Free of Cost ISBN: IPCC Gr. II. (Solution of May & Questions of Nov ) Paper - 6 Auditing and Assurance

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1 Free of Cost ISBN: IPCC Gr. II Appendix (Solution of May & Questions of Nov ) Paper - 6 Auditing and Assurance Chapter - 1: Nature of Auditing May [3] (b) Please refer Nov [4] (a) on page no. 21 Chapter - 2: Basic Concepts in Auditing May [1] {C} (b) (ii) Inquiry and Confirmation : (i) Inquiry involves seeking of appropriate information from knowledgeable persons inside or outside the entity. (ii) Inquiries may be: (a) Formal written inquiries addressed to third parties, or (b) Informal oral inquiries addressed to persons inside the entity. (iii) Responses to inquiries provide the auditor with (a) information, which he did not previously possess or, (b) corroborative evidence of existing information. (iv) Confirmation is the response to an inquiry to corroborate information contained in the accounting records. E.g.: the auditor may obtain confirmation of account balances by direct communication from debtors May [2] (vi) As per AS-240, compliance procedure is one of the technique adopted in obtaining audit evidence. These tests are conducted by the auditors to obtain reasonable assurance that the internal control system on which reliance is to be placed are effective. Since it constitutes a check on internal control system therefore, it is a part of internal control system May [7] (v) Assertions about Account Balances at the end of the reporting period: (a) Vouching the existence of Account Balances. II-1

2 II-2 (b) (c) (d) Verification of the controlling rights to the assets and liabilities. Proper valuation of the account balances. Completeness in recording of account balances. Chapter - 3: Preparation for an Audit May [1] {C} (b) (i) 1. One of the most important part of audit is the surprise check, the results of these checks are very helpful to the auditor as they help in deciding the scope of audit and also the reports. 2. Effectiveness of the audit is improved by the element of surprise. This element is also incorporated in audit programmes. 3. The element of surprise in an audit may be both in relation to the time of audit, that is selection of date, when the auditor will visit the clients office for audit and selection of the areas of audit. 4. Auditors visits for a surprise check in order to know whether the internal control system is working effectively or not and whether all accounting and other records are kept up to the date as per the statutory regulation. 5. These checks and surprise visits can bring good moral check on the client s staff. 6. Surprise checks also helps in determining the errors and frauds. 7. Surprise checks are very helpful for the organization having weak internal control system, very large and diversified. 8. Extent of the check will depend upon the auditor. 9. The consequences of the surprise check should be communicated to the managements. This is done to overcome the weakness. 10. The auditor gets satisfied only when proper action are taken by the management on the matters communicated by him May [3] (a) When auditor's assistants are involved continuously in checking the accounts of the client during the whole year round or when the staff attends audit work at intervals, during the financial period, it is called a continuous audit. It is suitable in cases where the final accounts are desired to be presented soon after the close of the financial year or where the internal check is weak. Features : 1. A continuous audit is one which involves detailed examinations of transaction & account by the audit staff continuously throughout the year or at regular intervals say fortnightly, monthly or quarterly. 2. At the year end the auditor takes up an examination of financial accounts. 3. It enables completion of audit at the quickest possible time after the closing of accounts. 4. It is also known as detailed audit or running audit.

3 II-3 Advantages : 1. Immediate detection of errors and frauds: Management can exercise a strict control over the accounts due to immediate detection of errors and frauds. 2. Deterrent : The frequent attendance of the audit staff deters persons from committing fraud. 3. Up to date accounts : The accounting staff of the client is motivated to keep the books of account up to date. 4. Early final audit : The final audit can be completed sooner than what would be otherwise. 5. Knowledge of client s affairs : The auditor can obtain a more detailed knowledge of the client s affairs which enables him to discharge his duties more efficiently. 6. Detailed coverage: All aspects of verification are carried out in detail as compared to final and or when test checks are applied. 7. Staff planning : Work scheduling can be done effectively and staff can be sent regularly by proper planning. 8. Interim reporting : Interim financial statements can be prepared easily and in a timely manner. Disadvantages : 1. Failure to keep track : Since work is carried out in several instalments, the audit staff may fail to keep tracks of things which they had not checked on their last or earlier visit. As a result some of the transactions may escape audit scrutiny. 2. Tampering : The client s staff may alter the entries in the books of account after checking thereof. 3. Uneconomic : It is uneconomic for a small sized concern as a great deal of time is wasted each time in preparing for the audit. 4. Interruption of work : The presence of audit staff at regular intervals may affect the regular work flow of the client. 5. Boredom : Routine checking on a continuous basis may become mechanical. 6. Time consuming : Since all transactions are verified, continuous audit will be time consuming. 7. No guarantee for fraud detection : A complete verification of all transactions in detail, does not guarantee detection of all errors and frauds. Some material misstatement may still exist May [7] (i), (iv) (i) When planning the audit, the auditor considers what would make the financial information materially mis-stated. The auditor's preliminary assessment of materiality related to specific account balances etc. helps the auditor to select audit procedures that in combination can be expected to support the audit opinion at an acceptably low degree of audit risk.

