SUGGESTED ANSWERS TO MAY 2015 IPCC EXAMS AUDITING & ASSURANCE DISCLAIMER

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1 SUGGESTED ANSWERS TO MAY 2015 IPCC EXAMS AUDITING & ASSURANCE Dear students, These suggested answers are meant for easy and quick assessment of possible outcome of IPCC aspirants for their in-advance preparation and future course of planning. Copyrights on these suggested answers are reserved to. No circulation of these suggested answers is permitted by any means. Those who download these suggested answers can only use them for their self assessment and they don t have any rights to circulate the same through any means. DISCLAIMER 1. Readers must aware that, these are not the suggested answers issued by ICAI. These suggested answers are only the recommendations by, Guntur. 2. ICAI will issue its own suggested answers in future and performs paper valuation based on its own suggested answers. So, if any difference in judgment is found in assessment of the readers based on Suggested Answers, then holds no responsibility. 3. The Suggested answers issued by both ICAI and are purely different and their own opinions. So, there is no guarantee that suggested answers issued by MASTER MINDS match with the suggested answer to be released by ICAI. Even if the suggested answers issued by match with the Suggested answers to be issued by ICAI, it is purely accidental. 4. These suggested answers are prepared based on the information available to us and with the best of our knowledge. Wherever needed assumptions have been taken. 5. Even after taking maximum care in preparation of these suggested answers, there may be chances for some errors, diverse opinions & judgments. So, has no responsibility for any such errors and diverse opinions. 1a) Advantages of Independent Audit Question No It produces reliable financial statements of accounts. 2. It protects the interest of persons who are not participating in the management of the entity. 3. It acts as a moral check on the employees from committing frauds. 4. Audited financial statements are helpful in: a) Settling liability for taxes, b) Bargaining loans and c) For determining the purchase consideration of a business. 5. These are useful to settle trade disputes for higher wages or bonus. Copy Rights Reserved To, Guntur 6. These are useful to settle claims in case of damages suffered by fire accidents, etc. 7. It also helps the client in deciding whether the necessary books and records have been properly kept. 8. Auditor reviews the operation of various controls in the organisation and reports weaknesses in them. 9. Government may require audited financial statements before it gives subsidies, etc. IPCC May 2015_Suggested Answers_Auditing & Assurance 1

2 Ph: /26 1b) Types of Modified Opinions: This SA establishes three types of modified opinions, namely, a qualified opinion, an adverse opinion, and a disclaimer of opinion. The decision regarding which type of modified opinion is appropriate depends upon: 1. The nature of the matter giving rise to the modification, that is, whether the financial statements are materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated; and 2. The auditor s judgment about the pervasiveness of the effects or possible effects of the matter on the financial statements. Nature of Matter Giving Rise to the Modification Financial statements are materially misstated Inability to obtain sufficient appropriate audit evidence Auditor s Judgment about the Pervasiveness of the effects or Possible effects on the Financial Statements Qualified opinion Qualified opinion Adverse opinion Disclaimer of opinion 1c) 1d) 1. Responsibility: The responsibility for the prevention and detection of fraud and error is of the management through the implementation of an internal control system. The presence of such a system reduces but does not eliminate the possibility of fraud and error. 2. Auditor s efforts: One of the audit objectives is to detect the fraud or error resulted in the accounts. To ensure that fraud or error has not occurred or even it was occurred it will be detected by him during the course of his audit, the auditor adopts the several audit techniques. Consequently, the auditor gets reasonably satisfied that fraud or error has not occurred or even it was occurred, the effect of fraud or error is properly corrected. 3. Limitations of audit: Due to the inherent limitations of an audit there is a possibility that misstatements in the financial statements resulting from fraud or error may not be detected. 4. Subsequent discovery: The subsequent discovery of fraud or error does not indicate that the auditor has discharged his job negligently. (*) 5. Question: The question whether the auditor has followed the basic principles governing an audit is answered by the adequacy of the audit procedures used by him and the suitability of the auditor s report based on the results of these procedures. 6. Liability: The liability of the auditor for failure to detect fraud or error arises only when such failure is clearly due to not exercising reasonable care and skill. * In spite of good efforts put by auditor in identifying the frauds, if he fails in doing so, it will not be construed as audit failure. The same is upheld by KINGSTON COTTON MILLS CO. s CASE. 1. The integrity of the principal owners, key management and those charged with governance of the entity; 2. Whether the engagement team is competent to perform the audit engagement and has the necessary capabilities, including time and resources; 3. Whether the firm and the engagement team can comply with relevant ethical requirements; and 4. Significant matters that have arisen during the current or previous audit engagement, and their implications for continuing the relationship. IPCC May 2015_ Suggested Answers_ Auditing & Assurance 2

