VIDYA SAGAR

CAREER INSTITUTE LIMITED

Answer of Aud
Mock Test - AUDITING AND ASSURANCE (May 2018)

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 VIDYA SAGARCAREER INSTITUTE LIMITED

Answer Key AUDITING AND ASSURANCE

Date 18.01.2018
Answer 1 (a)
Audit Documentation: According to SA 230 on ―Audit Documentation‖, audit documents once collected serves a number of
additional purposes. These purposes are as follows:-
(i) Assisting the engagement team to plan and perform the audit.
(ii) 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 ―Quality Control for an Audit of
Financial Statements‖.
(iii) Enabling the engagement team to be accountable for its work.
(iv) Retaining a record of matters of continuing significance to future audits.
(v) Enabling the conduct of quality control reviews and inspections.
(vi) Enabling the conduct of external inspections in accordance with applicable legal regulatory or other
requirements.

Answer 1 (b)
 In carrying out an audit of income, the auditor is primarily concerned with obtaining reasonable assurance
that the recorded income arose from transactions, which took place during the relevant period and pertain to the
bank, that there is no unrecorded income, and that income is recorded in proper amounts and is allocated
to the proper period.
 RBI has advised that in respect of any income which exceeds one percent of the total income of the bank if
the income is reckoned on a gross basis or one percent of the net profit before taxes if the income is
reckoned net of costs, should be considered on accrual as per AS-9.
 If any item of income is not considered to be material as per the above norms, it may be recognised when
received and the auditors need not qualify the statements in that situation.
 Banks recognise income (such as interest, fees and commission) on accrual basis, i.e., as it is earned. It is an
essential condition for accrual of income that it should not be unreasonable to expect its ultimate collection.
In modern day banking, the entries for interest income on advances are automatically generated through a batch
process in the CBS system.
 In view of the significant uncertainty regarding ultimate collection of income arising in respect of non-performing
assets, the guidelines require that banks should not recognize income on non-performing assets until it is
actually realised. When a credit facility is classified as non-performing for the first time, interest accrued
and credited to the income account in the corresponding previous year which has not been realized
should be reversed or provided for. This will apply to Government guaranteed accounts also.
 Interest on advances against Term Deposits, National Savings Certificates (NSCs), Indira Vikas Patras
(IVPs), Kisan Vikas Patras (KVPs) and Life policies may be taken to income account on the due date,
provided adequate margin is available in the accounts.
 In the case of bills purchased outstanding at the close of the year the discount received thereon should be
properly apportioned between the two years. [The Unexpired discount / rebate on bills discounted i.e.,
where part of receipt comprising discount charges on bills purchased relate to the period beyond the year-end,
should be recorded as ―Other Liabilities‖]. Interest (discount) component paid by Bank/Branch on rediscount of
bills from other financial institutions, is not to be netted off from the discount earned on bills discounted.
 In the case of bills for collection, the auditor should also examine the procedure for crediting the party on
whose behalf the bill has been collected. The procedure is usually such that the customer‘s account is credited
only after the bill has actually been collected from the drawee either by the bank itself or through its agents, etc.
This procedure is in consonance with the nature of obligations of the bank in respect of bills for collection. The
commission of the branch becomes due only when the bill has been collected.
 Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding
debts should be recognised on an accrual basis over the period of time covered by the re-negotiated or
rescheduled extension of credit. Test checks the Interest earned by the banks for sample items.
 Test check the Fees and commissions earned by the banks made for commission on Bills for collection;
Letters of credit; Bank Guarantees.

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Answer 1 (c)
Removal of first Auditor: As per sub section (1) of Section 140 of the Companies Act, 2013, an auditor appointed under
section 139 may be removed from his office before the expiry of his term only by a special resolution of the company,
after obtaining the prior approval of the Central Government in that behalf as per Rule 7 prescribed under Companies
(Audit & Auditors) Rules, 2014:
(i) The application to the Central Government for removal of auditor shall be made in Form ADT-2 and shall be
accompanied with fees as provided for this purpose under the Companies (Registration Offices and Fees) Rules,
2014.
(ii) The application shall be made to the Central Government within thirty days of the resolution passed by the Board.
(iii) The company shall hold the general meeting within sixty days of receipt of approval of the Central Government for
passing the special resolution.
It is important to note that before taking any action for removal before expiry of terms, the auditor concerned shall be given
a reasonable opportunity of being heard.

