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STANDARDS ON AUDITING
Question 1
Comment on the following:
"The auditors need not review accounting policies unless there is a change in the basis of
accounting". (8 marks)(Final May 2000)
Answer
The auditor while conducting an audit should critically examine' the accounting policies
adopted by the client and test them for conformity with the accounting standards and
recommendations of the Institute. The Companies Act, 1956, as well as many other
statutes require that the financial statements of an enterprise should give a true and fair
view of its financial position and working results. This requirement is implicit even in the
absence of a specific statutory provision to this effect. However, what constitutes a 'true
and fair' view has not been defined either in the Companies Act, 1956 or in any other
statute. The pronouncements of the Institute seek to describe the accounting principles
and the methods of applying these principles in the preparation and presentation of
financial statements so that they give a true and fair view. The 'Preface to the Statements
of Accounting Standards' issued by the Institute in 1979 states as under:
"While discharging their attest function, it will be the duty of the members of the Institute
to ensure that the Accounting Standards are implemented in the presentation of financial
statements covered by their audit reports. In the event of any deviation from the
Standards, it will be also their duty to make adequate disclosures in their reports so that
the users of such statements may be aware of such deviations."
In cases where no pronouncement of the Institute exists, the auditor should examine the
acceptability of the said accounting policy. The view presented in the financial statements
of an enterprise of its state of affairs and of the profit or loss can be significantly affected
by the accounting policies followed in the preparation and presentation of the financial
statements. The accounting policies followed vary from enterprise to enterprise.
Disclosure of significant accounting policies followed is necessary if the view presented is
to be properly appreciated. It is also quite clear that there is no single, list of accounting
policies which are applicable to all circumstances. The differing circumstances in which
enterprises operate in a situation of diverse and complex economic activity make
alternative accounting principles and methods of applying those principles acceptable.
The choice of the appropriate accounting principles and the methods of applying those
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principles in the specific circumstances of each enterprise calls for considerable
judgement by the management of the enterprise. SA 200A on "Objective and Scope of
the Audit of Financial Statements", requires auditor to determine whether the relevant
information is properly disclosed in the financial statements by considering the
judgements that management has made in preparing the financial statements;
accordingly, the auditor assesses the selection and consistent application of accounting
policies, the manner in which the information has been classified, and the adequacy of
disclosure.
Thus, the auditor should determine himself as to whether or not the said treatment is
consistent with the basic principles of accounting. Therefore, it would not be correct to
state that the auditor need not review the accounting policies unless there is a change in
the basis of accounting.
Question 2
Briefly describe the auditor's responsibility regarding subsequent events.
(10 marks) (Final May 2001)
Answer
Subsequent Events and Auditor's Responsibility: When the auditor draws up his audit
plan, checking of subsequent events is an important audit procedure irrespective of the
level of test checks employed for checking of the transactions during the year. In fact
more detailed check is normally required for subsequent events to confirm certain
assertions contained in the financial statements, e.g., the payment made by debtors after
the close of accounting period would confirm that outstanding debtors on the date of the
balance sheet date have been realised. 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, nonadjusting
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 further requires that the auditor should perform procedures designed to obtain
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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.
(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 appropriate.
Question 3
Briefly describe how an auditor can use the work of an expert. (8 marks) (Final Nov 2001)
Answer
Using the Work of an Expert: SA 620 on, “Using the Work of an Expert” discusses the
auditor’s responsibility in relation to, and the procedures the auditor should consider in, using
the work of an expert as audit evidence. The auditor has to first determine the need to use the
work of an expert considering the materiality of the item, its nature and complexity. It would
be necessary in cases of valuation of certain types of assets, determining the physical
condition of the assets like minerals, actuarial valuation of gratuity, determining work in
progress in case of construction contracts, etc. Generally, the auditor’s education and
experience enable him to be knowledgeable about business matters in general, but he is not
expected to have the expertise of a person trained for, or qualified to engage in, the practice
of another profession or occupation, such as an actuary or engineer.
When the auditor plans to use the expert’s work as audit evidence, the auditor is required to
assess skill and competence of the expert, his objectivity and, finally, evaluate the work done
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by him. So first of all, the auditor should satisfy himself as to the expert’s skills and
competence by considering the expert’s:
♦ professional qualifications, license or membership in an appropriate professional
body, and
♦ experience and reputation in the field in which the evidence is sought.
However, when the auditor uses the work of an expert employed by him, he will not need to
inquire into his skills and competence. The auditor should also consider the objectivity of the
expert. Finally, when the auditor intends to use the work of an expert, he should examine
evidence to gain knowledge regarding the terms of the expert’s engagement and such other
matters as:
♦ the objectives and scope of the expert’s work,
♦ a general outline as to the specific items in the expert’s report,
♦ confidentiality of the expert’s work, including the possibility of its communication to
third parties.
♦ the expert’s relationship with the client, if any,
♦ confidentiality of the client’s information used by the expert.
The auditor should seek reasonable assurance that the expert’s work constitutes appropriate
audit evidence in support of the financial information, by considering:
♦ the source data used,
♦ the assumptions and methods used and, if appropriate, their consistency with the
prior period,
♦ the results of the expert’s work in the light of the auditor’s overall knowledge of the
business and of the results of his audit procedures, and
♦ the auditor should also satisfy himself that the substance of the expert’s findings is
properly reflected in the financial information.
The auditor should consider whether the expert has used source data which are appropriate in
the circumstances. The procedures to be applied by the auditor should include :
♦ making inquiries of the expert to determine how he has satisfied himself that the
source data are sufficient, relevant and reliable, and
♦ conducting audit procedures on the data provided by the client to the expert to obtain
reasonable assurance that the data are appropriate.
The appropriateness and reasonableness of assumptions and methods used and their
application are the responsibility of the expert. The auditor does not have the same expertise
and, therefore, cannot always challenge the expert’s assumptions and methods. However, the
auditor should obtain an understanding of those assumptions and methods to determine that
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they are reasonable based on the auditor’s knowledge of the client’s business and on the
results of his audit procedures.
If after performing all these procedures the auditor concludes that the work of the expert is not
consistent with the information in the financial statements or that it does not constitute
sufficient appropriate audit evidence, the auditor should express a qualified, disclaimer or an
adverse opinion. In other cases, the opinion has to be unqualified. If while giving his report
the auditor considers it appropriate to disclose the identity of the expert, he should obtain his
prior consent.