3 Question No. 2 i) True: The C & AG shall have powers under Sec. 139 To conduct a supplementary or test audit of the company s accounts by such person as he may authorise in this behalf. ii) False: The auditor has to modify his audit report when the financial statements are materially misstated or, in the case of an inability to obtain sufficient appropriate audit evidence, may be materially misstated. iii) False: As per Section139 (7) provides that in the case of a Government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government, or Governments, or partly by the Central Government and partly by one or more State Governments, the first auditor shall be appointed by the Comptroller and Auditor-General of India within 60 days from the date of registration of the company. iv) False: As per section 138 of the Companies Act, 2013 the following class of companies (prescribed in rule 13 of Companies (Accounts) Rules, 2014). Every private company having a) Turnover of two hundred crores rupees or more during the preceding financial year; or b) Outstanding loans or borrowings from banks or public financial institutions exceeding one hundred crores rupees or more at any point of time during the preceding financial year: Provided that an existing company covered under any of the above criteria shall comply with the requirements within six months of commencement of such section. v) False: Written Representations as Audit Evidence Although written representations provide necessary audit evidence, they do not provide sufficient appropriate audit evidence on their own about any of the matters with which they deal. The auditor has to conduct the physical verification in order to verify the quality of inventory, otherwise he will be held for negligence. vi) False: This letter also known as letter on internal control refers to the communication by the auditor to the client disclosing the weaknesses observed in the IC system and the related accounting system. vii) True: The term audit techniques covers examination or scrutily of bank reconciliation statement. viii) True: Definition of Auditing: Most authoritative definition on auditing is An audit is an independent examination of financial information of any entity, whether profits oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to express an opinion thereon. (These matches with the famous definition given by Mr. Dick see). As per SA -200, the primary objective of audit is to enable an auditor to express an opinion on Financial Statements, ix) False: One of the disqualifications as per section 141(3): A person whose relative is a director or is in the employment of the company as a director or key managerial personnel; x) False: Where a firm including a limited liability partnership is appointed as an auditor of a company, only the partners who are chartered accountant shall be authorized to act and sign on behalf of the firm. Copy Rights Reserved To, Guntur IPCC May 2015_Suggested Answers_Auditing & Assurance 3

