Auditing & Assurance

CA- IPC Auditing & Assurance Solution of paper May 2016 By: Rathore Institute CA. Nitin Gupta Question 1 Discuss the following (4 X 5 = 20 Marks) a) With reference to SA 550, Identification of significant related party transaction outside the entity s normal course of business For identified significant related party transaction outside the entity s normal course of business, the auditor shall: 1) Inspect the underlying contracts or agreements, if any and evaluate whether i. The business rationale of the transactions suggest that they may have been entered into engage in fraudulent financial reporting or to conceal misappropriation of assets

ii. Terms of the transactions iii. The transactions have been appropriately accounted for and disclosed in accordance with the applicable financial reporting framework 2) Obtain audit evidence that the transactions have been appropriately authorized and approved. b) With reference to SA 530, meaning of audit sampling and requirement of sample design, sample size and selection of items for testing. Audit Sampling - The application of audit procedures to less than 100% of items within a population. Sample Design- When designing an audit sample, the auditor shall consider the purpose of the audit procedure and characteristics of the population from which the sample will be drawn. Sample Size- The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level. Selection of items for testing- The auditor shall select items for sample in such a way that each sampling unit in the population has chance of selection. c) How does an audit programme help to plan and perform the audit? The advantages of an audit programme are: 1) It provides the assistant carrying out the audit with total and sent of instructions of the work generally to be done. 2) It is essential, particularly for major audits, to provide a total perspective of the work to be performed 3) Selection of assistants for the jobs on the basis of capability becomes easier when the work is rationally planned, defined and segregated.

4) Audit can proceed systematically. 5) The assistants, by putting their signature on programme, accept the responsibility for the work carried out by them individually and, if necessary, the work done may be traced back to assistant. 6) The principal can control the progress of the various audits in hand by examination of audit programme initiated by the assistants deputed to the jobs for completed work. 7) It serves as a guide for audits to be carried out in the succeeding year. 8) A properly drawn up audit programme serves as evidence in the event of any charge of negligence being brought against the auditor. d) What are the specific risks related to internal controls in an IT environment? Following are the specific risks related to internal controls in an IT environment: 1) Reliance on system or programs that are inaccurately processing data, processing inaccurate data, or both 2) Unauthorized access to data that may result in destruction of data or improper changes to data, including the recording of unauthorized or non-existent transactions. 3) Unauthorized changes to data in master files. 4) Unauthorized changes to system or programs 5) Failure to make necessary changes to system or programs 6) Inappropriate manual intervention 7) Potential loss of data or inability to access data as required.

Question 2 State with reason (in short) whether the following statements are correct or incorrect ( any eight) (8 X 2 = 16 Marks) a) The scope of work of internal auditor may extend even beyond the financial accounting. Correct: The scope of work of internal auditor may extend beyond the financial accounting like management audit and operational audit. Hence above statement is correct. b) An auditor has nothing to do with the prudence or profitability of a company. Correct: The overall object of the audit is to express an opinion on true and fair view of the financial statement of an entity. It is nothing to him whether the business of company is being conducted prudently or imprudently, profitably or unprofitably. Hence above statement is correct. c) Evaluating responses to enquiries in an integral part of the inquiry process. Correct: As per SA 500 (Audit Evidence) inquiry is one of the audit techniques to obtain audit evidences. Inquiry consists of seeking information of knowledgeable persons. Evaluating responses to inquires is an integral part of the inquiry process. Hence above statement is correct. d) Internal control questionnaires are a good source of identifying weakness in internal control system. Correct: ICQ is a comprehensive series of questions concerning internal control. This is the most widely used form for collecting information about the existence, operation and efficiency of internal control is an

organization. So on the basis of ICQ auditor can identify weakness in internal control system. Hence above statement is correct. e) Cluster sampling is less effective than random sampling. Correct: Cluster sampling is less effective than random sampling as in cluster sampling items are not individually selected. Hence above statement is correct. f) Errors of duplication affect the Trial Balance. Incorrect: In an error of duplication a transaction is processed twice by the accounting system, like Purchase of goods is recorded twice in the books of account. Such an error will not affect the trial balance. Hence above statement is incorrect. g) Substantive procedures do not test the balance of accounts. Incorrect: As per SA 330 (Auditor s Response to Assessed Risk) substantive procedures are performed by auditor to examine completeness, accuracy and validity of data produced by the accounting system. In the substantive procedures the auditor examines test of details of transactions, account balances, overall presentation and disclosure of the financial statement. Hence above statement is incorrect. h) The first auditor of a Government company was appointed by Board of Directors. Incorrect: As per Section 139 (7) of the Companies Act, 2013, First auditor of Government Company shall be appointed by CAG of India within 60 days of incorporation of the Company. If CAG fails to appoint first auditor then BoD of the Company shall appoint first auditor first

auditor with in next 30 days. If BoD fails to appoint first auditor then members of the Company shall appoint first auditor with in next 60 days. Hence above statement is incorrect. Alternatively above statement may be correct, if such appointment is made by BoD within 30 days after failure of CAG to appoint first auditor. i) The members of XYZ Ltd preferred a complaint against the auditor stating that he has failed to send the auditor s report to them. Incorrect: The auditor s duty is to forward his report to the company. It is no part of auditor s duty to send a copy of his report to every member of the company. It is rather the responsibility of the company to send the report to every member of the company along with the notice of AGM. Hence above statement is incorrect. j) Mr. Pawan, a practicing Chartered Accountant, is appointed as Tax Consultant of ABC Ltd in which his father Mr. Singh is Managing Director. Correct: Mr. Pawan can be appointed as Tax Consultant of ABC Ltd as he is appointed as Tax Consultant not as the statutory auditor of the Company. Hence above statement is correct. Question 3 How will you vouch/verify the following? (4 X 4 = 16 marks) a) Preliminary Expenses The audit procedures for preliminary expenses are listed below:

1) Preliminary expenses are all expense relating to the formation of an enterprise such as registration fees, cost of printing of documents, stamp duty etc. 2) Examine the expenditure on various items of preliminary expenses by reference to the relevant supporting documents such as agreements, bills receipts statements etc. 3) Examine resolution, of BOD and the power in AOA, in case such expenses incurred by the promoters have been reimbursed to them. 4) Cross check the amount of preliminary expenses with that disclosed in the prospectus. 5) Check that no expense other than those constituting preliminary expenses are included under this head e.g. brokerage, underwriting commission. 6) Expenditure in connection with the preliminary expenses should be treated as an expense in the year of incurring and not to be carry forwarded for writing off in future years as per the compliance of AS 26. b) Custom & Excise Duties The audit procedures for custom duties are listed below: 1) Examine "Bill of entry" to ascertain actual import of goods. 2) Ensure that the amount of customs duties was calculated at the applicable rates as per customs Act and Customs Tariff Act. 3) Examine the agent's bill in case the custom duty is paid through clearing and forwarding agents. 4) Trace payment in cash book/bank statement. 5) Check acknowledgement from custom authorities. 6) Trace entry in custom duty paid account. 7) Verify claim for duty drawback by checking acknowledgement from authority. 8) In case of dispute as to amount payable verify the provisional amount paid in lieu of final amount and ensure that proper

adjustment have been made for short / excess payment on determination of final amount The audit procedures for excise duties are listed below 1) Check the computation of duty paid to ensure that rate applied is as per prevailing rates. 2) Check payment w.r.t. duty by examining Challans. 3) As it is levied on manufacturing, it is a manufacturing expense. Ensure about correct accounting treatment. 4) Trace the relevant entry in the nominal account. 5) Ensure that CENVAT credit is correctly claimed in respect of raw materials consumables. 6) In case of capital goods ensure that CENVAT credit has been reduced for the purpose of calculating depreciation 7) For excisable goods manufactured, which haven't been released till B/S date, check whether provision for unpaid excise duty has been made. 8) Compare excise duty paid in current year with that of preceding year. c) Floating assets In the case of these assets the attempt is to include them in the Balance Sheet at their realisable value. These, therefore are valued either at cost or market value whichever is less. For example Inventory, Current investment etc. The term cost refers to purchase price including duties and taxes, freight inward and other explanatory directly attributable to acquisition less trade discount, rebates, duties drawback and subsidies, in the year in which they are accounted. The term market value may be Net realizable value or Replacement Cost. So auditor should examine computation of cost, estimation regarding realisable value and proper valuation of such assets.

d) Recovery of bad debt written off Recovery of bad debt written off is verified with reference to relevant correspondence and proper authorization. 1) Ascertain the total amount lying as bad debts. 2) Ensure that all the recoveries of bad debts have properly recorded in the book of account. 3) Examine acknowledgement issued to debtors. 4) In case receipt of bankruptcy dividends, check correspondence with official receiver. 5) Trace relevant entry in cash book. 6) Ensure proper treatment in Profit and loss account as income. Question 4 (a) Mention the disclosure of current investment as per Schedule III of the Companies Act, 2013. [6 Marks] 1) Current investments shall be classified as trade investments and other investments and further classified as: a) Investments in Equity Instruments b) Investment in preference shares c) Investment in Government or trust securities d) Investment in debentures or bond e) Investment in Mutual Funds f) Investments in partnership firms g) Other non-current investments (specify nature) 2) The following shall also be disclosed: a) The basis of valuation of individual investment

b) Aggregate amount of unquoted investments and market value thereof; c) Aggregate amount of unquoted investments; d) Aggregate provision made for diminution in value of investments. Question 4 (b) What are the significant matters observed during the course of audit, a record of which should be kept in Audit Note Book? [6 Marks] Following are the significant matters observed during the course of audit, a record of which should be kept in Audit Note Book: 1) Audit queries not cleared immediately. 2) The mistakes or irregularities observed during the course of audit. 3) Unsatisfactory book-keeping arrangement, costing method, internal or financial administration or organization. 4) Important information about the company which is not apparent from the accounts. 5) Special points requiring consideration at the time of verification of final accounts. 6) Important matters for future reference. Question 4 (c) Write short note on the use of flowcharts in the evaluation of internal control. [4 Marks] 1) It is graphic presentation of each part of the company s system of internal control. 2) A flow chart is considered to be the most concise way of recording the auditor s review of the system.

3) It minimizes the time involved in getting narrative explanations. 4) It gives bird s eye view of the system. 5) Its disadvantages are (i) its time consuming (ii) technical knowledge is required Question 5 (a) Mention any six special points which you as an auditor would look into while auditing the books of a partnership firm? [6 Marks] The auditor to a firm is usually appointed by the partners either on the basis of a decision taken by them or to comply with a condition in the partnership agreement. His remuneration is fixed by the partners. It is important that the letter of appointment should clearly state the nature and scope of audit is to be carried out. Before starting the audit, the auditor should examine the partnership agreement and note the provision therein as regards the following matters: 1) The name and style under which the business shall be conducted 2) The duration of the partnership, if any that has been agreed upon 3) The amount of capital that shall be contributed by each partner. 4) Accounting period of the firm. 5) The provisions as regards maintenance of books of account 6) Borrowing capacity of partners. 7) Interest on capital 8) Interest on drawings 9) Salary to partners 10) Who will operate bank account of the firm? In the absence of a partnership agreement, the provisions of the Act which concern the auditor are following: 1) Each partner is required to contribute an equal amount of capital.

2) The partners shares equally in profits and losses 3) The partners are not entitled to any interest on capital 4) Every partner has the right to inspect books of the firm 5) Interest @ 6% p.a. will be provided on partner s loan The auditor should conduct vouching of transactions in the usual manner i.e. he should cover the assertions occurrence, completeness, accuracy and classification. The auditor should conduct examination of account balances in the usual manner i.e. he should cover the assertions existence, completeness, rights and obligation and valuation. Question 5 (b) Draft an audit programme for conducting the audit of accounts of local body. [6 Marks] Audit programme for local bodies 1) The Local Fund Audit Wing of the State Govt. is generally in charge of audit of municipal accounts. But large local bodies may appoint its auditor itself so auditor should ensure his appointment. 2) The auditor while auditing the local bodies should report on the fairness of the contents and presentation of the financial statements, the strength and weakness of system of the financial control, the adherence to legal and/or administrative requirements. 3) The auditor should ensure that the expenditure incurred confronts to the relevant provisions of the law and is in accordance with the rules and regulations framed by the competent authority. 4) He should ensure that all types of sanctions, either special or general, accorded by the competent authority

5) He should ensure that there is a provision of funds and the expenditure is incurred from the provision and same has been authorized by the competent authority. 6) The auditor should check that the different schemes, programmes and projects, where large financial expenditure has been incurred, are running economically and getting the expected results. Question 5 (c) What precautions should be taken by an auditor while applying test check techniques? [4 Marks] As per SA 530 (Audit sampling) following precautions should be taken by auditor while applying test check techniques: 1) The transaction of the concern should be classified under appropriate heads and may be stratified if wide variations are there between transactions of same kind. 2) Internal control relating to transaction should be reviewed. 3) Examination in depth should be done 4) Auditor should identify the item not suitable for test checking. 5) The number of transaction to be selected for each test check plan should be predetermined. 6) The auditor should properly design the sample 7) There should be no personal bias i.e. every sampling unit should have equal chance of selection. Question 6 (a) What are the matters to be included in Director s Responsibility Statement? [6 Marks]

Director s Responsibility Statement [Section 134 (5)] The Directors Responsibility Statement shall state that 1) in the preparation of the annual accounts, the applicable accounting standards had been followed along with proper explanation relating to material departures 2) the directors had selected such accounting policies and applied them consistently and made judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year and of the profit and loss of the company for that period; 3) the directors had taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the provisions of this Act for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities 4) the directors had prepared the annual accounts on a going concern basis; and 5) the directors, in the case of a listed company, had laid down internal financial controls to be followed by the company and that such internal financial controls are adequate and were operating effectively 6) the directors had devised proper systems to ensure compliance with the provisions of all applicable laws and that such systems were adequate and operating effectively

Question 6 (b) Discuss the provision of Section 134 of the Companies Act, 2013 regarding authentication of financial statements. [6 Marks] Authentication of Financial statements [Section 134(1), (2) & (7)] a) The financial statements, including consolidated financial statement, if any, shall be approved by the Board of Directors before they are signed on behalf of the Board at least by the following: [Section 134 (1)] 1) The chairperson of the company where he is authorised by the Board; or 2) By two directors out of which one shall be managing director and 3) The Chief Executive Officer, if he is a director in the company, 4) The Chief Financial Officer, wherever he is appointed; and 5) The Company Secretary of the company, wherever he is appointed b) In the case of a One Person Company, the financial statement shall be signed by only one director, for submission to the auditor for his report thereon. [Section 134 (1)] c) The auditors report shall be attached to every financial statement. [Section 134 (2)] d) A signed copy of every financial statement, including consolidated financial statement, if any, shall be issued, circulated or published along with a copy each of- [Section 134 (7)] 1) Any notes annexed to or forming part of such financial statement; 2) The auditor s report; and 3) The Board s report.

Question 6 (c) State the factors to be considered to verify the validity of any transaction. [4 Marks] For checking the validity of a transaction, it is usually necessary to refer to documentary evidence. It may exist in any of following forms: 1) The legal provision, if any, having bearing on the accounts of the entity under audit. 2) The rules or regulations governing the internal working of the organization. E.g. AoA, partnership Deed etc. 3) Minutes of the proceedings of a meeting of members of the company, that of the directors or that of the Managing committee 4) Copy of agreement, e.g. Lease Deed, Vendor s agreement, agency agreement. Question 7 Short Note [4 X 4 = 16 Marks] (a) Provision for applicability of internal audit as Companies Act, 2013 Companies required to appoint Internal Auditor: [Section 138] The following class of companies shall be required to appoint an internal auditor or a firm of internal auditors, namely:- a) every listed company; b) every unlisted public company having- i. Paid up Share Capital of 50 Crore rupees or more during the preceding financial year; or ii. Turnover of 200 Crore rupees or more during the preceding financial year; or

iii. Outstanding Loans or Borrowings from banks or public financial institutions exceeding 100 Crore rupees or more at any point of time during the preceding financial year; or iv. outstanding deposits of 25 Crore rupees or more at any point of time during the preceding financial year; and c) every private company havingi. turnover of 200 Crore rupees or more during the preceding financial year; or ii. outstanding loans or borrowings from banks or public financial institutions exceeding 100 Crore rupees or more at any point of time during the preceding financial year. (b) Prohibition to buy-back its own securities in certain circumstance Section 70 of the Companies Act, 2013 1) No company shall directly or indirectly purchase its own shares or other specified securitiesa) Through any subsidiary company including its own subsidiary companies; or b) Through any investment company or group of investment company c) If a default, by the company, in repayment of deposit or interest payable thereon, redemption of debentures or preference shares or payment of dividend to any share holder or repayment of any term loan or interest payable thereon to any financial institution or bank, is subsisting. Providing that the buyback is not prohibited if the default is remedied and a period of 3 years has been elapsed since the cessation of the default.

2) No company shall directly or indirectly purchase its own shares or other specified securities in case such company has not complied with provisions of Sections 92,123, 127, and 129. Section 92 relates to the filing of annual return, section 123 and 127 to declaration and payment of dividend and section 129 to the financial statement of the company. (c) Advantages of CAAT CAATs are generally applied by auditor while performing audit in CIS environment. Following are the advantages of CAAT 1) Time Saving: Auditor can check voluminous data in less time by using CAAT, so there is a much time saving. 2) Audit effectiveness: The effectiveness and efficiency of auditing procedure will be improved through the use of CAAT. 3) Effective test checking and examination in depth: CAAT permits effective examination in depth of selected transactions. 4) Lower Sampling Risk: As audit sample is selected and designed by CAAT, sampling risk may be reduced. (d) Changes in accounting policies 1) It is the responsibility of management of the entity to select acceptable accounting policies and apply them properly and consistently. 2) Accounting policies selected by the management can be changed in following circumstances a) If it is required by law b) For compliance with accounting standards c) On the opinion the management for better presentation of the financial statement.

3) If any accounting policy is changed in any financial year then such change in policy will be disclosed in financial statement along with following disclosures a) Old policy b) New policy c) Reason of change d) Impact on current FY s profit or loss (if it is material) For Classes of Auditing & Assurance (CA IPC) & Advanced Auditing & Professional Ethics (CA Final) BY: CA. Nitin Gupta Contact at: Rathore Institute, Laxmi Nagar, New Delhi. 011-43073355, 08527336600.