Question 4
Write short notes on the following:
(a) Financial indications to be considered for evaluating the assumption of going concern
(4 marks) (Final Nov 2001)
(b) Auditor's responsibilities regarding comparatives. (4 marks)(Final Nov 2003)
(c) Sampling Risk (4 marks)(Final May 2006)
(d) Reporting on a compilation engagements (4 marks)(Final Nov 2006)
Answer
(a) Financial Indications and Going Concern: SA 570 on “Going Concern”, aims to
establish standards on the auditor’s 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 be considered:
♦ Negative net worth or negative working capital.
♦ Fixed-term borrowings approaching maturity without realistic prospects or
renewal or repayment, or excessive reliance on short-term borrowings to finance
long-term assets.
♦ Adverse key financial ratios.
♦ Substantial operating losses.
♦ Substantial negative cash flows from operations.
♦ Arrears or discontinuance of dividends.
♦ Inability to pay creditors on due dates.
♦ Difficulty in complying with the terms of loan agreements.
♦ Change from credit to cash-on-delivery transactions with suppliers.
♦ Inability to obtain financing for essential new product development or other
essential investments.
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♦ Entering into a scheme of arrangement with creditors for reduction of liability.
(b) Auditor’s responsibilities regarding comparatives: SA 710, “Comparatives”,
establishes standards on the auditor’s responsibilities regarding comparatives.
The auditor responsibilities laid down are as under:
(i) The auditor should determine whether the comparatives comply, in all material
respects with the financial reporting framework relevant to the financial
statements being audited. Further, the auditor should obtain sufficient
appropriate audit evidence that the corresponding figures meet the requirements
of the financial reporting framework.
(ii) When the comparatives are presented as corresponding figures, the auditor’s
report should not specifically identify comparatives because the auditors opinion
is on the current period financial statements as a whole, including the
corresponding figures.
(iii) When the auditor’s report on the prior period, as previously issued, included a
qualified opinion, disclaimer of opinion, or adverse opinion and the matter which
gave rise to the modification in the audit report is:
(a) unresolved and results in a modification of the auditor’s report regarding
the current period figures, the auditor’s report should also be modified
regarding the corresponding figures; or
(b) unresolved, but does not result in a modification of the auditor’s report
regarding the current period figures, the auditor’s report should be modified
regarding the corresponding figures.
In such circumstances, the auditor should examine that appropriate
disclosures have been made or if appropriate disclosures have not been
made, the auditor should issue a modification report on the current period
financial modified with respect to the corresponding figures included
therein.
(iv) When the prior period financial statements are not audited, the incoming auditor
should state in the auditors report that the corresponding figures are unaudited.
(c) Sampling Risk: Sampling Risk arises from the possibility that the auditor’s
conclusion, based on a sample, may be different from the conclusion that would be
reached if the entire population were subjected to the same audit procedure. The
auditor is faced with sampling risk in both tests of control and substantive procedures
as follows:
(a) Tests of Control:
(i) Risk of Under Reliance: The risk that, although the sample result does not
support the auditor’s assessment of control risk, the actual compliance rate
would support such an assessment.
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(ii) Risk of Over Reliance: The risk that, although the sample result supports the
auditor’s assessment to control risk, the actual compliance rate would not
support such an assessment.
(b) Substantive Procedures:
(i) Risk of Incorrect Rejection: The risk that, although the sample result supports
the conclusion that a recorded amount balance or class of transactions is
materially mis-stated, in fact it is not material mis-stated.
(ii) Risk of Incorrect Acceptance: The risk that, although the sample result
supports the conclusion that a recorded amount balance or class of
transactions is no materially mis-stated, in fact it is materially mis-stated.
The risk of under reliance and the risk of incorrect rejection affect audit efficiency as
they would ordinarily lead to additional work being performed by the auditor, or the
entity, which would establish that the initial conclusions were incorrect. The risk of
over reliance and the risk of incorrect acceptance affect audit effectiveness and are
more likely to lead to an erroneous opinion on the financial statements then either
the risk of under reliance or the risk of incorrect rejection.
Sample size is affected by the level of sampling risk the auditor is willing to accept
from the results of the sample. The lower the risk the auditor is willing to accept, the
greater the sample size will need to be.
(d) Reporting on a compilation engagements: The report on compilation engagements
should ordinarily, be in the following layout:
(i) Title – The title of the report should be “Accountants Report on compilation of
un-audited financial Statements.”
(ii) Addressee: The report should ordinarily be addressed to the appointing
authority.
(iii) Identification of the financial information also noting that it is based on the
information provided by the management.
(iv) When relevant, a statement that the accountant is not independent of the entity;
(v) A statement that the Management is responsible for:
* Completeness and accuracy of the underlying data and complete disclosure of
all material and relevant information to the accountant;
* Maintaining adequate accounting and other records and internal controls and
selecting and applying appropriate accounting policies;
* Preparation and presentation of financial statements or other financial
information in accordance with the applicable laws and regulation, if any;
* Establishing controls to safeguard the assets of the entity and preventing and
detecting frauds or other irregularities.
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* Establishing controls for ensuring that the activities of the entity are carried out
in accordance with the applicable laws and regulations and preventing and
detecting any non-compliance.
(vi) A statement that the engagement was performed in accordance with the
Auditing and Assurance Standards.
(vii) A statement that the neither an audit nor a review has been carried out and that
accordingly no assurance is expressed on the financial information.
(viii) A paragraph, when considered necessary, drawing attention to the disclosure of
material departures from the identified financial reporting framework.
(ix) Date of the report
(x) Place of signature
(xi) Accountant’s signature.
Question 5
Explain what is meant by “ Written Representations” and indicate to what extent an auditor can
place reliance on such representations. (6 marks)(Final May 2002)
Answer
Written Representation : The management is responsible for the appropriate preparation
and presentation of financial information. Thus it is quite natural that during the course of
audit, management would be required to make several representations on various matters
relating to financial statements. These representations may be made by the management
either in orally or in writing to the auditor. For example, the auditor may ask the
management to confirm about the existence of contingent liabilities and disclosure
thereof, etc. In other words, representation by management constitutes acknowledgement
by the management about its responsibility for the preparation and approval of the
financial information. A written representation may either take the form of a letter from the
management or letter by auditor outlining auditor’s understanding and confirmation of the
same.