4 II-4 (iv) SA-320 requires that an auditor should consider materiality and its relationship with audit risk. The auditors assessment of materiality regarding various aspects such as specific account balances and classes of transactions helps him to decide such questions as what items are to be examined, which methods are to followed etc. This basically leads him to decide and plan out and select the audit procedure. The Auditor may become aware of weaknesses in Internal Control System as a result of obtaining an understanding of accounting and internal control system and tests of control. The Auditor should communicate in writing to the management, at an appropriate level of responsibility, material weaknesses in the design or operation of internal control system observed during conducting audit. The Auditor should indicate in the communication that- only weakness that have come to his attention as a result of audit have been reported; and the examination has not been designed to determine the adequacy of internal control for management purposes. Such a report of weakness is called "Letter of weakness" or "Management Letter". Chapter - 4: Internal Control (Including EDP Environment) May [2] (iv) Internal check consists of set of rules or procedures that are part of accounting system introduced to ensure that accounts of business are correctly maintained and errors and frauds eliminated. It is actually a part of the overall internal control system and operates as a built in device as far as the staff organisation and job allocation aspects of the control system are concerned May [4] (a) The Auditor should evaluate the following factors to determine the effects of CIS environment on the audit- (i) Extent to which the CIS environment is used to record, compile and analyse accounting information. (ii) Internal control systems existing in the entity with regard to complete data and correct data to the processing center and Processing, analysis and reporting tasks undertaken in the installation. (iii) Impact of computer-based accounting system on the audit trial which could otherwise be expected to exist in a manual system May [7] (iii) Internal Control Questionnaire : It is a comprehensive series of questions designed to provide a thorough view of internal control system prevailing in an organisation. The questionnaire is usually issued to the client, the client is requested to get it filled up by the concerned executives and employees.

5 II-5 Content of ICQ : In the questionnaire, the questions are generally prepared in sections of distinct control areas such as - (i) Sales and Purchases; (ii) Debtors and Creditors; (iii) Stocks; (iv) Fixed Assets; (v) Cash and Bank receipts and payments. These questions are so framed that a 'yes' answer denotes satisfactory position and a 'No' answer suggest weakness. If the questions are not relevant to the business 'Not Applicable' reply is given. Advantages : (i) In this method, there is less chance of oversight or omission of significant internal control review procedures. (ii) It enable to complete all internal control evaluation at one time. Weakness in the internal control system can easily be identified by examining answers to the question in the ICQ. (iii) ICQ also helps in testing whether the controls or procedures stated to be operating are actually in operation. On the basis of ICQ analysis the auditor can decide the extent and depth of checking required in accounting areas. (iv) ICQ analysis helps the auditor to adopt more detailed checking in weak control areas. Chapter - 6: Audit of Payments May [2] (i) Preliminary expenses are the expenses incurred by the promoters on behalf of the proposed company before incorporation of a company. Under writing expenses are incurred for issue of shares and debentures after incorporation of a company. Hence, PQR Ltd. should include stamp duty but exclude underwriting commission. Chapter - 9: Audit of Trading Transactions and Purchases May [4] (b) (i) Vouching of purchases transactions : Auditor should vouch credit purchases in the following ways: (i) Examine purchase book: The auditor should examine the transactions recorded in the purchase book with reference to related purchase invoice. (ii) Examine purchase invoices: (a) The auditor should select a small sample of vendors invoices at random and should conduct in-depth audit on them i.e., trace the transaction from placing the order to the entries in inventory goods for actual receipt and payment made to the suppliers.