4 Ph: /26 Question No. 3 3a) Rental Receipts 1. The auditor should obtain a complete schedule of properties held, showing particulars as regards the name of the tenant, location of the property, amount of rent, period of payment etc. 2. Auditor should vouch the rent received with the help of the carbon copies of rent receipts. 3. See that the terms & conditions of rental agreement have been complied with. 4. Where the rent is collected by a collecting agent, the a/c of the agent should be scrutinised. 5. The auditor should also vouch the entries for the rent outstanding. 6. The auditor should properly investigate into abnormal rent outstanding in particular. 7. See that the refundable deposits collected from the tenants are not shown as rent. 8. See that proper treatment was made for the TDS made by the tenants. 9. See that the disclosure requirements of Sch.III have been complied with or not. 3b) Repair to assets 1. The auditor should see that the work of repairing has been authorised by a responsible officer. 2. See that the expenditure is properly classified as capital and revenue. 3. The proportion of the charges which had the effect of increasing the value of an asset or enhancing its capacity or life, should be treated as capital expenditure. 4. If the work of repairs is based on A.M.C., see that the payments are made as per the agreement. 5. If Repairing is done through a contractor, the auditor should verify the bill of the contractor. 6. See that the voucher is supported by the receipt of the contractor for the payment of the bill. 7. See that the disclosure requirements of Sch.III, Part II have been complied with or not. 3c) Work in progress: The audit procedures regarding work-in-progress are similar to those used for raw materials and finished goods. However, the auditor has to carefully assess the stage of completion of the work-in-progress for assessing the appropriateness of its valuation. For this purpose, the auditor may examine the production/costing records (i.e., cost sheets), hold discussions with the personnel concerned, and obtain expert opinion, where necessary. Further steps: 1. Ascertain that the cost sheets are duly attested by the works engineer and works manager 2. Test the correctness of the cost as disclosed by the cost records by verification of quantities and cost of materials, wages and other charges included in the cost sheets by reference to the records maintained in respect thereof. 3. Ensure that the allocation of overhead expenses have been made on a rational basis. 4. Compare the WIP with that of the previous year. If they vary materially, investigate the cause. 5. See that this is disclosed under the head "Stock in trade" on the assets side of the B/s. 3d) Insurance claims: 1. Verify the insurance policy document to observe the terms and conditions of the policy. 2. Check the basis of computation of the claim. 3. Verify that the insurance claims received are as per the claims lodged by the Company. 4. If claim is received against the fixed asset, see that proper adjustments are made to F.A. a/c. 5. See that the amount accounted for in the books of account gets tallied with the amount mentioned in the claim discharge note. 6. Enquire the reasons for non settlement of claims which were long outstanding. IPCC May 2015_ Suggested Answers_ Auditing & Assurance 4

5 4a) Significant Difficulties: Question No Significant delays in management providing required information. 2. An unnecessarily brief time within which to complete the audit. 3. Extensive unexpected effort required to obtain sufficient appropriate audit evidence. 4. The unavailability of expected information. 5. Restrictions imposed on the auditor by management. 6. Management s unwillingness to make or extend its assessment of the entity s ability to continue as a going concern when requested. 4b) Significant risks often relate to significant non-routine transactions or judgmental matters. Nonroutine transactions are transactions that are unusual, due to either size or nature, and that therefore occur infrequently. Judgmental matters may include the development of accounting estimates for which there is significant measurement uncertainty. Routine, non-complex transactions that are subject to systematic processing are less likely to give rise to significant risks. Risks of material misstatement may be greater for significant non-routine transactions arising from matters such as the following: 1. Greater management intervention to specify the accounting treatment. 2. Greater manual intervention for data collection and processing. 3. Complex calculations or accounting principles. 4. The nature of non-routine transactions, which may make it difficult for the entity to implement effective controls over the risks. Risks of material misstatement may be greater for significant judgmental matters that require the development of accounting estimates, arising from matters such as the following: 1. Accounting principles for accounting estimates or revenue recognition may be subject to differing interpretation. 2. Required judgment may be subjective or complex, or require assumptions about the effects of future events, for example, judgment about fair value. SA 330 describes the consequences for further audit procedures of identifying a risk as significant.11 Significant risks relating to the risks of material misstatement due to fraud SA 240 provides further requirements and guidance in relation to the identification and assessment of the risks of material misstatement due to fraud. 4c) Rotation: Applicability: As per rules prescribed in Companies (Audit and Auditors) Rules, 2014, Rotation of Auditor is applicable for the following companies except one person companies and small companies:- 1. All listed companies 2. All unlisted public companies having paid up share capital of rupees ten crore or more; (or) having borrowings from financial institutions, banks or public deposits of rupees fifty crores or more. 3. All private limited companies having paid up share capital of rupees twenty crore or more; (or) having borrowings from financial institutions, banks or public deposits of rupees fifty crores or more. IPCC May 2015_Suggested Answers_Auditing & Assurance 5

6 Ph: /26 Period and Term of Auditor s Office: 1. As per Section 139(2) the companies as mentioned above, shall not appoint or re-appoint a) an individual as auditor for more than one term of five consecutive years; and b) an audit firm as auditor for more than two terms of five consecutive years. 2. An individual auditor (or) firm who (or) which has completed term as above shall not be eligible for re-appointment as auditor in the same company for five years from the completion of his term. Other points: 1. The audit committee shall recommend to the Board, the name of an individual auditor or of an audit firm who may replace the incumbent auditor on expiry of the term of such incumbent. 2. Where a company is required to constitute an Audit Committee, the Board shall consider the recommendation of such committee, and in other cases, the Board shall itself consider the matter of rotation of auditors and make its recommendation for appointment of the next auditor by the members in annual general meeting. 3. For the purpose of the rotation of auditors: i) in case of an auditor (whether an individual or audit firm), the period for which the individual or the firm has held office as auditor prior to the commencement of the Act shall be taken into account for calculating the period of five consecutive years or ten consecutive years, as the case may be; ii) the incoming auditor or audit firm shall not be eligible if such auditor firm is associated with the outgoing auditor or audit firm under the same network of audit firms. 5a) Advantages of audit documentation: Question No Evidence of the auditor s basis for audit report; and 2. Evidence that the audit was planned and performed in accordance with SAs and applicable legal and regulatory requirements. 3. Assisting the engagement team to plan and perform the audit. 4. Assisting members of the engagement team responsible for supervision to direct and supervise the audit work. 5. Enabling the engagement team to be accountable for its work. 6. Retaining a record of matters of continuing significance to future audits. 7. Enabling the conduct of quality control reviews and inspections. 8. Enabling the conduct of external inspections in accordance with applicable legal, regulatory or other requirements. 5b) Inherent limitations of Internal Control: The extent of audit procedures to be performed depending upon the effective working of the Internal Control System. Even the Internal Control System also has some limitations: 1. The potentiality for human error. 2. The possibility of dilution of controls through collusion. 3. The possibility that a person exercising control could abuse (misuse) that authority. 4. The possibility that control procedures may become outdated. 5. Manipulation by management with respect to transactions required in the preparation of financial statements. IPCC May 2015_ Suggested Answers_ Auditing & Assurance 6

7 5c) The reliability of audit evidences depends on its source- internal or external and on its form -visual documentary or oral. Third party confirmations are a kind of external source of evidence. Obtained from Sundry debtors Sundry creditors Banks Share brokers Warehouse keeper Experts Lawyers Consignee Insurance company Obtained for For confirming the amount of debt. For confirming the amount of credit. For confirming the amount of bank balance. For confirming the share certificates held, the cost & sale value of shares etc. For confirming stock value in the warehouse. For confirming the issue which needs expert knowledge. For confirming the contingent liabilities. For confirming the on consignment. For confirming Insurance coverage. SA 500 on audit evidence says that external evidence (e.g. confirmation received from a third party) is usually more reliable than internal evidence, since they are created outside the organisation on which the client and its staff have no control. 6a) Advantages of audit of partnership firms: Question No Audit enables the partners of the firm to settle their disputes mutually, because the accounts are audited by an independent person. 2. At the time of admission of a new partner audited accounts would be more useful for determining the value of goodwill. 3. In the event of the retirement or death of a partner audit enables determination of the amounts payable. 4. An audit is an effective safeguard against any undue advantage being taken by a working partner, for the sleeping partners. 5. The visit by auditor acts as a moral check on the employees. 6. Audited/reliable information is available to the firm and therefore the firm is able to take more accurate decisions. 7. The firm will be very much benefited by the suggestions given by the auditor, with regard to the system of accounts, internal controls and checks over employees etc. 8. The income tax authorities place more reliance on audited statements of accounts while assessing the income. 9. Banks generally rely on audited accounts even in case of firms. 10. Insurance companies also rely on audited accounts in case of any insurance claims. 11. At the time of sale of the business, audited accounts would be more useful for deciding the purchase consideration 6b) Objectives & Functions of AASB: 1. To review the existing and emerging auditing practices worldwide and identify areas in which Standards on Quality Control, Engagement Standards and Statements on Auditing need to be developed. IPCC May 2015_Suggested Answers_Auditing & Assurance 7