Extent of Reliance: SA 580, “Written Representations”, states that management
representations whether obtained orally or in writing constitute audit evidence and
establishes standards for evaluating the same. SA 580, requires that the auditor may rely
upon the management’s representation, preferably in writing, as a sort of information or
evidence to consider and if the representations relate to matters which are material to
financial information, Further, the auditor should:
(a) seek corroborative evidence from sources inside or outside the entity.
(b) evaluate whether the representations made by the management appear reasonable
and consistent with other audit evidence obtained, including other representations;
and
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(c) consider whether the individuals making the representations are expected to be well
informed on the matter.
However, it must be note that representations by the management cannot be the
substitute for other audit evidence that the auditor could reasonably expected to be
available. For example, a representation by the management as to existence, quantity
and cost of inventories is not substitute for adopting audit procedures regarding
verification and valuation of inventories. If a representation by management is
contradicted by other evidence, the auditor should examine the circumstances and, when
necessary, reconsider the reliability of other representations made by the management as
well.
Question 6
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)(Final Nov 2002)
Answer
(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 550 on Related Parties. As per SA 550 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, SA 550 requires that to identify
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 officers 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;
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(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–
♦ 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) Evaluating the Work of an Expert: The duties of an auditor regarding using the
work of an expert are contained in SA 620 “Using the Work of an Expert”. The
auditor has to first evaluate the skills and competence of the expert and also his
objectivity. When the auditor decides to use the work of an expert, he should
examine evidence to gain knowledge regarding the terms of the expert’s engagement
and such other matters like:
♦ the objectives and scope of the expert’s work,
♦ a general outline as to the specific items in the expert’s report,
♦ confidentiality of the experts work, including the possibility of its communication
to third parties,
♦ the expert’s relationship with the client, if any, and
♦ confidentiality of the client’s information used by the expert.
The auditor should also seek reasonable assurance that the expert’s work constitutes
appropriate audit evidence in support of the financial information. This can be done
by considering:
♦ the source data used,
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♦ the assumptions and the methods used and, if appropriate, their consistency
with the prior period,
♦ the results of the experts work in the light of the auditor’s overall knowledge of
the business and of the results of his audit procedures, and
♦ the auditor should also satisfy himself that the substance of the expert’s findings
are properly reflected in the financial information.
The auditor should also consider whether the expert has used source data that is
appropriate in the circumstances. This can be done by making inquiries to determine that
the source data is sufficient, relevant and reliable and also conducting audit procedures
on the data provided by the client to the expert to obtain reasonable assurance that the
data are appropriate. 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 the results of his audit procedures. The standard also
provides that in case the auditor comes across any inconsistency, the auditor may discuss
the matter with the client and the expert and, may employ additional procedures including
possibly engaging another expert may also assist the auditor in resolving the
inconsistency.
Question 7
“There should be sufficient liaison between a principal auditor and other auditors”. Discuss the
above statement and state in this context the reporting considerations, when the auditor uses the
work performed by other auditor. (8 marks)(Final Nov 2002)
Answer
SA 600 on “Using the work of another auditor” lays down the procedure to be applied in
situations where a principal auditor reporting on the financial statement of the entity uses
the work of another independent auditor. SA 600 contemplates coordination between
auditors and requires that there should be sufficient liaison between the principal auditor
and the other auditor. For this purpose, the principal auditor may find it necessary to issue
written communication(s) to the other auditor.
The other auditor, knowing the context in which his work is to be used by the principal
auditor, should coordinate with the principal auditor. For example, by bringing to the
principal auditor’s immediate attention any significant findings requiring to be dealt with at
entity level, adhering to the time-table for audit of the component, etc. He should ensure
compliance with the relevant statutory requirements. Similarly, the principal auditor should
advice the other auditor on any matters that come to his attention that he thinks may have
an important bearing on the other auditor’s work.
When considered necessary, the principal auditor may require the other auditor to answer
a detailed questionnaire regarding matters on which the principal auditor requires
information for discharging his duties. The other auditor should respond to such
questionnaire on a timely basis.
The reporting considerations laid down by SA are as under:
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When the principal auditor concludes, based on his procedures, that the work of the other
auditor can not be used and the principal auditor has not been able to perform sufficient
additional procedures regarding the financial information of the component audited by the
other auditor, the principal auditor should express a qualified opinion or disclaimer of
opinion because there is a limitation on the scope of audit.
In all circumstances, if the other auditor issues, or intends to issue, a qualified report, the
principal auditor should consider whether the subject of the qualification is of such nature
and significance, in relation to the financial information of the entity on which the principal
auditor is reporting, that it requires a qualification in the principal auditor’s report.
Question 8
As a Statutory Auditor, how would you deal with the following?
(a) While commencing the statutory audit of B Company Limited, the auditor undertook
the risk assessment and found that the detection risk relating to certain class of
transactions cannot be reduced to acceptance level. (4 marks)
(b) While auditing accounts of a public limited company for the year ended 31st March
2003, an auditor found out an error in the valuation of inventory, which affects the
financial statement materially – Comment as per auditing and assurance standards.
(5 marks)
(c) At the statutory audit of TOR Limited, the physical verification of fixed assets was
conducted. However the auditor was not able to confirm the existence of valuables
and important machinery. In this connection, the auditor obtained a certificate from
the management to prove its existence and value and accepted the same blindly
without any further procedures. (4 marks) (Final Nov 2003)
Answer
(a) Assessment of Risk and Acceptable Level
SA 315 and SA 330 “Identifying and Assessing the Risk of Material Misstatement
Through Understanding the Entity and its Environment” and “The Auditor’s
Responses to Assessed Risks” establishes standards on the procedures to be
followed to obtain an understanding of the accounting and internal control systems
and on audit risk and its components: inherent risk, control risk and detection risk.