Conclusion: In the instant case the first auditor appointed by the Board of Directors was removed by a resolution in the
meeting of the Board of Directors inspite of the Special resolution of the Company as per the requirement of section 140(1)
alongwith the prior approval of the Central Government in that behalf.
Decision
Due to contravention of the provision of sub section (1) of Section 140, the auditor should qualify the audit report.

Answer 1 (d)
Definition of Key Audit Matters : Those matters that, in the auditor‟s professional judgment, were of most
significance in the audit of the financial statements of the current period. Key audit matters are selected from matters
communicated with those charged with governance.
Communicating key audit matters in the auditor‘s report is in the context of the auditor having formed an opinion on the
financial statements as a whole. Communicating key audit matters in the auditor‟s report is not:
(a) A substitute for disclosures in the financial statements that the applicable financial reporting framework requires
management to make, or that are otherwise necessary to achieve fair presentation;
(b) A substitute for the auditor expressing a modified opinion when required by the circumstances of a specific
audit engagement in accordance with SA 705 (Revised);
(c) A substitute for reporting in accordance with SA 570 when a material uncertainty exists relating to events or
conditions that may cast significant doubt on an entity‘s ability to continue as a going concern; or
(d) A separate opinion on individual matters.

Answer 2 (a)
False: According to SA 510 ―Initial Audit Engagements—Opening Balances‖, it is the duty of the auditor to obtain
sufficient appropriate audit evidence about whether the opening balances contain misstatements that materially affect the
current period‘s financial statements.

Answer 2 (b)
False: Test of control are tests designed to obtain reasonable assurance that those internal controls on which audit
reliance is to be placed are in effect. Here auditor is concerned with assertions that the control exists and is operating
effectively.

Answer 2 (c)
False: Inherent and control risks differ from detection risk in that they exist independently of an audit of financial
information. Inherent and control risks are functions of the entity‟s business and its environment and the nature of
the account balances or classes of transactions, regardless of whether an audit is conducted. Even though inherent
and control risks cannot be controlled by the auditor, the auditor can assess them and design his substantive procedures to
produce an acceptable level of detection risk, thereby reducing audit risk to an acceptably low level.
Answer 2 (d)
False: Primary security refers to the security offered by the borrower for bank finance or the one against which
credit has been extended by the bank. This security is the principal security for an advance.

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Answer 2 (e)
False: 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
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.

Answer 2 (f)
False: As per SA 230 on ―Audit Documentation‖, audit documentation is the property of the auditor. He may at his
discretion, make portions of, or extracts from, audit documentation available to clients, provided such disclosure
does not undermine the validity of the work performed, or, in the case of assurance engagements, the
independence of the auditor or of his personnel.
Main auditor does not have right of access to the working papers of the branch auditor. In the case of a company, the
main auditor has to consider the report of the branch auditor and has a right to seek clarification and to visit the branch but
cannot ask for the copy of working papers and therefore, the branch auditor is under no compulsion to give photocopies of
his working papers to the principal auditor of the Company.

Answer 2 (g)
True: As per SA 240 ―The Auditor‘s Responsibilities Relating to Fraud in an Audit of Financial Statements‖, if an auditor
identifies a fraud or has obtained information that indicates that a fraud may exist, it is his responsibility to
communicate the matter with those charged with the governance on a timely basis and, in some circumstances, when
so required by laws or regulations, to regulatory and enforcement authorities also.
However, 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.

Answer 2 (h)
True: AS 29 ―Provisions, Contingent Liabilities and Contingent Assets‖, a provision should be recognised when, an
enterprise has a present obligation as a result of a past event; it is probable that an outflow of resources embodying
economic benefits will be required to settle the obligation; and a reliable estimate can be made of the amount of the
obligation.
Furthermore, as per AS 4 ―Contingencies and Events Occurring after the Balance Sheet Date‖, adjustments to assets and
liabilities are required for events, occurring between the balance sheet date and the date on which the financial statements
are approved, that provide additional information materially affecting the determination of the amounts relating to conditions
existing at the balance sheet date.