6 II-6 (iii) (iv) (v) (b) In respect of imports, documents such as bill of lading, customs clearance, etc. should be examined. The auditor should ensure that subsidies, rebates, duty drawbacks or other similar items have been properly accounted for. Examine the numerical sequence of source documents: The auditor should ensure the numerical sequence of source documents such as purchase requisitions, purchase orders, receiving reports and vouchers have been maintained and missing numbers have been duly accounted for. Examine cut off points: (a) The auditor should examine cut-off points on pre-numbered purchase requisitions, purchase orders and goods received notes. (b) The auditor should, then trace the goods received notes pertaining to a few days before the end of the period under audit to the related purchase invoices. Such a comparison would ensure that purchases represented by such invoices have been recorded as the purchases of the period under audit. Examine transition with related parties. The auditor should examine all related parties, carefully. Chapter - 13: Depreciation and Reserves May [2] (v) The rates as per Schedule XIV are the minimum rates prescribed. A company can charge depreciation at a rate higher than Schedule XIV but not at a lower rate May [7] (ii) Please refer Nov [8] (c) on page no. 211 Chapter - 14: Verification of Assets May [2] (iii), (viii) (iii) Inventories normally comprise raw material including components, WIP, finished goods. It is generally part of production and therefore as per AS-2 selling and distribution cost should not be included in cost of Inventories. (viii) Intangible assets are those assets which do not have physical identity but are used by the enterprise for production or supply purpose. As such computer software which is an integral part of related hardware has to be treated as a fixed asset May [4] (b)(ii), (iii) (ii) Several entities have large investments in such assets which have a relatively short useful life and low unit cost, their treatment in the books of account differs from entities to entities. So, the auditor has to see what accounting treatment has been followed by the auditor enterprise. The auditor should consider the following points:

7 II-7 1. Production Accounts : (i) Ensure that small tools and other similar items are charged off to the production A/c. (ii) A proper record of issues & receipts of tools has also been maintained. (iii) Obtain list of those items which are not usable / in damaged or depleted condition. (iv) Ensure that sum total of opening balance plus purchase minus value of closing stock of these assets is charged off to Production Account. 2. Cost : The auditor should find out- (i) The method of valuation adopted by the management (ii) The cost of purchase on the basis of date of acquisition and the market price either from the latest purchase or from market quotations. Examine copy of invoice for purchased items and costing records for internally manufactured items. 3. Valuation method : Verify whether the method of valuation is adopted consistently. Following are the methods for different items: Items Purchased items Manufactured items Obsolete items Defective / Damaged items Method of valuation Cost of purchase reduced by the amount of depreciation. On the basis of Standard Cost with necessary adjustment for material variances reduced by the amount of depreciation decided by the management considering the life of the tools. Valued on Net Realizable scrap value. Relevant adjustment in valuation shall be made after evaluating the conditions. Any change in the methods of valuation shall be disclosed along with its effect on the financial results of the company. (iii) Please refer May [4] (c) on page no. 235 Chapter - 17: Company Auditor May [2] (ii) As per Sec. 224 (1) of the Companies Act, 1956, an Auditor is appointed for a period from one general meeting till another. In case AGM is not held at the prescribed time, the auditor shall continue his office till the AGM is held. His office cannot be vacated automatically.

8 II-8 Chapter - 18: Powers & Duties of Auditors, Audit Report May [2] (vii) According to Sec. 228 (4) of the company s (Branch Audit Exemption) Rules, 1961, if the aggregate value of goods sold by a branch office does not exceed ` 2 lakhs or 2% of average of the total turnover of the company, whichever is higher, the branch shall be exempted from audit. Turnover of ABC Ltd. is 10,000 and that of its branch is ` 1.5 crore. 2% of ` 100 crore is ` 2 crore. Hence, the branch is exempt from audit as per AS May [2] (ix) The statement is incorrect. CARO, 2003 applies to all companies including foreign companies except Banking Co.,insurance Co. Sec. 25 Co. and Pvt. Ltd. Co. with same conditions May [5] (a), (b) (a) There are four types of audit reports: 1. Clean audit report or use qualified audit report, 2. Qualified audit report, 3. Disclaimer of opinion & 4. Negative audit report or adverse audit report. 1. Clean audit report : A clean audit report or unqualified report is issued when the auditor has no reservation in respect of matters contained in the financial statements. He is satisfied in all material respects with all the points required to be stated in his report and states them in affirmative, adding no reservation anywhere the audit report shall state that : "The financial statements give a true and fair view of the state of affairs and profit and loss account during the period." A clean report is issued, if, the auditor is justified that : (i) The financial information has been prepared using acceptable accounting polices and they are applied consistently. (ii) The financial information comply with relevant regulations and statutory requirements. (iii) There are adequate disclosure of all material matters relevant to the proper presentation of the financial information, subject to statutory requirements, where applicable. 2. Qualified audit report: A qualified audit report means an opinion given by the auditor on the truth and fairness of the financial statements, which is subject to certain reservations. An auditor may give his: (i) Particular objection a reservation in the audit report, and (ii) State: "subject to the above, we report that the balance-sheet shows a true and fair view"

