Sample for Auditing Mantras for CA IPCC

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/

Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Publisher Book Corporation 4, R.N.Mukherjee Road (Near Birla Building, Dalhousie) Kolkata - 700001 Phone : 033-22306669 / 22305367 / 09830010297 http://bookcorporation.com/ Order Online at http://www.auditingmantras.com/p/order-online_17.html Rs 225 after discount Available in Delhi at Somani Law Book Company 23 D/ Pocket B, DAA Flats West Gorkah Park Extension, Shardara Delhi-32 Ph. No: - 09810315220 Singhania Books &Stationery U-110 Ground Floor, Shakarpur-Delhi Opp Laxminagar Metro Station Ph : 9213241941,9213168238


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ About the Author CA. Anurag Singal is a Chartered Accountant and a graduate from St Xavier’s College, Kolkata. He secured All India Rank 22 and 25 in CA Final and CA PE-II respectively, having secured All India Highest in Mathematics in CA PE-I. He received the “CA Professional Achiever-Manufacturing Sector” at 6th ICAI Awards 2012 for his professional contribution across his stints across leading corporate houses in India. His E-learning lectures on Auditing, Strategic Financial management and Advance d Management Accounting for CA IPCC and CA Final are hosted on the Board of Studies Knowledge Portal of ICAI http://www.auditingmantras.com/ [email protected]


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ PREFACE “I wouldn’t have had to write my CA Audit paper thrice to clear my IPCC. I wish something like this had come before” – was a spontaneous reply from the first student to whom I had showcased this book for an honest feedback. I wish this sentiment resonates amongst the larger student community

This book has been an outcome of my experiences as a student and a faculty for CA-IPCC Audit. I was always in search of book which could showcase the basic concepts of auditing in a lucid manner. Yet it had to come across a smart learning solution, striking the fine balance between detail and brevity as the CA-IPCC student gears to cover a wide array of 7 subjects for IPCC in a short span of time. This will enable the student to effectively acquire knowledge in the initial phase, as well as multiple revisions to consolidate the content from an examination preparation standpoint. This book is an exhaustive coverage of ICAI’s coverage material and also contains the chapter-wise questions list for the past 15 years at the end of each chapter. The key features of 34 SAs have been covered in a diagrammatic form I hope that my endeavours shall benefit the vast majority of students CA. Anurag Singal Kolkata http://www.auditingmantras.com/ [email protected] "Even if you lose faith in yourself, don't lose faith in what you stand for, the cause. Resurrection then is just a matter of time."



Dedicated to my Mother who has been an unflinching support all through


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ TABLE OF CONTENTS Chapter 1: Introduction to Auditing Chapter 2: Basic Concepts in Auditing Chapter 3: Preparation for an Audit Chapter 4: Internal Control Chapter 5: Vouching Chapter 6: Verification of Assets and Liabilities Chapter 7: The Company Audit – I Chapter 8: The Company Audit – II Chapter 9: Special Audits Chapter 10: Standards on Auditing



Chapter 1: Introduction to Auditing Auditing Definition – as per ICAI Did you know that the word “auditing” has been derived from the Latin word “audire” which means “to hear” As per Dicksee: a) Examine accounting records and assess whether they capture the essence of transactions that have occurred in a period b) Whether the statement of accounts is true and fair (t&f) As per ICAI: Audit is An systematic /independent examination of financial information, of any entity whether profit making or not, irrespective of its size and legal structure the ultimate objective is to express an opinion thereon While SA-200 definition stated above covers only the financial information aspect, audit today encompass a broad spectrum of non-financial areas such as Marketing, HR, Production etc.

Internal Auditor vs. External Auditor: External (appointed by the owners of the organisation, say, shareholders of the company, scope of work is determined by the statute under which they have been appointed) while Internal (management appoints and determines scope of work). Independent vis-a-vis the management of the organisation Scope of work of an internal auditor may extend even beyond the financial accounting and may include cost investigation, inquiries relating to losses and wastages, production audit, performance audit, etc.

Qualities of Auditor (N’04)

(a) SA-200 mentions IOI (Integrity, Objectivity and Independence) (b) Knowledge: Knowledge of client’s business, its peculiar trends and general economic environment etc. Legislative framework such as Income Tax Act, Contract Act, Partnership Act, Companies Act, Cooperative Societies Act etc. is also required He must continuously update his knowledge to conduct audit effectively. Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ (c) Technical skills: He must have good hands on experience in accounting & auditing. Moreover, he should be aware of the latest developments in auditing standards so that he can perform audit in effective manner. (d) The Personal Qualities required, according to Dicksee, are tact, caution, firmness, good temper, integrity, discretion, industry, judgement, patience, clear headedness and reliability. (Elaborate) London & General Bank case: An auditor must be honest that is, he must not certify what he does not believe to be true and must take reasonable care and skill before he believes that what he certifies is true Objective and Scope of Audit The objective of audit of financial statements is to enable the auditor to express an opinion on whether they represent true and fair view. Royal Mail Steam Packet Company’s Case: Shift of emphasis from arithmetical accuracy to the question of reliability to the financial statements. A statement may be reliable even though there are some errors or even frauds, provided they are not so big as to vitiate the picture Kingston Cotton Mills Co Case: If there remains a deep laid fraud in the accounts, which in the normal course of examination of accounts may not come to light, it will not be construed as failure of audit, provided the auditor was not negligent in the carrying out his normal work Unless doubtful situations are there, auditor is totally justified in relying upon the management / employees of the client. He is a watchdog not a bloodhound Detection of errors and frauds is not the primary aim of audit; the primary aim is the establishment of a degree of reliability of the annual statements of account It can be examined by considering whether a) Financial statements have been prepared using consistent and acceptable accounting policies b) Financial statements comply with relevant rules and regulations c) Financial statements contain disclosure of all material matters As per SA-200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing,” Auditor to opine whether the financial statements are prepared, in all material respects, as per the applicable financial reporting framework. Auditor’s opinion therefore does not assure, for example, the future viability of the entity nor the efficiency or effectiveness of management unless specific requirements such 227 (1A) and 227 (4A) of the Companies Act, 1956 Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ As per SA-240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Fi nancial Statements” (a) Primary responsibility of prevention, detection and correction of misstatement is that of management (b) However, if there are doubtful situations where some material misstatement may exist, auditor should extend his procedure to confirm / dispel the doubt (c) Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements will not be detected, even though the audit is properly planned and performed in accordance with the SAs (d) Audit may not reveal all the misstatements (due to inherent limitations of audit) (e) If auditor performs his work in accordance with basic principles governing an audit, he cannot be held liable for non-detection of misstatement in financial statements of clients (f) However, if he notices material misstatement resulting from fraud, he should communicate the same at appropriate level of management. If the auditor can prove with the help of his papers (documentation) that he has followed adequate procedures necessary for the proper conduct of an audit, he cannot be held responsible for postaudit detection of fraud and error Fraud Risk Factors (M’98, N’01) Conditions which increase the risk of misstatement in financial statement 1. Weakness in internal control system 2. Doubt about competence and integrity of management. domination by one person, high turnover rate of employees, frequent change of legal counsels or auditors 3. Unusual pressure within entity e.g. entity facing problems in getting finance, need to raise share prices 4. Unusual transactions e.g. transactions with related parties 5. Problems in obtaining sufficient and appropriate audit evidence. E.g., inadequate documentation, significant differences between the figures as per the accounting records and confirmation received from third parties, etc Objective and Scope of Audit of Financial Statements Objective an Audit

of (a) Express an opinion on financial statements prepared by the management of entity (b) Must ensure that financial statements are prepared as per the recognised accounting policies and relevant statutory requirement and they should disclose all material matters (c) However, his opinion does not constitute an assurance as to future viability of the enterprise or the efficiency or effectiveness with which its management has conducted the affairs of the enterprise Responsibility (a) The management is responsible for maintaining an up to date and proper for the accounting system and finally to prepare financial statements financial (b) The auditor is responsible for forming and expressing an opinion on the financial statements statements (c) The audit of financial statement does not relieve the management of its Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ responsibility Scope of an The auditor decides the scope of his audit having regard to: Audit The requirement of relevant legislation The pronouncements of the Institute (ICAI) Terms of engagement However, the terms of engagement cannot supersede the pronouncements of the Institute or the provisions of the relevant legislations

Basic Principles Governing and Audit (N’00, N’06, N’08, N’09, N’02)

SA 200 “Basic Principals Governing an Audit”, describes the basic principles which govern the auditor’s professional responsibilities and which should be complied with wherever an audit is carried. (See Chapter 10) Inherent limitations of Audit – what are they? (N’01, M’03, N’05, M’11) SA 200 “Overall Objectives of the Independent Auditor and the Conduct of an Audit in accordance with Standards on Auditing”, the objectives of an audit of financial statements, prepared per recognised accounting policies and practices and statute is to enable an auditor to express an opinion on such financial statements. In forming his opinion on the financial statements, the auditor follows procedures to check whether t&f Nature of Reporting

Financial Auditor exercises judgment in evaluating the reasonableness of judgments and estimates made by the management in preparing the financial statements

The judgment made by auditor may not always be correct The Nature of Audit Auditors use sampling during performance of audit. It is not possible for him to Procedures e.g. Test conduct detailed checking due to time constraints and other practical Checking problems. As he does not check each and every item, it is impossible for him to detect all frauds and errors Management or others may not provide, intentionally or unintentionally, the complete information Fraud =sophisticated and carefully organised; involving senior management or collusion Nature of evidences

The evidences obtained by the auditor are persuasive rather than conclusive

They can enable auditor to draw only reasonable conclusions there-from Inherent limitations of Internal controls suffer from limitation such as collusion among employees or internal control wrong use of authority by management etc. Auditing Mantras for CA IPCC [email protected]


If internal controls are weak, auditor may not be in a position to obtain assurance

Unavoidable risk: Some material misstatements of f.s. not detected, though the audit is properly planned and performed in accordance with SAs State the matters which the statutory Auditor should look into before framing opinion on accounts on finalisation of audit of accounts? Discuss over all audit approach. Answer Formation of opinion on accounts: The principal aspect to be covered in an audit to form an opinion, an auditor has to look into following matters: a) Examine accounting system and internal control (ASIC) to check if appropriate for the business and helps in properly recording all transactions b) Reviewing the system and procedures to find out whether they are adequate for F&E detection c) Arithmetical accuracy of the books of account by the verification of postings, balances, etc. d) Verification of the authenticity and validity of transactions e) Whether a proper distinction between items of capital and revenue nature and that the amounts of various items of income and expenditure adjusted in the accounts corresponding to the accounting period. f) Comparison of the P&L and BS with the underlying record in order to see that they are in accordance therewith g) Reporting to the appropriate person/body whether the statements of account examined do reveal a t&f view of the state of affairs and of the profit and loss of the organisation



Scanner-Chapter 1

Sl. Question Term No 1 Mention briefly the conditions or events, which increase the M’98,N’01 risk of fraud or error leading to material misstatement in Financial Statements 2 Write a short note on – Errors of Commission N’98,M’01

Marks

3

Distinguish between Auditing and Investigation

M’99,N’12

10

4

Comment on the “An opinion expressed by the auditor is neither an assurance as to the future viability of the enterprise nor the efficiency or effectiveness with which management has conducted the affairs of the enterprise”. What are the basic principles governing an audit as laid down in AAS 1 (SA 200)? Do you agree with the view that there are inherent limitations of Audit? Mention briefly the conditions or events, which increase the risk of fraud or error leading to material misstatement in Financial Statements Comment on the “Auditor’s professional responsibilities are governed by basic principles which should be complied with whenever an audit is carried out.”? Mention any twelve title of Statements on AASs (hitherto known as SAs) and the dates of coming into force What are the auditor’s responsibilities for detection of Frauds and Errors? State briefly the qualities of Auditors

M’00

6

N’00,N’06,N’08,N’09

10

N’01,M’03,N’05,M’11,

8/4

N’01

8

N’02

10

M’04

6

N’04

8

N’04

4

Auditors of M/s Fortune India (P) Ltd. were changed for the accounting year 2004-05. The closing stock of the company as on 31.3.2004 amounting to Rs. 100 lacks continued as it is and became closing stock as on 31.3.2005. The auditors of the company propose to exclude from their audit programme the audit of closing stock of Rs. 100 lacks on the understanding that it pertains to the preceding year which was audited by another auditor. Mr. K. auditor of ABC Ltd. Is of the opinion that “Auditing and Assurance Standards” are meant only for references and it is not necessary to follow such Auditing and Assurance Standards Procedural error arises as a result of transactions having been recorded in a fundamentally incorrect manner Audit is not an insurer

N’05

5

M’07

6

M’08

2

N’08

2

5 6 7

8

9 10 11 12

13

14 15


8

4

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ 16

N’09

2

M’10

2

M’10

2

N’10

5

M’11

8

21

The auditor, in the interest of the users, while explaining the nature of his reservation, can describe the work of the expert with his name, in the audit report without obtaining prior consent of the expert. The auditor compares entries in the books of accounts with vouchers and if two agrees, his work is done When an auditor identifies a Misstatement resulting from fraud, it is his responsibility to communicate it to the regulatory and enforcement authorities apart, from those charged with governance Factors governing modes of communication of auditor with those charged with governance Discuss perquisites and fundamental principles to be possessed by an auditor Discuss the types of audits required under law

N’11

5

22

What are the advantages of an independent audit?

M’12

8

17 18

19 20



Chapter 2: Basic Concepts in Auditing Auditor’s Independence-Concept SA-200 Independence is one of the basic principles governing an audit Guidance Note issued by the ICAI on “Independence of Auditors” “Independence implies that the judgment of a person is not subordinate to the wishes or directions of another person who might have engaged him or to his own self-interest”. Companies Act 1956 A person is disqualified to act as an auditor from being appointed as such if he is: i) An officer or employee of the company; ii) A partner or an employee of an officer or employee of the company; or iii) Indebted to the company for a sum exceeding of ` 1,000. iv) A person holding any security (any financial instrument which carried voting rights) of that company after a period of one year from the date of the commencement of the Companies (Amendment) Act, 2000. Auditor purchases goods or services from a company audited Independence violated by him on credit>Rs 1,000 Auditor recovers his fees on a progressive basis in accordance Not violated with the terms of his engagement

Ceiling on the number of audits that can be undertaken by a CA Special Resolution for appointing auditors in certain cases Other provisions on appointment, re-appointment and removal of auditors Power to qualify his report Chapter on Professional Misconduct enacted in the Schedules to the Chartered Accountants Act, 1949

Auditor’s Independence-Importance Why Audit? a) Company - Divorce between ownership and management - shareholders have no direct control on the day-to-day administration of the company b) Proprietorship – e.g. Funds from financial institution, etc. c) Partnership firm – e.g. Valuation of goodwill at the time of admission, retirement and death of a partner. Auditing Mantras for CA IPCC [email protected]


Informed, objective and forthright opinion by an independent professional auditor

One can easily understand the state of affairs

Advantages Users can know whether financial statements are reliable and accurate and not fraudulent./misleading

Used by stakeholders such as shareholders for making significant economic decisions (Shareholders,Investors, Management etc)

Audit Evidence (M’00) SA 500 “Audit evidence” a) Information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based. b) Includes both information contained in the accounting records underlying the financial statements and other information. i) ii)

Necessary to support the auditor’s opinion and report. Cumulative in nature and is primarily obtained from audit procedure s

Sufficient and Appropriate (S/A): Quantum and Quality Higher the assessed risks of misstatement/materiality of item, the more audit evidence is likely to be required Higher the quality (Relevance and reliability to support audit opinion, the less quantu m may be required SA 330 requires the auditor to conclude whether sufficient appropriate audit evidence has been obtained.

Audit Procedures to Obtain Audit Evidence Compliance procedures are performed to check designing, operating effectiveness and continuity of I.C. system. Auditor performs compliance procedures in respect of the following assertions relating to internal control system:



D C

O

Design Operating Effectiveness Continuity

Are appropriate controls designed? Were they implemented effectively? Throughout the period?

When internal control is found to be to an acceptable level, the accounting entries generated in such a system is more reliable than in one where the control is weak Substantive procedures (N’99, M04, and M’10) are performed to check completeness, accuracy and validity of transactions and balances. Auditors perform substantive procedures in respect of following assertions relating to data produced by accounting system:

P V

R

O

E

C Presentation disclosure Rights Obligations Existence Measurement Completeness Occurrence Valuation

M & An item is disclosed, classified and described as per recognized accounting policies and relevant statutory requirements, if any. & That an asset is a right of the entity and liability is an obligation of the entity at a given date. That an asset or liability exists at a given date. That a transaction is recorded in the proper period at proper amount. That there is no unrecorded asset or liability or transaction. That a transaction or an event took place which pertains to the entity during the relevant period. That an asset or liability is recorded at an appropriate carrying value.


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ The checking of transaction and balances involves vouching of sales, purchases, payments, receipts and scrutiny of ledgers. The analytical procedure involves critically examining the accounts in an overall manner and it may entail computation of ratios, trend analysis so as to dwell in length for examination of unusual or unexplained deviations

Types of Audit Evidence



Types of Audit Evidence Difference between Internal & External Evidence Basis Internal Meaning Created & retained within client’s organisation. Example Copies of sales invoice, wage sheet Source Inside the entity Reliability Less reliable

External Originates outside client’s organization. Purchase invoice, bank statements Outside the entity More reliable

Methods to Obtain Audit Evidence (M ’03, M’11)



Inspection External Confirmation

Observation

Reperformance

Inquiry

Analytical Procedures

Recalculation

Fundamental Accounting Assumptions (N’99, M’01, N’03)

Consistency

Going Concern

Accrual

CAG- Consistency; Accrual and Consistency: It is assumed that accounting policies are consistent from one period to another. Accrual: Revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. Going Concern: Continuing in operation for the foreseeable future. Neither the intention nor the need of liquidation or of curtailing materially the scale of the operations a) AS 1 – These form the base of the preparation and presentation of financial statements. b) They are usually not specifically stated because their acceptance and use are assumed. c) Disclosure is necessary if they are not followed. Appropriateness of Going Concern assumption (N’05) Covered by SA 570 "Going Concern” Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Events or conditions that may cast significant doubt on an entity’s ability to continue as a going concern e.g. a) Funding arrangements are guaranteed by the Central Government and suddenly withdrawn b) Privatisation Financial Net liability or net current liability position.

Inability to comply with the terms of loan agreements.

Adverse key financial ratios.

Change from credit to cash-on-delivery transactions with suppliers.

Arrears or discontinuance of dividends.

Inability to pay creditors on due dates. Operational



Management intentions to liquidate the entity or to cease operations.

Loss of key management without replacement.

Loss of a major market, key customer(s), franchise, license, or principal supplier(s).

Others


Shortages of important supplies.

Emergence of a highly successful competitor.


Non-compliance with capital or other statutory requirements.

Uninsured or underinsured catastrophes when they occur.

Pending legal or regulatory proceedings against the entity that may, if successful, result in claims that the entity is unlikely to be able to satisfy.

Changes in law or regulation or government policy expected to adversely affect the entity.

Mitigants e.g. new supplier Risk Assessment: The auditor should consider the risk that the going concern assumption may no longer be appropriate


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Chapter 3: Preparation for an Audit Letter of Engagement Scenario Pepsi Ltd wants to appoint KPMG as its auditors for YE Mar’14 but wants to clarify before hand as to what would be the work that KPMG would perform for it so that no dispute later SA 210 “Agreeing the Terms of Audit Engagement - How auditor should agree to the terms of engagement and how to respond if client request change – wants lower level of assurance Appointment of auditor = under law for companies, co-operative societies, and registered societies Appointment of auditor = under contract for preparation of accounts for tax returns, checking of the sales tax –returns Objective and Scope of work, auditor’s responsibilities to the client and the form of report are documented in the engagement letter = No Misunderstanding later on Key Theme 7 Vows of Marriage between husband and wife: who needs to do what? When it is repetitively issued: (i) Client has misunderstood the objective and scope of audit. (ii) Change in management, board, or ownership so that it is felt that it is pertinent to remind them of the engagement terms again. (iii) Revision by way of +/-/change in the engagement letter originally issued. (iv) Significant changes had occurred in nature, volume of the business transactions of the client e.g. a company with Rs 5 crores turnover has grown 100 times into Rs 500 crores; started exporting into African markets etc (v) Need to modify audit approach to be in line with the pronouncements of ICAl, the Companies Act Key Theme Misunderstood scope / Change in terms/Change in business/Change in law Example of an Engagement Letter for an Audit under a Statute



To the Board of Directors (or the appropriate representative of senior management :) You have requested that we audit the balance sheet of Vodafone Ltd as at 31st March, 2013 and the related profit and loss account and the (cash flow statement) for the year ended on that date. We are pleased to confirm our acceptance and our understanding of this engagement by means of this letter. Our audit will be conducted with the objective of our expressing an opinion on the financial statements. We will conduct our audit in accordance with the auditing standards generally accepted in India and with the requirements of the Companies Act, 1956. Those Standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. However, having regard to the test nature of an audit, persuasive rather than conclusive nature of audit evidence together with inherent limitations of any accounting and internal control system, there is an unavoidable risk that even some material misstatements of financial statements, resulting from fraud, and to a lesser extent error, if either exists, may remain undetected. In addition to our report on the financial statements, we expect to provide you with a separate letter concerning any material weaknesses in accounting and internal control systems which might come to our notice. The responsibility for the preparation of financial statements on a going concern basis is that of the management. The management is also responsible for selection and consistent application of appropriate accounting policies, including implementation of applicable accounting standards along with proper explanation relating to any material departures from those accounting standards. The management is also responsible for making judgments and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the entity at the end of the financial year and of the profit or loss of the entity for that period. The responsibility of the management also includes the maintenance of adequate accounting records and internal controls for safeguarding of the assets of the company and for the preventing and detecting fraud or other irregularities. As part of our audit process, we will request from management written confirmation concerning representations made to us in connection with the audit. We also wish to invite your attention to the fact that our audit process is subject to 'peer review' under the Chartered Accountants Act, 1949. The reviewer may examine our working papers during the course of the peer review. We look forward to full cooperation with your staff and we trust that they will make available to us whatever records; documentation and other information are requested in connection with our audit. Our fees will be billed as the work progresses. This letter will be effective for future years unless it is terminated, amended or superseded.



Please sign and return the attached copy of this letter to indicate that it is in accordance with your understanding of the arrangements for our audit of the financial statements. Deloitte Haskins & Sells Chartered Accountants .......... (Signature) (Name of the Member) (Designation) Acknowledged on behalf of Vodafone Ltd. .......... (Signature) Name and Designation Date

Key Points Objective & Scope/Applicable Law& auditing framework/ financial statements on going concern & ASIC for safeguarding assets= management’s responsibility/ auditor merely expresses opinion/test nature/ access to records/peer review Case Study X, a Chartered Accountant was engaged by PQR & Co. Ltd. for auditing their accounts. He sent his letter of engagement to the Board of Directors, which was accepted by the Company. In the course of audit of the company, the auditor was unable to obtain appropriate sufficient audit evidence regarding receivables. The client requested for a change in the terms of engagement Analogy You can’t change horses’ mid-stream Audit Programme As per Standards on Auditing: -


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ A written audit programme which contains the procedures needed to implement the audit plan. It may contain area-wise audit objectives and should be detailed enough to guide assistants involved and as a means to control. Plan in detail as to how you would conduct the audit in a given situation to meet your audit goal Guides the audit staff Nature, Timing and Extent of Audit Procedures (NTE)

Objective and Scope of work

Nature, size and composition of the business

Past Experience with this client

Internal control

Should be regularly reviewed in course of audit and updated (Decide whether more work/less work is required) Case Law Pacific Acceptance Corporation Ltd. v. Forsyth and Others: Audit programme for company that finances house needs to be modified when it starts financing real estate acquisition How useful is an Audit Programme? Theme Auditing Mantras for CA IPCC [email protected]


If Grant Thornton didn’t have an audit programme, how would it efficiently manage 20 audits of different industries with different focus areas and allot its staff, known who worked where and performed which procedure, which partner reviewed and prove (if required) in court that it did the work as per the highest standards But audit programme cannot be mechanical; nor should restrict the creativity of people and should be updated with change in business/staff/Int. Control Sample Audit Programme- Audit of Receipts of Participation Fees of a National Convention for doctors by Medical Council of India One time event- a Special Cell made to handle the entire event. Since few people would be handling the event, the internal controls may not be that strong and, thus, more emphasis is required to be given on substantive procedure. Audit of receipt of participation fees should be under the following areas: The theme revolves around Total Collection = Rate per participant * No of Participants

Rate: Board Resolution, Brochure

No of Receipts issued: ASIC, BRS

(I)

No of Participants: Kits, Lunch, Auditorium Seating Capacity. Free participants? Authorisation

Internal Control System (i)

Check the organization structure- Special Cell, division of responsibilities amongst persons and control/custody over receipt books.

(ii) Internal control system to stop participation of unregistered delegates. (II) Rate of Participation Fees (i)

Resolution passed by the Organizing Committee/Medical Council of India.


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ (ii) Brochure/registration form for the conference. Charge more from Foreign Delegates (if) (III) Receipts of Participation Fees (i)

Verify counter foil of the receipts issued for individual registration.

(ii) Cash received  Receipt issued for registration (iii) Accounting entry in Bank Statement/Cash Book. (iv) BRS for dishonoured cheques. (v) Subsequent recovery in respect of dishonoured cheques. (IV) Overall Checking (i)

Total Collection = Rate per participant * No of Receipts issued

(ii) Cross check the total number of delegates with reference to kits/meals/participati on certificates (iii) Check Auditorium seating capacity Vs Actual Participants (iv) How many absentees? If nil, then enquire (v) Proper authorization for free participants Classification of audit based on frequency Continuous Audit/Concurrent Audit (N’98) (N’01) Audit Frequency = Round the clock / Frequent intervals say weekly. Going to the temple (Daily/every Tuesday) to confess your sins

Advantages: Control perspective - Quicker detection of Fraud/Error; transaction checked as soon as it occurs, rectification = quick Staff less likely to commit as fraud (as they are afraid of quick detection) Books of account up-to-date. Continuous interaction with client = More detailed knowledge of the client’s affairs = More efficient discharge of duty Drawbacks Audit in several instalments = Possible Gaps = Some transactions may escape audit scrutiny Post-audit tampering of books Uneconomic if company is small – suitable for Reliance industries, not for Balaji Traders Final Audit Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Starts after the books have closed at the end of the accounting period and continues till completion and signing of audit report Advantages: No need to return repeatedly No possibility of Post-audit tampering of books Easier allocation of work for staff Drawbacks Delay in audit since accounting periods of several clients end on the same date say 31st March Confess your sins@ Durga Puja (once a year) Audit Risk (N’02, M’ 04) Even though you do an audit thoroughly, the risk that some material misstatements may remain undetected (Due to the test nature and other inherent limitations of Internal control system) SA-500 on “Audit Evidence” also makes it clear that the auditor’s procedures should get sufficient appropriate audit (S/A) evidence. (S/A) evidence = function (assessment of risk of misstatement) Low –risk areas: Vouching, casting, checking High-risk areas: Adequacy of provisions, full disclosure of liabilities, including contingent liabilities SA 330 "The Auditor’s Responses to Assessed Risks High audit risk at inherent level = More elaborate audit procedures to be performed before you sign the report SA-400, three components of audit risk- misstatement in transaction, account balance, financial statement



Inherent Risk

Control Risk

Detection Risk

Detection Risk α 1/ (Inherent Risk+ Control Risk)

Comment on what should be the Overall Audit Approach (1) Management responsible for preparation of financial statements (as a going concern), choose and apply proper accounting policies , reasonable accounting estimates to give a true and fair view (t&f) (2) Management responsible for Accounting System and Internal Control (ASIC) (3) Auditor entitled to unrestricted access to records, documentation etc Audit Working Papers (M’10, N’11, M’07, and N’12)

Theme If you haven’t documented, you haven’t performed SA 230 “Audit Documentation (N’08) Utility: Document the Nature, Timing and Extent of Audit Procedures (NTE) performed Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Responsibility since audit staff sign the checklists Allows senior to review audit work by juniors Evidence in the court of law when a charge of negligence is brought against the auditor. Enable the conduct of quality control reviews and inspections in accordance with SQC 1. Engagement Quality Control Review Applicable for audits of financial statements of listed entities etc Quality control reviewer shall review (a) Significant matters with the engagement partner; (b) Financial statements and the proposed auditor’s report; (c) Audit documentation relating to the significant judgments the engagement team made and the conclusions (d) How appropriate are the conclusions reached (e) Firm’s independence in relation to the audit engagement ( for listed company’s audit) Audit Sampling Tasting a spoon of rice to check whether the entire 2 kg in the utensil is good! Principal asking questions from only selected students to form an opinion about the whole batch SA 530, Audit Sampling Applying audit procedures to <100% of the population; samples are selected randomly, checked from beginning to end (Auditing in Depth) and conclusions drawn about the entire population Sampling ≠ Mandatory but if used to form an opinion, he must use standard techniques Sampling ≠ Suitable for high value transactions, disclosures as per Acctg Standards, where Internal Control is weak etc Choice between statistical or non-statistical sampling = function (Professional Judgement) Sample size ≠ valid criteria Advantages Saves time More thorough checking Methods

Random selection Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ (Applied through random number generators, e.g. random number tables)

Sampling Risk: (SA 530) Sampling – repeat concept above Conclusion through checking a sample ≠ Conclusion through checking the entire population Compliance procedure Test of controls Controls are more effective than they actually are Controls are less effective than they actually are

Substantive procedure i.e. test of Wrong Conclusion detail Material misstatement does not Unnecessary happy exist when it actually does Material misstatement when it actually does not

exists Unnecessary sad

Note on Statistical Sampling (M’08) Enables auditor to take calculated risk Effectively manage a large population More detailed examination = Obtain better results than testing the entire population Sample Size = function ( Risk and Desired Accuracy levels) Scientific sample selection, based on mathematical law of probability = No partiality/bias Test Checking-Precautions (i)

Transactions - classified under appropriate heads / stratified if wide variations

(ii) Is Internal Control = Effective? Is accounting data = Reliable? Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ (iii) System of authorization, documentation, recording and evidencing of transaction (iv) No bias in selection of transactions (v) Critical area where no test checks (vi) Sample Size = function ( Desired Confidence ) ; Check more, get more confidence (vii) Materiality of the error to be calculated. Check the material errors thoroughly. Both Apple I-Phone and Samsung Guru fall together! What upsets you more? Test Checking in System Based Audit Check whether accounting system and internal control (ASIC) is reliable Are all transaction recorded? Would Fraud and errors, if any, while preparing the accounts be identified? Correctness of figures? Is Compliance with statutory regulations done? Strong ASIC = Less Audit Weak ASIC =More Audit Note on Analytical Review Procedures (ARP) - SA 520

Evaluations of financial information through analysis of plausible relationships among both financial and non-financial data’ Creates audit evidence w.r.t. Completeness, Accuracy and Validity (CAV) of the data produced by the accounting system Level of reliance on ARP = function (Materiality) ARP = Suitable for Income Expenditure items when not material ARP ≠ Suitable for debtors balances when material, should be backed by corroborative evidence e.g. Subsequent cash receipts for debtors Level of reliance on ARP = function (Assessment of Inherent and Control Risk) If Internal Control over Sales = Weak, Control Risk = High, more reliance on tests of details of transactions and balances than on ARP Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Level of reliance on ARP = function (Controls, if any, over the preparation of information used in applying ARP) For example, an entity in establishing controls over the processing of sales invoices may incl ude controls over the recording of unit sales ARP allows auditor to find out aspects of business about which he didn’t know and thus helps him determine NTE of audit procedures Note on Surprise Checks (M ’05) Improve audit effectiveness Moral check on employees When the auditor will visit the client’s office? What areas? Check efficiency of accounting system and internal control (ASIC) Accounting system - is it upto date? Internal control - is it working? Verification of cash and investments, test checking of stock, verification of accounting records, statutory registers and internal control system Management Representation (MR) If Bharti Airtel has purchased shares of Nestle worth Rs 200 crores, how would the auditor know whether it is long-term/short-term, a matter of intention? It can take a MR for this But MR cannot be used as a shortcut/excuse for not doing audit A doctor can rely on the patient’s statement for telling him whether he gets a sound sleep but not to check whether there is a blockage in his heart since there are tests available for that SA 580 “Written Representations” MR= just like inquiry = Audit evidence used to derive the audit opinion Situations where Only management knows the facts of the case Where matter is principally of intention E.g. intention of management to hold a specific investment for long term MR cannot be a substitute for other audit evidences expected to be available. Auditing Mantras for CA IPCC [email protected]


Auditor can’t obtain MR to reduce costs even there is a method to check the transaction by himself Situation-1 The audit evidences available for checking debtors- say, invoices, debt acknowledgement documents, receipts, statement of accounts, confirmations etc., are available evidences which auditor is duty bound to verify. Just because management has given MR for the debtors, the auditor cannot shirk his responsibility Situation-2 In case of stock of imported material lying with the transporter, auditor to check purchase order, invoice, bill of entry, custom documents and payment of Foreign Currency. Mere client MR will not do Physical verification of fixed assets "at reasonable intervals" Clause 4(i) (b) of CARO 2003 - Auditor to comment whether the fixed assets of the company have been physically verified by the management at reasonable interval “Reasonable Intervals” = function (number of assets, nature of assets, relative value of assets, difficulty in verifications, situation and spread of the assets etc. ) Management decides - Annually / At least once in every 3 years if annual not feasible Auditor to comment Any material discrepancies on verification found? Proper adjustment to accounts made? Obtain a MR Fixed assets are physically verified by the company in accordance with policy Periodicity of the physical verification Material discrepancies noticed during the physical verification External Confirmation

Ask the Outsider SA 505 “External Confirmation”


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ The factors that affect the reliability of confirmations include: (i)

The control which the auditor exercises over confirmation request and responses;

(ii) Who are the respondents? Individuals/Corporates etc? (iii) Any restrictions included in the response or imposed by the management Procedures to be performed by the auditor in expressing opinion on 'going concern' assumption

The asset will not discontinue operations in the near future SA 570, “Going Concern” Cash flow, profit and other relevant forecasts with management. Events after the balance sheet date for items affecting the entity's ability to continue as a going concern. Latest available interim financial statements. Breach of terms of debentures and loan agreements? Financing difficulties in minutes of the meetings of shareholders, Board of directors etc. Status of matters under litigation and claims. Existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assess the financial ability of such parties to provide additional funds. Entity's position concerning unfilled customer orders. Say, Audit is done in May of accounts for year ending 31st March. Focus is on deriving info from events after the balance sheet date Letter of Weakness (LoW) (M’09) Compliance procedure adopted whether internal control system exists and works continuously during review period. If detects any weakness in the control points, issues LoW. Report issued by auditor stating Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ a) Weakness in design of IC and remedial measures b) Lapses in operation of IC ≠ Review and comment on adequacy of the control mechanism for management purpose.



Chapter 4: Internal Control Concept of Internal Control SA-315, “Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and its Environment” Objective = reliability of financial reporting, effectiveness of operations, prevention and detection of errors/frauds, safeguarding of assets, statutory compliance etc SA-400- Risk Assessment and Internal Control: Auditor to obtain an understanding of accounting and internal control systems (ASIC) sufficient to plan the audit and develop an effective audit approach. Should use professional judgement to assess audit risk and to design audit procedures to ensure that it is reduced to an acceptably low level Environment of Internal Control Tata Steel is the second largest private sector steel maker in India/BSE listed/Majority owned by Tata Sons/Board of Directors headed by Mr Cyrus Mistry/ Acquired Corus in 2007- Losses of /Setting up Kalinganagar steel plant in Orissa through a SPV-100% subsidiary/Follows Companies Act 1956, Indian Accounting Standards and IFRS/Writes of relining expenses of blast furnace in year of incurrence instead of capitalising- common practice in steel industry/Recession in European steel industry and high debt are huge risks/In-house internal audit team- Reports to Audit Committee headed by Mr Cyrus Mistry Auditor must understand: (a) Relevant industry, regulatory, financial reporting framework. (b) The nature of the entity, including: (i)

Operations;

(ii) Ownership and governance structures; (iii) Types of investments that the entity is making and plans to make including investments in special-purpose entities; and (iv) the way that the entity is structured and how it is financed (c) Accounting policies, including the reasons for changes thereto. Are they appropriate? Consistent with accounting policies used in the relevant industry? (d) Entity’s objectives and strategies, and those related business risks that may result in risks of material misstatement. (e) Entity’s financial performance (f)

Governance Structure and Review Mechanism


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Internal Control is affected by Organisational Structure – Segregation of incompatible duties; No individual can override the IC system Management Supervision- Devising and maintaining system, periodic review, establish Internal Audit dept Personnel-Integrity and competence of people operating the system Case Study: Mention any six points to be considered for good internal control for collection of tuition fees from students of college

Fee structure approved by college council

Challan: Roll No, Period

Cashier scroll and authorising officer/s scroll should be checked by an officer daily

All remittance should be banked each day

Periodic Arrears list . If conncession, approval? If delay, penaty?

If readmitted after removal for non-payment of fees, permission?

Case Study: A trader is worried that in-spite of substantial increase in sales in YE 31.03.2012 compared to YE 31.03.2011, there is considerable fall in Gross Profit after satisfying himself that sales and expenses are correctly recorded and that the valuation of inventories is on consistent basis, he wants to ensure that purchases have been truthfully recorded. How will you proceed with this assignment?


•Approved purchase requisition for raw materials • Negotiation with suppliers: terms • Inspection report/GRN for goods recd. •Payment Voucher •Physical controls over inventory •Separation of duties w.r.t. processing and recording of purchase transactions.

Analytical procedures

Vouching of purchases transactions

internal control system


•Purchase Book •Indepth examination of select transactions w.r.t supplier's invoice, calculations of duty etc •Numerical sequence of source documents such as purchase requisitions, PO, receiving reports and vouchers •Cut-off points for transactions - recording in correct period

•Compare quantity and value of purchases ; item-wise and location-wise of 2012 with 2011

Examination in Depth (M’00, M’11) Checking a few selected transactions from the beginning to the end Recording of transactions / Authorisations/ Prescribed procedures Requisitions are pre-printed, prenumbered and authorised

Goods Received Note at store

Purchase CycleAudit Trail

Payment and recording

Purchase Order pre-numbered, authorised and placed with approved suppliers

Supplier’s invoice/Purchase Day Book/Posting

As Auditor’s “level of confidence” increases, No of transactions at each successive stage within a depth test decreases Test samples selected Statistical grounds (based on probability theory) Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Also called vertical vouching as against horizontal vouching Sometime it is also referred to as the cradle to the grave approach Tracing from birth to death Audit Risk “SA 200 (Revised) Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing”, audit risk is a function of the risks of material misstatement and detection risk Audit risk = Function of the risks of material misstatement and detection risk Audit risk = Technical term related to auditing ≠ Auditor’s business risks such as loss from litigation, adverse publicity Inherent risk (risk that material errors will occur); Complex Calculations/Estimates/Technological Obsolescence leading to Inventory Overvaluation Control risk (risk that the client’s system of internal control will not prevent or correct such errors); Internal control, no matter how well designed/operated, can only reduce, but not eliminate, risks of material misstatement, because of the inherent limitations of internal control . Human errors or mistakes, or of controls being circumvented by collusion or inappropriate management override Detection risk (risk that any remaining material errors will not be detected by the auditor). Relationship between Detection Risk and the Assessments of Inherent and Control Risks Detection Risk α 1/ (Inherent Risk+ Control Risk)