Answer 2 (i)
False: 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. Therefore, branch audit is required.

Answer 2 (j)
True: As per section 141 (3)(g) Government companies will be considered for ceiling on number of audits.

Answer 3 (a)
According to section 54 of the Companies Act, 2013, the employees may be compensated in the form of ‗Sweat Equity
Shares‖.
“Sweat Equity Shares” means equity shares issued by the company to employees or directors at a discount or for
consideration other than cash for providing know-how or making available right in the nature of intellectual property
rights or value additions, by whatever name called.
The auditor needs to verify that the Sweat Equity Shares issued by the company are of a class of shares already issued
and following conditions have been complied with:

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 (a) the issue is authorised by a special resolution passed by the company;
(b) the resolution specifies the number of shares, the current market price, consideration, if any, and the class or
classes of directors or employees to whom such equity shares are to be issued;
(c) not less than one year has, at the date of such issue, elapsed since the date on which the company had
commenced business; and
(d) where the equity shares of the company are listed on a recognised stock exchange, the sweat equity shares are
issued in accordance with the regulations made by the Securities and Exchange Board in this behalf and if
they are not so listed, the sweat equity shares are issued in accordance with such rules as may be prescribed.
The rights, limitations, restrictions and provisions as are for the time being applicable to equity shares shall be
applicable to the sweat equity shares issued under this section and the holders of such shares shall rank pari passu with
other equity shareholders.
The auditor also needs to verify whether the fresh issue of shares was a rights issue or a preferential issue and
whether the relevant requirements for issue of share capital as per provisions of Companies Act, 2013 have been
complied with.

Answer 3 (b)
 Review board minutes for approval of new lending agreements. During review, make sure that any new loan
agreements or bond issuances are authorized. Ensure that significant debt commitments should be approved by
the board of directors.
 Agree details of loans recorded (interest rate, nature and repayment terms) to the loan agreement. Verify that
borrowing limits imposed by agreements are not exceeded.
 Agree overdrafts and loans recorded to bank confirmation / confirmation to lenders.
 Agree details of leases and hire purchase creditors recorded to underlying agreement.
 Examine trust deed for terms and dates of redemption, borrowing restrictions and compliance with covenants.
 When debt is retired, ensure that a discharge is received on assets securing the debt.
 If we become aware of significant transactions that are outside the normal course of business or that otherwise appear
to be unusual given our understanding of the entity and its environment, perform the following procedures:
a. Gain an understanding of the business rationale for such significant unusual transaction.
b. Consider whether the transactions involve previously unidentified related parties or parties that do not
have the substance or the financial strength to support the transaction without assistance from the entity we are
auditing.

Answer 3 (c)
 For verifying interest income on fixed deposits:
 Obtain a listing of fixed deposits opened during the period under audit along with the applicable interest rate
and the number of days for which the deposit was outstanding during the period. Verify the arithmetical
accuracy of the interest calculation made by the entity by multiplying the deposit amount with the applicable rate
and number of days during the period under audit.
 For deposits still outstanding as at the period- end, trace the same to the direct confirmation obtained from the
respective bank/ financial institution.
 Obtain a confirmation of interest income from the bank and verify that the interest income as per bank
reconciles to the calculation shared by the entity.
 Also, obtain a copy of Form 26AS (TDS withholding by the bank/ financial institution) and reconcile the interest
reflected therein to the calculation shared by client.
 For Dividends, verify that the same are recognised in the statement of profit and loss only when the entity‘s
right to receive payment of the dividend is established, provided it is probable that the economic benefits
associated with the dividend will flow to the entity and the amount of the dividend can be measured reliably.
 Verify that Gain/(loss) on sale of investment in mutual funds is recorded as other income only on transfer of title
from the entity and is determined as the difference between the redemption price and carrying value of the
investments. For the purpose, obtain the mutual fund statement and trace the gain / loss as recorded in the books of
account to the gain/ loss as reflected in the statement.

Answer 3 (d)
Legal and professional expenses-
Obtain a month wise and consultant wise summary.
In case of monthly retainer ship agreements, verify if the expenditure for all 12 months has been recorded correctly. For
non- recurring expenses, select a sample and vouch for the attributes discussed above.

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The auditor should be cautious while vouching for legal expenses as the same may highlight a dispute for which the
entity may not have made any provision and the matter may also not have been discussed/ highlighted to the auditor for
his specific consideration.

Answer 4 (a)
(1) The object clause of leasing company to see that the goods like capital goods, consumer durables etc. in respect of
which the company can undertake such activities. Further, to ensure that whether company can undertake financing
activities or not.
(2) Whether there exists a procedure to ascertain the credit analysis of lessee like lessee‘s ability to meet the
commitment under lease, past credit record, capital strength, availability of collateral security, etc.
(3) The lease agreement should be examined and the following points may be noted:
(i) the description of the lessor, the lessee, the equipment and the location where the equipment is to be installed.
(The stipulation that the equipment shall not be removed from the described location except for repairs. For the
sake of identification, the lessor may also require plates or markings to be attached to the equipment).
(ii) the amount of tenure of lease, dates of payment, late charges, deposits or advances etc. should be noted.
(iii) whether the equipment shall be returned to the lessor on termination of the agreement and the cost shall be
borne by the lessee.
(iv) whether the agreement prohibits the lessee from assigning the subletting the equipment and authorises the
lessor to do so.
(4) Examine the lease proposal form submitted by the lessee requesting the lessor to provide him the equipment on
lease.
(5) Ensure that the invoice is retained safely as the lease is a long-term contract.
(6) Examine the acceptance letter obtained from the lessee indicating that the equipment has been received in order
and is acceptable to the lessee.
(7) See the Board resolution authorising a particular director to execute the lease agreement has been passed by
the lessee.
(8) See that the copies of the insurance policies have been obtained by the lessor for his records.

Answer 4 (b)
1. 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:
(i) Source of the information available. For example, information may be more reliable when it is obtained
from independent sources outside the entity;
(ii) 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;
(iii) 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
(iv) 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.
2.
i. 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.
ii. 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.
iii. 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.
iv. 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.
v. Alternatively, the auditor may consider whether the information was subjected to audit testing.
vi. SA 500 establishes requirements and provides guidance in determining the audit procedures to be performed
on the information to be used for substantive analytical procedures.

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Answer 4 (c)
The advantages of an audit programme are:
(a) It provides the assistant carrying out the audit with total and clear set of instructions of the work generally to be
done.
(b) It is essential, particularly for major audits, to provide a total perspective of the work to be performed.
(c) Selection of assistants for the jobs on the basis of capability becomes easier when the work is rationally planned,
defined and segregated.
(d) Without a written and pre-determined programme, work is necessarily to be carried out on the basis of some
„mental‟ plan. In such a situation there is always a danger of ignoring or overlooking certain books and records.
Under a properly framed programme, the danger is significantly less and the audit can proceed systematically.
(e) The assistants, by putting their signature on programme, accept the responsibility for the work carried out by
them individually and, if necessary, the work done may be traced back to the assistant.
(f) The principal can control the progress of the various audits in hand by examination of audit programmes initiated
by the assistants deputed to the jobs for completed work.
(g) It serves as a guide for audits to be carried out in the succeeding year.
(h) A properly drawn up audit programme serves as evidence in the event of any charge of negligence being brought
against the auditor. It may be of considerable value in establishing that he exercised reasonable skill and care that
was expected of professional auditor.

The disadvantages are:

(a) The work may become mechanical and particular parts of the programme may be carried out without any
understanding of the object of such parts in the whole audit scheme.
(b) The programme often tends to become rigid and inflexible following set grooves; the business may change in
its operation of conduct, but the old programme may still be carried on. Changes in staff or internal control may
render precaution necessary at points different from those originally decided upon.
(c) Ineffcient assistants may take shelter behind the programme i.e. defend deficiencies in their work on the ground
that no instruction in the matter is contained therein.
(d) A hard and fast audit programme may kill the initiative of efficient and enterprising assistants.

Answer 5 (a)
Engagement Standards: The following standards issued by the Auditing and Assurance Standards Board under the
authority of the Council are collectively known as the Engagement Standards.
(i) Standards on Auditing (SAs), to be applied in the audit of historical financial information.
(ii) Standards on Review Engagements (SREs), to be applied in the review of historical financial information.
(iii) Standards on Assurance Engagements (SAEs), to be applied in assurance engagements, dealing with subject
matters other than historical financial information.
(iv) Standards on Related Services (SRSs), to be applied to engagements involving application of agreed-upon
procedures to information, compilation engagements, and other related services engagements, as may be specified by
the ICAI.
Answer 5 (b)
Methods to obtain Audit Evidence: The auditor obtains evidence in performing compliance and substantive procedures by
one or more of the following methods:-
(i) Inspection:
Inspection involves examining records or documents, whether internal or external, in paper form, electronic
form, or other media, or a physical examination of an asset.
Inspection of records and documents provides audit evidence of varying degrees of reliability, depending on their
nature and source and, in the case of internal records and documents, on the effectiveness of the controls over their
production. An example of inspection used as a test of controls is inspection of records for evidence of authorisation.
Some documents represent direct audit evidence of the existence of an asset, for example, a document
constituting a financial instrument such as a stock or bond. Inspection of such documents may not necessarily provide
audit evidence about ownership or value. In addition, inspecting an executed contract may provide audit evidence
relevant to the entity‘s application of accounting policies, such as revenue recognition.
Inspection of tangible assets may provide reliable audit evidence with respect to their existence, but not
necessarily about the entity‘s rights and obligations or the valuation of the assets. Inspection of individual inventory
items may accompany the observation of inventory counting.

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(ii) Observation:
Observation consists of looking at a process or procedure being performed by the others. For example, the
auditor‘s observation of inventory counting by the entity‘s personnel, or of the performance of control activities.
Observation provides audit evidence about the performance of a process or procedure, but is limited to the
point in time at which the observation takes place, and by the fact that the act of being observed may affect how the
process or procedure is performed.
(iii) External Confirmation:
An external confirmation represents audit evidence obtained by the auditor as a direct written response to the
auditor from a third party (the confirming party), in paper form, or by electronic or other medium.
External confirmation procedures frequently are relevant when addressing assertions associated with certain
account balances and their elements.
However, external confirmations need not be restricted to account balances only. For example, the auditor may
request confirmation of the terms of agreements or transactions an entity has with third parties; the confirmation request
may be designed to ask if any modifications have been made to the agreement and, if so, what the relevant details are.
External confirmation procedures also are used to obtain audit evidence about the absence of certain conditions,
for example, the absence of a ―side agreement‖ that may influence revenue recognition.
(iv) Recalculation:
Recalculation consists of checking the arithmetical accuracy of documents or records.
Recalculation may be performed manually or electronically.
(v) Reperformance: It involves the auditor‟s independent execution of procedures or controls that were originally
performed as part of the entity‘s internal control.
(vi) Analytical Procedure:
Analytical procedures consist of evaluations of financial information made by a study of plausible
relationships among both financial and non-financial data.
Analytical procedures also encompass the investigation of identified fluctuations and relationships that are
inconsistent with other relevant information or deviate significantly from predicted amounts.
(vii) Inquiry:
Inquiry consists of seeking information of knowledgeable persons, both financial and non- financial, within the
entity or outside the entity.
Inquiry is used extensively throughout the audit in addition to other audit procedures. Inquiries may range
from formal written inquiries to informal oral inquiries.
Evaluating responses to inquiries is an integral part of the inquiry process.
Answer 5 (c)
(i) The auditor shall modify the opinion in the auditor‘s report when:
a. The auditor concludes that, based on the audit evidence obtained, the financial statements as a whole are
not free from material misstatement; or
b. The auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial
statements as a whole are free from material misstatement.
(ii) The auditor shall disclaim an opinion when
i. the auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, and
ii. the auditor concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be both material and pervasive.
The auditor shall disclaim an opinion when, in extremely rare circumstances involving multiple uncertainties,
the auditor concludes that, notwithstanding having obtained sufficient appropriate audit evidence regarding each of
the individual uncertainties, it is not possible to form an opinion on the financial statements due to the potential
interaction of the uncertainties and their possible cumulative effect on the financial statements.
(iii) The auditor shall express an adverse opinion
when the auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements,
individually or in the aggregate, are both material and pervasive to the financial statements.
(iv) The auditor shall express a qualified opinion when:
i. The auditor, having obtained sufficient appropriate audit evidence, concludes that misstatements,
individually or in the aggregate, are material, but not pervasive, to the financial statements; or
ii. The auditor is unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the
auditor concludes that the possible effects on the financial statements of undetected misstatements, if any,
could be material but not pervasive.

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Answer 6 (a)
Auditor‘s Duty Regarding Audit of LLP
1. The auditor should get definite instructions in writing as to the work to be performed by him.
2. The auditor should mention
(a) Whether the records of the firm appear to be correct & reliable.
(b) Whether he was able to obtain all information & explanation necessary for his work.
(c) Whether any restriction was imposed upon him.
3. The auditor should read the LLP agreement & note the following provisions
(a) Nature of the business of the LLP.
(b) Amount of capital contributed by each partner.
(c) Interest – in respect of additional capital contributed.
(d) Duration of partnership.
(e) Drawings allowed to the partners.
(f) Salaries, commission etc payable to partners.
(g) Borrowing powers of the LLP.
(h) Rights & duties of partners.
(i) Method of settlement of accounts between partners at the time of admission, retirement, admission etc.
(j) Any loans advanced by the partners.
(k) Profit sharing ratio
4. If partners maintain minute book he shall refer it for any resolution passed regarding the accounts
Answer 6 (b)
Detection of Fraud after Completion of Statutory Audit: As per SA 240,
1.
i. the primary responsibility for the prevention and detection of fraud rests with both those charged with
governance of the entity and management.
ii. It is important that management, with the oversight of those charged with governance, place a strong emphasis on fraud
prevention, which may reduce opportunities for fraud to take place, and fraud deterrence, which could persuade
individuals not to commit fraud because of the likelihood of detection and punishment. Such a system reduces but does not
eliminate the possibility of fraud and error.
2.
i. 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.
ii. Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the
financial statements will not be detected, even though the audit is properly planned and performed in accordance with the SAs.
3.
i. The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting one
resulting from error.
ii. This is because fraud may involve sophisticated and carefully organized schemes designed to conceal it, such as forgery,
deliberatefailuretorecordtransactions,orintentional misrepresentations being made to the auditor.
iii. Such attempts at concealment may be even more difficult to detect when accompanied by collusion.
4.
i. The subsequent discovery of material misstatement of the financial information resulting from fraud or error
existing during the period covered by the auditor‟s report does not, in itself, indicate that whether the auditor has
adhered to the basic principles governing an audit.
ii. The question of whether the auditor has adhered to the basic principles governing an audit (such as performance
of the audit work with requisite skills and competence, documentation of important matters, details of the audit
plan and reliance placed on internal controls, nature and extent of compliance and substantive tests carried out, etc.) is
determined by the adequacy of the procedures undertaken in the circumstances and the suitability of the auditor‘s report
based on the results of these procedures.
5. The liability of the auditor for failure to detect fraud exists only when such failure is clearly due to not exercising reasonable
care and skill.
i. Thus, in the instant case after the completion of the statutory audit, if a fraud has been detected, the same by
itself cannot mean that the auditor did not perform his duty properly.
ii. If the auditor can prove with the help of his papers (documentation) that he has followed adequate
procedures necessary for the proper conduct of an audit, he cannot be held responsible for the same.
iii. If however, the same cannot be proved, he would be held responsible.