9 II-9 (b) He must : (i) Clearly mention the nature and reasons of qualification in the report, and (ii) Quantify the overall effect of qualification on the financial statement, if possible. But if it is not possible then the auditor may do so on the basis of estimates. Usually, items which are the subject-matter of qualification are not so material, that it will affect the truth and fairness of whole of accounts but merely create uncertainty about a particular item. Contrary to that, if qualifications are material so as to negate the main report itself, it will be proper to give an adverse opinion. In practice, it is quite common to come across qualified report. 3. Disclaimer of opinion : As per SA 500 (old AAS 5), the auditor must collect sufficient & appropriate audit evidence, on the basis of which he draws his conclusion to form an opinion, on the financial statements. But, if the auditor fails to obtain sufficient information to form an overall opinion on the matter contained in the financial statements, he issues a disclaimer of opinion. The reasons due to which the auditor is not able to collect the audit evidence are: (i) Scope of audit is restricted, (ii) The auditor may not have access to the books of accounts, e.g : (a) books of A/c s of the company seized by IT authorities, (b) Sometimes inventory verifications at locations outside the city bound the scope of duties of the auditor. In such a case, the auditor must state in his audit report that: "He is unable to express an opinion because he has not been able to obtain sufficient and appropriate audit evidence to form an opinion." 4. Adverse audit report - An adverse audit report is issued if the auditor is of the opinion that based on his examination he does not agree with the affirmation made in the financial statements. In such case the reservations or objections of the auditor are so material that he feels that the overall view of the accounts as presented would be a serious distortion. He must state the reasons for such a type of report. As per section 233 A the Central Government has the power to order a special audit of the accounts of the company for a specified period, if the Central Government is of opinion that: 1. The affairs of the company are not being managed in accordance with sound business principles or prudent commercial practice or

10 II The Company is being managed in a manner likely to cause serious injury or damage to the interests of the trade, industry or business to which it pertains; or The financial position of the company is such as to endanger its solvency. Appointment : Any of the following persons appointed by the Central Government may conduct the special Audit:- 1. A Chartered Accountant u/s 2 (1) (b) of the Chartered Accountants Act 1947; or 2. The Company Auditor Such person so appointed shall be called as the Special Auditor. Remuneration : The Central Government may determine the remuneration of the Special Auditor and it is paid by the company. Powers : The special auditor will have the same powers in the matter of special audit as the statutory auditor of a company. Duties: 1. The special Auditor must report to the Central Government instead of the shareholders 2. Action by Central Government on Report: (i) As per sec. 233 A (6), on receipt of the Report of the special Auditor, the Central Government may take such action on the Report as it considers necessary in accordance with the provisions of this Act or any other law for the time being in force. (ii) If no action is taken on the report within 4 months of receipt, the Central Government shall send to the Company either a copy of or relevant extracts from the report with its comments to be circulated among the members or to be read before the company at its next general meeting. Chapter - 19: Company Audit May [5] (c) Sl. No. Documents to be vouched 1 Memorandum & Articles Aspect to be verified (i) Ascertain whether the Articles permit the capitalisation of profits. (ii) Ensure that the procedures has been followed as prescribed by the Articles. (iii) Check that the company has sufficient member of unissued shares within the Authorised Capital to cover the Bonus Shares.

11 II-11 2 Minutes Book (i) Inspect the Minutes Book of Shareholders for the resolution authorizing the declaration of Bonus and Director s Minutes for the resolution appropriating profits for being applied in payment of shares to be allotted to the shareholders as bonus shares. (ii) Inspect the Minutes of the Director s Meeting to see that they are properly recommended after complying with the accounting requirements. 3 Special Considerations (i) (ii) (iii) (iv) (v) (vi) Chapter - 21: Audit of NGOs May [6] (b) Please refer Nov [7] on page no. 410 Chapter - 22: Miscellaneous Audits May [6] (a) Please refer May [7] (a) on page no. 432 Verify the allotment of shares as per particulars contained in the Allotment Book / sheets into the Register of Members. Confirm that all statutory requirements / SEBI Guidelines relevant to the Bonus Issue have been compiled with. Confirm that the particulars of the Bonus Shares allotted are filed with the ROC together with a copy of the Resolution pursuant to which allotment has been made. Confirm that the issue of fully paid up bonus shares in pursuance of sec. 205 (3) has been kept in abeyance in respect of shares for which any instrument of transfer of such shares has been delivered to the company for registration but transfer has not been registered by the company. Ensure that Bonus issue is made out of Securities Premium Account or Capital Redemption Reserve Account, which cannot be used for any other purposes. Ensure that share certificates issued are signed by the authorised officials.

