Workbook. Compiled by: Pankaj Garg

Transcription

1 P a g e 1 Workbook Advanced Auditing and Professional Ethics (CA Final) Compiled by: Pankaj Garg

2 P a g e 2 Must Read - Preface to Workbook This workbook contains topics which are not covered in main notes but important to study as questions on these concepts are regularly asked in the exams. Such Topics are Guidance Notes, Accounting Standards, Companies (AS) Rules, 2006, Schedule VI etc. As these topics, in itself are very much detailed and the part of IPCC Account / Final Financial Reporting, only the portion that is relevant for Auditing paper is covered here. Most of the practical illustrations covered in these notes are taken from Chartered Accountant Journal, RTP, Suggested answers, Practice Manuals and Compiler. On analysis of past year question papers, it can be concluded that around one question covering marks is from the areas mentioned above and generally that question is compulsory one. I hope that readers will be satisfied with the contents of these notes. Still, there always remains scope for improvement. I will be grateful to the readers for their valuable feedback for improvement of these notes. Wishing every success to the readers. CA. Pankaj Garg ca.gargpankaj@sify.com Best of Luck. Schedule of Upcoming Batches IPCC - Audit F2F 31-May TT a.m p.m. SmartteachCA, IMA - ITO, New Delhi F2F 31-May TT p.m p.m. SmartteachCA, Pitampura, New delhi Satellite 21-May SS a.m p.m. ETEN Centers - Across India IPCC - Law F2F 30-May MWF a.m p.m. SmartteachCA, Pitampura, New delhi Final - Audit F2F 30-May MWF p.m p.m. SmartteachCA, IMA - ITO, New Delhi Satellite 28-May SS p.m p.m. ETEN Centers - Across India

3 P a g e 3 CONTENTS S. No. Name of Topic Page No. No. of Illustrations/Questions Preface 02 Contents 03 1 Guidance Notes Questions on Standards on Auditing AS and Companies (AS) Rules Company Audit and Schedule VI Additional Illustrations / Questions Professional Ethics Bank audit Tax Audit Misc Total Illustrations/Questions 110

4 GUIDANCE NOTES P a g e 4 Statements Issued with a view to securing compliance by members on matters which in the opinion of the council of the institute are critical for the proper discharge of their functions. Compliance is Mandatory in Nature Examples Statement on Reporting u/s 227(1A) of the Companies Act, 1956 Statement on the CARO, Framework for the Preparation and Presentation of Financial Statements. Duties of members to examine whether Statements relating to accounting matters are complied with in the presentation of F.S. In the event of any deviation from such Statements, to make adequate disclosures in their audit reports so that the users of F.S. may be aware of such deviations to ensure that the Statements relating to auditing matters, are followed in the audit of financial information covered by their audit reports. If, for any reason, a member, has not been able to perform an audit in accordance with such Statements his report should draw attention to the material departures there from. Guidance Notes Designed to provide guidance to members on matters which may arise in the course of their professional work and on which they may desire assistance. Compliance is recommendatory in nature Example Accounting Guidance Note on Accounting Treatment for Excise Duty. Guidance Note on Accounting for Depreciation in Companies. Guidance Note on Accounting Treatment for CENVAT. Guidance Note on Accounting for Corporate Dividend Tax Auditing Guidance Note on Independence of Auditors. Guidance Note on Audit of Fixed Assets. Guidance Note on Audit u/s 44AB of the Income -tax Act. Guidance Note on Audit of Abridged Financial Statements. Duties of member Accounting Examine whether the recommendations in a guidance note relating to an accounting matter have been followed or not. If the same have not been followed, consider whether keeping in view the circumstances of the case, a disclosure in his report is necessary. Auditing Follow recommendations in a guidance note except where he is satisfied that in the circumstances of the case, it may not be necessary to do so. Expected Question Q. No. 1: The Institute has, from time to time, issued Statements and Guidance Notes on a number of matters. Discuss the level of authority attached to these documents and the degree of compliance required in respect thereof.

5 P a g e 5 GUIDANCE NOTES Accounting and Auditing Practical Illustrations Treatment of Reserve created on Revaluation of Fixed Assets Guidance Note on provision for liability for taxation Terms used in F.S. Q. No. 1 As a statutory auditor of a Public Limited Company, how would you deal with the following situation: As at the beginning of the year, the company has a capital of `.2.50 crores, free reserves of ` 0.50 crores and Revaluation Reserve of ` 4.50 crores. In the relevant year under audit the company has incurred a loss of ` 4 crores. The company proposes to adjust the loss with the Revaluation Reserve. Answer: Adjustment of Loss against Revaluation Reserve: Relevant Provisions: Guidance Note on Treatment of Reserve created on Revaluation of Fixed Assets states that where the value of fixed assets is written up in the books of account of a company, the corresponding credit appearing as revaluation reserve does not represent a realised gain and is, therefore, not available for distribution as dividend. Therefore any accumulated losses / depreciation (including arrears) should not be adjusted against revaluation reserve since this would amount to setting off actual losses against unrealized gains. Conclusion: The auditor should explain to the management that accumulated losses cannot be adjusted against the revaluation reserve created on revaluation of the fixed assets. In case the company in question does so, the balance sheet of the company will not reflect a true and fair view of the state of affairs of the company, keeping in view the magnitude of the amounts involved, i.e., accumulated losses amount to ` 4 crores and share capital and reserves amount to `3 crores (excluding revaluation reserve). If the management does not agree with the opinion of the auditor, the auditor may even issue an adverse report. Q. No. 2 As a Statutory auditor, how would you deal with following: While finalizing its accounts, a company does not provide for Income-tax payable under the provisions of the Income-tax Act, A note is however given that since adequate tax has been deducted at source, no additional tax is payable. [Nov. 08 Old (5 Marks)] Answer: No provisions for Income Tax Payable: Guidance Note on provision for liability for taxation, provides that the provision for anticipated tax liability in respect of profits of the company has to be made while finalizing its accounts. According to it, non-provision for taxation would amount to contravention of the provisions of Sec. 209 and 211 of the Companies Act i.e. maintenance of proper books of account and disclosures of true and fair view of the state of affairs of the company. Conclusion: Auditor is required to quality his report and such qualification should bring out in what manner the accounts do not disclose "True and Fair view of the state of affairs of the Company and its Profit or loss. However, the qualification should also mention clearly that TDS is in excess of the estimated tax liability for the year. Q. No. 3 Comment on the following: S Ltd. issued Bonds to the tune of `100 lacs and provided security to the tune of `80 lacs for the same. It insists that it will disclose the Bonds as Secured in the Balance Sheet of the Company. [May 10 New (5 Marks)] Answer: Prima facie, the Bonds issued to the tune of `100 lacs are provided with security to the tune of `80 lacs i.e. neither fully secured nor unsecured. Guidance Note on the Terms used in Financial Statements issued by ICAI, states Secured Loans as loan secured wholly or partly against an asset. Conclusion: Bonds should be classified under Secured Loans for the purpose of disclosure in the Balance Sheet. However the nature of security should be clearly specified.

6 P a g e 6 Accounting for Credit available in respect of MAT under the IT Act 1961 Revised Accounts of Companies Before Circulation to Shareholders Q. No. 4 As a Statutory Auditor, how would you deal with the following: For the year ended 31st March, 2011, a company has paid Minimum Alternative tax under section 115 JB of the Income Tax Act, The company wants to disclose the same as an Asset since the company is eligible to claim credit for the same. [Nov. 09 New (5 Marks)] Answer: Disclosure of MAT paid as an Asset: As per Guidance Note on Accounting for Credit available in respect of MAT under the IT Act 1961, although MAT credit is not a deferred tax asset under AS 22, yet it give rise to expected future economic benefit in the form of adjustment of future income tax liability arising within the specified period. The Framework for the Preparation and Presentation of Financial Statements, issued by the ICAI, defines the term asset as follows: An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise. MAT paid in a year in respect of which the credit is allowed during the specified period under the Income Tax Act is a resource controlled by the company as a result of past event, namely the payment of MAT. MAT credit has expected future economic benefits in the form of its adjustment against the discharge of the normal tax liability if the same arises during the specified period. Accordingly, MAT credit is an asset. Conclusion: If the auditor is satisfied that the probability of the company to claim the said credit is high, it could recognize the same as an asset. In Balance sheet it should be shown under the head Loans & Advances as MAT credit entitlement. Q. No. 5 Comment on the following: The statutory audit of Fortune Limited for the year ended on was completed and auditor also submitted his report with the audited Financial Statements to the management of the company. Thereafter, the management of the company approached the auditor to revise certain items in the Financial Statements. [Nov. 09 New (5 Marks)] Or A company wants to amend its accounts after the completion of the audit and adoption of the Accounts by the Board, but before circulation to the shareholders. It requires its statutory auditor to report on the amended accounts. State the steps the statutory audit should adopt in such a situation. Answer: Revision of F.S.: As per the Guidance Note on Revised Accounts of Companies Before Circulation to Shareholders, Mngt. can revise its accounts after adoption on which report has been issued by the Auditors, but before circulation to the shareholders. In the instant case, the statutory auditor should ascertain whether the original audit report along with audited accounts has been circulated to the share-holders. If not, he can issue a revised report on the amended F.S. subject to following: (i) Revised accounts must be re-approved by the Board of Directors of the company. (ii) Ask the company to return all the original copies of the earlier audit report along with the audited accounts. (iii) The fact of revision of F.S. with reasons should be incorporated in the Directors Report. If it is neither included nor found adequately disclosed in the Director s Report, auditor should include the fact with figures and reasons in his revised audit report to the shareholders. (iv) Mention specifically that it is a revised audit report.

7 P a g e 7 Audit of Payment of Dividend Accounting for Derivatives Q. No. 6 State your views as an auditor on the following: During the year under audit Z Ltd. credited to the P & L Account, the entire profit of `20 lakhs on the sale of land not required for its use. You are informed that the directors would like to propose dividend out of the above profit. Answer: Payment of dividend out of Capital profits: Profit of Rs. 20 lakhs on the sale of land is a capital profit. It represents the excess of sale value over the original cost of the asset, i.e capital profits. As per Guidance Note on Audit of payment of Dividend the capital profits can be distributed by a company only if all the following conditions are fulfilled: 1. The articles of association should permit distribution of capital profits. 2. The capital profit which is sought to be distributed should have actually been realised. 3. The capital profit should remain after a proper valuation has been fairly taken of the whole of the assets and liabilities. Conclusion: The profit arise on sale of land is realized in cash and hence subject to satisfaction of other conditions can be distributed as dividend. distributable. Q. No. 7 As an auditor, how would you deal with the following: XY Ltd. had entered into derivative transactions in foreign currency which were based on probable export orders. As at the year end on 31st March, 2011, the mark-to-market (MTM) loss on the said derivatives was `250 lakhs. The company contends that since the MTM loss is notional and likely to be recouped in the next year, the same need not be provided for. [Nov. 09 Old (5 Marks)] Answer: Derivative transactions (MTM) Loss: As per ICAI announcement on Accounting for Derivatives the entity is required to provide for losses in respect of all outstanding derivative contracts at the balance sheet date by marking them to market, keeping in view the principle of prudence as enunciated in AS 1 Disclosure of Accounting Policies. Conclusion: In the given case, XY Ltd. should provide for mark to-market (MTM) losses amounting `250 Lakhs. Auditors, should consider for making appropriate disclosures in their reports if the aforesaid accounting treatment and disclosures are not made by the company.

8 P a g e 8 STANDARDS ON AUDITING AND RELATED SERVICES SA 210 Q. No. 1 What is an audit engagement letter? What are the principal contents of audit engagement letters? SA 230 Q. No. 2 As an auditor, how would you deal with the following: The statutory auditor of the Holding Company demands for the working papers of the auditors of the subsidiary company, of which you are the auditor. [Nov. 09 Old (4 Marks)] Answer: Demand of working papers: As per SA 230, Audit Documentation working papers are the property of the auditor. The auditor may, at his discretion, make portion of or extracts of his working papers available to his client. SA 600 Using the Work of Another Auditors also states that an auditor should respect the confidentiality of information acquired during the course of his audit work and should not disclose such information unless there is a legal or professional duty to disclose. As per ICAI Guidelines, statutory auditor of an enterprise do not have right of access to the audit working papers of the branch auditor. An auditor can rely on the work of another auditor, without having any right of access to the audit working papers of other auditor. Conclusion: Statutory auditor of Holding company can not have access to audit working papers of the subsidiary company s auditor. He can however, ask the auditor to answer certain questions about the manner in which the audit is conducted and certain other clarifications regarding audit. SA 240 Q. No. 3 As a Statutory Auditor, how would you deal with the following cases: In the books of accounts of M/s OPQ Ltd. huge differences are noticed between the control accounts and subsidiary records. The Chief Accountant informs that this is common due to huge volume of business done by the company during the year. Answer: Difference between Control Accounts and Subsidiary Records: The huge differences found between control accounts and subsidiary records in the books of M/s OPQ Ltd. indicate that there may be material misstatements requiring detailed examination by the auditor to ascertain the cause. The contention of Chief Accountant cannot be accepted simply because the company has done huge volume of business. Such a phenomenon indicates that recording of transactions is not being done properly or the accounting system fails to capture all transactions in time. Having regard to all these circumstances, it appears from the facts of the case that these differences indicate the possibility of some kind of material misstatements. According to SA 240 The Auditors responsibilities relating to Fraud in an audit of F.S., when the auditor comes across such circumstances indicating the possible misstatements resulting from entity s procedure, the auditor shall evaluate whether such a misstatement is indicative of fraud. In this case, the circumstances indicate the possibility of material misstatements (that might be due to fraud) and accordingly, the auditor must investigate further to consider effect on F.S. Q. No. 4 Explain briefly duties and responsibilities of an auditor in case of material misstatement resulting from Management Fraud. [Nov. 09 New (6 Marks)]

9 P a g e 9 SA Q. No. 5 Comment on the following: While conducting statutory Audit of ABC Ltd., you come across IOUs amounting to Rs. 2 crores as against a cash balance shown in books of `2.10 crores. You also observe that despite similar high balances throughout the year, small amounts of `50,000 are withdrawn from the bank to meet day-to-day expenses. [May 09 New (5 Marks)] Answer: According to SA 240 The Auditors responsibilities relating to Fraud in an audit of F.S., when the auditor comes across such circumstances indicating the possible misstatements resulting from entity s procedure, the auditor shall evaluate whether such a misstatement is indicative of fraud. In this case, the circumstances indicate the possibility of fraud and accordingly, the auditor must investigate further to consider effect on F.S. The Guidance Note on Audit of Cash and Bank balances also mentions that if the entity is maintaining an unduly large balance of cash, auditor should carry out surprise verification of cash more frequently to ascertain whether it agrees. If cash in hand is not in agreement with the book balance, he should seek explanations and if the same are not satisfactory, he should state this fact appropriately in his Audit Report. SA 250 Q. No. 6 State briefly the Communication/Reporting requirements as per SA 250 on Non- Compliance in an audit of F.S.: (i) To the management (ii) To the users of the auditor's report on the financial statements. (iii) To the regulatory and enforcement authorities. [May 09 Old (8 Marks)] SA 315 Q. No. 7 What are the points to be considered while evaluating the Knowledge of the Business in the conduct of an audit? [May 09 New (8 Marks)] SA 500 Q. No. 8 Write short note on: Assessing the reliability of Audit Evidence. [May 09 Old (4 Marks)] Q. No. 9 As a Statutory Auditor, how would you deal with the following case: M/s LNK s group gratuity scheme s valuation by actuary shows wide variation compared to the previous year s figures. Answer: Using the work of Management Expert as an audit evidence: SA 500 (Revised), Audit Evidence states that the auditor has to evaluate the work of management expert, say, actuary, before adopting the same. This becomes more crucial since M/s LNK s group gratuity scheme s valuation by actuary shows wide variation compared to previous year figures. There is no doubt that appropriateness, reasonableness of assumptions and methods used are the responsibility of the expert, but the auditor has to determine whether they are reasonable based on the auditor s knowledge of the client s business and result of his audit procedures. In the present case, the auditor must verify the reasonableness of assumptions made and methods adopted by the actuary in the evaluation particularly with reference to factors such as rate of return on investments, retirement age, number and salary of employees, etc. Accordingly, the auditor has to satisfy himself whether valuation done by the actuary can be adopted, otherwise he may report on his findings for wide variation. Q. No. 10 Comment on the following: Z Ltd. had appointed an outside expert to assess accrued gratuity liability of the company. Based on the said report, the company provides Rs. 80 lakhs as gratuity in the financial statements. [May 09 New (4 Marks)] SA 505 Q. No. 11 Write short note on: Situations where external confirmations can be used. Q. No. 12 As a Statutory Auditor, how would you deal with the following: The accountant of C Ltd. has requested you, not to send balance confirmations to a particular group of debtors since the said balances are under dispute and the matter is pending in the Court.

10 P a g e 10 CA Final Advanced Auditing & Professional Ethics SA 510 Q. No. 14 Comment on the following: You have been appointed as the auditor of Good Health Ltd. for which was audited by CA Trustworthy in As the Auditor of the company state the steps you would take to ensure that the Closing Balances of have been brought to account in as Opening Balances and the Opening Balances do not contain misstatements. [Nov. 08 New (5 Marks)] Q. No. 15 What are the procedures to be followed by a Statutory Auditor in the audit of opening balances if the financial statements for the preceding year were audited by another auditor? [Nov. 09 Old (8 Marks)] SA 520 Q. No. 16 As an auditor to what extent you can rely on Analytical Procedures. SA 530 Q. No. 17 An auditor while analyzing the errors in a sample need not consider the qualitative aspects of errors detected. Comment. SA 550 Q. No. 18 As a Statutory Auditor, how do you verify the existence of Related Parties and disclosure of Related Party Transactions? [Nov. 09 Old (8 Marks)] Answer: Verification of Existence of related parties and disclosures: SA 550 (Revised) Related Parties requires that during the audit, the auditor shall remain alert, when inspecting records or documents, for arrangements or other information that may indicate the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor. In particular, the auditor shall inspect the following for indications of the existence of related party relationships or transactions that management has not previously identified or disclosed to the auditor: (a) Bank, legal and third party confirmations obtained during the audit; (b) Minutes of meetings of shareholders and of TCWG; and (c) Such other records or documents as the auditor considers necessary. Records or Documents that auditor may inspect: Entity income tax returns. Information supplied by the entity to regulatory authorities. Shareholder registers to identify the entity s principal shareholders. Statements of conflicts of interest from management and TCWG. Records of the entity s investments and those of its pension plans. Contracts and agreements with key management or TCWG. Significant contracts and agreements not in the entity s ordinary course of business. Specific invoices and correspondence from the entity s professional advisors. Life insurance policies acquired by the entity. Significant contracts re-negotiated by the entity during the period. Internal auditors reports. Documents associated with the entity s filings with a securities regulator (Prospectus). Examinations of arrangements that may indicate the existence of related party relationships or transactions: Participation in unincorporated partnerships with other parties. Agreements for the provision of services to certain parties under terms and conditions that are outside the entity s normal course of business. Guarantees and guarantor relationships.

11 P a g e 11 SA 560 Q. No. 19 Briefly explain: Audit procedures on subsequent events. [Nov. 09 New (4 Marks)] Q. No. 20 Comment on the following: A Co. Ltd. has not included in the Balance Sheet as on a sum of `1.50 crores being amount in the arrears of salaries and wages payable to the staff for the last 2 years as a result of successful negotiations which were going on during the last 18 months and concluded on The auditor wants to sign the said Balance Sheet and give the audit report on The auditor came to know the result of the negotiations on Answer: Treatment of subsequent Events: [Nov. 10 New (5 Marks)] SA 560 Subsequent Events requires that in respect of events occurring between the date of F.S. and date of the AR, the auditor shall perform audit procedures to obtain sufficient & appropriate audit evidence to ensure that events which require adjustments or disclosure in the F.S. have been identified. If auditor identifies events that require adjustment or disclosure in the F.S., the auditor should determined whether each such event is appropriately reflected in the F.S. The auditor shall request the management to provide a Written Representation that all events occurring subsequent to the date of the F.S. and requires adjustment or disclosure have been adjusted or disclosed. Conclusion: The facts of the case indicates the event as of adjusting nature as per AS 4 Contingencies and Events Occurring after the Balance Sheet date and requires adjustment in assets and liabilities, which has not been made by the management. Auditor should request mngt. to adjust the sum of `1.50 crores by making provision for expenses. If the mngt. does not accept the request the auditor should qualify the AR. SA 570 Q. No. 21 What are the Financial indications to be considered by an auditor for evolution of the going Concern assumption? [Nov. 08 Old (4 Marks)] Q. No. 22 Comment on the following: A Company's net worth is eroded and creditors are unpaid due to liquidity constraints. The management represents to the statutory auditor that the promoter's wife is expected to give an unsecured loan to meet the liquidity constraints and that negotiations are underway to secure large export orders. Answer: Appropriateness of Going Concern Assumption: [May 09 New (4 Marks)] In this case, it is subjective, but prima-facie a mere expectation of future cash flows from the promoter s wife without any firm commitment and the possibility of an export order being negotiated, may not that be sufficient appropriate audit evidence of mitigating factors for resolving the going concerns question under SA 570 Going Concern. SA 580 Q. No. 23 What is meant by Written Representations and indicate to what extent an auditor can place reliance on such representations. Q. No. 24 An auditor of Mohan Ltd. was not able to get the confirmation about the existence and value of certain machineries. However, the management gave him a certificate to prove the existence and value of the machinery as appearing in the books of account. The auditor accepted the same without any further procedure and signed the audit report. Is he right in his approach? Answer: Validity of Management Representation: The physical verification of fixed assets is the primary responsibility of the management. The auditor, however, is required to examine the verification programme adopted by the management. He must satisfy himself about the existence, ownership and valuation of fixed assets. In the case of Mohan Ltd., the auditor has not been able to verify the existence and value of some machinery despite the verification procedure followed in routine audit. He accepted the certificate given to him by the management without making any further enquiry.

12 P a g e 12 SA 580 As per SA 580 Written Representation the representations received from management are recognised as audit evidence, but they do not constitutes Sufficient and appropriateness. Auditor is required to seek corroborative audit evidence from other sources inside or outside the entity, to evaluate whether such representations are reasonable and consistent with other evidences. Representation received from Management cannot be a substitute for other audit evidence that the auditor could reasonably expect to be available. If the auditor is unable to obtain sufficient appropriate audit evidence that he believes would be available regarding a matter, which has or may have a material effect on the financial information, this will constitute a limitation on the scope of his examination even if he has obtained a representation from management on the matter. Conclusion: The approach adopted by the auditor is not right. SA 600 Q. No. 25 There should be sufficient liaison between a principal auditor and other auditors. Discuss the above statement and state in this context the reporting considerations, when the auditor uses the work performed by other auditor. SA 610 Q. No. 26 Enumerate, in brief, the important aspects to be evaluated by the external auditor in determining the efficiency and extent of reliance to be placed on the work and function of an Internal Auditor. Q. No. 27 You are appointed as statutory auditor of X Ltd. X Ltd. has an internal audit system and reports for the same are given to you. Mention the factors you will consider to ensure that the said system of internal audit of X Ltd. is commensurate with the size of the company and nature of its business. [May 09 New (8 Marks)] SA 620 Q. No. 28 Briefly explain how an auditor can use the work of an expert. SA 710 Q. No. 29 Write short note on: Auditor s responsibilities regarding comparatives. Q. No. 30 The audit report of P Ltd. for the year contained a qualification regarding non provision of doubtful debts. As the statutory auditor of the company for the year , how would you report, if: (i) The company does not make provision for doubtful debts in ? (ii) The company makes adequate provision for doubtful debts in ? [June 09 New (8 Marks)] Answer: As per SA 710, when the Audit Report on the prior period intended a qualified opinion and the said matter is: (i) Unresolved and results in an modification of the AR regarding current year s figures, his report should be modified regarding corresponding figures. (ii) Resolved and properly dealt with in the F.S., the current report need not refer to such modification. In the instant Case, if P Ltd. does not make provision for doubtful debts the auditor will have to modify his report for both current and previous year s figures. If however, the provision is made, the auditor need not refer to the earlier years modification. SRE 2400 Q. No. 31 The directors of C Ltd. are concerned about the reliability and usefulness of the monthly financial management information that they receive. As a result, the company s auditors have been engaged to review the system and the information it generates, and to report their conclusions. What an ordinary procedure includes for the review of financial statements?

13 P a g e 13 SRS 4400 SRS 4410 Q. No. 32 What is engagement to perform agreed upon procedures. What are the general principles governing an agreed upon procedures engagement. Q. No. 33 You have been asked by a company to compile financial statements for the purpose of obtaining loan from a Bank. Draft a report to be given to the Management for the same. [Nov. 08 Old (8 Marks)] Q. No. 34 Draft an illustrative engagement letter for an engagement to compile financial statements of DEF Ltd. [Nov. 09 Old (8 Marks)] Q. No. 35 While compiling the financial statements of a concern, you observed that the input information supplied by the concern is incomplete, incorrect and few of the Accounting Standards have not been followed. Describe, in brief, the procedure you will follow in the above. Answer: Compilation of Financial Information: 1. As per SA 4410 Engagements to Compile Financial Information, an accountant would normally have to rely upon the management for information to compile the F. S. in a compilation engagement. 2. If in the course of compilation of financial statements, it is observed that the information supplied by the entity is incorrect, incomplete or otherwise unsatisfactory, the accountant should perform following procedures: Make any enquiries of management to assess the reliability and completeness of the information provided; Assess internal controls prevailing in the entity; and Verify any matters or explanations. 3. The accountant may also request the management to provide additional information. This may be asked in the form of management representation letter. 4. If the management refuses to provide additional information, the accountant should withdraw from the engagement, informing the entity of the reasons for such withdrawal. 5. If one or more ASs are not complied with, the same should be brought to the notice of the management and if the same is not rectified by the management, the accountant should include the same in notes to the accounts and the compilation report to the management. Q. No. 36 Comment on the following: You are appointed to compile financial statements of Y & Co. for tax purposes. During the course of work, you learn that the inventory is grossly understated. On pointing the same, the partners of Y & Co. tell you that since you are not conducting an audit, the said figures duly certified by the firm should be accepted. [May 09 New (5 Marks)] Answer: As per SRS 4410 Engagement to Compile Financial Information if an accountant becomes aware of material misstatements, the accountant should persuade the management to carry out necessary amendments in the F.S. or other compiled financial information. If such amendments are not made and the F.S. are still considered to be misleading the accountant should withdraw from the engagement.

14 P a g e 14 ACCOUNTING STANDARDS Applicability of AS Companies (AS) Rules 2006 The Preface to the Statements of AS clarifies that the ASs are issued "for use in the presentation of G.P.F.S. issued to the public by such commercial, industrial or business enterprises, as may be specified by the Institute from time to time and subject to the attest function of its members. The term 'G.P.F.S. includes balance sheet, statement of profit and loss and other statements and explanatory notes which form part thereof, issued for use of shareholders/ members, creditors, employees and public at large". As far as companies, whether limited or unlimited incorporated under the Companies Act, 1956 are concerned, all such companies are expected to adhere to specified AS in terms of section 211(3A) of the said Act. The compliance with AS has to be examined by the auditors while auditing general purpose F. S. which are statutorily required to be audited under any law. Thus, compliance with AS is required to be examined by an auditor in an audit of F. S. of individuals and non-corporate enterprises (for example: Partnership firms, Societies, trusts, HUF, AOP) only where the F.S. are statutorily required to be audited under any law. The AS are also applicable to commercial, industrial or business activities of even charitable or religious organisations. Accounting Standards do not apply to those organisations whose entire activities are not of commercial, industrial or business nature, e.g., an organisation collecting donations to finance education of poor children. However, even if a very small proportion of the activities of an entity is commercial, industrial or business in nature, the accounting standards will apply to all its activities. Q. No. 1 Comment: The AS issued by the ICAI need to be followed only by limited companies and not by partnership firms or proprietorships. Q. No. 2 As an auditor, how would you deal with the following: In the audit of an organization whose objects are charitable or religious, the organization holds that the Accounting Standards are not applicable to it since only a very small proportion of its activities are business in nature. [May 09 Old (5 Marks)] Small and (i) Whose equity or debt securities are not listed or are not in the process of listing on Medium any stock exchange, whether in India or outside India; Size (ii) Which is not a bank, financial institution or an insurance company; Company (iii) Whose turnover (excluding other income) does not exceed `50 Cr. in the immediately preceding accounting year, (iv) Which does not have borrowings (including public deposits) in excess of `10 Cr. at any time during the immediately preceding accounting year; and (v) which is not a holding or subsidiary company of a company which is not a small and medium-sized company. Explanation: For this purpose, a company shall qualify as a Small and Medium Sized Company, if the conditions mentioned therein are satisfied as at the end of the relevant accounting period. Q. No. 3 Comment whether the following Companies can be classified as a Small and Medium Sized Company (SMC) as per the Companies (Accounting standards) Rules, 2006: (i) A Pvt. Ltd., a subsidiary of a multinational company listed on London Stock Exchange. It has a turnover of `12 crores and borrowings of `5 crores. (ii) B Pvt. Ltd. has a turnover of `45 crores, other income of `7 crores and bank borrowings of Rs.9 crores. (iii) C Ltd. has appointed Merchant bankers to prepare a Red-herring prospectus for the purpose of filing the same with SEBI. [Nov. 08 Old (12 Marks)]

15 P a g e 15 Companies (AS) Rules 2006 Answer: Determination of Small and medium Sized Company: (i) Since A Pvt. Ltd. is a subsidiary of MNC which is listed, on London Stock Exchange (and is therefore not a SMC), A Pvt. Ltd. cannot be a SMC. The turnover and borrowings are not relevant in this case. (ii) Since B Pvt. Ltd. has a turnover of `45 corers and borrowing of `9 corers, it will be classified as SMC. Note: Other incomes are not considered (iii) Since C Pvt. Ltd. has appointed merchant bankers to prepare a Red Herring Prospectus for the purpose of filling the same with SEBI, it is in the process of listing on a Stock Exchange, therefore C Ltd. cannot be classified as a SMC. Q. No. 4 As a Statutory auditor, how would you deal with following: A company which satisfies the conditions of a Small and Medium sized Company (SMC) as per Companies (AS) Rules, 2006 has represented that it does not require to give disclosures required by AS-3 Cash Flow Statements and AS-18 Related Party Disclosures in its F.S. [Nov. 08 Old (4 marks)] Answer: Compliance of AS-3 and AS-18 by SMC: As per the Companies (AS) Rules, 2006, Compliance of Certain ASs is not mandatory, but optional. AS-3, as per the above Rules is not mandatory for SMC. However, AS-18 is required to be complied with mandatorily. Conclusion: T company, even if it is a SMC, will have to give disclosures for: (i) related party relationships, and (ii) transactions between a reporting enterprise and its related parties. Q. No. 5 Comment: The management tells you that there is no need for them to follow AS specified by the ICAI as these are for the auditor to follow. Answer: Observance of AS: In terms of Companies (AS) Rules, 2006 prescribed by the C.G. u/s 211(3)(c) of the Companies Act, 1956, it is mandatory for a Company to follow all the prescribed AS while preparing and presenting its F.S. If a Company does not follow AS, the auditor is required to give a qualification in his report in terms of section 227(3) of the Companies Act, Infact directors of the companies are also required to give a written statement as part of Director Responsibility Statement u/s 217 of the Companies Act that all the AS prescribed has been followed and there are no discrepancies. Conclusion: The contention of the company is not correct. Q. No. 6 LMN Pvt. Ltd. is a dealer in government securities. The turnover on account of sale of securities for the year ended 31 st March, 2011 is `85 crores whereas the net profit is `0.10 Cr. While finalizing the accounts the company did not prepare the Cash Flow Statement. [May 10 Old (5 Marks)] Answer: Exemption for applicability of AS 3, preparing Cash Flow Statement is available only to Small and Medium Size Companies) preparation of Cash Flow Statement, as per AS 3 is now made mandatory in respect of the following enterprises: (i) Enterprises whose equity of debt securities are listed on a recognized Stock Exchange in India and Enterprises that are in the process of issuing equity or debt securities that will be listed on a recognized Stock Exchange in India. (ii) All other Commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crores.

16 P a g e 16 In the instant case, LMN Pvt. Ltd. did not prepare the Cash Flow Statement, even its turn over exceeded Rs. 50 crores. It is not considered as a small and medium size company as per Companies (AS) Rules, 2006 (AS-3) as discussed earlier, hereinabove. Therefore, if LMN Pvt. Ltd. does not prepare cash flow statement it is a violation of AS-3 and section 211(3C) of the Companies Act, The auditor will have to accordingly qualify his report that 211(3C) is not complied with, the profit & loss account would give a True & Fair View. AS-2 Q. No. 7 A company was engaged in the business of buying IMFL (Indian Made Foreign Liquor) and beer and selling same through retail vending shops and bars run by it. The company sold beer to some of the customers who consumed them in bars run by it and left the bottles behind. (Technically, these bottles were the property of the customers.) These bottles were later on disposed off by the company. Answer the followings: 1. Are these bottles left behind by the customers assets of the company? 2. Are they inventories? 3. If they are inventories, how they should be valued? 4. Can the bottles be valued at net realisable value and treated as income? Answer: 1. An asset is a resource controlled (not necessarily owned ) by an enterprise as a result of past events from which future economic benefits to the enterprise are expected. In assessing whether an item meets the above definition of assets, the consideration should be given to economic reality and substance and not merely legal form. Accordingly, the bottles can be considered as assets of the company. 2. The stock of empty bottles is inventory as the company holds them for sale in the ordinary course of its business of running the bars. 3. These bottles should be valued at the lower of cost and NRV. However, the cost of purchase and selling price of beer / IMFL are both inclusive of cost of bottles as beer / IMFL cannot be sold without bottles the primary packing. Practically, the empty bottles do not appear to cost anything to the company (i.e. zero cost), if that be the case, the bottles should be reflected at nominal value of Re It would not be correct to value the bottles at NRV with credit being given to income as the bottles have not been sold at the balance sheet date. Q. No. 8 As an auditor state your views on the following: Included under Current Assets of XYZ Ltd. is inventory aggregating to `20 crores. A part of the said inventory manufactured for export had to be sold earlier at a discounted price offshore due to moisture content present at the time of delivery. A part of similar inventory is included in `20 crores. Answer: Valuation of Damaged Inventory: Auditor is required to examine what part of the inventory is included in the inventory valued at `20 crores. He will also have to satisfy himself that whether such part left with the company has also been damaged on account of moisture content. If required, the auditor may obtain a certificate from an expert about the condition of the inventory. Thereafter, it should be verified whether the principle of valuation enunciated in AS 2 Valuation of Inventories have been followed. The standard requires that the inventories should be valued at the lower of cost or NRV. Conclusion: In the present case the auditor shall satisfy himself whether the balance inventory lying with the company is carrying the same quality issue. If yes, than value of inventory will be revised based on its NRV(if lower than cost).

17 P a g e 17 Q. No. 9 The management tells you that WIP is not valued since it is difficult to know the same in view of multiple processes involved and in any case opening and closing WIP would be more or less the same. Answer: Valuation of WIP: As per AS-2, Valuation of inventories inventories includes any item held in the process of production. This is known as WIP. Company is required to find out the stage of completion of products and value of the same. In certain cases, due to nature of the product and the manufacturing process involved, physical verification of WIP may be impracticable. But in such cases, the advice of an expert can be taken. The value of such WIP is normally done by taking the basic raw material cost and adding thereto the proportionate factory overhead cost incurred up to the stage of completion. Valuation of WIP is important due to following: WIP is an item of Manufacturing, Trading & Profit & Loss A/c and also forming part of current assets, is relevant and can not be ignored. Omitting WIP will result in under or over statement of profit and current assets. Part II of Schedule VI to the Companies Act also prescribes that the figures of opening and closing balances of stock and WIP be disclosed in the profit & loss account. Part I of the same schedule requires that the mode of valuation of stock be shown in the Balance Sheet. Conclusion: The argument of the management that the opening and closing WIP would be more or less the same is not justified because the cost incurred for raw materials and overheads would be different and would give different value of opening and closing WIP. Taking into consideration all the above aspects, management is wrong and if WIP is not valued or taken into consideration, auditor should qualify his report. AS - 4 Q. No. 10 During the course of audit of D Co. Ltd. you as an auditor have observed that Inter corporate deposit of ` 50 lakhs has been over due. The D Co. Ltd. has disclosed this in the notes to accounts note No. 15 in schedule no. 21 stating that ` 50 lakhs is over due from XYZ Co. Ltd. and the said company is in the process of liquidation. The management is taking steps to appoint the liquidator. Answer: [Nov. 10 New (5 Marks)] 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 that provide additional information materially affecting the determination of the amounts relating to conditions existing at the balance sheet date. In the instant case, it appears from the note no 15 that the overdue of outstanding inter corporate deposit may not be realisable in full. The company is in the process of liquidation, makes it clear that on the balance sheet date, the amount of deposit is not safe and is not likely to be realised. Conclusion: As per AS 4 provision for the loss was required in the accounts. Accordingly, auditor should qualify the Audit Report. Q. No. 11 State your views as an auditor on the following: V Ltd. had announced a voluntary retirement plan for its employees on January 1, The scheme is scheduled to close on June 30, The scheme envisaged an initial lump sum payment of maximum of Rs. 2 lakhs and monthly payments over the balance period of service of employees coming under the plan. 200 employees opted for the scheme as on March 31, The total lump sum payment for these employees would be Rs. 250 lakhs and the aggregate of future payments to them would amount to Rs.1,500 lakhs. However, no payment had been made to the employees under the scheme up to March 31, Nor the company made any provision in its accounts towards any liability under the scheme.

18 P a g e 18 AS - 4 Answer: Event occurring after the B/S Date: Relevant Provision: As per AS- 4 on 'Contingencies and Events Occurring After the Balance Sheet Date', assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption of going concern is not appropriate. Facts of the case: A condition existed on the balance sheet date (31st March, 2010) regarding the liability towards the Voluntary Retirement Plan since the management started the scheme in the month of January, 2010 and 200 employees opted for the scheme as on March 31, Conclusion: Since it was probable that future events will confirm that a liability has been incurred on the balance sheet date and that the amount could be estimated on reasonable basis, a provision for payments under the scheme would be required to be made for an appropriate amount for the aforesaid number of employees. Q. No. 12 Arya Ltd. was under audit for the year ended An appeal filed by Arya Ltd. against the demand of Excise Duty of `26 crores was pending before the Supreme Court for which neither provision was made nor was disclosed in the notes to the financial statements. On 12th July, 2010, the auditor came to know through paper reports that the point involved in the appeal of Arya Ltd. was adjudicated by the Supreme Court in the case of some other assessee, which is in favour of the department of Excise Duty. The auditor insisted that provisions be made of `26 crores in the financial statements. The Management was of the view that since its own case is still pending, no provision is called for. It was also of the view that the event does not have any effect on the financial position of the company on the date of the Balance Sheet. Is the view of the Management tenable? Answer: Subsequent Events: Relevant Provisions: As per AS- 4 on 'Contingencies and Events Occurring After the Balance Sheet Date', assets and liabilities should be adjusted for events occurring after the balance sheet date that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date or that indicate that the fundamental accounting assumption of going concern is not appropriate. SA 560 on Subsequent Events lays down that the auditor should consider the effect of subsequent events on the F.S. and on the auditor s report. Explanation: The issue involved in the appeal of Arya Ltd. was similar to the point in case of some other company and since the appeal of that company was decided against that company and in favour of the Excise Department, it is necessary for Arya Ltd. to make a provision of Rs. 26 crores. Conclusion: The view of the management that its own appeal is undecided or that it has no effect on the financial position as on is not at all tenable. Since the financial position is materially affected, the auditor should express a qualified opinion or an adverse opinion as may be appropriate. AS - 5 Q. No. 13 As a statutory auditor, how would you deal when PQ Ltd., as part of overall cost cutting measure announced voluntary retirement scheme (VRS) to its employees, to reduce the employee strength. During the first half year ended the company paid a compensation of `72 lakhs to those who availed the scheme. The Chief Accountant has reflected this payment as part of regular salaries and wages paid by the company. Is this correct?