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Answer 6 (c)
Verification of Inventory:
1. SA 510 ―Initial Audit Engagements – Opening Balances‖, requires that for initial audit engagements, the auditor
should obtain sufficient appropriate audit evidence that:
(i) the closing balances of the preceding period have been correctly brought forward to the current period;
(ii) the opening balances do not contain misstatements that materially affect the financial statements for the
current period; and
(iii) appropriate accounting policies are consistently applied.
2. When the financial statements for the preceding period were audited by the another auditor, the current
auditor may be able to obtain sufficient appropriate audit evidence regarding opening balances by
(i) perusing the copies of the audited financial statements.
(ii) 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.
3. General principles governing verification of assets require that
(i) the auditor should confirm that assets have been correctly valued as on the balance sheet date.
(ii) The contention of the management that the inventory has not undergone any change cannot be
accepted, it forms part of normal duties of auditor to ensure that the figures on which he is expressing opinion
are correct and properly valued.
(iii) Moreover, it is also quite likely that the inventory lying as it is might have deteriorated and the same
need to be examined.
The auditor is advised not to exclude the audit of closing inventory from his audit programme.

Answer 7 (a)
Advantage of Statistical Sampling in Auditing:
(i) The sample size does not increase in proportion to the increase in the size of population.
(ii) The sample selection is more objective and is based on mathematical law of probability.
(iii) This provides a means of estimating the minimum sample size associated with a specified risk and precision level.
(iv) It also provides a means for taking a calculated risk and corresponding precision i.e., the probable difference in
the result due to checking of transaction on sample basis in lieu of checking the entire universe
(v) It may provide a better description of large mass of data than a complete examination of all the data, since non-
sampling errors such as processing and clerical mistake are not large.

Answer 7 (b)
1. When a business operates in a more automated environment it is likely that we will see several business functions
and activities happening within the systems. Consider the following aspects instead of:
 Computation and Calculations are automatically carried out (for example, bank interest computation and
inventory valuation).
 Accounting entries are posted automatically (for example, sub-ledger to GL postings are automatic).
 Business policies and procedures, including internal controls, are applied automatically (for
example, delegation of authority for journal approvals, customer credit limit checks are performed
automatically).
 Reports used in business are produced from systems. Management and other stakeholders rely on
these reports and information produced (for example, debtors ageing report).
 User access and security are controlled by assigning system roles to users (for example,
segregation of duties can be enforced effectively).
2. Companies derive benefit from the use of IT systems
i. as an enabler to support various business operations and activities.
ii. Auditors need to understand the relevance of these IT systems to an audit of financial statements.
3. While it is true that the use of IT systems and automation benefit the business by making operations more
accurate, reliable, effective and efficient, such systems also introduce certain new risks, including IT specific
risks, which need to be considered, assessed and addressed by management.
To the extent that it is relevant to an audit of financial statements, even auditors are required to understand,

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 assess and respond to such risks that arise from the use of IT systems.
In an audit of financial statements, the primary focus is around those risks that are relevant to financial
reporting. However, there could be other non-audit assurance engagements that auditors maybe
involved wherein the area of focus could include those IT risks relevant to company‟s compliance and
business operations in addition to financial reporting risks.
Examples of such non-audit assurance engagements are internal audits, IT audits, pre-
implementation reviews, data migration audits, third party assurance.
With the introduction of the Companies Act 2013, there is greater emphasis given to internal financial controls
(IFC) from a regulatory point of view. Directors and those charged with governance (including Board of
directors, Audit committee) are responsible for the implementation of internal controls framework within the company.
The auditors‘ responsibilities now include reporting on Internal Financial Controls over Financial Reporting which
include and understanding IT environment of the company and relevant risks & controls.
4. Given below are some situations in which IT will be relevant to an audit,
 Increased use of Systems and Application software in Business (for example, use of ERPs)
 Complexity of transactions has increased (multiple systems, network of systems)
 Hi-tech nature of business (Telecom, e-Commerce).
 Volume of transactions are high (Insurance, Banking, Railways ticketing).
 Company Policy (Compliance).
 Regulatory requirements - Companies Act 2013 IFC, IT Act 2008.
 Required by Indian and International Standards - ISO, PCI-DSS, SA 315, SOC, ISAE.
 Increases effciency and effectiveness of audit.

In some of the above situations it is likely that carrying out audit using traditional substantive audit procedures
may be difficult or even not feasible if the company prepares, records and conducts majority of business
activities through IT systems only.
5. On the other hand, many companies may use less complex IT systems including desktop based
accounting or spreadsheets. In such situations, the relevance of IT to an audit could be less. However,
the auditor is still required to carry out at least an understanding the IT environment of the company and
document the same.
6. Another area where IT can be relevant to audit is by using data analytics using computer assisted audit
techniques (CAATs). By using data analytics, it is possible to improve the effectiveness and efficiency of an
audit. We will learn more about data analytics in the later sections of this chapter.
We can see how IT is relevant to an audit under different situations viz., audit, non-audit and meeting regulatory
compliance requirements.

Answer 7 (c)
1. Cost Audit is an audit process for verifying the cost of manufacture or production of any article, on the basis of
accounts as regards utilisation of material or labour or other items of costs, maintained by the company.
2. It is covered by Section 148 of the Companies Act, 2013. The audit conducted under this section shall be in
addition to the audit conducted under section 143.
3. As per section 148 the Central Government may by order specify audit of items of cost in respect of certain
companies.
4. Further, the Central Government may, by order, in respect of such class of companies engaged in the production of
such goods or providing such services as may be prescribed, direct that particulars relating to the utilisation of
material or labour or to other items of cost as may be prescribed shall also be included in the books of account kept by
that class of companies.
5. In this regard, the Central Government has notified the Companies (Cost Records and Audit) Rules, 2014 which
prescribes the classes of companies required to include cost records in their books of account, applicability of cost
audit, maintenance of records etc.

Answer 7 (d)
Having learnt about the various IT risks and controls, let us understand the different ways testing is performed in an
automated environment. There are basically four types of audit tests that should be used. They are inquiry,
observation, inspection and reperformance.
1. As shown in the illustration below, inquiry is the most efficient audit test but it is also gives the least audit evidence.
Hence, inquiry should always be used in combination with any one of the other audit testing methods.
Inquiry alone is not sufficient.

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 2. Reperformance is most effective as an audit test and gives the best audit evidence. However, testing by
reperformance could be very time consuming and least efficient most of the time.
3. Generally, applying inquiry in combination with inspection gives the most effective and efficient audit
evidence.
4. However, which audit test to use, when and in what combination is a matter of professional judgement and
will vary depending on several factors including risk assessment, control environment, desired level of evidence
required, history of errors/ misstatements, complexity of business, assertions being addressed, etc.
5. The auditor should document the nature of test (or combination of tests) applied along with the judgements in the
audit file as required by SA 230.
When testing in an automated environment, some of the more common methods are as follows:
 Obtain an understanding of how an automated transaction is processed by doing a walkthrough of one end-to-end
transaction using a combination of inquiry, observation and inspection.
 Observe how a user processes transactions under different scenarios.
 Inspect the configuration defined in an application.

Example:
 Inspect the system logs to determine any changes made since last audit testing.
 Inspect technical manual / user manual of systems and applications.
 Carry out a test check (negative testing) and observe the error message displayed by the application.
 Conduct reperformance using raw source data and independently applying formulae, business rules or validations
on the source data using CAATs.

Answer 7 (e)
The auditor‘s report shall include a section, directly following the Opinion section, with the heading “Basis for Opinion”, that:
(a) States that the audit was conducted in accordance with Standards on Auditing;
(b) Refers to the section of the auditor‟s report that describes the auditor‟s responsibilities under the SAs;
(c) Includes a statement that the auditor is independent of the entity in accordance with the relevant ethical
requirements relating to the audit and has fulfilled the auditor‘s other ethical responsibilities in accordance with these
requirements..
(d) States whether the auditor believes that the audit evidence the auditor has obtained is sufficient and
appropriate to provide a basis for the auditor‘s opinion.

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