8 Ph: / To formulate Engagement Standards, Standards on Quality Control and Statements on Auditing so that these may be issued under the authority of the Council of the Institute. 3. To review the existing Standards and Statements on Auditing to assess their relevance in the changed conditions and to undertake their revision, if necessary. 4. To develop Guidance Notes on issues arising out of any Standard, auditing issues pertaining to any specific industry or on generic issues, so that those may be issued under the authority of the Council of the Institute. 5. To review the existing Guidance Notes to assess their relevance in the changed circumstances and to undertake their revision, if necessary. 6. To formulate General Clarifications, where necessary, on issues arising from Standards. 7. To formulate and issue Technical Guides, Practice Manuals, Studies and other papers under its own authority for guidance of professional accountants in the cases felt appropriate by the Board. 6c) The important objectives of audit are: 1. Reporting on the fairness of the content & presentation of financial statements; 2. Reporting upon the strengths and weaknesses of systems of financial controls; 3. Reporting on the adherence to legal and/ or administrative requirements; 4. Reporting upon whether value is being fully received on money spent; and 5. Detection and prevention of error, fraud and misuse of resources. 7a) Fundamental Accounting Assumptions: Question No The following have been generally accepted as fundamental accounting assumptions: a) Going Concern: The enterprise is normally viewed as a going concern, i.e., as continuing in operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation or of curtailing materially the scale of the operations. b) Consistency: It is assumed that accounting policies are consistent from one period to another. c) Accrual: Revenues and costs are accrued, i.e., recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. 2. Disclosure: a) If the fundamental accounting assumptions, viz., Going concern, Consistency and Accrual are followed in financial statements, specific disclosure is not required. b) If a fundamental accounting assumption is not followed, the fact should be disclosed. 7b) Methods to obtain audit evidence 1. Inspection: Inspection includes examining books, documents and tangible assets. a) Inspection of books and documents provides evidence of different degrees of reliability depending on their source and form 3 major categories of documentary evidences which provide different degrees of reliability are: i) Documentary evidence created by the entity and held by the third parties, ii) Documentary evidence created by third parties & held by the entity & iii) Documentary evidence created and held by the entity. b) Inspection of tangible assets provides reliable evidence with respect to their existence. IPCC May 2015_ Suggested Answers_ Auditing & Assurance 8

9 2. Observation consists of looking at a process or procedure being performed by others. 3. Inquiry consists of getting the information from related persons inside or outside the entity. Inquiry may be in the form of written or oral questions addressed to inside or outside parties. 4. Confirmation consists of the response to an enquiry. For example, the auditor normally requests confirmation of debtors. 5. Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may be performed manually or electrically. 6. Re performance involves the auditor s independent execution of procedures or controls that were originally performed as part of the entities internal control. 7. Analytical review consists of studying significant ratios and trends and investigating unusual fluctuations in them. 7c) Importance of working papers: 1. To help in the planning and performance of the audit. 2. To help in the supervision and review of the audit work. 3. Provide evidence of the audit work performed to support the auditor s opinion. 4. Record and demonstrate the audit work performed to support the Auditor s opinion. 5. Plan the timing and extent of audit procedures to be performed. 6. Draw conclusions from the evidence obtained. 7. Standardise the working papers and audit procedures to improve the efficiency of the audit. 7d) Random sampling method is further classified into following 2 methods. 1. Simple Random Sampling: The procedure used under this method is use of random number tables for selection of sample. By using random number tables the element of bias is removed. 2. Stratified Random Sampling: This method involves dividing the whole population in a few separate groups and then taking sample from each of the group. The group thus, formed shall be called strata. Each strata is considered as a separate Population and proportionate items are selected from each of the strata. The auditor uses his judgement in selecting the number of groups or strata. 7e) Defalcation of Cash: Defalcation of cash made generally by way of inflating the cash payments and suppressing cash receipts. 1. Making payments against fictitious vouchers. 2. Making payments against vouchers, the amounts whereof have been inflated. 3. Manipulating totals of wage rolls either by including therein names of dummy workers or by inflating them in any other manner. 4. Adjusting unauthorised or fictitious rebates, allowances, discounts, etc. to customer accounts and misappropriating amount paid by them. 5. Writing off as debts in respect of such balances against which cash has already been received but has been misappropriated. 6. Not accounting for cash sales fully. 7. Not accounting for miscellaneous receipts, e.g., sale of scrap, quarters allotted to the employees, etc. THE END Copy Rights Reserved To, Guntur Copy Rights Reserved To, Guntur IPCC May 2015_Suggested Answers_Auditing & Assurance 9