SAs 315 and 330 requires that the auditor should use professional judgement to
assess audit risk and to design audit procedures to ensure that it is reduced to an
acceptably low level. “Detection risk” is the risk that an auditor’s substantive
procedures will not detect a misstatement that exists in an account balance or class
of transactions that could be material. The higher the assessment of inherent and
control risks, the more audit evidence the auditor should obtain from the performance
of substantive procedures. When both inherent and control risks are assessed as
high, the auditor needs to consider whether substantive procedures can provide
sufficient appropriate audit evidence to reduce detection risk, and therefore audit
risk, to an acceptably low level. The auditor should use his professional judgement
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to assess audit risk and to design audit procedures to ensure that it is reduced to an
acceptably low level. If it cannot be reduced to an acceptable level, the auditor
should express a qualified opinion or a disclaimer of opinion as may be appropriate.
(b) Errors in Valuation of Inventories and Auditor’s Responsibilities
SA 240, “The Auditor’s Responsibility to Consider Fraud and Error in an Audit of
Financial Statements”, requires that if circumstances indicate the possible existence
of fraud or error, the auditor should consider the potential effect of the suspected
fraud or error on the financial information. If the auditor believes the suspected fraud
or error could have a material effect on the financial information, he should perform
such modified or additional procedures as he determines to be appropriate. SA 240
also requires that the auditor should consider the implications of the misstatement in
relation to other aspects of the audit, particularly, the reliability of management
representations. Further, SA 320 also requires that in such circumstances, the
auditor should consider requesting the management to adjust the financial
information or consider extending his audit procedures. If the management refuses to
adjust the financial information and the results of extended audit procedures do not
enable the auditor to conclude that the aggregate of uncorrected misstatements is
not material, the auditor should express a qualified or adverse opinion, as
appropriate. In the instant case, the auditor has detected the material errors affecting
the financial statements; the auditor should communicate his findings to the
management on a timely basis, consider the implications on true and fair view and
also ensure that appropriate disclosures have been made.
(c) Management Representation
The physical verification of fixed assets is the primary responsibility of the
management. The auditor, however, is required to examine the verification
programme. Further, he must satisfy himself about the existence, ownership,
procession and valuation of fixed assets. It appears from the facts of the case that
the auditor has not been able to verify either existence or valuation of significant
fixed assets despite conducting physical verification audit procedure himself.
Ultimately, he accepted the certificate from the management without performing
further procedures. As per SA 580, “Written Representations”, representation by
management cannot be a substitute for other audit evidence that the auditor could
reasonably expect to be available. Thus, a representation by management as to the
existence of valuables and machinery is no substitute for adopting normal audit
procedures regarding verification of valuable and important machinery. If the auditor
is unable to obtain sufficient appropriate audit evidence that he believes will be
available, this will constitute a limitation on the scope of his examination even if he
has obtained a representation from management on the matter and the auditor may
express a disclaimer of opinion.
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Question 9
“There should be sufficient liaison between a principal auditor and other auditors”. Discuss the
above statement and state in this context the reporting considerations, when the auditor uses the
work performed by other auditor. (8 marks) (Final Nov 2003).
Answer
SA 600 on, “Using the Work of Another Auditor”, lays down the procedure to be applied
in situations where a principal auditor reporting on the financial statement of the entity
uses the work of another independent auditor. SA 600 contemplates coordination
between auditors and requires that there should be sufficient liaison between the principal
auditor and the other auditor. For this purpose, the principal auditor may find it necessary
to issue written communication(s) to the other auditor.
The other auditor, knowing the context in which his work is to be used by the principal
auditor, should co-ordinate with the principal auditor. For example, by bringing to the
principal auditor’s immediate attention any significant findings requiring to be dealt with at
entity level, adhering to the timetable for audit of the component, etc. He should ensure
compliance with the relevant statutory requirements. Similarly, the principal auditor
should advise the other auditor of any matters that come to his attention that he thinks
may have an important bearing on the other auditor’s work.
When considered necessary, the principal auditor may require the other auditor to answer
a detailed questionnaire regarding matters on which the principal auditor requires
information for discharging his duties. The other auditor should respond to such
questionnaire on a timely basis.
The reporting considerations laid down by SA are as under:
When the principal auditor concludes, based on his procedures, that the work of the other
auditor can not be used and the principal auditor has not been able to perform sufficient
additional procedures regarding the financial information of the component audited by the
other auditor, the principal auditor should express a qualified opinion or disclaimer of
opinion because there is a limitation on the scope of audit.
In all circumstances, if the other auditor issues, or intends to issue, a qualified report, the
principal auditor should consider whether the subject of the qualification is of such nature
and significance, in relation to the financial information of the entity on which the principal
auditor is reporting, that it requires a qualification in the principal auditor’s report.
Question 10
What are your views on the following?
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) (Final Nov 2004)
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Answer
Validity of Written Representation: The physical verification of fixed assets is the
primary responsibility of the management. The auditor, however, is required to examine
the verification programme adopted by the management. He must satisfy himself about
the existence, ownership and valuation of fixed assets. In the case of 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 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. “Written
Representations” 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.
Question 11
(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 affect 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) (Final Nov 2004)
Answer
(a) Initial Engagement – Opening Balances: As per SA 510 ‘Initial Engagements -
Opening Balances’ initial audit engagements mean
(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 (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
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statements of the entity for the immediately preceding period. The situation
mentioned in (ii) above arises whenever there is a change of auditor.
(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 accounted for and
adequately disclosed, the auditor should express a qualified opinion or an adverse
opinion, as appropriate.
Question 12
Enumerate the ‘Basic Elements of Audit Report’ as enshrined in SA 700.
(8 marks) (Final Nov 2004)
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Answer
Basic Elements of Auditor’s Report: As per SA 700, “The Auditor’s Report on
Financial Statements”, the auditor’s report includes the following basic elements:
1. Title: It is appropriate to use the term “Auditor’s Report’ in the title so as to
distinguish the same from other reports, e.g., Board of Directors’ Report, etc.
2. Addressee: Ordinarily, the auditor’s report is addressed to the authority appointing
the auditor.
3. Opening or Introductory Paragraph: The auditor’s report should identify the
financial statements of the enterprise that has been audited including the date of and
period covered by the financial statements. This introductory paragraph must state
that the preparation of financial statements is the responsibility of the management
and that the auditor’s responsibility is to express an opinion based on audit.
4. Scope Paragraph: The auditor’s report should describe the scope of the audit
stating that the audit was conducted in accordance with auditing standards generally
accepted in India. It must also lay down briefly the work performed by the auditor
and the constraints involved in discharge of his attest function.