12 II-12 Chapter - 23: SA and Guidance Notes May [1] {C} (a) (i), (ii) (i) Please refer Nov [4] (d) of chapter 1 on page no. 18 (ii) Please refer Nov [4] (a) of chapter 3 on page no May [2] (x) Arms length transaction is a transaction which is conducted on such terms and conditions between a buyer and seller who are unrelated and are acting independently of each other pursuing their own best interest. Question Paper of Nov Chapter - 1: Nature of Auditing Nov [1] {C} Discuss the following: (b) The discipline of behavioural science is closely linked with the subject of auditing. (5 marks) Chapter - 2: Basic Concepts in Auditing Nov [1] {C} Discuss the following: (c) The reliability of audit evidence is influenced by its source, nature and circumstances under which it is obtained. (5 marks) Nov [2] State with reason (in short) whether the following statements are correct or incorrect. (h) Financial statements should show True and Correct view of the affairs of the entity. (2 marks) Chapter - 3: Preparation for an Audit Nov [1] {C} Discuss the following: (a) Despite of several disadvantages, audit programme is required to start an audit. (5 marks) Nov [7] Write short notes on the following : (c) Importance of audit working papers. (4 marks) Chapter - 4: Internal Control (Including EDP Environment) Nov [2] State with reason (in short) whether the following statements are correct or incorrect. (b) Examination in depth implies that the auditor vouches almost all transactions in a manner that the chances of not checking any transaction are left at minimum. (f) Inherent and control risk, and detection risk have same meaning. (2 marks each) Nov [3] (a) Explain inherent limitations of internal control system. (8 marks) Nov [7] Write short notes on the following : (b) Use of flow charts in evaluation of internal control. (4 marks)

13 II-13 Chapter - 6: Audit of Payments Nov [4] How will you vouch and verify the following? (a) Remuneration paid to directors. (4 marks) (b) Assets acquired on hire purchase. (4 marks) (d) Advertisement expenses. (4 marks) Chapter - 14: Verification of Assets Nov [4] How will you vouch and verify the following? (c) Profit or loss arising on sale of plots held by real estate dealer. (4 marks) Chapter - 16: Other Verifications Nov [2] State with reason (in short) whether the following statements are correct or incorrect. (i) Events occurring after the balance sheet date must be disclosed in the financial statements. (2 marks) Chapter - 17: Company Auditor Nov [2] State with reason (in short) whether the following statements are correct or incorrect. (a) Rajat, an auditor recovers his fees on progressive basis is said to be indebted to company. (d) The first auditor of PQR Ltd., a Government Company was appointed by the board of directors of company. (e) Mr. R, a practicing Chartered Accountant, is appointed as a Tax Consultant of MN Ltd., in which his father Mr. C is the managing director. (j) Audit of Private Limited Companies are to be excluded while calculating ceiling on number of audits. (2 marks each) Nov [5] (b) Under what circumstances the retiring auditor can not be reappointed? (6 marks) Chapter - 18: Powers & Duties of Auditors, Audit Report Nov [2] State with reason (in short) whether the following statements are correct or incorrect. (c) Branch auditor of a company should give photocopies of his working papers on demand by Company Auditor. (g) Deviation in accounting policies are to be reported in auditor s report. (2 marks each) Nov [5] (a) What are the general considerations about the duties of an auditor that can be summarized on the basis of legal decisions taken by court so far? (5 marks)

14 II-14 Chapter - 19: Company Audit Nov [5] (c) LMN Ltd. forfeited 1,000 equity shares because of non payment of final call money. On 1 st November, 2013 directors reissued all these forfeited shares. As an auditor how will you verify the transaction? (5 marks) Nov [7] Write short notes on the following : (e) Verification of issue of sweat equity shares. (4 marks) Chapter - 20: Government Audit and Audit of Local Bodies Nov [7] Write short notes on the following : (a) Basic standards set for audit of government expenditure. (4 marks) Chapter - 22: Miscellaneous Audits Nov [6] (a) What procedure may be adopted by an auditor, while auditing leasing transactions entered into by the leasing company? (8 marks) (b) Mention any eight important points which an auditor will consider while conducting audit of club? (8 marks) Chapter - 23: SA and Guidance Notes Nov [1] {C} Discuss the following: (d) As per SA 530, meaning of audit sampling, sample design, sample size and selection of items for testing. (5 marks) Nov [3] (b) With reference of SA 250 give some examples or matters indicating to the auditor about non compliance of laws & regulations by management. (8 marks) Nov [7] Write short notes on the following : (d) Identification of significant related party transaction outside business. (4 marks) Shuchita Prakashan (P) Ltd. 25/19, L.I.C. Colony, Tagore Town, Allahabad Visit us: