1 Auditing and Assurance

Transcription

1 Star Rating On the basis of Maximum marks from a chapter On the basis of Questions included every year from a chapter On the basis of Compulsory questions from a chapter Nil 1 Auditing and Assurance Standards & Guidance Notes This Chapter Includes : Statements on SAP; Guidance notes on Accounting for excise duty; Treatment of Revaluation Reserve; Treatment of Expenditure during construction period; Audit of Abridged Financial statements. Marks of Short Notes, Distinguish Between, Descriptive & Practical Questions CA Final Gr. I (New Course) SHORT NOTES Nov [7] Write short notes on the following : (c) Frauds through supplier ledger. (4 marks) Q&A-3.15

2 Q&A-3.16 O Solved Scanner CA Final Gr. I Paper - 3 Frauds though suppliers ledger : Fraud through supplies ledger could be made in any of the following ways, which the auditor has to take care of: 1. Adjusting fictitious as duplicate invoices as purchases in the accounts of suppliers and subsequently misappropriating the money when payments are made in respect of these invoices. 2. Suppressing credit notes issued by suppliers and withdrawing the corresponding amount not claimed by them. 3. Withdrawing amounts which remain unclaimed for more than the normal time limit for one reason or other by showing the same have been paid to the parties. 4. Accepting invoices at prices considerably highest than the market price and collecting the excess claim from the suppliers directly Nov [7] Write short notes on : (c) Guidance note on Audit of Miscellaneous Expenditure (revised). (4 marks) This Guidance Note provides guidance on audit procedures to be applied while auditing miscellaneous expenditure. Miscellaneous expenditure shown in the balance sheet of companies (or shown under this or some other appropriate heading in the balance sheet of other enterprises) embraces within its fold a variety of items of expenditure which are not entirely charged to income in the year in which they are incurred, but are carried forward in the balance sheet to be written-off in subsequent periods. Unless some benefit from the expenditure can reasonably be expected to be received in future and unless the amount of such benefit is reasonably determinable, there is no justification for carrying forward the expenditure for being written-off in subsequent periods. Also, the amount of expenditure to be carried forward should not exceed the expected future revenue/other benefits related to the expenditure. The Guidance Note deals with the audit considerations related to the following items that normally constitute 'miscellaneous expenditure': (a) Preliminary expenses; (b) Expenses including commission or brokerage on underwriting or subscription of shares or debentures including discount allowed on the issue of shares or debentures; (c) Research and development expenditure, etc. Since AS 26, applies to different entity from different dates, it may happen that certain enterprises, till the date the standard becomes mandatory for them may continue to defer the expenditure incurred on items that normally constitute miscellaneous expenditure.

3 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.17 Once an entity applies AS 26 to account for intangible assets, the expenditure incurred on items that normally constitute miscellaneous expenditure shall be governed by the Standard, except in the case of already appearing miscellaneous expenditure in the balance sheet which is to be accounted for using AS 26. As per Guidance note on Audit of Miscellaneous Expenditure (Revised), the auditor should examine whether the financial statements contain adequate disclosures as required by AS 26. The auditor should also examine that the financial statements disclose the accounting policy with regard to miscellaneous expenditure. On the first occasion when AS 26 is applied by an enterprise for accounting for items of miscellaneous expenditure, the financial statements should also disclose the change in accounting policy with regard to miscellaneous expenditure in accordance with the requirements of Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies. DESCRIPTIVE QUESTIONS Nov [3] (a) Briefly explain : (i) Audit procedures on subsequent events (4 marks) Audit Procedures on Subsequent Events : As per SA 560 Subsequent Events, events occurring between the dates of balance sheet and audit report and the facts that become known to the auditor after the date of the auditor s report. The Auditor should perform the following procedure to obtain sufficient appropriate evidence to find out the adjustments or disclosures of those subsequent events: (i) Review the procedures adopted by the management to identify subsequent events. (ii) Examine the minutes of the Board of Directors, Executive Committees and the General Meetings of the shareholders. (iii) Collect information from the other sources like budgets/estimates, cash flows, forecasts, interim financial statements etc. (iv) Make enquiries and hold discussions with the top management. (v) Details from company s lawyers for any litigation matter May [3] (c) What are the auditors responsibilities in respect of corresponding figures? (4 marks)

4 Q&A-3.18 O Solved Scanner CA Final Gr. I Paper - 3 As per 710 Comparatives, in respect of corresponding figures, (i) The auditor should obtain sufficient appropriate audit evidence that the corresponding figures meet the requirements of the relevant financial reporting framework. The extent of audit procedure performed on the corresponding figures is significantly less than that for the audit of current period figures and is ordinarily limited to ensuring that the corresponding figures have been correctly reported and are appropriately classified. This involves the auditor assessing whether: (a) accounting policies used for corresponding figures are consistent with those of the current period or whether appropriate adjustments and/or disclosures have been made and (b) corresponding figures agree with the amounts and other disclosures presented in the prior period or whether appropriate adjustments and/or disclosures have been made. (ii) When the financial statements of the prior period have been audited by another auditor, the incoming auditor should assess whether the corresponding figures meet the conditions specified above. (iii) When the financial statements of the prior period have not been audited, the incoming auditor nonetheless should assess whether the corresponding figures meet the conditions specified above. (iv) If the auditor becomes aware of a possible material misstatement in the corresponding figures when performing the current period audit, the auditor should perform such additional procedures as are appropriate in the circumstances May [4] (a) In the course of audit of Q Ltd, its statutory auditor wants to be sure of the adequacy of related party disclosures? Kindly guide the auditor in identifying the possible source of related party information. (8 marks) Please refer Nov [3] (a) on page no May [6] (c) In the course of audit of A Ltd you suspect the management has indulged in fraudulent financial reporting? State the possible source of such fraudulent financial reporting. (6 marks) 1. Recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate operating results or achieve other objectives. 2. Inappropriately adjusting assumptions and changing judgements used to estimate account balances.

5 [Chapter 1] Auditing and Assurance Standards &... O Q&A Omitting, advancing or delaying recognition in the financial statements of events and transactions that have occurred during the reporting period. 4. Concealing, or not disclosing, facts that could affect the amounts recorded in the financial statements. 5. Engaging in complex transactions that are structured to misrepresent the financial position or financial performance of the entity. 6. Altering records and terms related to significant and unusual transactions. 7. Embezzling receipts (for example, misappropriating collections on accounts receivable or diverting receipts in respect of written-off accounts to personal bank accounts) Nov [1] {C} As a statutory auditor of a company, comment on the following: (b) While verifying the employee records in a company, it was found that a major portion of the labour employed was child labour. On questioning the management, the auditor was told that it was outside his scope of the financial audit to look into the compliance with other laws. (5 marks) Compliance with other laws: According to SA 250 (Revised), Consideration of laws and regulation in an audit of financial statement (w.e.f. 1 st April 2009), the auditor shall obtain sufficient audit evidence with regards to compliance with the provisions of those laws and regulation which generally are recognised to have a direct effect on the determination of material amounts and disclosures in the financial statement including tax and labour laws. Even if non compliance does not have direct effect but if it results in fines, litigation or other consequences, it may have to be considered for the purpose of financial statements. Present Case While verifying the employee records in a company, it was found that a major portion of the labour employed was child labour. On questioning the management, the auditor was told that it was outside his scope of the financial audit to look into the compliance with other laws. The contention of management is not correct. This is so because the cost of fine, litigation or other consequences may have material effect on the financial statement. Auditor s duty The auditor should make sure the disclosure of above fact and provision for the cost of fines, litigation for the organisation. If the auditor is of the view that non compliance has a material effect on the financial statement, he may express a qualified or adverse opinion on the financial statement.

6 Q&A-3.20 O Solved Scanner CA Final Gr. I Paper Nov [4] Answer the following: (b) Under the applicable Standards on Auditing, in what circumstances does the report of the statutory auditor require modifications? What are the types of modifications possible to the said report? (8 marks) According to SA 700, Forming an Opinion and Reporting on Financial Statements, Under following situations auditor s report may have to be modified Matters that do not affect the auditor s opinion (Emphasis of matter) Matters that do affect the auditors opinions including qualified opinion, disclaimer of opinion or adverse opinion. Matters that do not affect the auditor s opinion (Emphasis of matter) In respect of matters that do not affect the auditor s opinion, the auditor should modify the report by adding a paragraph to highlight a matter. The addition of such an emphasis of matter paragraph does not affect the auditor s opinion. The paragraph would preferably be included preceding the opinion paragraph. For example: Some uncertainty, the resolution of which is dependent on future events and which may significantly affect the financial statements and the same has already been incorporated by management in financial statement. In such matters, the opinion paragraph would refer to the fact that auditor s opinion is not qualified in this respect. Matters that do affect the auditor s opinion: For such matters, he can provide any of following as per stated criterion : (a) A qualified opinion should be expressed when the auditor concludes that an unqualified opinion cannot be expressed but that the effect of any disagreement with the management is not so material and pervasive as to require an adverse opinion, or limitation on scope is not material and pervasive as to require a disclaimer of opinion. (b) A disclaimer of opinion should be expressed when the possible effect of a limitation on scope is so material and pervasive that the auditor is unable to obtain sufficient appropriate audit evidence and is thus unable to express an opinion on the financial statements. (c) An adverse opinion should be expressed when the disagreement with management is so material and pervasive to the financial statements that the auditor concludes that a qualification of the report is inadequate to disclose the misleading or incomplete nature of the financial statements Nov [5] Answer the following: (b) As an auditor how will you verify the existence of Related Parties? (8 marks)

7 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.21 Related Party According to SA 550, Related Parties, Related party is a party that is either (i) (ii) A related party as defined in the applicable financial reporting framework, or Where the applicable financial reporting framework establishes minimal or no related party requirement. Verification of Existence of Related Parties : As per SA 550 Related Parties, 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. 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 those charged with governance. Records of the entity s investments and those of its pension plans. Contracts and agreements with key management or those charged with governance. 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 auditor s reports. Documents associated with the entity s filings with a securities regulator (e.g, prospectuses) May [3] (c) The auditor of H Ltd. wanted to obtain confirmation from its creditors. But the management made a request to the auditor not to seek confirmation from certain creditors citing disputes. Can the auditor of H Ltd. accede to this request? (4 marks) PRACTICAL QUESTIONS May [1] {C} Comment on the following : (a) 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. (5 marks)

8 Q&A-3.22 O Solved Scanner CA Final Gr. I Paper - 3 According to AAS 31(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 financial statements or other compiled financial information. If such amendments are not made and the financial statements are still considered to be misleading the accountant should withdraw from the engagement. Hence, in this case, there is a clear violation of AAS 31(SRS 4410) Nov [1] Comment on the following : (c) Moon Limited replaced its statutory auditor for the Financial year During the course of audit, the new auditor found a credit item of ` 5 lakhs. On enquiry, the company explained him that it is a very old credit balance. The creditor had neither approached for the payment nor he is traceable. Under the circumstances, no confirmation of the credit balance is available. (5 marks) This is a case of external confirmation, covered by SA 505 External Confirmation. The identities of creditors are not traceable to confirm the credit balance as appearing in the financial statement of the company. It is also not a case of pending litigation. It might be a case that an income of `.4 lakhs had been hidden in previous year/s. The statutory auditor should examine the validity of the credit balance as appeared in the company s financial statements. He should obtain sufficient evidence in support of the balance. He should apply alternative audit procedures to get documentary proof for the transaction/s and should not rely entirely on the management representation. Finally, he should include the matter by way of a qualification in his audit report to the members May [1] {C} (a) In the course of the audit of R Ltd., the audit manager of ABC & Co. observed that R Ltd. has outsourced certain activities to an outsourcing agency. As the engagement partner guide the audit manager in the assessment of services provided by the outsourcing agency in relation to the audit. (4 marks) (b) In the course of audit of T Ltd., the audit team is not sure of the possible source of misstatements in the financial statements. As the audit manager identify the sources of misstatements. (4 marks) (c) While auditing Z Ltd., you observe certain material financial statement assertions have been based on estimates made by the management. As the auditor how do you minimize the risk of material misstatements? (6 marks) (d) The management of S Ltd. request you not to seek confirmation from its debtors. As the auditor of S Ltd., what can be an appropriate response? (6 marks)

9 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.23 (a) According to SA 402 Audit Considerations relating to an Entity Using A Service Organisation the user auditor shall obtain an understanding of how a user entity uses the services of a service organization. It shall include an understanding of : (i) The nature of services provided by the service organisation and the significance of such services to the user entity, including its effect on the internal control of user entity. (ii) The nature and materiality of the transactions processed or accounts or financial reporting processes affected by the service organisation. (iii) The degree of interaction between the activities of the service organization and those of user entity and (iv) The nature of the relationship between the user entity and the service organization including the relevant contractual terms for the activities undertaken by the service organisation. (b) According to SA 450 Evaluation of Misstatements Identified during the Audit, misstatements may result from (i) An inaccuracy in collecting or processing data by which the financial statements are prepared. (ii) An omission of an amount of which should have been disclosed. (iii) An accounting estimate incorrect due to overlooking or clear misinterpretation of facts. (iv) Judgements of management concerning accounting estimates that the auditor considers unreasonable. (v) The selection and application of accounting policies that the auditor considers inappropriate. (c) According to SA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures, The auditor should assess the following with relation to identification and assessment of the risk of material misstatement. (i) The requirements of the applicable financial reporting framework relevant to the accounting estimates, including related disclosures. (ii) How is the Management identifying those transactions, events and conditions that might give rise to the need for, accounting estimates to be recognised or disclosed, in the financial statement. (iii) In obtaining this understanding, the auditor shall make inquiries of management about changes in circumstances that may give rise to new, or the need to revise existing, accounting estimates.

10 Q&A-3.24 O Solved Scanner CA Final Gr. I Paper - 3 (iv) The estimation making process adopted by the management including 1. The method, including where applicable the model, used in making the accounting estimates 2. Relevant controls 3. Whether management has used an expert? 4. The assumption underlying the accounting estimates 5. Whether there has been or ought to have been a change from the prior period in the methods for making the accounting estimates, and if so, why; and 6. Whether and, if so, how the management has assessed the effect of estimation uncertainty. (d) SA 505 External Confirmations, establishes standards on the auditor s use of external confirmation as means of obtaining audit evidence. If the management refuses to allow the auditor to send a confirmation request, the auditor shall (i) Inquire as to Management s reasons for the refusal, and seek audit evidence as to their validity and reasonableness. (ii) Evaluate the implications of management s refusal on the auditor s assessment of the relevant risks of material misstatement, including the risk of fraud, and on the nature, timing and extent of other audit procedures and (iii) Perform alternative audit procedures designed to obtain relevant and reliable audit evidence. If the auditor concludes that management s refusal to allow the auditor to send a confirmation request is unreasonable or the auditor is unable to obtain relevant and reliable audit evidence from alternative audit procedures, the auditor shall communicate with those in charge of governance and also determine its implication for the audit and his opinion May [1] {C} (b) R & Co. is the statutory auditor of S Ltd. For the financial year ended on 31 st March 2012, S Ltd. had disclosed in the notes (Note No. X) The state pollution control board had ordered the closure of the company s only manufacturing plant on the ground that it is environmentally damaging, which the company had challenged in a law suit. Pending the outcome of the law suit the financial statements are prepared on a going concern basis. Further the financial statements prepared by the management of S Ltd. include financial statements of certain branches which are audited by other auditors. What are the reporting responsibilities of R & Co? (10 marks) Answer: SA 570 on "Going Concern" requires the auditor to consider the appropriateness of the going concern assumption underlying the preparation of the financial statements which

11 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.25 may no longer be appropriate. The following indications inter alia have to be taken into consideration in determining the appropriateness of the going concern assumption: (i) Financial indications such as negative net worth, adverse key financial ratios, substantial operating losses, inability to pay creditors on due dates, etc. (ii) Operating indications such as labour difficulties, loss of major market, etc. (iii) Other indications include pending legal proceedings which may affect the concern adversely, sickness of entity under statutory definition, etc.. As per SA i.e. Using the work of an Expert an Auditor during the course of an audit may have to place reliance on the work of an expert. During the course of audit, an auditor may seek to obtain, either independently or from client audit evidence by way of reports, opinions, valuations and statements of experts. The auditor should satisfy himself regarding the experts spill and competence and consider the objectivity of the expert. In the present situation management of S Ltd. had disclosed the above fact in the financial statement. Further, use of the going concern assumption is appropriate but a material uncertainty exists so assuming the assessment and disclosure of S Ltd. in order, R & Co. should include an Emphasis of Matter paragraph in the auditor s report. As per Sec. 227 of the Companies Act, 1956, the auditor has to state that whether the report on the accounts of any branch office audited under section 228 by a person other than the company s auditor has been forwarded to him and how he has dealt with the same in preparing the auditor s report. Further, as per SA 600 Using the work of Another Auditor. When the principal auditor has to base his opinion on the financial information of the entity as a whole relying upon the statements and reports of the other auditors, his report should state clearly the division of responsibility for the financial information of the entity by indicating the extent to which the financial information of components audited by the other auditors have been included in the financial information of the entity, e.g., the number of divisions / branches / subsidiaries or other components audited by other auditors. CA Final Gr. I SHORT NOTES Nov [8] Write short notes on the following : (c) Revaluation Reserve and its uses. (4 marks)

12 Q&A-3.26 O Solved Scanner CA Final Gr. I Paper - 3 Meaning : The term Revaluation Reserve refer to a reserve created on the revaluation assets or net assets of an enterprise represented by the surplus of the estimated replacement cost or estimated market values over the book values thereof. When created : Revaluation Reserve is created if there is an upward revision of value of fixed assets over their book value to show their current replacement cost in the balance sheet. It is not a realised gain. It is not available for distribution as dividends. Use : It can be used for adjustment of additional depreciation on increased amount due to revaluation from year to year or on the retirement of fixed assets. Amount credited to Revaluation Reserve cannot be used for issue of both shares or for paying up debentures or stock or calls on partly paid up shares. According to Schedule VI of the Companies Act, 1956 every balance sheet subsequent to revaluation shall show the increased figure with the date of increase in place of original cost for the first five years Nov [8] Write short notes on the following : (d) Accounting for CDT. (4 marks) Corporate Dividend Tax Accounting : CDT is chargeable on any amount declared, distributed or paid by company by way of dividends (whether interim or otherwise) on or after the 1st day of June, According to Generally Accepted Accounting Principles, the provision dividend is recognised in the financial statements of the year to which the dividend relates. In view of this, CDT on dividend, being directly linked to the amount of the dividend concerned, should also be reflected in the accounts of the same financial year even though the actual tax liability in respect thereof may arise in a different year. CDT liability should be recognised in the accounts of the same financial year which the dividend concerned is recognised. CDT liability should be discussed separately in the profit and loss account, below the line. Provision for Corporate Dividend Tax should be disclosed separately under the head Provisions in the balance sheet Nov [8] Write short notes on the following : (b) Financial indications to be considered for evaluating the assumption of going concern (4 marks) SA 570 on "Going Concern", aims to establish standards on the auditor responsibilities in the audit of financial statements regarding the appropriateness of the going concern assumption as a basis for the preparation of the financial statements. The following are the financial indications to be considered : 1. Negative net worth or negative working capital.

13 [Chapter 1] Auditing and Assurance Standards &... O Q&A Fixed-term borrowings approaching maturity without realistic prospects or renewal or repayment, or excessive reliance on short-term borrowings to finance long-term assets. 3. Adverse key financial ratios. 4. Substantial operating losses. 5. Substantial negative cash flows from operations. 6. Arrears or discontinuance of dividends. 7. Inability to pay creditors on due dates. 8. Difficulty in complying with the terms of loan agreements. 9. Change from credit to cash-on-delivery transactions with suppliers. 10. Inability to obtain financing for essential new product development or other essential investments. 11. Entering into a scheme of arrangement with creditors for reduction of liability. Operating Indications : 1. Turnover and departure of key management personnel without replacement. 2. Loss of market, franchise, license or key supplier. 3. Labour difficulties or shortage of important supplies Other indications : 1. Non-compliance with statutory requirements. 2. Legal cases with possibility of adverse judgement which could not be met. 3. Changes in legislations or government policy. 4. Sickness of the entity under any statutory definition May [8] Write short notes on the following : (e) Eight situations of external confirmations. (4 marks) (i) Bank balance from bankers (ii) Account receivable balances (iii) Stocks held by third parties (iv) Property title deeds held by third parties (v) Investments purchased but delivery not taken (vi) Loan from lenders (vii) Account payable balance (viii) Long outstanding share application money Nov [8] Write short notes on the following: (f) Situations where external confirmations can be used. (4 marks) Please refer May [8] (e) on page no. 27

14 Q&A-3.28 O Solved Scanner CA Final Gr. I Paper - 3 DESCRIPTIVE QUESTIONS Nov [1] {C} State your views on the following requests made by the management of X Ltd.: (e) Revaluation Reserve is available for issue of Bonus shares. (4 marks) Please refer Nov [8] (c) on page no May [2] {C} Answer the following : (a) Briefly describe the auditor's responsibility regarding subsequent events. (10 marks) SA 560 on "subsequent Events" establishes standards on the auditor s responsibility regarding subsequent events. SA 560 on "Subsequent Events" states that the term"subsequent events" refers to significant events occurring between the balance sheet date and the date of the auditor s report. AS 4 on "Contingencies and Events Occurring after the Balance Sheet Date" deals with all those significant events, both favourable and unfavourable, that occur between the balance sheet date and the date on which the financial statements are approved by the Board of Directors in the case of a company and by the corresponding approving authority in the case of any other entity. As per AS 4, events can be identified as adjustable events which provide further evidence of conditions that existed at the balance sheet date; and, non-adjusting events are those which are indicative of conditions that arose subsequent to the balance sheet date. SA 560 lays down that the "auditor should consider the effect of subsequent events on the financial statements and on the auditor s report". When the time between the close of the year-end and the adoption of accounts is about to take place, examination of subsequent events gains more importance. SA 560 on Subsequent Events further requires that the auditor should perform procedures designed to obtain sufficient appropriate audit evidence that all events up to the date of auditor s report that may require adjustment of, or disclosure in, the financial statements have been identified. The procedures to identify events that may require adjustment of, or disclosure in the financial statements would be performed as near as practicable to the date of the auditor s report and ordinarily include the following: (i) Reviewing procedures that the management has established to ensure that subsequent events are identified. (ii) Reading minutes of the meetings of shareholders, the Board of Directors and audit and executive committees held after the balance sheet date and inquiring about matters discussed at meetings for which minutes are not yet recorded.

15 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.29 (iii) Reading the entity s latest available interim financial statements and, as considered necessary and appropriate, budgets, cash flow forecasts and other related management reports. (iv) Inquiring, or extending previous oral or written inquiries, of the entity s lawyers concerning litigation and claims. (v) Inquiring of management as to whether any subsequent events have occurred after the balance sheet date which might affect the financial statements. When the auditor becomes aware of events which materially affect the financial statements, the auditor should consider whether such events are properly accounted for in the financial statements. When the management does not account for such events that the auditor believes should be accounted for, the auditor should express a qualified opinion or an adverse opinion as may be appropriate May [4] Comment on the following : (c) For Excise Duty on finished goods in stock as at the end of the year, there is an option available to provide for the same or to show the same as a Contingent liability. (4 marks) Accounting Treatment of Excise Duty : The AS-2 (Revised) on, "Valuation of Inventories" states that finished goods are to be valued by taking into account the costs of purchase, costs of conversion and other costs incurred in bringing the inventories to the present location and condition. The costs of conversion to be included would be all direct factory overheads related to the said finished goods. Excise duty is a duty which is payable on the manufacture of the finished goods inside a factory. Though the collection of the same is deferred till the goods leave the factory, the liability for the same arises when the manufacture takes place. The Institute, before the enactment of the revised AS-2, in its Guidance Notes on Accounting Treatment for Excise Duty gave an option to entities to provide the excise duty payable on finished goods and add the same to the valuation of finished goods or not to make any provision but only make a disclosure of the said liability. After the revised AS-2 was issued effective from , the ICAI revised its earlier guidance note and removed the alternative of not providing for the excise duty. Thus it is now mandatory for an entity to provide for liability for excise duty on finished goods lying in stock at the end of the year and add the same to the value of closing stock. According to Guidance Note on "Accounting Treatment of Excise Duty", excise duty should be considered as a manufacturing expense and like other manufacturing expenses be considered as an element of cost for inventory valuation. Where excise duty is paid on excisable goods and such goods are subsequently utilised in the manufacturing process, the duty paid on such goods, if the same is not recoverable from taxing authorities, becomes a manufacturing cost and must be included in the valuation of

16 Q&A-3.30 O Solved Scanner CA Final Gr. I Paper - 3 work-in-progress or finished goods arising from the subsequent processing of such goods. Further, where the liability for excise duty has been incurred but its collection is deferred, provision for the unpaid liability should be made. Excise duty cannot be treated as a period cost, Accordingly excise duty now cannot be shown as a contingent liability. Thus, it is now mandatory for an entity to provide for liability for excise duty on finished goods lying in stock at the end of the year and add the same to the value of closing stock. If the said provision is not made, the revised Guidance Note on Accounting Treatment for Excise duty says that the auditor should qualify his report and, if possible, also mention the quantum of the duty not so provided Nov [4] Answer the following : (b) Briefly describe, how an auditor can use the work of an expert. (8 marks) An expert (or a specialist) is a person, firm or other association of persons possessing special skill knowledge and experience in a particular field other than accounting and auditing. When determining whether to use the work of an expert or not, the auditor should consider: (a) Materiality of the item being examined in relation to the financial information as a whole. (b) Nature and complexity of the item including the risk of error therein. (c) Other audit evidence available with respect to the item. Skill and Competence: When the auditor plans to use an external experts work as audit evidence he should satisfy himself as to the experts skill and competence by considering the experts. professional qualifications, licence or membership in an appropriate professional body, experience and reputation in the field in which the evidence is sought. Objectivity : The auditor should also consider the objectivity and independence of the expert. Evaluating the Expert Work : When the auditor intends to use the work of an expert, he should examine evidence to gain knowledge regarding the terms of the experts engagement and other matters such as :- (a) Objectives and scope of the experts work (b) A general outline as to the specific items in experts report. (c) Confidentiality of expert work. (d) The experts relationship with the client May [3] (b) Explain what is meant by "Representations by Management" and indicate to what extent an auditor can place reliance on such representations. (6 marks)

17 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.31 As per SA- 580 Representation by Management refers to written or oral confirmation by them regarding the items presented in financial statements. The auditor should obtain representations from management, where considered appropriate. He should exercise his professional judgement in determining the matters on which he wishes to obtain representations from management. The auditor should obtain evidence that management acknowledges its responsibility for the appropriate preparation of financial information and that management has approved the financial information. Audit Procedures: When representations relate to matters which are material to the financial information, the auditor should: (a) (b) (c) seek corroborative audit evidence from sources inside or outside the entity. evaluate whether the representations made by management appear reasonable and consistent with other. Audit evidence obtained, including other representations, and consider whether the individuals making the representations can be expected to be well-informed on the matter. Documentation : The auditor should document in his working papers evidence of management s representations. Forms of Representation :A written representation is better audit evidence than an oral representation and can take the form of. (a) a representation letter from management (e) confidentiality of the clients information used by the expert. Appropriate Audit Evidence : The auditor should seek reasonable assurance that the expert s work constitutes appropriate audit evidence in support of financial information, by considering, the source data used the assumptions and methods used the results of the expert work in the light of the auditor s overall knowledge of the business. the auditor should also satisfy himself that the substance of the expert s findings is properly reflected in financial information. Data used by Expert : The auditor should consider whether the expert has used appropriate source data, by employing procedures like (a) Inquiring the expert to determine how he has satisfied himself that source data are sufficient. Relevant and reliable and (b) conducting audit procedures on the data provided by client to expert to obtain reasonable assurance that data are appropriate. Assumptions adopted by Expert : The auditor should obtain an understanding of those assumptions and methods to determine that they are reasonable based on the auditor s knowledge of the client s business and on results of his audit procedures.

18 Q&A-3.32 O Solved Scanner CA Final Gr. I Paper - 3 Qualified Report : If the auditor concludes that the work of the expert (a) is inconsistent with the information in financial statement or (b) does not constitute sufficient appropriate audit evidence he should express a qualified opinion, disclaimer of opinion or adverse opinion as may be appropriate Nov [3] Answer the following in brief : (a) How can an Auditor identify Related Parties? (8 marks) (b) How does an Auditor evaluate the work of an Expert? (8 marks) (a) Identification of Related Parties : The duties of an auditor with regard to reporting of transactions with related parties as required by Accounting Standard 18 are given in SA on Related Parties. As per SAP-23 on "Related Parties" the auditor should review information provided by the management of the entity identifying the names of all known related parties. Since it is the management which is primarily responsible for identification of related parties, SAP-23 requires that to identity names of all known related parties, the auditor may carry out the following procedures : (i) review his working papers for previous years for names of known related parties; (ii) review the entity s procedures for identification of related parties; (iii) inquire as to affiliation of directors, key management personnel and offices with other entities, etc; (iv) review shareholder records to determine the names of principal shareholders or, if appropriate, obtain a list of principal shareholders from the share register; (v) review memorandum and articles of association, minutes of the meetings of shareholders and the board of directors and its committees and other relevant statutory records such as the register of directors interests; (vi) inquire of other auditors such as internal auditor, special auditors appointed under any statute, cost auditors, and concurrent auditors of the entity as to their knowledge of additional related parties and review the report of the predecessor auditors. (vii) review the entity s income tax returns and other information supplied to regulatory agencies; and (viii) review the joint venture and other relevant agreements entered into by the entity. In addition, the auditor needs to be alert for transactions which appear unusual in the circumstances and which may indicate the existence of previously unidentified related parties. Examples include-

19 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.33 Transactions which have abnormal terms of trade, such as, unusual prices, interest rates, guarantees, and repayment terms. Transactions which lack an apparent logical business reason for their occurrence. Transactions in which substance differs from form. Transactions processed in an unusual manner. High volume or significant transactions with certain customers or suppliers as compared with others. Rendition of services without receipt or provision of management services at no charge. Finally, the auditor should also obtain a written representation from the management concerning the completeness of information provided regarding the identifications of related parties. (b) Please refer Nov [4] (b) on page no Nov [1] {C} What are your views on the following? (c) An auditor of Sagar 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? (5 marks) (d) A firm of a father and a son is receiving `2 lakhs towards job work done for XYZ Ltd. during the year ended on The total job work charges paid by XYZ Ltd. during the year are over Rs. 50 lakhs. The father is a Managing Director of XYZ Ltd. having substantial holding. The Managing Director told the auditor that since he is not involved in the activities of the firm and since the amount paid to it is insignificant; there is no need to disclose the transaction. He further contended that such a payment made in the last year was not disclosed. Is Managing Director right in his approach? (5 marks) (c) 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 Sagar 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. AS per SA 580, when representation relate to matters which are material to the financial information, then the auditor should seek corroborative audit evidence for other sources inside or outside the entity. He should evaluate whether such

20 Q&A-3.34 O Solved Scanner CA Final Gr. I Paper - 3 representations are reasonable and consistent with other evidences and should consider whether individuals making such representations can be expected to be well informed on the matter. "Representation by 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. Therefore, the approach adopted by the auditor is not right. (d) Accounting Standard 18, "Related Party Disclosures" applies to the facts of the case. AS 18 requires disclosure of party relationship and transactions between a reporting enterprise and its related parties. The parties are considered to be related if at any time during the reporting period, one party has the ability to control the other party of exercise significant influence over the other party in making decisions. As per the explanation given in AS 18, significant influence is said to exist in case the investing party has 20% or more voting power in the enterprise. In the instant case, the managing director of XYZ Ltd. is a partner in the firm with his son which has been paid `2 lakhs as job work charges. The managing director is having a substantial holding in the firm. The case is squarely covered by AS 18, The approach of the managing director is not tenable under the law and accordingly all disclosure requirements have to be complied. Accordingly, the approach followed by the Managing Director is not right. Under the circumstances, the auditor shall have to modify his report. Also it has to be seen whether section 299 regarding disclosure of interest by interested directors has been complied with. If it is not complied with, the auditor needs to modify the report appropriately Nov [3] (a) What are Initial Audit Engagements? (2 marks) (b) In an initial audit engagement the auditor will have to satisfy about the sufficiency and appropriateness of Opening Balances to ensure that they are free from misstatements, which may materially effect the current financial statements. Lay down the audit procedure, you will follow in cases (i) when the financial statements are audited for the preceding period by another auditor; and (ii) when financial statements are audited for the first time. (7 marks) (c) If, after performing the procedure, you are not satisfied about the correctness of Opening Balances ; what approach you will adopt in drafting your audit report in two situations mentioned in (b) above? (7 marks) (a) Initial Engagement-Opening Balances : As per SA510 Initial Engagements Opening Balances initial audit engagements mean :

21 [Chapter 1] Auditing and Assurance Standards &... O Q&A-3.35 (i) When the auditor is engaged to carry out the audit of financial statements of an entity for the first time; or. (ii) When the financial statements of the entity for the preceding period were audited by another auditor; The situation mentioned in (ii) above arises whenever there is a change of auditor. The situation mentioned in (i) above is obviously when the auditor is appointed to take up the audit for the first time or no audit was carried out of the financial statements of the entity for the immediately preceding period. (b) (i) Financial Statements Audited by Another Auditor-Audit Procedure : (a) Ordinarily the current auditor can place reliance on the closing balances contained in the audited financial statements of the preceding period. Sufficient audit evidence will be obtained for verifying opening balances, which are closing balances of the earlier period by perusing the copies of the audited financial statements. (b) If during the performance of audit for the current period the possibility of misstatements in opening balances is indicated, some indirect audit evidence can be obtained as part of the audit procedures performed during the current period. For example, the collections and payments of opening balances in the accounts of debtors and creditors respectively during the current period will provide evidence as to their existence, correctness and valuation at the beginning of the period. (ii) Audit of Financial Statements for the First Time-Audit Procedure : When the audit of financial statements is being conducted for the first time, the auditor has to perform auditing procedures to obtain sufficient appropriate audit evidence. Since opening balances represent effect of transaction and events of the preceding period and accounting policies applied in the preceding period, the auditor need to obtain evidence having regard to nature of opening balances, materiality of the opening balances and accounting policies. Since it will not be possible for auditor to perform certain procedures, e.g., observing physical verification of inventories, etc. the auditor may obtain confirmation, etc. and perform suitable procedures in respect of fixed assets, investments, etc. The auditor can also obtain management representation with regards to the opening balances. (c) Drafting Audit Report : If after performing the laid down procedure in SA 510, "Initial Engagements -Opening Balances, the auditor is not satisfied in either of the above situations, he should, as appropriate express a qualified opinion or disclaimer of opinion. At times, it is also likely that the auditor opines that the profit and loss account is qualified but balance sheet is found to be unqualified. If the opening balances contain misstatements which materially affect the financial statements for the current period and the effect of the same is not properly