5. Opinion Paragraph: This paragraph is mainly devoted for expression of opinion as
to whether the financial statements give a true and fair view and whether they comply
with the statutory requirements.
6. Date of Report: The date of an auditor’s report on the financial statements is the
date on which the auditor signs the report expressing an opinion on the financial
statements. The date of report informs the reader that the auditor has considered
the effect on the financial statements and on the report of the events and
transactions of which the auditor became aware and that occurred up to that date.
Since the auditor’s responsibility is to report on the financial statements as prepared
and presented by management, the auditor should not date the report earlier than the
date on which the financial statements are signed or approved by management.
7. Place of Signature: The report should name specific location, which is ordinarily the
city where the audit report is signed.
8. Auditor’s Signature: The report should be signed by the auditor in his personal
name. Where the firm is appointed as the auditor, the firm name should also be
mentioned. The proprietor or partner signing the report should also mention his
membership number.
Question 13
Write a short note on Responsibility of Joint Auditors (4 marks) (Final Nov 2004)
Answer
Responsibility of Joint Auditors: SA 299 on, “Responsibility of Joint Auditors” deals
with the professional responsibilities, which the auditors undertake in accepting such
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appointments as joint auditors. The responsibilities of joint auditors, as a rule are no
different from the responsibilities of individual auditors as enumerated in the Companies
Act, 1956. Main features of the said SA are discussed below:
♦ Division of Work: Where joint auditors are appointed, they should, by mutual
discussion, divide the audit of identifiable units or specified areas. Certain areas of
work, owing to their importance or owing to the nature of work involved would not be
divided and would be covered by all the joint auditors. Such a division affected by
the joint auditors should be adequately documented and preferably communicated to
the auditee.
♦ Coordination: Where in the course of his work, a joint auditor comes across matters
which are relevant to the areas of other joint auditors and which require joint
discussion, he should communicate the same to all the other joint auditors in writing
before the finalisation of audit and preparation of audit report.
In respect of the work divided amongst the joint auditors, each joint auditor is responsible
only for the work allocated to him, whether or not he has made a separate report on the
work performed by him. On the other hand the joint auditors are jointly and severally
responsible in respect of the audit conducted by them as under:
(a) in respect of the audit work which is not divided among the joint auditors and is carried out
by all of them;
(b) in respect of decisions taken by all the joint auditors concerning the nature, timing or extent
of the audit procedures to be performed by any of the joint auditors.
(c) in respect of matters which are brought to the notice of the joint auditors by any one of
them and on which there is an agreement among the joint auditors;
(d) for examining that the financial statements of the entity comply with the disclosure
requirements of the relevant statute; and
(e) for ensuring that the audit report complies with the requirements of the relevant statute.
(f) it is the separate and specific responsibility of each joint auditor to study and evaluate the
prevailing system of internal control relating to the work allocated to him, the extent of
enquiries to be made in the course of his audit.
(g) the responsibility of obtaining and evaluating information and explanation from the
management is generally a joint responsibility of all the auditors.
(h) each joint auditor is entitled to assure that the other joint auditors have carried out their part
of work in accordance with the generally accepted audit procedures and therefore it would
not be necessary for joint auditor to review the work performed by other joint auditors.
Normally, the joint auditors are able to arrive at an agreed report. However where the joint auditors
are in disagreement with regard to any matters to be covered by the report, each one of them
should express his own opinion through a separate report. A joint auditor is not bound by the
views of majority of joint auditors regarding matters to be covered in the report and should express
his opinion in a separate report in case of a disagreement.
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Question 14
As a Statutory Auditor, how would you deal with the following?
(a) The Managing Director of the Company has committed a “Teeming and Lading”
Fraud. The amount involved has been however subsequently after the year end
deposited in the company. (4 marks)
(b) The accountant of C Ltd. Has requested you, not to send balance confirmations to a
particular group of debtors since the said balances are under dispute and the matter
is pending in the court. (4 marks) (Final May 2005)
Answer
(a) Fraud Committed by Managing Director: The Managing Director of the company
has committed a “Teeming and Lading” fraud. The fact that the amount involved has
been subsequently deposited after the year end is not important because the auditor
is required to perform his responsibilities as laid down in SA 240 , “The Auditor’s
Responsibility to Consider Fraud and Error in an Audit of Financial Statements”.
First of all, as per SA 240, the auditor need to perform procedures whether the
financial statements are materially misstated. Because an instance of fraud cannot
be considered as an isolated occurrence and it becomes important for the auditor to
perform audit procedures and revise the audit risk assessment. Secondly, the
auditor need to consider the impact of fraud on financial statements and its
disclosure in the audit report. Thirdly, the auditor should communicate the matter to
the Chairman and Board of Directors. Finally, in view of the fact that the fraud has
been committed at the highest level of management, it affects the reliability of audit
evidence previously obtained since there is a genuine doubt about representations of
management. Finally, the auditor shall have to report under CARO, 2003 indicating
the nature and amount involved in respect of fraud noticed during the year.
(b) External confirmation Requests: SA 505, “External Confirmations”, establishes
standards on the debtor’s use of external confirmation as a means of obtaining audit
evidence. It requires that the auditor should employ external confirmation
procedures in consultation with the management. The auditor may come across
certain situations in which the management may request him not to seek external
confirmation from certain parties because of dispute with the debtors, etc. The
management, for example, might make such a request on the grounds that due to a
dispute with the particular debtor, the request for confirmation might aggravate the
sensitive negotiations between the entity and the debtor. In such cases, when an
auditor agrees to management’s request not to seek external confirmation regarding
a particular debtor, the auditor should consider validity of grounds for such a request
and assess management’s integrity and obtain evidence to support the same. The
auditor should also ask the management to submit its request in a written form,
dealing therein the reasons for such a request. The auditor agrees to management’s
request not to seek external confirmation regarding a particular matter, the auditor
should document the reasons for acceding to the management’s request and should
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apply alternative procedures to obtain sufficient appropriate evidence regarding that
matter. While considering the validity of request, in case the auditor reaches at a
conclusion that the same was not valid, he may appropriately modify the report.
Question 15
Answer the following:
(a) Enumerate, in brief, the important aspects to be evaluated by the external auditor in
determining the efficiency and extent of reliance to be placed on the work and
function of an Internal Auditor. (6 marks)
(b) While compiling the financial statements of a concern, you observed that the input
information supplied by the concern is incomplete, incorrect and few of the
Accounting Standards have not been followed. Describe, in brief, the procedure you
will follow in the above. (5 marks) (Final May 2005)
Answer
(a) Evaluation of Internal Audit Function: The external auditor should as a part of his
audit, carryout general evaluation of the internal audit function to determine the
extent to which he can place reliance upon the work of the internal auditor. As per
SA 610 "Relying Upon the Work of an Internal Auditor", the important aspects to be
considered by external auditor are:
(i) Organisational Status: An important aspect is whether the audit is being carried
out by outside agency or by departmental team. Another related aspect is level
in the organisation to whom the report is addressed and whether he is free to
communicate with the external auditor.
(ii) Scope of Function: Nature and depth of coverage of the internal audit and to
what extent the management considers and where appropriate, act upon the
recommendations of the internal auditor.
(iii) Technical competence: Internal audit work is performed by persons having
adequate technical training and proficiency. Professional qualification and
experience of the persons carrying out internal audit function also need to be
considered.
(iv) Due Professional care: It should be ascertained that the internal audit appears
to be properly planned, supervised, reviewed and documented. Existence of
proper internal audit manual, programmes and working papers will lead to the
establishment of due professional care.
The external auditor should document his evaluation and conclusion of all the
above factors.
(b) Compilation of Financial Information: According to SRS 4410 “Engagements to
Compile Financial Information”, an accountant would normally have to rely upon the
management for information to compile the financial statements in a compilation
engagement. If in the course of compilation of financial statements, it is observed
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that the information supplied by the entity is incorrect, incomplete or otherwise
unsatisfactory, the accountant should perform following procedures:
(i) Make any enquiries of management to assess the reliability and completeness
of the information provided;
(ii) Assess internal controls prevailing in the entity; and
(iii) Verify any matters or explanations.
The accountant may also request the management to provide additional information.
This may be asked in the form of management representation letter. If the
management refuses to provide additional information, the accountant should
withdraw from the engagement, informing the entity of the reasons for such
withdrawal.
If one or more accounting standards are not complied with, the same should be
brought to the notice of the management and if the same is not rectified by the
management, the accountant should include the same in notes to the accounts and
the compilation report to the management.
Question 16
Answer the following”
(a) Enumerate (in brief) the basic principles governing an audit. (5 Marks)
(b) While examining the going concern assumption of an entity, what important
indications should be evaluated and examined? (6 Marks) (Final Nov 2005)
Answer
(a) SA 200, “Basic Principles Governing an Audit”, describes the basic principles which
govern the auditor’s professional responsibilities and which should be complied with
whenever an audit is carried out. Basic principles are:
(i) Integrity, Objectivity and Independence: The auditor should be
straightforward, honest and sincere in his approach to his professional work.
He must be fair and must not allow prejudice or bias to override his objectivity.
He should maintain an impartial attitude and both be and appear to be free of
any interest which might be regarded, whatever its actual effect, as being
compatible with integrity and objectivity.
(ii) Confidentiality: The auditor should respect the confidentiality of information
acquired in the course of his work and should not disclose any such information
to a third party without specific authority or unless there is a legal or
professional duty to disclose.
(iii) Skills and Competence: The audit should be performed and the report
prepared with due professional care by persons who have adequate training,
experience and competence in auditing.
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(iv) Work performed by others: When the auditor delegates work to assistants or
uses work performed by other auditor and experts, he will continue to be
responsible for forming and expressing his opinion on the financial information.
The auditor should carefully direct, supervise and review work delegated to
assistants. The auditor should obtain reasonable assurance that work
performed by other auditors or experts is adequate for his purpose.
(v) Documentation: The auditor should document matters which are important in
providing evidence that the audit was carried out in accordance with the basic
principles.
(vi) Planning: The auditor should plan his work to enable him to conduct an
effective audit in an efficient and timely manner. Plans should be based on a
knowledge of the client’s business.
(vii) Audit evidence: The auditor should obtain sufficient appropriate audit evidence
through the performance of compliance and substantive procedures to enable
him to draw reasonable conclusions therefrom on which to base his opinion on
the financial information.
(viii) Accounting System and Internal Control: The auditor should reasonably
assure himself that the accounting system is adequate and that all the
accounting information which should be recorded has in fact been recorded.
Internal controls normally contribute to such assurance.
(ix) Audit conclusions and reporting: The auditor should review and assess the
conclusions drawn from the audit evidence obtain and from his knowledge of
business of the entity as the basis for the expression of his opinion on the
financial information.
(b) Evaluating Going Concern Assumption: SA 570, “Going Concern”, requires that
while planning a performing audit procedures and in evaluating the results thereof,
the auditor should consider the appropriateness of the going concern assumption
underlying the preparation of the financial statements. In assessing such a risk, the
auditor should examine the following indications.
I. Financial indications
♦ Negative net worth or negative working capital
♦ Excessive use of short term borrowing for long term assets
♦ Fixed term borrowings approaching maturity without prospect of renewal or
repayment.
♦ Adverse key financial ratio
♦ Substantial operating losses
♦ Substantial negative cash flow from operations
♦ Arrears or discontinuance of dividend payment
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♦ Inability to pay creditors in time
♦ Default in compliance with loan agreements
♦ Change from credit to cash term with suppliers
♦ Inability to arrange finance for new development need
♦ Arrangement with creditors for reduction in liabilities
II. Operating Indications
♦ Turnover and departure of key management personnel without replacement
♦ Loss of market, franchise, license or key supplier
♦ Labour difficulties or shortage of important supplies
III. Other indications
♦ Non-compliance with statutory requirements
♦ Legal cases with possibility of adverse judgement which could not be met
♦ Changes in legislations or government policy
♦ Sickness of the entity under any statutory definition.
Question 17
Enumerate the risks and internal control characteristics in an audit conducted in Computer
Information Systems (CIS) environment. (8 Marks) (Final Nov 2005)
Answer
The risks and internal control characteristics in CIS environment as per SA 315,
“Identifying and Assessing the Risk of Material Misstatement Through Understanding the
Entity and its Environment” and SA 330 “The Auditor’s Responses to Assessed Risks”
include the following:
♦ Lack of transaction trails: Some computer information systems are designed so that a
complete transaction trail that is useful for audit purposes might exist for only a short
period of time or only in computer readable form. Where a complex application system
performs a large number of processing steps, there may not be a complete trail.
Accordingly, errors embedded in an application’s program logic may be difficult to detect
on a timely basis by manual (user) procedures.
♦ Uniform processing of transactions: Computer processing uniformly processes like
transactions with the same processing instructions. Thus, the clerical errors ordinarily
associated with manual processing are virtually eliminated. Conversely, programming
errors (or other systemic errors in hardware or software) will ordinarily result in all
transactions being processed incorrectly.
♦ Lack of segregation of functions: Many control procedures that would ordinarily be
performed by separate individuals in manual systems may become concentrated in a CIS
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environment. Thus, an individual who has access to computer programs, processing or
data may be in a position to perform incompatible functions.
♦ Potential for errors and irregularities: The potential for human error in the
development, maintenance and execution of computer information systems may be
greater than in manual systems, partially because of the level of detail inherent in these
activities. Also, the potential for individuals to gain unauthorised access to data or to alter
data without visible evidence may be greater in CIS than in manual systems.
In addition, decreased human involvement in handling transactions processed by
computer information systems can reduce the potential for observing errors and
irregularities. Errors or irregularities occurring during the design or modification of
application programs or systems software can remain undetected for long periods of
time.
♦ Initiation or execution of transactions: Computer information systems may include the
capability to initiate or cause the execution of certain types of transactions, automatically.
The authorisation of these transactions or procedures may not be documented in the
same way as that in a manual system, and management’s authorisation of these
transactions may be implicit in its acceptance of the design of the computer information
systems and subsequent modification.
♦ Dependence of other controls over computer processing: Computer processing may
produce reports and other output that are used in performing manual control procedures.
The effectiveness of these manual control procedures can be dependent on the
effectiveness of controls over the completeness and accuracy of computer processing. In
turn, the effectiveness and consistent operation of transaction processing controls in
computer applications is often dependent on the effectiveness of general computer
information systems controls.
♦ Potential for increased management supervision: Computer information systems can
offer management a variety of analytical tools that may be used to review and supervise
the operations of the entity. The availability of these analytical tools, if used, may serve
to enhance the entire internal control structure.
♦ Potential for the use of computer-assisted audit techniques: The case of processing
and analysing large quantities of data using computers may require the auditor to apply
general or specialised computer audit techniques and tools in the execution of audit
tests.
Question 18
A Company gets its accounting data processed by a third party to achieve cost reduction.
As a Statutory Auditor of such a company, what are the additional precautions/checks that
you would consider for conduct of the audit? (8 Marks)(Final May 2006)
Answer
Precaution to be taken by auditor in case Accounting Data Processed by Third
Party: Processing of accounting data may be given to a third party on account of various
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considerations such as economy, own computer working to full capacity, an interim
measures restricting accessibility to sensitive information, etc. A client may use a service
organisation such as one that executes transactions and maintains related accountability
or records transactions and processes related data (e.g., a computer systems service
organisation). If a client uses a service organisation, certain policies, procedures and
records maintained by the service organisation might be relevant to the audit of the
financial statements of the client. Consequently, the auditor would consider the nature and
extent of activities undertaken by service organisations so as to determine whether those
activities are relevant to the audit and, if so, to assess their effect on audit risk. SA 402,
“Audit Considerations Relating to Entities Using Service Organisations”, while planning
the audit, the auditor of the client should determine the significance of the activities of the
service organisation to the client and their relevance to the audit. In doing so, the auditor
of the client would need to consider the following, as appropriate:
Nature of the services provided by the service organisation.
Terms of contract and relationship between the client and the service organisation.
The material financial statement assertions that are affected by the use of the service
organisation.
Inherent risk associated with those assertions.
Extent to which the client's accounting and internal control systems interact with the
systems at the service organisation.
Client's internal controls that are applied to the transactions processed by the service
organisation.
Service organisation's capability and financial strength, including the possible effect of
the failure of the service organisation on the client.
Information about the service organisation such as that reflected in user and technical
manuals, if any.
Information available on general controls and computer systems controls relevant to the
client's applications.
The auditor of the client would also consider the availability of third-party reports from service
organisation’s auditors, internal auditors, or regulatory agencies as a means of providing
information about the accounting and internal control systems of the service organisation and
about its operation and effectiveness.
Question 19
Elaborate how the Statutory Auditor can verify the existence of related parties for the
purpose of reporting under Accounting Standard 18. (8 Marks)(Final May 2006)
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Answer
Verification of Existence of Related Parties: Related Parties (for AS 18), the auditor
should adopt audit procedures laid down in SA 550, “Related Parties”, to identify the
existence of such parties. The auditor should review information provided by the
management of the entity, identifying the names of all known related parties and should
perform the following procedures in respect of the completeness of this information:
(a) review his working papers for the prior years for names of known related parties;
(b) review the entity’s procedures for identification of related parties;
(c) inquire as to the affiliation of directors and key management personnel, officers with
other entities;
(d) review shareholder records to determine the names of principal shareholders or, if
appropriate, obtain a list of principal shareholders from the share register;
(e) 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;
(f) inquire of other auditors of the entity as to their knowledge of additional related
parties and review the report of the predecessor auditors;
(g) review the entity’s income tax returns and other information supplied to regulatory
agencies; and
(h) review the joint venture and other relevant agreements entered into by the entity.
If, in the auditor’s judgment, the risk of significant related parties remaining undetected is low,
these procedures may be reduced or modified as appropriate.
Question 20
As a Statutory Auditor, how would you deal with the following?
You notice a misstatement resulting from fraud or suspected fraud during the audit and
conclude that it is not possible to continue the performance of audit.
(5 Marks)(Final Nov 2006)
Answer
Impossibility to continue the performance of audit: If an auditor concludes that it is not
possible to continue the performance of auditing because of misstatement resulting from
fraud or suspected fraud, he should take action in accordance with the requirement of SA
240 “The Auditor’s Responsibility to consider Fraud and Error”.
(i) He should consider the professional and legal responsibilities applicable in the
circumstances including whether there is a requirement for the auditor to report to
the person(s) who made the audit appointment.
(ii) He should consider whether he has to report to the regulatory authorities.
