. that should be taken into account while planning the audit, explaining clearly why these matters should be taken into account.

b) Describe the extent to which the work performed by the internal auditor may affect your planning, and the factors that could limit the use you may wish to make of his work.

A-54

a) Planning an Audit: As per SA 300 “Planning an Audit of Financial Statements”, the objective of the auditor is to plan the audit so that it will be performed in an effective manner. For this, the auditor shall establish an overall audit strategy that sets the scope, timing and direction of the audit and that guides the development of the audit plan. The auditor is also required to update and change the overall audit strategy and the audit plan as necessary during the course of the audit.

In the instant case, YSPPP Ltd. is a company which operates 30 petrol stations throughout India. The company’s sites are long-established and supplying fuel, oil, air and water. Over the last few years, due to the intense price competition in petrol trading, the company has expanded its shops into mini -markets as discussed in question. This induction has also lead to scarcity of staff; therefore, part-time staffs were also recruited. Point-of-sale PCs are also linked on-line via a network to the computer at head office. However, sales and inventory data are entered directly from the PCs at branches.

Circumstances particular to YSPPP Ltd. that should be taken into account while planning the audit, along with explanation for consideration is as under:

Circumstances	Why taken into account
Multiple business locations	Increases inherent risk (e.g. if the organizational structure is loose and difficult to manage).
Intense price competition.	May lead to uneconomic price discounting, possibly threatening viability of business.
Recent expansion of outlets into mini-markets	Increases complexity of business and may lead to loss of management control.
Perishable nature and limited shelf-life of food and drinks inventories	Increase risk of over statement of inventory values.
Large volume of cash transactions.	Increases risk of incomplete income recording
Nature of the business (garage environment).	Increases risk of loss of inventories and cash due to theft or staff pilferag May limit effectiveness of physical security controls (e.g. over access to terminals).
Direct input via PCs at branches.	Increases risk of misstatement, as batch controls will not be feasible and scope for other input controls may be limited.
Small number of staff at each location (e.g. one or two).	Limits scope for segregation of duties within branches and therefore increases control risk.
Branch-based nature of business.	Limits effectiveness of management control over activities of individual branches thereby increasing control risk.
Use of part-time staff and high staff turnover.	May inhibit effectiveness of controls within branches

(b) Effect of Work of Internal Auditor on Audit Planning:

The internal auditor’s identification and documentation of areas of weakness will give direction to areas requiring increased substantive procedures.
Work of the internal auditor may assist in selection of branches for audit visits, (e.g. where control failures have occurred).
The internal auditor may attend year-end inventory counts at one or more branches, potentially reducing the number of branches to be visited by us.
Work performed by the internal auditor may provide evidence to confirm operation of control procedures, on which we may seek to rely to reduce the extent of our own procedures.
Documentation of systems and controls by the internal auditor may reduce extent of our planning visits, as walkthrough checks may be sufficient to confirm systems documentation.

Q-55

MW&F Associates has been appointed as an auditor of a Multinational Company TTS Ltd. The company is working in a CIS environment. You are a member of the audit team of MW&F Associates. The partner in charge of MW&F Associates wants you to train your audit team member about use of Computer Assisted Auditing Techniques (CAATs). You are required to:

a)Explain the factors that a statutory auditor has to consider, in determining, whether to use Computer Assisted Auditing Techniques (CAATs).

b)Indicate the control procedures which the auditor should adopt in applying CAAT (Computer Assisted Audit Technique) in an audit under CIS environment.

A-55

(a) Consideration of Factors in Use of CAATs: In determining whether to use CAATs, the auditor should consider the following factors:

Availability of sufficient IT knowledge and expertise- It is essential that members of the audit team should possess sufficient knowledge and experience to plan, execute and use the results of CAAT. The audit team should have sufficient knowledge to plan, execute and use the results of the particular CAAT adopted.
Availability of CAATs and suitable computer facilities and data in suitable format- The auditor may plan to use other computer facilities when the use of CAATs on an entity’s computer is uneconomical or impractical, for example, because of an incompatibility between the auditor’s package programme and entity’s computer.
Impracticability of manual tests due to lack of evidence- Some audit procedures may not be possible to perform manually because they rely on complex processing (for example, advanced statistical analysis) or involve, amounts of data that would overwhelm any manual procedure.
Impact on effectiveness and efficiency in extracting a data- It includes selection of samples, applying analytical procedures, time involved in application of CAAT, etc.
Time constraints in certain data, such as transaction details, are often kept for a short time and may not be available in machine-readable form by the time auditor wants them. Thus, the auditor will need to make arrangements for the retention of data required, or may need to alter the timing of the work that requires such data.

(b) Control Procedure While Applying Computer Assisted Auditing Techniques (CAATs): Computer Assisted Auditing Techniques (CAATs) involve performing audit procedures while conducting audit through the computer. Audit software and Test Data are two common types of CAATs. Using CAATs involves taking various measures including monitoring so that the use of CAATs by the auditor provides reasonable assurance that the audit objectives and detailed specifications of CAATs have been met. It is to be seen that CAATs are not manipulated by staff of the entity. The specific procedures necessary to control the use of CAATs will depend on the particular application.

Procedures Carried Out by the Auditor to Control CAATs Applications may include:

When using a CAAT, the auditor may require the cooperation of the entity’s staff who have extensive knowledge of the computer installation. In such circumstances, the auditor should have reasonable assurance that the entity’s staff did not improperly influence the results of the CAAT.

Q-56

M/s Renault & Co., Chartered Accountants, appointed as a statutory auditor of R Ltd. for the financial year 2013-14. The company is also in need of some actuarial services. Consequently, the Board of Directors of the company offered the same to M/s Sona & Co., an associate to M/s Renault & Co., which has been duly accepted by the firm. Comment.

A-56

Services Not To Be Rendered By Auditor: This provision is newly inserted by section 144 of the Companies Act, 2013. Section 144 prescribes certain services not to be rendered by the auditor. An auditor appointed under this Act shall provide to the company only such other services as are approved by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the following services (whether such services are rendered directly or indirectly to the company or its holding company or subsidiary company), namely (i) accounting and book keeping services; (ii) internal audit; (iii) design and implementation of any financial information system; (iv) actuarial services; (v) investment advisory services; (vi) investment banking services; (vii) rendering of outsourced financial services; (viii) management services; and (ix) any other kind of services as may be prescribed.

Further section 141(3)(i) of the Companies Act, 2013 also disqualify a person for appointment as an auditor of a company whose subsidiary or associate company or any other form of entity, is engaged as on the date of appointment in consulting and specialized services as provided in section 144.

Additionally, in accordance with section 141(4) of the Act, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned above after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the given case, M/s Renault & Co., Chartered Accountants, was appointed as an auditor of R Ltd. Further, the company offered actuarial services to M/s Sona & Co., an associate to M/s Renault & Co., which has also been duly accepted by the firm. Therefore, M/s Renault & Co. is disqualified to hold office as an auditor of R Ltd. under section 141(3)(i), as its associate is involved in providing such services, to R Ltd., as mentioned in section 144 of the Companies Act, 2013.

Subsequently, M/s Renault & Co. shall have to vacate the office of auditor of R Ltd. accordingly.

Q-57

Navy and Cavy Associates, a Chartered Accountant firm, has been appointed as Statutory Auditor of Poor Ltd. for the financial year 2013-2014. Mr. Savy, the relative of Mr. Navy, a partner in Navy and Cavy Associates, is indebted for ` 6,00,000 to Wealthy Ltd., a subsidiary company of Poor Ltd. Comment

A-57

Indebtness to the Subsidiary Company: As per sub-section (3)(d)(ii) of Section 141 of the Companies Act, 2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for appointment as an auditor of a company, who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of ` 5 lakhs.

Also, as per sub-section 4 of Section 141 of the Companies Act, 2013, where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual vacancy in the office of the auditor.

In the present case, Mr. Savy, the relative of Mr. Navy, a partner in Navy and Cavy Associates, has been indebted to Wealthy Ltd., a subsidiary company of Poor Ltd., for ` 6 lakhs.

Therefore, the firm, Navy and Cavy Associates would be disqualified to be appointed as statutory auditor of Poor Ltd. as per section 141(3)(d)(ii), which is the holding company of Wealthy Ltd., because Mr. Savy, the relative of Mr. Navy, a partner in Navy and Cavy Associates, has been indebted to Wealthy Ltd. for an amount exceeding the minimum approved limit

Q-58

Orange Ltd. is an unlisted public company. Its balance sheet shows paid up share capital of ` 5 crore and public deposits of ` 100 crore. The company appointed M/s Santra & Co., a chartered accountant firm, as the statutory auditor in its annual general meeting held at the end of September, 2014 for 11 years.

You are required to state the provisions related to- rotation of auditor and cooling off period as per the section 139(2) of the Companies Act, 2013 in case of an individual auditor or an audit firm, both, and comment upon the facts of the case provided above with respect to aforesaid provisions

A-58

Rotation of Auditor & Cooling Off Period Provisions: The provision related to Rotation of Auditor & Cooling Off Period is newly inserted by section 139(2) of the Companies Act, 2013 read with Rule 5 of the Companies (Audit & Auditors) Rules, 2014, which is discussed as under:

The provisions related to rotation of auditor are applicable to those companies which are prescribed in Companies (Audit and Auditors) Rules, 2014, which prescribes the following classes of companies excluding one person companies and small companies, namely:-

all unlisted public companies having paid up share capital of ` 10 crore or more;
all private limited companies having paid up share capital of ` 20 crore or more;
all companies having paid up share capital of below threshold limit mentioned above, but having public borrowings from financial institutions, banks or public deposits of ` 50 crores or more.

As per Section 139(2) of the Companies Act, 2013, no listed company or a company belonging to such class or classes of companies as mentioned above, shall appoint or re-appoint-

an individual as auditor for more than one term of 5 consecutive years; and
an audit firm as auditor for more than two terms of 5 consecutive years.

In the given case, Orange Ltd. is an unlisted public company having paid up share capital of ` 5 crore and public deposits of ` 100 crore. The company has appointed M/s Santra & Co., a chartered accountant firm, as the statutory auditor in its AGM held at the end of September, 2014 for 11 years.

The provisions relating to rotation of auditor will be applicable as the public deposits exceeds ` 50 crore. Therefore, Orange Ltd. can appoint M/s Santra & Co. as an auditor of the company for not more than one term of five consecutive years twice i.e. M/s Santra & Co. shall hold office from the conclusion of this meeting upto conclusion of sixth AGM to be held in the year 2019 and thereafter can be re appointed as auditor for one more term of five years i.e. upto year 2024. The appointment shall be subject to ratification by members at every annual general meeting of the company. As a result, the appointment of M/s Santra & Co. made by Orange Ltd. for 11 years is void.

Cooling off period: As per the proviso to section 139(2) of the Companies Act, 2013-

an individual auditor who has completed his term under clause (a) shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of his term;
an audit firm which has completed its term under clause (b), shall not be eligible for re-appointment as auditor in the same company for 5 years from the completion of such term.

Therefore, M/s Santra & Co. shall not be re-appointed as Auditor in Orange Ltd. for further term of 5 years i.e. upto year 2029

Q-59

Mr. Pratiq, a practicing Chartered Accountant, has been appointed as an auditor of Opus Ltd. He is holding securities of the company having face value of ` 89,000 only.

You are required to state, whether Mr. Pratiq is qualified to be appointed as an auditor of Opus Ltd.
Would your answer be different, if instead of Mr. Pratiq; Mr. Quresh, the step-father of Mr. Pratiq, is holding the securities?

A-59

Disqualification due to Holding of Securities: According to section 141(3)(d)(i) of the Companies Act, 2013 read with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, an auditor is disqualified to be appointed as an auditor if he, or his relative or partner holding any security of or interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such holding company.

However, as per the proviso to this Section, the relative of the auditor may hold the securities or interest in the company of face value not exceeding of ` 1,00,000.

Further, the term “relative” has been defined under the Companies Act, 2013 which means anyone who is related to another as members of a Hindu Undivided Family; husband and wife; Father (including step- father), Mother (including step- mother), Son (including step- son), Son’s wife, Daughter, Daughter’s husband, Brother (including step- brother), Sister (including step- sister).

In the present situation,

Mr. Pratiq is holding securities in Opus Ltd., which is not allowed as per the provisions of section 141(3)(d)(i) of the Act. Therefore, Mr. Pratiq will be disqualified to be appointed as an auditor of Opus Ltd.
Mr. Quresh, the step-father of Mr. Pratiq, is holding the securities in Opus Ltd.

It may be noted that step-father is included in the definition of the term “relative” as per the Companies Act, 2013. Further, proviso to section 141(3)(d)(i) of the Act allows a relative of the auditor to hold securities in the company of face value not exceeding of ` 1,00,000.

Here, Mr. Quresh is holding securities for face value of ` 89,000 which is below the limit as prescribed under the said proviso.

Therefore, Mr. Pratiq will not be disqualified to be appointed as an auditor of Opus Ltd.

Q-60

a) You have been appointed as a statutory central auditor of SABKA Bank, a Nationalized bank. What special points would you borne in mind while conducting the audit of compliance with "Statutory Liquidity Ratio" (SLR) requirements?

b) While auditing APNA Bank, you observed that a lump sum amount has been disclosed as contingent liability collectively. You are, therefore, requested by the management to guide them about the disclosure requirement of Contingent Liabilities for Banks. Kindly guide.

A-60

a) Statutory Liquidity Ratio (SLR) Requirements: The Reserve Bank of India requires statutory central auditors of banks to verify the compliance with SLR requirements of 12 odd dates in different months of a financial year not being Fridays. The resultant report is to be sent to the top management of the bank and to the Reserve Bank. The report of the statutory auditors in relation to compliance with SLR requirements has to cover two aspects-

i) correctness of the compilation of DTL (Demand and Time Liabilities) position; and

ii) maintenance of liquid assets.

Audit Approach and Procedure:

Obtain an understanding of the relevant circulars of the RBI, particularly regarding composition of items of DTL.
Require the branch auditors to send their weekly trial balance as on Friday and these are consolidated at the head office. Based on this consolidation, the DTL position is determined for every reporting Friday. The statutory central auditor should request the branch auditors to verify the correctness of the trial balances relevant to the dates selected by him. The branch auditors should also be specifically requested to examine the cash balance at the branch on the selected dates.
Examine, on a test basis, the consolidations regarding DTL position prepared by the bank with reference to the related returns received from branches. The auditor should examine whether the valuation of securities done by the bank is in accordance with the guidelines prescribed by the RBI.
While examining the computation of DTL, specifically examine that the following items have been excluded from liabilities-

a) Part amounts of recoveries from the borrowers in respect of debts considered bad and doubtful of recovery.

b) Amounts received in Indian currency against import bills and held in sundry deposits pending receipts of final rates.

c) Un-adjusted deposits/balances lying in link branches for agency business like dividend warrants, interest warrants, refund of application money, etc., in respect of shares/debentures to the extent of payment made by other branches but not adjusted by the link branches.

d) Margins held and kept in sundry deposits for funded facilities-

5.Similarly, specifically examine that the following items have been included in liabilities-

Net credit balance in branch adjustment accounts including these relating to foreign branches.
Interest on deposit as at the end of the firm half year reversed in the beginning of the next half-year.
Borrowings from abroad by banks in India needs to be considered as ‘liabilities to other’ and thus, needs to be considered at gross level unlike ‘liabilities towards banking system in India’, which are permitted to be netted off against ‘assets towards banking system in India’. Thus, the adverse balances in Nostro Mirror Account needs to be considered as ‘Liabilities to other’
The reconciliation of Nostro accounts (with Nostro Mirror Accounts) needs to be scrutinized carefully to analyze and ascertain if any inwards remittances are received on behalf of the customers / constituents of the bank and have remained unaccounted and / or any other debit (inward) entries have remained unaccounted and are pertaining to any liabilities for the bank.

6. Examine whether the consolidations prepared by the bank include the relevant information in respect of all the branches.

7. It may be noted that, even though interest accrues on a daily basis, it is recorded in the books only at periodic intervals. Thus, examine whether such interest accrued but not accounted for in books is included in the computation of DTL.

The auditor at the central level should apply the audit procedures listed above to the overall consolidation prepared for the bank as a whole. Where such procedure is followed, the central auditor should adequately describe the same in his report.

8. While reporting on compliance with SLR requirements, the auditor should specify the number of unaudited branches and state that he has relied on the returns received from the unaudited branches in forming his opinion. Recently, there has been introduction of Automated Data Flow (ADF) for CRR & SLR reporting and the auditors should develop necessary audit procedures around this.

b) Contingent Liabilities for Banks: The Third Schedule to the Banking Regulation Act, 1949, requires the disclosure of the following as a footnote to the balance sheet-

A) Contingent liabilities

Claims against the bank not acknowledged as debts.
Liability for partly paid investments.
Liability on account of outstanding forward exchange contracts.
Guarantees given on behalf of constituents-

In India.
Outside India.

5. Acceptances, endorsements and other obligations.

6.Other items for which the bank is contingently liable.

B)Bills for collection.

Q-61

a) As a branch auditor of a Nationalised bank, how would you classify the following advances based on securities?

i) Advances covered by ECGC/DISGC guarantees.

ii) An account which is fully secured but the margin in which is lower than that stipulated by the bank.

iii) Advances covered against cheques purchased including self cheques.

iv) Advances against supply bill.

b) As the concurrent auditor of Nagpur Main Branch of XYZ Bank Ltd., state the issues which have to be considered in the audit of advances.

A-61

(a) Classification of Advances of a Bank based on Security:

i) Advances covered by ECGC/DICGC guarantee should be treated as covered by guarantee to the extent of guarantee cover available. The amount received from ECGC/DICGC and kept in sundry creditor account pending adjustment should be deducted from advances.

iii) An account which is fully secured but the margin in which is lower than stipulated by the bank should nevertheless be treated as fully secured for the purpose of balance sheet presentation Cheques purchased including self cheques should be treated as unsecured.

iv) Advances against supply bill unless collaterally secured, should be classified as unsecured even if they have been accepted by the drawee.

b) Audit of Advances: The items to be covered in the current audit of advances of a bank are as follows-

Ensure that loans and advances are sanctioned properly.
Verify whether the sanctions are in accordance with the delegated authority.
Ensure that securities and documents have been received and properly charged/registered.
Ensure that post disbursement supervision and follow up is proper.
Verify whether there is any misuse of loans and advances and whether there are instances indicative of diversion of funds.
Check whether letters of credit issued by the branch are within the delegated power and ensure that they are genuine trade transactions.
Check bank guarantees issued are properly worked and recorded.
Ensure proper follow up of overdue bills of exchange.
Verify the classifications of advances are as per RBI directions.
Verify whether the submission of claims to DICGC and ECGC is in time.
Verify the instances of exceeding delegated powers have been promptly reported.
Verify the frequency and genuiness of such exercise of authority beyond to delegated powers of the concerned officials.

Q-62

(a) A firm of a father and a son is receiving ` 1 lakh towards job work done for ABC Ltd. during the year ending on 31.03.14. The total job work charges paid by ABC Ltd. during the year are over ` 25 lakhs. The father is a Managing Director of ABC Ltd. having substantial holding. The Managing Director told the auditor that since he is not involved in the activities of the firm and since the amount paid to it is insignificant; there is no need to disclose the transaction explicitly. He further contended that such a payment made in the last year was also not disclosed. Is Managing Director right in his approach?

A-62

Related Party Disclosures: As per definition given in the AS 18 “ Related Party Disclosures” parties are considered to be related if at any time during the reporting period one party has the ability to control the other party or exercise significant influence over the other party in making financial and/or operating decisions. Related party transaction means a transfer of resources or obligations between related parties, regardless of whether or not a price is charged.

In the instant case, the managing director of ABC Ltd. is a partner in the firm with his son which has been paid ` 1 lakh as job work charges. The managing director is having a substantial holding in ABC Ltd. The case is squarely covered by AS 18. According to AS-18, in the case of related party transactions, the reporting enterprise should disclose the following:

the name of the transacting related party;
a description of the relationship between the parties;
a description of the nature of transactions;
volume of the transactions either as an amount or as an appropriate proportion;
any other elements of the related party transactions necessary for an understanding of the financial statements;
the amounts or appropriate proportions of outstanding items pertaining to related parties at the balance sheet date and provisions for doubtful debts due from such parties at that date; and
amounts written off or written back in the period in respect of debts due from or to related parties.”

Further, SA 550 on Related Parties, also prescribes the auditor’s responsibilities and audit procedures regarding related party transactions.

The approach of the managing director is not tenable under the law and accordingly all disclosure requirements have to be complied with in accordance with the AS 18. Auditor should insist to make proper disclosure as per the AS and if management refuses, the auditor shall have to modify his report. Also it has to be seen whether section 184 of the Companies Act, 2013 regarding disclosure of interest by director has been complied with. If it is not complied with, the auditor needs to modify the report appropriately.

Q-63

Divergence Pvt. Ltd. is an unlisted closely held company with turnover less than` 50 crores. While finalizing the accounts, Mr. Nix, Director (finance), disputed the applicability of AS 20 to the company, on the basis of the fact that the company’s shares are not listed on any recognised stock exchange in India.

A-63

Applicability of Accounting Standard: AS 20, “Earning Per Share”, came into effect in respect of accounting periods commencing on or after 1-4-2001 and is mandatory in nature, from that date, in respect of enterprises whose equity shares or potential equity shares are listed on a recognised stock exchange in India. As such AS 20 does not mandate an enterprise, which has neither equity shares nor potential equity shares which are so listed, to calculate and disclose earnings per share, but, if that enterprise discloses earnings per share for complying with therequirements of any statute or otherwise, it should calculate and disclose earnings pershare in accordance with AS 20.

Further, Part II of Schedule III to the Companies Act, 2013, requires, among other things, disclosure of earnings per share. Accordingly, every company, which is required to give information under Part II of Schedule III to the Companies Act, 2013, should calculate and disclose earning per share in accordance with AS 20, whether or not its equity shares or potential equity shares are listed on a recognised stock exchange in India.

Accordingly, Divergence Pvt. Ltd. should compute and disclose EPS according to AS 20.

Therefore, the contention of Mr. Nix, Director (Finance) of the company, is incorrect. The auditor will have to ensure that EPS is disclosed as per AS 20 or else the auditor should appropriately modify the audit report accordingly.

Q-64

Mr. Man is a whole-time director of Manthan Ltd. who has a very good relation with the Director (Operations) of the company. Consequently, he entered into a purchase contract for supply of goods of ` 5,00,000 with the company without obtaining prior consent of the Board. What is the responsibility of the auditor in relation to the Companies Act, 2013?

A-64

Responsibility of Auditor in Relation to the Companies Act, 2013: As per Section 188 of the Companies Act, 2013, no company shall enter into any contract or arrangement with a related party 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. Further, it is provided that no contract or arrangement, in the case of a company having specified paid-up share capital, or transactions exceeding prescribed sum, shall be entered into except with the prior approval of the company by a special resolution.

The contracts or arrangements mentioned above are those for which the register(s) are maintained under section 189 of the Companies Act, 2013 .The scope of the auditor’s inquiry under this clause is restricted to such transactions referred to in sections 184 and 188 of the Act.

The auditor should, while reporting, in the first instance, determine whether the aggregate value of all the transactions entered into with any of the companies/firms/parties covered in the register maintained under section 189 of the Act exceed the value of rupees five lakhs in the year. If so, the auditor has to examine whether each of the transactions entered into with such a company/firm/party have been made at prices which are reasonable having regard to the prevailing market prices at the relevant time. Further, the auditor while reporting should clearly bring out the reasons as to why no adverse comment was considered necessary.

The contracts referred to in section 188 are for sale, purchase or supply of any goods, materials or services and contract of underwriting the subscription of any securities or derivatives of the company between a Company and its director or, its relative, a firm in which the director or relative is a partner, any other partner in such a firm or a private company of which the director is a member or director. The auditor will have to obtain the list of such parties which are covered by section 188 mentioned above.

Hence, the auditor should ensure that all the above mentioned provisions have been compiled with.

Q-65

Mr. A, a practicing Chartered Accountant, audited the financial statements of C Ltd. for the previous year 2012-13 and expressed an unmodified opinion. C Ltd. was of the view that Mr. A is not conducting the audit properly and therefore, for the current year 2013-14, it appointed Ms. B, a leading practicing Chartered Accountant to conduct the audit and present Comparative Financial Statements.

Ms. B, while performing the auditing procedures, found that C Ltd. has undercharged the wages of ` 10 lakhs during the previous year resulting in overstatement of profits. What are the further procedures, Ms. B is required to pursue?

A-65

Misstatement in Prior Period Financial Statements Audited by a Predecessor Auditor: According to SA 710 “Comparative Information—Corresponding Figures and Comparative Financial Statements”, if the financial statements of the prior period were audited by a predecessor auditor, in addition to expressing an opinion on the current period’s financial statements, the auditor shall state in an Other Matter paragraph:

That the financial statements of the prior period were audited by a predecessor auditor;
The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the reasons therefor; and
The date of that report,

unless the predecessor auditor’s report on the prior period’s financial statements is revised with the financial statements.

However, if the auditor concludes that a material misstatement exists that affects the prior period financial statements on which the predecessor auditor had previously reported without modification, the auditor shall communicate the misstatement with the appropriate level of management and those charged with governance and request that the predecessor auditor be informed. If the prior period financial statements are amended, and the predecessor auditor agrees to issue a new auditor’s report on the amended financial statements of the prior period, the auditor shall report only on the current period.

In the given case, Mr. A has issued an audit report without modification for the previous year 2012-13. While Ms. B found a material discrepancy of undercharging wages of ` 10 lakhs during the year 2012-13. Hence, Ms. B is required to communicate the matter to the management and request them to inform the same to Mr. A. After revision or non-revision of the prior period’s financial statements, Ms. B may report accordingly as stated above.

Q-66

PK Ltd. has taken a term loan from a nationalized bank in 2012 for ` 350 lakhs repayable in 7 equal yearly instalments (including interest) of ` 50 lakhs beginning from 31st March, 2013 onwards. It had repaid the instalments due in 2013 & 2014, but defaulted in repayment of principal as well as interest for the current financial year 2015. Discuss the reporting responsibilities of the auditor of PK Ltd. in accordance with the Companies Act, 2013

A-66

Reporting Requirement as per Schedule III to the Companies Act, 2013: 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 specifying the 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, PK Ltd. has taken a loan from a nationalized bank three years back in 2012. It was regular in payment of instalments (including interest) for last two years but defaulted for the current financial year 2015. Therefore, it needs to be reported in the notes to accounts.

The draft report for above matter is as under“PK Ltd. has taken a loan during the year 2012, from a nationalized bank amounting to ` 350 lakhs @ X% p.a. which is repayable by yearly installment of ` 50 lakhs for 7 years.

The company has defaulted in repayment of dues including interest to a nationalized bank during the financial year 2014-15 amounting to ` 50 lakhs which remained outstanding as at March 31, 2015.”

Q-67

While auditing the accounts of XYZ Ltd., it has come to the notice of the auditor that receipts have been suppressed. Discuss explaining at least five techniques as to how receipts may be suppressed

A-67

Five Techniques of how receipts are suppressed are:

Teeming and Lading: Amount received from a customer being misappropriated; also to prevent its detection the money received from another customer subsequently being credited to the account of the customer who has paid earlier. Similarly, moneys received from the customer who has paid thereafter being credited to the account of the second customer and such a practice is continued so that no one account is outstanding for payment for any length of time, which may lead the management to either send out a statement of account to him or communicate with him.
Adjusting unauthorised or fictitious rebates, allowances, discounts, etc. to customer accounts and misappropriating amount paid by them.
Writing off as debts in respect of such balances against which cash has already been received but has been misappropriated.
Not accounting for cash sales fully.
Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the employees, etc.

Q-68

“The relationship between auditing and law is very close one.” Discuss

A-68

The relationship between auditing and law is very close one. Auditing involves examination of various transactions from the view point of whether or not these have been properly entered into. It necessitates that an auditor should have a good knowledge of business laws affecting the entity. He should be familiar with the law of contracts, negotiable instruments, etc. The knowledge of taxation laws is also inevitable as entity is required to prepare their financial statements taking into account various provisions affected by various tax laws. In analysing the impact of various transactions particularly from the accounting aspect, an auditor ought to have a good knowledge about the direct as well as indirect tax laws.

Q-69

“Weaknesses in the design of the internal control system and non-compliance with identified control procedures amongst other conditions or events increase the risk of fraud or error.” Discuss.

A-69

In planning and performing his examination, the auditor should take into consideration the risk of material misstatements of the financial information caused by fraud or error. Weaknesses in the design of the internal control system and non-compliance with identified control procedures amongst other conditions or events which increase the risk of fraud or error are:

Weaknesses in the design of internal control system and non-compliance with the laid down control procedures, e.g., a single person is responsible for the receipt of all dak and marking it to the relevant sections or two persons are responsible for receipt of dak but the same is not followed in actual practice, etc.
Doubts about the integrity or competence of the management, e.g., domination by one person, high turnover rate of employees, frequent change of legal counsels or auditors, significant and prolonged understaffing of the accounts department, etc.
Unusual pressures within the entity, for example, industry is doing well but the company is not performing accordingly, heavy dependence on a single line of product, inadequate working capital, entity needs raising share prices to support the market price in the wake of public offer, etc.
Unusual transactions such as transactions with related parties, excessive payment for certain services to lawyers, etc.
Problems in obtaining sufficient and appropriate audit evidence, e.g., inadequate documentation, significant differences between the figures as per the accounting records and confirmation received from third parties, etc.

Q-70

(b) “If the books of account are not properly maintained and if the control system is weak, the possibility of frauds and errors are enormous and the auditor, even with the best of his efforts, may not be able to detect all of them. The fact is recognised by the Courts as is obvious from a study of the various judgments.” Discuss the tests applied by the courts to judicially view the auditor’s performance.

A-70

If the books of account are not properly maintained and if the control system is weak, the possibility of frauds and errors are enormous and the auditor, even with the best of his efforts, may not be able to detect all of them. The fact is recognised by the Courts as is obvious from a study of the various judgments. The auditor’s performance is judicially viewed by applying the following tests:

whether the auditor has exercised reasonable care and skill in carrying out his work;
whether the errors and frauds were such as could have been detected in the ordinary course of checking without the aid of any special efforts;
whether the auditor had any reason to suspect the existence of the errors and frauds; and
whether the error or fraud was so deep laid that the same might not have been detected by the application of normal audit procedures.

Q71

Discuss with the help of examples how certain characteristics or circumstances may increase the susceptibility of assets to misappropriation.

A-71

Certain characteristics or circumstancesmay increase the susceptibility of assets to misappropriation. For example, opportunities to misappropriate assets increase when there are the following:

Large amounts of cash on hand or processed.
Inventory items that are small in size, of high value, or in high demand.
Easily convertible assets, such as bearer bonds, diamonds, or computer chips.

Fixed assets which are small in size, marketable, or lacking observable identification of ownership.

Q-72

“In terms of the Revised Preface, the Auditing and Assurance Standards are now renamed based on the type of assurance provided by the engagement undertaken by a member.” Discuss.

A-72

The Auditing and Assurance Standards Board, in 2007, adopted the Revised Preface to Standards on Quality Control, Auditing, Review, Other Assurance and Related Services. In terms of the Revised Preface, the Auditing and Assurance Standards are now renamed based on the type of assurance provided by the engagement undertaken by a member, viz.,

Standards on Auditing (SAs)- to be applied in the audit of historical financial information
Standards on Review Engagements (SREs) - to be applied in the review of historical financial information
Standards on Assurance Engagements (SAEs) - to be applied in assurance engagements, engagements dealing with subject matters other than historical financial information
Standards on Related Services (SRSs) - to be applied to engagements to apply agreed upon procedures to information and other related services engagements such as compilation engagements

Q-73

“Disclosure of significant accounting policies followed is necessary if the view presented is to be properly appreciated.” Comment

A-73

Disclosure of Accounting Policies: The view presented in the financial statements of an enterprise of its state of affairs and of the profit or loss can be significantly affected by the accounting policies followed in the preparation and presentation of the financial statements.

The accounting policies followed vary from enterprise to enterprise. Disclosure of significant accounting policies followed is necessary if the view presented is to be properly appreciated. The disclosure of some of the accounting policies followed in the preparation and presentation of the financial statements is required by some cases.

The purpose of AS 1 is to promote better understanding of financial statements by establishing through an accounting standard and the disclosure of significant accounting policies and the manner in which such accounting policies are disclosed in the financial statements.

Such disclosure would also facilitate a more meaningful comparison between financial statements of different enterprises.

To ensure proper understanding of financial statements, it is necessary that all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed. Such disclosure should form part of the financial statements.

It would be helpful to the reader of financial statements if they are all disclosed at one place instead of being scattered over several statements, schedules and notes which form part of financial statements.

Any change in accounting policy, which has a material effect, should be disclosed. The amount by which any item is in the financial statement is affected by such change should also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies, which has not material effect on the financial statements for the current period, which is reasonably expected to have material effect in latter periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.

Q-74

What do you understand by “Risk of material misstatement”? Describe its two components at the assertion level.

A-74

Risk of material misstatement may be defined as the risk that the financial statements are materially misstated prior to audit.

This consists of two components described as follows at the assertion level

Inherent risk:The susceptibility of an assertion to a misstatement that could be material before consideration of any related controls.
Control risk: The risk that a misstatement that could occur in an assertion that could be material will not be prevented or detected and corrected on a timely basis by the entity’s internal control. Less evidence would be required in case assertions that have a lower risk of material misstatement. But on the other hand if assertions have a higher risk of material misstatement, more evidence would be required.

Q-75

Discuss the Objectives of an auditor as stated in SA 570 ‘Going Concern’.

A-75

The objectives of the auditor as stated in SA 570 ‘Going Concern’ are:

To obtain sufficient appropriate audit evidence about the appropriateness of management’s use of the going concern assumption in the preparation and presentation of the financial statements;
To conclude, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern; and
To determine the implications for the auditor’s report.

Q-76

“Because of the uncertainties inherent in business activities, some financial statement items can only be estimated.” Discuss explaining the meaning of accounting estimates according to the SA 540 and also by giving examples

A-76

According to the SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosure”, accounting estimate means 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, as well as for other amounts that require estimation. SA 540 addresses only accounting estimates involving measurement at fair value, the term “fair value accounting estimates” is used.

Because of the uncertainties inherent in business activities, some financial statement items can only be estimated. Further, the specific characteristics of an asset, liability or component of equity, or the basis of or method of measurement prescribed by the financial reporting framework, may give rise to the need to estimate a financial statement item. Some financial reporting frameworks prescribe specific methods of measurement and the disclosures that are required to be made in the financial statements, while other financial reporting frameworks are less specific.

Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements, for example:

Accounting estimates arising in entities that engage in business activities that are not complex.
Accounting estimates that are frequently made and updated because they relate to routine transactions.

For some accounting estimates, however, there may be 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.

Additional examples of accounting estimates are:

Allowance for doubtful accounts.
Inventory obsolescence.
Warranty obligations.
Depreciation method or asset useful life.
Provision against the carrying amount of an investment where there is uncertainty regarding its recoverability.

Outcome of long term contracts.

Financial Obligations / Costs arising from litigation settlements and judgments

Q-77

Explain clearly the meaning of vouching. Also discuss the essential points to be borne in mind while examining a voucher

A-77

The act of examining vouchers is referred to as vouching. It is the practice followed in an audit with the objective of establishing the authenticity of the transactions recorded in the primary books of account. It essentially consists of verifying a transaction recorded in the books of account with the relevant documentary evidence and the authority on the basis of which the entry has been made; also confirming that the amount mentioned in the voucher has been posted to an appropriate account which would disclose the nature of the transaction on its inclusion in the final statements of account. On these considerations, the essential points to be borne in mind while examining a voucher are:

that the date of the voucher falls within the accounting period;
that the voucher is made out in the client’s name;
that the voucher is duly authorised;
that the voucher comprised all the relevant documents which could be expected to have been received or brought into existence on the transactions having been entered into, i.e., the voucher is complete in all respects; and
that the account in which the amount of the voucher is adjusted is the one that would clearly disclose the character of the receipts or payments posted there to on its inclusion in the final accounts

Q-78

What are the factors that determine the extent of reliance that the auditor places on results of analytical procedures? Explain with reference to SA 520 on "Analytical Procedures."

A-78

Extent of reliance on analytical procedures (SA 520) : The reliability of data is influenced by its source and nature and is dependent on the circumstances under which it is obtained. Accordingly, the following are relevant when determining whether data is reliable for purposes of designing substantive analytical procedures:

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

The auditor may consider testing the operating effectiveness of controls, if any, over the entity’s preparation of information used by the auditor in performing substantive analytical procedures in response to assessed risks. When such controls are effective, the auditor generally has greater confidence in the reliability of the information and, therefore, in the results of analytical procedures. The operating effectiveness of controls over non-financial information may often be tested in conjunction with other tests of controls. For example, in establishing controls over the processing of sales invoices, an entity may include controls over the recording of unit sales. In these circumstances, the auditor may test the operating effectiveness of controls over the recording of unit sales in conjunction with tests of the operating effectiveness of controls over the processing of sales invoices.

Alternatively, the auditor may consider whether the information was subjected to audit testing.

Q-79

How will you verify/vouch the following ?

Stock lying with Third Party.
Purchase of Motor Car.
Sales Commission Expenditure
Sales Return.

A-79

(1) Stock lying with third party

Obtain confirmations from the third party including the time period and reasons thereof. Evaluate condition of goods and see whether adequate provision has been made.

Check whether subsequently the goods lying with third party were sold or received back after the expiry of stipulated time period.

Ensure that the goods have been included in the closing stock though lying with third party.

(2)Purchase of Motor Car

Ascertain whether the purchase of car has been properly authenticated. Check invoice of the car dealer to confirm purchase price.

Examine registration with Transport Authorities to verify the ownership.

Ensure that all expenses relating to purchase of car have been properly capitalized and the same have been disclosed properly in the balance sheet.

(3)Sales Commission Expenditure

Ascertain agreement, if any, in respect of sales transaction actually occurred during the year carried out by authorized parties on its behalf. If yes the commission should be in accordance with the terms and conditions as specified.

Check evidence of services rendered by the party to whom commission is paid with reference to correspondence etc.

Ensure that the sales in fact have taken place and the same has been charged to profit and loss account.

Compare the amount incurred in previous years with reference to total turnover.

(4)Sales Return

Examine the accounting basis for such transactions with reference to corresponding Debit Note to Debit Note. The relevant correspondence may also be examined.

Verify by reference to relevant corresponding record in good inward book or the stores records. Further, the figures in these documentary evidences

should be compared with the original invoices for rates and other charges and calculation should also be checked.

Examine in depth to eliminate the possibility of fictitious sales returns for covering bogus sales recorded earlier when such returns outwards are in substantial figure either at the start or end of the accounting year.

Cross-check with reference to original invoices any rebates in price or allowances if any given by buyers on strength of their Debit Notes.

Q-80

Give your comments and observations on the following:

Balance confirmations from debtors/creditors can only be obtained for balances standing in their accounts at the year-end.
The management has obtained a certificate from an actuary regarding provision of gratuity payable to employees.
Fixed assets have been revalued and the resulting surplus has been adjusted against the brought forward losses.

A-80

1) Confirmation of Balances: Direct confirmation of balances from debtors/creditors in respect of balances standing in their accounts at the year-end is, perhaps, the best method of ascertaining whether the balances are genuine, accurately stated and undisputed particularly where the internal control system is weak. The confirmation date, method of requesting confirmation, etc. are to be determined by the auditor.

“Guidance Note on Audit of Debtors, Loans and Advances” issued by the ICAI recommends that the debtors may be requested to confirm the balance either:

As at the date of the balance sheet; or

As at any other selected date which is reasonably close to the date of the balance sheet.

The date should be settled by the auditor in consultation with the entity. Where the auditor decides to confirm the debtors at a date other than the balance sheet date, he should examine the movements in debtor balances which occur between the confirmation date and the balance sheet date and obtain sufficient evidence to satisfy himself that debtor balances stated in the balance sheet are not materially misstated.

Therefore, it is not necessary that balances of debtors/ creditors should necessarily be verified only at the end of the year only. In fact, in order to incorporate an element of surprise, the auditor may consider different confirmation dates periodically, i.e., Dec, 31 as a cut- off date in one year and June 30 in another year and so on. Therefore, the statement that balance confirmation from debtors/creditors can only be obtained for balances standing in their accounts at the year-end is not correct.

2)Certificate from an Expert: The computation of gratuity liability payable to employees is dependent upon several factors such as age of the employee, expected span of service in the organisation, life expectancy of the employee, prevailing economic environment, etc. Thus, it gives rise to uncertainty in the determination of provisions of liabilities. Under such circumstances, the management is required to make an assessment and estimate the amount of provision. In view of this, the management may engage an expert in the field to assist them in arriving at fair estimation of the liability. Therefore, it is an accepted auditing practice to use the work of an expert. SA 620 on “Using the Work of an Expert”, also states that an expert may be engaged / employed by the client. It further requires the auditor to assess skill, competence and objectivity of the expert amongst other factors and evaluate the work of an expert independently to conclude whether or not to rely upon such a certificate obtained by the management from the actuary. Therefore, the auditor must follow the requirements of SA 620 before relying upon the certificate obtained by the management from the actuary.

3) Revaluation of Fixed Assets: The revaluation of fixed assets is a normally accepted practice which involves writing up the book value of fixed assets. AS 10 on ‘Accounting for Fixed Assets’ requires that “an increase in net book value arising on revaluation of fixed assets is normally credited directly to owner’s interests under the heading of revaluation reserves and is regarded as not available for distribution”. Thus, creation of revaluation reserves does not result into any cash inflows and represents unrealised gains. However, brought forward losses are in the nature of revenue losses. As a matter of prudence, revenue losses can be adjusted against revenue reserves only and not the capital reserves. Therefore, the accounting treatment followed by the entity is not correct and the auditor should qualify the audit report by mentioning the above fact.

Q-81

Answer the following-

KVT Limited could not recover an amount of ` 8 lakhs from a debtor. The company is aware that the Trade receivable is in great financial difficulty. The accounts of the company for the year ended 31-3-2013 were finalized by making a provision @ 25% of the amount due from that Trade receivable. In May 2013, the Trade receivable became bankrupt and nothing is recoverable from him. Do you advise the company to provide for the entire loss of ` 8 lakhs in books of account for the year ended 31-3-2013?
M Co. Limited purchased goods at the cost of ` 40 lakhs in October, 2012. Till March, 2013, 75% of the stocks were sold. The company wants to disclose closing stock at ` 10 lakhs. The expected sale value is ` 11 lakhs and a commission at 10% on sale is payable to the agent. Accountant has disclosed the value of Stock at ` 990000. Give your views as an auditor.

A-81

(1) As per AS 4, ‘Contingencies and Events Occurring after the Balance Sheet Date’, adjustments to assets and liabilities are required for events occurring after the balance sheet date if such event provides/relates to additional information to the conditions existing at the balance sheet date and is also materially affecting the valuation of assets and liabilities on the balance sheet date.

As per the information given in the question, the Trade receivable was already in a great financial difficulty at the time of closing of accounts. Bankruptcy of the Trade receivable in May 2013 is only an additional information to the condition existing on the balance sheet date. Also the effect of a Trade receivable becoming bankrupt is material as total amount of ` 8 lakhs will be a loss to the company. Therefore, the company is advised to provide for the entire amount of ` 8 lakhs in the books of account for the year ended 31st March, 2013.

(2) As per AS 2 “Valuation of Inventories”, the inventories are to be valued at lower of cost and net realizable value.In this case, the cost of inventory is ` 10 lakhs. The net realizable value is 11,00,000 × 90% = ` 9,90,000. So, the stock should be valued at ` 9,90,000.

Q-82

Describe the salient features of Financial Administration of Local Bodies. Draft an audit programme for conducting audit of accounts of a Local Body

A-82

(a) Salient Features of Financial Administration of Local Bodies

Budgetary Procedure: The objective of local bodies budgetary procedure are financial accountability, control of expenditure, and to ensure that funds are raised and moneys are spent by the executive departments in accordance with the rules and regulations and within the limits of sanction and authorisation by the legislature or Council. Different aspects covered in budgeting are determining the level of taxation, fees, rates, and laying down the ceiling on expenditure, under revenue and capital heads.
Expenditure Control: At the State and Central level, there is a clear demarcation between the legislature and executive. In the local body, legislative powers are vested in the Council whereas executive powers are delegated to the officers, e.g., Commissioners. All matters of regular revenue and expenditures are generally delegated to the executive wing. For special situations like, reduction in property taxes, refund of security deposits, etc., sanction from the legislative wing is necessary.
Accounting System: Municipal Accounting System has been conventionally prepared under the cash system. In the recent past however, it is being changed to the accrual system of accounting. The accounting system is characterized by (a) subsidiary and statistical registers for taxes, assets, cheques etc., (b) separate vouchers for each type of transaction, (c) compulsory monthly bank reconciliation, (d) submission of summary reports on periodical basis to different authorities at regional and state level.

(b)Audit of Local Bodies :

The Local Fund Audit Wing of the State Govt. is generally in charge of the audit of municipal accounts. Sometimes bigger municipal corporations e.g. Delhi, Mumbai etc have power to appoint their own auditors for regular external audit. So the auditor should ensure authenticity of his appointment.
The auditor while auditing the local bodies should report on the fairness of the contents and presentation of financial statements, the strengths and weaknesses of system of financial control, the adherence to legal and/or administrative requirements; upon whether value is being fully received on money spent. His objective should be to detect errors and fraud and misuse of resources.
The auditor should ensure that the expenditure incurred conforms to the relevant provisions of the law and is in accordance with the financial rules and regulations framed by the competent authority.
He should ensure that all types of sanctions, either special or general, accorded by the competent authority.
He should ensure that there is a provision of funds and the expenditure is incurred from the provision and the same has been authorized by the competent authority.
The auditor should check that the different schemes, programmes and projects, where large financial expenditure has been incurred, are running economically and getting the expected results.

Q-83

With reference to Government Audit, what do you understand by “Audit of Commercial Accounts”?

A-83

Audit of Commercial Accounts: The government also engages in commercial activities and for the purpose it may incorporate following types of entities:

Departmental enterprises engaged in commercial and trading operations, which are governed by the same regulations as other Government departments such as defence factories, mints, etc.
Statutory corporations created by specific statues such as LIC, Air India, etc.
Government companies, set up under the Companies Act,

All aforesaid entities are required to maintain accounts on commercial basis. The audit of departmental entities is done in the same manner as any Government department, where commercial accounts are kept. Audit of statutory corporations depends on the nature of the statute governing the corporation. In respect of government companies, the relevant provisions of Companies Act, 2013 are applicable. As per section 619 of the Companies Act, 2013 the statutory auditor of a Government company shall be appointed or re-appointed by the CAG. Such an auditor must be a chartered accountant. Further, the Companies Act, 2013, provides that the CAG shall have the powers:

to direct the manner in which the company’s accounts shall be audited by the auditor, and to give the auditor instructions in regard to any matter relating to the performance of his functions; and
to conduct a supplementary or test audit of the company’s accounts by such person, as he may authorise in this behalf, and for the purposes of such audit to require information or additional information to be furnished to any person or persons, so authorised on such matters by such person or persons, and in such form as the CAG may direct.

The statutory auditor shall submit a copy of his audit report to the CAG, who shall have the right to comment upon or supplement the audit report in such manner he may think fit.

Any such comments upon or supplement to the audit report shall be placed before the company, at the same time, and in the same manner, as the audit report. Thus, it is seen that there is a two layer audit of a Government company, by the statutory auditors, being qualified chartered accountants, and by the CAG. The general standards, principles, techniques and procedures for audit adopted by the C&AG are a mixture of government audit and commercial audit as known and practiced by professional auditors. The concepts of autonomy and accountability of the institution / bodies / corporations / companies have influenced the nature and scope of audit in applying the conventional audit from the angle of economy, efficiency and effectiveness.

Q-84

Discuss the auditor’s responsibilities for detection of frauds and errors with specific reference to Standards on Auditing and Companies Act, 2013

A-84

Auditor’s Responsibilities for Detection of Fraud and Error: As per SA 240 “The Auditor’s Responsibilities relating to fraud in an audit of Financial Statements”, an auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.

The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one resulting from error. This is because fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional misrepresentations being made to the auditor. Such attempts at concealment may be even more difficult to detect when accompanied by collusion. Collusion may cause the auditor to believe that audit evidence is persuasive when it is, in fact, false.

When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of professional skepticism throughout the audit, considering the potential for management override of controls and recognizing the fact that audit procedures that are effective for detecting error may not be effective in detecting fraud.

An audit conducted in accordance with the auditing standards generally accepted in India is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be held responsible for the prevention of fraud and error.

The auditor's opinion on the financial statements is based on the concept of obtaining reasonable assurance; hence, in an audit, the auditor does not guarantee that material misstatements, whether from fraud or error, will be detected. Therefore, the subsequent discovery of a material misstatement of the financial statements resulting from fraud or error does not, in and of itself, indicate:

failure to obtain reasonable assurance,
inadequate planning, performance or judgment,
absence of professional competence and due care, or,
failure to comply with auditing standards generally accepted in India.

In planning and performing his examination the auditor should take into consideration the risk of material misstatement of the financial information caused by fraud or error. He should inquire with the management as to any fraud or significant error, which has occurred in the reporting period, and modify his audit procedures, if necessary. If circumstances indicate the possible existence of fraud and error, the auditor should consider the potential effect of the suspected fraud and error on the financial information. If he is unable to obtain evidence to confirm, he should consider the relevant laws and regulations before expressing his opinion.

The auditor also has the responsibility to communicate the misstatement to the appropriate level of management on a timely basis and consider the need to report to it then changed with governance. He may also obtain legal advice before reporting on the financial information or before withdrawing from the engagement. The auditor should satisfy himself that the effect of fraud is properly reflected in the financial information or the error is corrected in case the modified procedures performed by the auditor confirm the existence of the fraud.

The auditor should also consider the implications of the frauds and errors, and frame his report appropriately. In case of a fraud, the same should be disclosed in the financial statement. If adequate disclosure is not made, there should be a suitable disclosure in his audit report.

Further, as per sub section 12 of section 143 of the Companies Act, 2013, if an auditor of a company, in the course of the performance of his duties as auditor, has reason to believe that an offence involving fraud is being or has been committed against the company by officers or employees of the company, he shall immediately report the matter to the Central Government within 60 days of his knowledge and after following the prescribed procedure.

Q-85

“The process of auditing is such that it suffers from certain limitations which cannot be overcome irrespective of the nature and extent of audit procedures.” Explain

A-85

Inherent limitations of Audit: As per SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”, the objectives of an audit of financial statements, prepared with in a framework of recognised accounting policies and practices and relevant statutory requirements, if any, is to enable an auditor to express an opinion on such financial statements. In forming his opinion on the financial statements, the auditor follows procedures designed to satisfy him that the financial statements reflect a true and fair view of the financial position and operating results of the enterprise. The process of auditing, however, is such that it suffers from certain limitations, i.e. the limitation which cannot be overcome irrespective of the nature and extent of audit procedures. The limitations of an audit arise from:

(i) The Nature of Financial Reporting: The preparation of financial statements involves judgment by management in applying the requirements of the entity’s applicable financial reporting framework to the facts and circumstances of the entity. In addition, many financial statement items involve subjective decisions or assessments or a degree of uncertainty, and there may be a range of acceptable interpretations or judgments that may be made. Consequently, some financial statement items are subject to an inherent level of variability which cannot be eliminated by the application of additional auditing procedures.

(ii)The Nature of Audit Procedures: There are practical and legal limitations on the auditor’s ability to obtain audit evidence. For example:

There is the possibility that management or others may not provide, intentionally or unintentionally, the complete information that is relevant to the preparation and presentation of the financial statements or that has been requested by the auditor.
Fraud may involve sophisticated and carefully organised schemes designed to conceal it. The auditor is neither trained as nor expected to be an expert in the authentication of documents.
An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is not given specific legal powers, such as the power of search, which may be necessary for such an investigation.

(iii) Timeliness of Financial Reporting and the Balance between Benefit and Cost: The relevance of information, and thereby its value, tends to diminish over time, and there is a balance to be struck between the reliability of information and its cost. There is an expectation by users of financial statements that the auditor will form an opinion on the financial statements within a reasonable period of time and at a reasonable cost, recognising that it is impracticable to address all information that may exist or to pursue every matter exhaustively on the assumption that information is in error or fraudulent until proved otherwise.

(iv) Other Matters that Affect the Limitations of an Audit: In the case of certain assertions or subject matters, the potential effects of the limitations on the auditor’s ability to detect material misstatements are particularly significant. Such assertions or subject matters include:

Fraud, particularly fraud involving senior management or collusion.
The existence and completeness of related party relationships and transactions.
The occurrence of non-compliance with laws and regulations.
Future events or conditions that may cause an entity to cease to continue as a going concern.

Because of the limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with SAs.

Q-86

“Audit is not legally obligatory for all types of business organisations or institutions” Discuss.

A-86

Audits required under Law: Audit is not legally obligatory for all types of business organisations or institutions. On this basis audits may be of two broad categories i.e., audit required under law and voluntary audits.

The organisations which require audit under law are the following:

Companies governed by the Companies Act;
Banking companies governed by the Banking Regulation Act, 1949;
Electricity supply companies governed by the Electricity Supply Act, 1948;
Co-operative societies registered under the Co-operative Societies Act, 1912;
Public and charitable trusts registered under various Religious andEndowment Acts;
Corporations set up under an Act of Parliament or State Legislature such as the Life Insurance Corporation of India.
Specified entities under various sections of the Income-tax Act, 1961. Audit required under Sales-tax and VAT by various State Government.

Q-87

“Having accounts audited by independent auditor, among other advantages, acts as a moral check on the employees from committing fraud.” Explain stating the advantages of Independent audit

A-87

Advantages of Independent Audit: Advantages of having the accounts audited by an independent auditor are:-

It safeguards the financial interest of persons not associated with the management like partners or shareholders.
It acts as a moral check on the employees from committing fraud.
It is helpful in settling tax liability, negotiations for loans and for determining purchase consideration for sale/merger.
It is also helpful in settling trade or labour disputes for higher wages/bonus.
It helps in detection and minimizing wastages and losses.
It ensures maintenance of adequate books and records, statutory register etc.

Q-88

“Auditor is expected to be familiar with the overall economic environment in which his client is operating.” Discuss.

A-88

Auditing and Economics: As, it is well known, accounting is concerned with the accumulation and presentation of data relating to economic activity. Though the concept of income as put forward by economists is different as compared to the accountants concept of income, still, there are lot of similar grounds on which the accounting has flourished. From the auditing view point, the auditors are more concerned with Micro economics rather than with the Macro economics. The knowledge of Macro economics should include the nature of economic force that affect the firm, relationship of price, productivity and the role of Government and Government regulations. Auditor is expected to be familiar with the overall economic environment in which his client is operating.

Q-89

Discuss the procedure to be followed by the auditor in case he has sufficient reason to believe that an offence involving fraud has been committed against the company by its officers.

A-89

Procedure to be Followed in case of Fraud: Rules 13 of the Companies (Audit and Auditors) Rules, 2014, prescribes that in case the auditor has sufficient reason to believe that an offence involving fraud, is being or has been committed against the company by officers or employees of the company, he shall report the matter to the Central Government immediately but not later than sixty days of his knowledge and after following the procedure indicated herein below:

auditor shall forward his report to the Board or the Audit Committee, as the case may be, immediately after he comes to knowledge of the fraud, seeking their reply or observations within forty-five days; on receipt of such reply or observations the auditor shall forward his report and the reply or observations of the Board or the Audit Committee alongwith his comments (on such reply or observations of the Board or the Audit Committee) to the Central Government within fifteen days of receipt of such reply or observations; in case the auditor fails to get any reply or observations from the Board or the Audit Committee within the stipulated period of forty-five days, he shall forward his report to the Central Government alongwith a note containing the details of his report that was earlier forwarded to the Board or the Audit Committee for which he failed to receive any reply or observations within the stipulated time.

Q-90

“Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements whereas for some accounting estimates there may be relatively high estimation uncertainty particularly where they are based on significant assumptions”. Explain by giving examples.

A-90

(a) Accounting Estimates: Some accounting estimates involve relatively low estimation uncertainty and may give rise to lower risks of material misstatements, for example:

Accounting estimates arising in entities that engage in business activities that are not complex.
Accounting estimates that are frequently made and updated because they relate to routine transactions.

For some accounting estimates, however, there may be 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.

Additional examples of accounting estimates are:

Allowance for doubtful accounts.
Inventory obsolescence.
Warranty obligations.

Depreciation method or asset useful life.

Provision against the carrying amount of an investment where there is uncertainty regarding its recoverability.

Outcome of long term contracts.

Financial Obligations / Costs arising from litigation settlements and judgments

Q-91

Explain what do you mean by Analytical procedures. How such procedures are helpful in auditing?

A-91

SA 520 ‘Analytical Procedures’: As per SA 520 the term “analytical procedures” means evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount. The auditor’s choice of procedures, methods and level of application is a matter of professional judgement.

Analytical procedures include the consideration of comparisons of the entity’s financial information with, for example: comparable information for prior periods, anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor, such as an estimation of depreciation and similar industry information, such as a comparison of the entity’s ratio of sales to accounts receivable with industry averages or with other entities of comparable size in the same industry.

Analytical procedures also include consideration of relationships, for example: among elements of financial information that would be expected to conform to a predictable pattern based on the entity’s experience, such as gross margin percentages and between financial information and relevant non-financial information, such as payroll costs to number of employees.

Various methods may be used to perform analytical procedures. These methods range from performing simple comparisons to performing complex analyses using advanced statistical techniques. Analytical procedures may be applied to consolidated financial statements, components and individual elements of information.

Analytical procedures are used for the following purposes:

To obtain relevant and reliable audit evidence when using substantive analytical procedures; and

To design and perform analytical procedures near the end of the audit that assist the auditor when forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity

Q-92

What do you mean by the term 'Sufficient Appropriate Audit Evidence'? State various factors that help the auditor to ascertain as to what is sufficient appropriate audit evidence.

A-92

Sufficient appropriate audit evidence: The auditor shall design and perform audit procedures that are appropriate in the circumstances for the purpose of obtaining sufficient appropriate audit evidence.

SA 500 on ‘Audit Evidence’ further expounds this concept. According to it, the sufficiency and appropriateness of audit evidence are interrelated. Sufficiency is the measure of the quantity of audit evidence. The quantity of audit evidence needed is affected by the auditor’s assessment of the risks of misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and also by the quality of such audit evidence (the higher the quality, the less may be required). Obtaining more audit evidence, however, may not compensate for its poor quality.

Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing support for the conclusions on which the auditor’s opinion is based. The reliability of evidence is influenced by its source and by its nature, and is dependent on the individual circumstances under which it is obtained.

SA 330 requires the auditor to conclude whether sufficient appropriate audit evidence has been obtained. Whether sufficient appropriate audit evidence has been obtained to reduce audit risk to an acceptably low level, and thereby enable the auditor to draw reasonable conclusions on which to base the auditor’s opinion, is a matter of professional judgment. Further, SA 200 contains discussion of such matters as the nature of audit procedures, the timeliness of financial reporting, and the balance between benefit and cost, which are relevant factors when the auditor exercises professional judgment regarding whether sufficient appropriate audit evidence has been obtained.

In general the various factors which may influence the auditor’s judgment as to what is sufficient and appropriate audit evidence are as under:

Degree of risk of misstatements which may be affected by factors such as the nature of items, adequacy of internal control, nature and size of businesses carried out by the entity, situations which may exert an unusual influence on management and the financial position of the entity.
The materiality of the item.
The experience gained during previous audits.
The results of auditing procedures, including fraud and errors which may have been found.
The type of information available.
The trend indicated by accounting ratios and analysis.

Q-93

The audit working papers constitute the link between the auditor’s report and the client’s records. Discuss stating clearly the objectives of audit working papers.

A-93

Audit Working Papers: The audit working papers constitute the link between the auditor’s report and the client’s records. SA 230 on “Audit Documentation” states that Audit Working papers are the record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached. The object of Audit working papers is to provide:

Evidence of the auditor’s basis for a conclusion about the achievement of the overall objective of the auditor; and
Evidence that the audit was planned and performed in accordance with SAs and applicable legal and regulatory requirements.

Besides above, they serve a number of additional purposes, including the following:

Assisting the engagement team to plan and perform the audit.
Assisting members of the engagement team responsible for supervision to direct and supervise the audit work, and to discharge their review responsibilities in accordance with SA 220.
Enabling the engagement team to be accountable for its work.
Retaining a record of matters of continuing significance to future audits.
Enabling the conduct of quality control reviews and inspections in accordance with SQC 1.
Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other requirements.

Working papers should contain audit plan, the nature, timing and extent of auditing procedures performed, and the conclusions drawn from the evidence obtained. The auditor shall assemble the audit working papers in an audit file and complete the administrative process of assembling the final audit file on a timely basis after the date of the auditor’s report. The retention period for audit working papers ordinarily is no shorter than ten years from the date of the auditor’s report, or, if later, the date of the group auditor’s report. Unless otherwise specified by law or regulation, audit working papers are the property of the auditor. He may at his discretion, make portions of, or extracts from, audit documentation available to clients.

Q-94

What role is played by Comptroller and Auditor General of India in the audit of a Government company?

A-94

Role of C&AG in the Audit of a Government company : Role of C&AG is prescribed under sub section (5), (6) and (7) of section 143 of the Companies Act, 2013.

In the case of a Government company, the comptroller and Auditor- General of India shall appoint the auditor under sub-section (5) or sub- section (7) of section 139 i.e. appointment of First Auditor or Subsequent Auditor and direct such auditor the manner in which the accounts of the Government company are required to be audited and thereupon the auditor so appointed shall submit a copy of the audit report to the Comptroller and Auditor- General of India which, among other things, include the directions, if any, issued by the Comptroller and Auditor-General of India, the action taken thereon and its impact on the accounts and financial statement of the company.

The Comptroller and Auditor-General of India shall within sixty days from the date of receipt of the audit report have a right to, conduct a supplementary audit of the financial statement of the company by such person or persons as he may authorize in this behalf; and for the purposes of such audit, require information or additional information to be furnished to any person or persons, so authorised, on such matters, by such person or persons, and in such form, as the Comptroller and Auditor-General of India may direct; and comment upon or supplement such audit report:

It may be noted that any comments given by the Comptroller and Auditor- General of India upon, or supplement to, the audit report shall be sent by the company to every person entitled to copies of audited financial statements under sub-section (1) of section 136 i.e. every member of the company, to every trustee for the debenture-holder of any debentures issued by the company, and to all persons other than such member or trustee, being the person so entitled and also be placed before the annual general meeting of the company at the same time and in the same manner as the audit report.

Test Audit : Further, without prejudice to the provisions relating to audit and auditor, the Comptroller and Auditor- General of India may, in case of any company covered under sub-section (5) or sub-section (7) of section 139, if he considers necessary, by an order, cause test audit to be conducted of the accounts of such company and the provisions of section 19A of the Comptroller and Auditor-General's (Duties, Powers and Conditions of Service) Act, 1971, shall apply to the report of such test audit.

Q-95

“Audit of the accounts of stores and inventories has been developed as a part of expenditure audit with reference to the duties and responsibilities entrusted to C&AG.” Discuss.

A-95

Audit of Stores and Inventories: Audit of the accounts of stores and inventories has been developed as a part of expenditure audit with reference to the duties and responsibilities entrusted to C&AG. Audit is conducted to ascertain whether the Regulations governing purchase, receipt and issue, custody, sale and inventory taking of stores are well devised and properly carried out. The aim is also to bring to the notice of the government any deficiencies in quantities of stores held or any defects in the system of control. The audit of purchase of stores is conducted in the same manner as audit of expenditure, namely, that these are properly sanctioned, made economical and in accordance with the Rules for purchase laid down by the competent authority. The auditor has to ensure that the prices paid are reasonable and are in agreement with those shown in the contract for the supply of stores, and that the certificates of quality and quantity are furnished by the in-specting and receiving units. Cases of uneconomical purchase of stores and losses attributable to defective or inferior quality of stores are specifically brought by the audit. Accounts of receipts, issues and balances are checked regarding accuracy, correctness and reasonableness of balances in inventories with particular reference to the specified norms for level of consumption of inventory holding. Any excess or idle inventory is specifically mentioned in the report and periodical verification of inventory is also conducted to ensure their existence. When priced accounts are maintained, the auditor should see that the prices charged are reasonable and have been reviewed from time to time. The valuation of the inventories is seen carefully so that the value accounts tally with the physical accounts and that adjustment of profits or losses due to revaluation, inventory taking or other causes is carried out.

Q-96

Mention any ten special points to be examined by you in the audit of Income and Expenditure of a Charitable Institution running a hospital

A-96

Audit of Hospital: While auditing the Income and Expenditure Account of a charitable institution running a hospital, following special points may be examined:

Verify the register of patients with duplicate copy of bills and patients admission record to see that bills have been properly and correctly prepared for all the services, tests and treatments.
Check cash collections from patients by tracing the receipt issued into cash book.
Check receipt of interest, rent, dividend etc., with receipt counterfoil into cash book and bank book and ensure that all such income has been duly accounted for.
Check collection of subscription, donations from the receipt issued, correspondence etc., into cash book.
Verify that all grants from government and other bodies have been duly accounted for and have been applied in the manner as specified.
Verify all recurring nature of revenue expenditure, with necessary evidence like bill, authority, period etc.

Examine the internal check as regards the receipt and issue of stores, medicines, linen etc., to ensure that these have been properly recorded and issued/consumed only on proper authorisation.
See that depreciation has been written off in respect of all the assets at appropriate rate and method as in the earlier year.
Verify the receipts from supply of food and canteen receipts and compare the same with previous year as regards number of patients.
Ensure that all outstanding liabilities have been adequately provided for and similarly all accrued incomes and receipts have been duly accounted for.
Obtain inventory of stock and stores as at the end of the year and physically check a percentage of items.

Q-97

Discuss the special precautions in verification of purchase invoice. Explain the steps involved in carrying out the audit of ledgers

A-97

Special Precautions in Verification of Purchase Invoices:

When an invoice runs into several pages and the total of each page has been carried forward to the next or where the amount of an invoice has been distributed over several accounts, it should be confirmed that the amounts relating to different parts of the invoice have been adjusted together. When the total amount of the invoice has been adjusted in separate accounts, the entire amount so adjusted should be added together to confirm that there has not been error under adjustment.

At times, invoices are received in duplicate and even triplicate. In such cases, payment usually is made on the basis of the original invoice. Sometimes, however, the original is kept in record and the price is adjusted on the basis of the duplicate. In such a case, it should be confirmed that the original invoice has also been paid or adjusted separately.

Often supplies are received on certain special conditions. In such cases, it should be verified that these are the same as were agreed to at the time the order was placed, e.g., payment of freight and insurance charges of goods while in transit, etc. If the amount of an invoice was payable after the lapse of some time, subsequent to the receipt of goods, it should be ascertained that it has not been paid earlier and the benefit of cash discount, if any, has been obtained. Where a trade discount has been deducted from the amount of the invoice, it should be seen that only the net amount has been credited to the supplier.

Where goods have been purchased for the use of an officer or a subordinate but the invoice is made out in the name of the concern for obtaining the benefit of trade discount, it should be seen that the cost has been charged to the person concerned and not to the Purchases Account.

Purchases of goods from the allied and associated concerns can be made only under an appropriate sanction.

If the case of an invoice addressed to an individual, particular care should be taken when vouching such an item, since the individual may have attempted to procure goods for his own use while allowing the company to pay for them. The system of internal check for purchases should be such as to preclude such a possibility. Nevertheless, it should be seen whether the goods are of a type which the company usually requires, and whether the invoice has been duly checked by someone other than the individual to whom it was addressed.

The delivery note and the goods inward note should be examined and it should be seen that the goods were inspected on arrival. Further evidence should also be sought to establish whether the goods were actually received into inventory. The original order for goods should have been duly authorised by a responsible official. The firm supplying the goods should be requested not to submit invoices addressed in this way.

If materials are bought for delivery direct to a account receivable, the exact circumstances of the transaction should be ascertained and the reasons for the goods having been delivered direct to the account receivable. The auditor should make appropriate inquiries in order to establish that the transaction was appropriately authorised by a responsible official. A copy of the delivery note signed by the account receivable on delivery of the goods should be examined, and it should be ascertained whether the account receivable is a regular purchaser of the company’s goods and not an employee of the company wishing to take advantage of a weakness in the system. The original order should also be seen to have duly authorised by the appropriate official, and if this practice is a regular feature of the company’s mode of transacting busi-ness, the system of internal check should be such as to ensure that no fraud may by perpetrated as a result of this practice. The payment for the goods, if it has been received, should be vouched to the cash book and bank statement.

Though it is not practicable for an auditor to verify that every item of goods purchased has been entered in inventory, he should trace into the inventory record at least purchases of goods during the opening and closing months and accept the correctness of the rest only if he is satisfied that there exists a system of internal control which prevent payment being made for any goods not received in inventory.

Audit of Ledgers - General Considerations: The audit of ledgers generally involves the under mentioned steps -

Testing the strength and quantity of internal check;
Tracing the opening balances from the previous year’s records;
Checking the postings from subsidiary books and, if they are kept on the self- balancing system, also tallying the totals of balances in subsidiary ledgers with those in the total of control account;
Checking the closing balances of individual accounts on the balance schedules afterwards from the schedules on to grouping schedules and then into the final accounts;
Checking the totals of ledger accounts, trial balance, schedules and groupings;
Verifying the balances in personal accounts, either with the statements of account or confirmation of balances obtained from the parties; verifying the balances in impersonal accounts, viz., those of fixed assets, bank balances, etc. with the schedules containing details of assets and liabilities as well as those of nominal accounts (featuring various items of income and expense by reference to the documentary evidence which may exist in a variety of forms to ensure that all the outstanding amounts, both receivable and payable have been properly adjusted);

© Ascertaining the extent of clearance of the balances brought forward from the previous year particularly those relating to receivables and payables, sale or disposal of fixed assets and of inventories.

The audit of ledgers is thus an important step in the process of verification of the correctness of Final Accounts. It is an occasion to review the transactions entered during an accounting period, duly classified, in the totality; also that of studying the relationship which exists between different sets of figures. Ledgers, therefore, should be examined carefully and comprehensively. The composition of the balance of each account should be scrutinised and, if a doubt arises, the transaction or the set of transactions, which have given rise to the doubt should be examined in depth.

When a comprehensive and effective system of internal control exists, it is possible to limit the routine checking of ledgers by the application of test checks as stated below:

verifying the postings into the ledgers from the various books of prime entry;
verifying the totals of the account;
tracing the balances of the personal and nominal accounts from the ledgers into the schedule of balances;
comparing schedules totals with the balances in the Control Accounts; and
checking the position of the daily entries into Control Accounts.

The foregoing audit tests are applied to a selected group of entries in the ledgers. Alternatively, steps (i) to (iv) should be applied to accounts for parts of the year determined on a selection. However, the posting of the Control Accounts should be verified for the whole year. In selecting the period or periods of verification of posting and totals, preference should be given to the accounts the composition whereof is not clear or in which items on either side cannot be correlated. Moreover, instead of certain periods being selected for the application of test checks, a few accounts could be selected for being test checked for the whole of the year.

If, however, the system of internal control on application of procedural tests is found to be ineffective, it would be necessary for the auditor to extend the programme of verification of balances of the accounts in the ledgers as aforementioned. In doing so, the auditor should take into account the existence of possibilities of frauds being committed through manipulation of entries in the ledgers, for example, the possibility of the ledger clerk colluding with others for misappropriating amounts collected from the account receivables and subsequently covering up misdeeds by adjusting fictitious credit in the account receivable accounts.

Such a fraud in a ledger would not be disclosed merely on extracting balances from the ledger and agreeing their totals with the balance in the respective Control Accounts, since the balances, despite the fraud, would agree. It would be discovered either on postings being checked in detail, or on obtaining detailed statements of account from account receivables and comparing them with those stated in the books of account.

Q-98

a) Discuss the audit procedure for verification of payment of dividends.

b) ABC Ltd. issued shares to its equity shareholders in the proportion of one bonus share for every four existing shares. As an auditor of the company, how would you verify this issue?

A-98

a) Verification of Payment of Dividends: The procedure for the verification of payment of dividends is stated below-

Examine the company’s Memorandum and Articles of Association to ascertain the dividend rights of different classes of shares.
Confirm that the profits appropriated for payment of dividend are distributable having regard to the provisions contained in Section 123 of the Companies Act, 2013. If the company proposes to pay the dividend out of past profit in reserves, see that either this is in accordance with the rules framed by the Central Government in this behalf.
Inspect the Shareholders’ Minute Book to verify the amount of dividend declared and confirm that the amount recommended by the directors.
If a separate bank account was opened for payment of dividends, check the transfer of the total amount of dividends payable from the Dividends Accounts.
Check the particulars of members as are entered in the Dividend Register or Dividend List by reference to the Register of Members, test check the calculation of the gross amount of dividend payable to each shareholder on the basis of the number of the shares held and the amount of CDT, if applicable. Verify the casts and crosscast of the different columns.
Check the amount of dividend paid with the dividend warrants surrendered. Reconcile the amount of dividend warrants outstanding with the balance in the Dividend Bank Account.
Examine the dividend warrants in respect of previous years, presented during the year for payment and verify that by their payment, any provision contained in the Articles in the matter of period of time during which amount of unclaimed dividend can be paid had not been contravened.
It is compulsory for a company to transfer the total amount of dividend which remains unpaid or unclaimed, within thirty days of the declaration of the dividend to a special bank account entitled “Unpaid Dividend Account”. Such an account is to be opened only in a scheduled bank. The transfer must be made within 7 days from the date of expiry of thirty days.
In case any money transferred to the unpaid dividend amount of a company remain unpaid or unclaimed for a period of 7 years from the date of such transfer shall be transferred to Investor Education and Protection Fund.
Ensure the compliance, in case dividend is paid in case of inadequate profits.

b) Verification of Issue of Bonus Shares: Section 63 of the Companies Act, 2013 allows a company to issue fully paid-up bonus shares to its members, in any manner whatsoever, out of-

its free reserves;
the securities premium account; or
the capital redemption reserve account.

The auditor should ensure that no issue of bonus shares shall be made by capitalising reserves created by the revaluation of assets.

Further, he should also ensure the compliance of condition for capitalization of profits or reserves for the issuing fully paid-up bonus shares like -

it is authorised by its articles;
it has, on the recommendation of the Board, been authorised in the general meeting of the company;
it has not defaulted in payment of interest or principal in respect of fixed deposits or debt securities issued by it;
it has not defaulted in respect of the payment of statutory dues of the employees, such as, contribution to provident fund, gratuity and bonus;
the partly paid-up shares, if any outstanding on the date of allotment, are made fully paid-up;
it complies with such conditions as may be prescribed like the company which has once announced the decision of its Board recommending a bonus issue, shall not subsequently withdraw the same;
the bonus shares shall not be issued in lieu of dividend.

Q-99

(a) Sri & Company, a firm of Chartered Accountants was appointed as statutory auditors of Aaradhana Company Ltd. Aaradhana Company Ltd. holds 51% shares in Sarang Company Ltd. Mr. Sri, one of the partners of Sri & Company, owed ` 1,500 as on the date of appointment to Sarang Company Ltd. for goods purchased in normal course of business. Comment.

b) Audit Committee is to be formed by each and every company and the auditor has right to vote in the meeting of such Audit Committee. Comment.

c) “CARO, 2016 applies to all companies”. Discuss

A-99

a) Indebtness to the Subsidiary Company: As per Section 141(3)(d)(ii) of the Companies Act, 2013, a person who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate company, or a subsidiary of its holding company, for an amount exceeding ` 5,00,000, then he is not qualified for appointment as an auditor of a company.

Where an auditor purchases goods or services from a company audited by him or its subsidiary, or its holding or associate company, or a subsidiary of its holding company, whether in normal course of business, he is definitely indebted to the company and if the amount outstanding exceeds ` 5,00,000, he is disqualified for appointment as an auditor of the company. In such a case, he becomes indebted to the company and consequently he has deemed to have vacated his office.

In the given case, Sri & Company, a firm of Chartered Accountants was appointed as statutory auditors of Aaradhana Company Ltd. where the company holds 51% shares in Sarang Company Ltd. Mr. Sri, one of the partners of Sri & Company owed 1,500 as on the date of appointment to Sarang Company Ltd. for goods purchased

Accordingly, the partner Mr Sri is not disqualified to be appointed as auditor of the company as he is indebted to the company for an amount not exceeding ` 5,00,000.

Due to this, Sri & Company, is not disqualified to be appointed as an auditor of Aaradhana Company Ltd.

b) Formation of Audit Committee: As per section 177 of the Companies Act, 2013 read with the Companies (Meeting of Board and its Powers) Rules, 2014, audit committee is to be formed by every listed companies and following classes of companies:

all public companies with a paid up capital of ten crore rupees or more,
all public companies having turnover of one hundred crore rupees or more,
all public companies having in aggregate, outstanding loans or borrowings or debentures or deposits exceeding fifty crore rupees or more.

Further, the auditor shall have the 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.

c) Applicability of CARO, 2016: It shall apply to every company including a foreign company as defined in clause (42) of section 2 of the Companies Act, 2013 except–

a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);
an insurance company as defined under the Insurance Act,1938 (4 of 1938);
a company licensed to operate under section 8 of the Companies Act;
a One Person Company as defined under clause (62) of section 2 of the Companies Act and a small company as defined under clause (85) of section 2 of the Companies Act; and
a private limited company, not being a subsidiary or holding company of a public company, having a paid up capital and reserves and surplus not more than rupees one crore as on the balance sheet date and which does not have total borrowings exceeding rupees one crore from any bank or financial institution at any point of time during the financial year and which does not have a total revenue as disclosed in Scheduled III to the Companies Act, 2013 (including revenue from discontinuing operations) exceeding rupees ten crore during the financial year as per the financial statements.

From the above it is clear that CARO, 2016 does not apply to all companies.

Q-100

How will you vouch and/or verify the following:

a)Sale proceeds of Scrap Material.

b) Trade Marks and Copyrights.

c) Machinery acquired under Hire-purchase system.

d) Work-in-progress.

A-100

(a) Sale Proceeds of Scrap Material:

Review the internal control on scrap materials, as regards its generation, storage and disposal and see whether it was properly followed at every stage.
Ascertain whether the organisation is maintaining reasonable records for the sale and disposal of scrap materials.
Review the production and cost records for determination of the extent of scrap materials that may arise in a given period.
Compare the income from the sale of scrap materials with the corresponding figures of the preceding three years.
Check the rates at which different types of scrap materials have been sold and compare the same with the rates that prevailed in the preceding year.
See that scrap materials sold have been billed and check the calculations on the invoices.
Ensure that there exists a proper procedure to identify the scrap material and good quality material is not mixed up with it.
Make an overall assessment of the value of the realisation from the sale of scrap materials as to its reasonableness.

(b)Trade Marks and Copyrights:

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

(c)Machinery Acquired Under Hire-Purchase System:

Examine the Board’s Minute Book approving the purchase on hire-purchase terms.
Examine the hire-purchase agreement carefully and note the description of the machinery, cost of the machinery, hire purchase charges, and terms of payment and rate of purchase.
Assets acquired under Hire Purchase System should be recorded at the full cash value with corresponding liability of the same amount. In case cash value is not readily available, it should be calculated presuming an appropriate rate of interest.
Hire purchased assets are shown in the balance sheet with an appropriate narration to indicate that the enterprise does not have full ownership thereof. The interest payable along with each installments, whether separately or included therein should be debited to the interest account and not to the asset account.

d) Work-in-Progress: The audit procedures regarding work-in-progress are similar to those used for raw materials and finished goods. However, the auditor has to carefully assess the stage of completion of the work-in-progress for assessing the appropriateness of its valuation. For this purpose, the auditor may examine the production/costing records (i.e., cost sheets), hold discussions with the personnel concerned, and obtain expert opinion, where necessary. The auditor may advise his client that where possible the work-in-progress should be reduced to the minimum before the closing date. Cost sheets of work-in-progress should be verified as follows-

Ascertain that the cost sheets are duly attested by the works engineer and works manager.
Test the correctness of the cost as disclosed by the cost records by verification of quantities and cost of materials, wages and other charges included in the cost sheets by reference to the records maintained in respect thereof.
Compare the unit cost or job cost as shown by the cost sheet with the standard cost or the estimated cost expected.
Ensure that the allocation of overhead expenses had been made on a rational basis.
Compare the cost sheet in detail with that of the previous year. If they vary materially, investigate the cause thereof.

< >Ensure that the Work-in-Progress as at Balance Sheet date has been appropriately disclosed in Balance Sheet as per the requirements of Part I of Schedule III of the Companies Act, 2013.