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(iii) If the auditor withdraws, he should discuss with the appropriate level of management
and those who charged with the governance about the reasons for the withdrawal.
In view of the exceptional nature of circumstances and the need to consider the legal
requirement, he may also seek legal advice for determining the appropriate course of action.
Question 21
“The auditors should communicate audit matters of governance interest arising from the
audit of financial statements with those charged with the governance of an entity”. Briefly
state the matters to be included in such Communication. (8 Marks)(Final Nov 2006)
Answer
Communications of audit matters with those charged with governance SA 260
SA 260 deals with communications of audit matters with those charged with governance.
The following are the audit matters of governance interest which are to be communicated.
(i) The general approach and overall scope of audit including expected limitations.
(ii) The selection of or change in significant accounting policies and practices that have
a material effect on the entity’s financial statements.
(iii) The potential effect on the financial statements of any significant risks and
exposures.
(iv) Adjustment to financial statements arising out of audit which have a significant effect
on the financial statement.
(v) Material uncertainties that may cast significant doubt on the entity’s ability to
continue as a going concern.
(vi) Disagreement with management on matters which could have significant impact to
the financial statements and to audit report.
(vii) Expected modifications to the audit report.
(viii) Others matters like material weakness in internal control measures, questions on
management integrity and fraud involving management.
(ix) Other matters agreed in terms of audit engagement.
Question 22
(a) (i) What are general matters to be considered by an auditor while taking up a
engagement?
(ii) What are the major sources of obtaining information about the client’s business?
(4x2=8 Marks)
(b) State the reporting responsibility of an auditor in the context of non-compliance of
Law and Regulation in an audit of Financial Statement. (8 Marks)(Final Nov 2006)
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Answer
(a) (i) General matters to be considered while taking up a new engagement
General Economic factors: General level of economic activity (for example,
recession, growth)
(i) The market and competition.
(ii) Cyclical or seasonal activity
(iii) Government policies
The industry- important conditions affecting the client’s business
(i) The market and competitions
(ii) Cyclical or seasonal activity
(iii) Changes in product technology
(iv) Business risk
The entity:
(i) Management and ownership- important characteristics
(ii) Operating Management
(iii) The entity’s business – products markets, suppliers, expenses, operations.
(a) Nature of business(es) (for example, manufacturing whole seller,
financial services, import/ exports)
(b) Location of production facilities, warehouses, offices.
(c) Employment (for example, by location, supply, wage levels, union
contracts, pension commitments, Government regulation)
(d) Products or services and markets.
(iv) Financial performance– factors concerning the entity’s financial condition and
profitability.
(v) Reporting environment- external influences which affect management in the
preparation of the financial statements.
(vi) Legislation:
(a) Regulatory environment and requirements
(b) Taxation both direct and indirect.
(ii) Information about the client’s business: The auditor can obtain information
about client’s business from the following sources:
(i) The client’s annual reports to shareholders;
(ii) Minutes of meetings of shareholders, board of directors and important
committees;
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(iii) Internal financial management report for current and previous periods, including
budgets, if any;
(iv) The previous year’s audit working papers, and other relevant files;
(v) Firm personnel responsible for non audit services to the client who may be
able to provide information on matters that may affect the audit;
(vi) Discussions with the client;
(vii) The client’s policy and procedures manual;
(viii) Relevant publications of the Institute of Chartered Accountants of India and
other professional bodies, industry publication, trade Journals, magazines,
newspapers or text books;
(ix) Consideration of the state of the economy and its effects on the client’s
business;
(x) Visits to the client’s premises and plant facilities to the management.
(b) Reporting responsibility of an auditor in the context of non-compliance of Law
and Regulation: The auditor should as soon as practicable, either communicate with
the audit committee, the Board of Directors and senior management or obtain
evidence that they are appropriately informed regarding non-compliance that comes
to the auditors attention.
If in the auditor’s Judgment, the non-compliance is believed to be intentional and/ or
material, the auditor should communicate the findings without delay.
If the auditor suspects that members of senior management, including members of
the Board of Directors, are involved in non-compliance, the auditor should
communicate the matter to the next higher level of authority at the entity, such as,
the audit committee or Board of Directors, to the users of the auditors report or
financial statements.
If the auditors concludes that the non-compliance has a material effect on the
financial statements and has not been properly reflected in the financial statements
the auditor should express a qualified or an adverse opinion.
If the auditor is precluded by the entity from obtaining sufficient and appropriate audit
evidence to evaluate whether non-compliance is, or is likely to have occurred that
have or may have material impact on the financial statements, the auditor should
express a qualified opinion or a disclaimer of opinion on the financial statements on
the basis of a limitation on the scope of the audit.
If the auditor is unable to determine whether non compliance has occurred because
of limitations imposed by the circumstances rather then by the entity, the auditor
should consider the effect on the auditor’s report.
Advanced Auditing
30
The auditor’s duty of confidentiality would ordinarily preclude reporting non
compliance to a third party. However, in certain circumstances, that duty of
confidentiality is overridden by statement, law or by courts of laws.
Question 23
Write short notes on the following:
(a) Eight situations of external confirmations.
(b) Situations where external confirmations can be used.
(4x 2 = 8 Marks) (Final Nov 2007)
Answer
(a) Eight situations of external confirmations
(i) Bank balances from bankers.
(ii) Accounts receivable balances.
(iii) Accounts payable balances.
(iv) Stocks held by third parties.
(v) Property title deeds held by third parties.
(vi) Investments purchased but delivery not taken.
(vii) Loans from lenders.
(viii) Long outstanding share application money.
(b) Situations where external confirmations can be used: Refer SA 505
(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 balances
(viii) Long outstanding share application money.
Question 24
What are the Financial indications to be considered by an auditor for evolution of the going
Concern assumption? (4 Marks) (Final Nov 2008)
Standards on Auditing
31
Answer
As per SA 570 on Going Concern, the following are the financial indications to be considered:-
(i) Negative Net worth;
(ii) Long-term borrowings not being repaid on due dates and without any realistic prospects of
renewal or repayment;
(iii) Adverse Financial Ratio;
(iv) Operating losses.
(v) Negative Cash Flow;
(vi) Inability to pay creditors on due dates;
(vii) Increasing credit period from suppliers and entering into a scheme with them for reschedulement;
(viii) Inability to obtain financing for essential new product development.