If IR+CR=high, DR has to be low and thus more persuasive audit evidence Internal Control in small business(M’11) Obtain to obtain same degree of assurance as in large company before he issues unqualified opinion Controls relevant to large entities not practical in the small business Limited staff strength Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Lack of Internal Check: Same person could have both operating and custodial responsibilities; nil or limited segregation of functions In many cases, inadequate segregation of duties off-set by owner’s supervisory controls because of direct personal knowledge of the business Audit Risk: It is reasonable to expect that risk of not detecting errors may go up substantially Perform substantive procedure to get evidence necessary to support auditors’ opinion on f/s Internal Control and the Computerised Information System (CIS) Environment Requirements of Internal Control System at a Service Bureau (M’04) Situation: Dabur Ltd outsources its payroll processing to Mafoi Consultants, an external agency that specialises in payroll processing. Dabur Ltd is the “user” and Mafoi Consultants is “bureau”. But the complexity in internal control arises because Mafoi is an external party 1) Co-ordination between Mafoi and Dabur = clearly defined while senior officers of Dabur appointed as liaison officer 2) System testing including all clerical procedures at the user company 3) If errors identified, prompt correction and resubmission to meet the Mafoi’s processing schedule 4) Clerical control to verify the accuracy of computer processing 5) Since Dabur has no physical control over the files ; it should maintain high control over the data on master files Comment - The overall objective and scope of an audit does not change in an Electronic data Processing (EDP) environment. (M’00) Situation A: Auditing the accounts of a small trader which are maintained manually Situation B: Auditing the account of a small firm which uses Tally Accounting package for accounting Situation C: Auditing the accounts of State Bank of India which uses a complex Enterprise Resource Planning (ER) Package The complexity of audit increases at each stage, because in SBI, the accounting will be mostly system driven. Even interest calculation is done by the computer and credited to customer account automatically Objective of Audit of financial statements = t&f view Scope = function (terms of the engagement, relevant legislation and ICAI) Overall objective and scope = same in EDP environment


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Using a computer -> Change in processing and storage of financial information -> Change in internal control procedure -> Change in auditor’s evaluation procedure for ASIC and NTE of substantive procedures Auditor should have knowledge of computer hardware, software and processing systems; how auditing procedures including computer-assisted audit techniques (CAAT) would be differently applied Comment - “Installation of Computer Operating System has created both benefits and problems for auditors” (M’99, M’04) Difficult to imagine a PC (stand-alone/networked) without an operating system ->Flexibility to user +auditor -> need based extraction of data e.g., region-wise, city-wise, examination centre-wise student records to compare the performance -> sample selection Unless data access restricted - passwords and other access controls; system hacked and database manipulated Comment - ‘Doing an audit in an EDP environment is simpler since the trial balance always tallies. (N’00, M’10) In Tally you make a Journal Entry with a debit and a credit, posting to the ledger and then to the Trial Balance are done by the computer system itself and there is no possibility of any error. However what if an entry got omitted or there was a wrong account credited or capital expense charged to revenue? Merely totalling of the debit and credit column of trial doesn’t make the auditor’s life easy

The statement is true but job of an auditor does not become simpler. At present, arithmetical accuracy ≠ enough; but focus on the nature of transactions recorded in the books Errors of omission / commission/compensating errors, duplication of entries “Window Dressing” and/or “Creation of Secret Reserves” where the trial balance tallied


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Financial instruments like F&O (futures/options), derivatives, off balance sheet financing etc Recording and disclosure of transactions Estimation of provision for depreciation, Inventory Valuation Evidence – Tests of Compliance and Substantive procedure, verification of assets & liabilities their valuation etc. = Judgement to be exercised by the auditor. Responsibility of expressing an audit opinion and objectives of an audit are not changed in the audit in EDP environment Different design and procedural aspects of EDP systems (N’01, M’08)

Consistent Performance

Vulnerability of Data and Programme Storage Media

Systems Generated Transactions

(i)

Programmed Control Procedures

Single Transaction Update of Multiple Computer Files

Consistent Performance: Perform functions exactly as programmed, more reliable than manual systems, but GIGO= Garbage in Garbage Out

(ii) Programmed Control Procedures: Internal control procedures established Controls with limited visibility (e.g., passwords - protect against unauthorized access) Review of reports printed for exception and error reporting (iii) Single Transaction Update of Multiple Computer Files: Single input to the accounting system = automatically update all relevant records (e.g., shipment of goods documents -> Sales and customers’ accounts receivable files as well as the inventory file). (iv) Systems Generated Transactions: Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Certain transactions initiated by the EDP system itself -> no input document. No documented authorisation exists (e.g., in a bank’s ERP, interest may be calculated and charged automatically to customers’ account balances as per pre -authorized terms coded into the computer program). (v) Vulnerability of Data and Programme Storage Media Large volumes of data stored on portable or fixed storage media, such as magnetic discs and tapes - Vulnerable to theft, or intentional or accidental destruction. Consistent/ Control/ Multiple aspects updated/ Auto Transactions/ Vulnerability Organizational Structure in a CIS Environment

Internal Controls in a CIS/EDP Environment (N’02, M’03)

General EDP Controls

EDP Application Controls

EDP Internal controls

General EDP Controls Policies/procedures that aim at control and appropriate segregation of incompatible functions (a) Application systems development and maintenance controls: How new or revised systems are tested, converted, implemented and documented Changes to application systems. Access to systems documentation Buying application systems from third parties. (b) Systems software controls include: Authorisation, approval, testing, implementation and documentation when new systems are bought or modifications carried out Restriction of access to systems software and documentation to authorised personnel. (c) Computer operation controls include: Only authorised people can access use authorised programs on computer for authorised purposes Processing errors are detected and corrected. (d) Data entry and program controls are designed to provide reasonable assurance that : Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Authorisation structure for transactions being entered into the system. Access to data and programs is restricted to authorised personnel. Offsite back-up of data and computer programmes. How to recover in case of theft, loss or international or accidental destruction. How to process off-site in the event of disaster Key Theme Controls w.r.t system implementation/modification, Authorisation for system use, Backup EDP Application Control procedures to ensure that all transactions are authorised and recorded, and are processed completely, accurately and on a timely basis.

Controls over input Authorisation before Transactions ≠ lost, added, duplicated or improperly changed Controls over processing and computer data files Transactions ≠ lost, added, duplicated or improperly changed; If there is improper processing, it is rectified timely Controls over output Data is processed accurately and only authorised people can access the results Key Theme Controls w.r.t transaction processing Control over input in a computerized data system Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Get access to computer through password and logging procedures. Only accurate +authorized input should be allowed to be fed into the system The input document should be reviewed and verified by another person after preparation Validity and cross reference checks in-built in the system to throw light on errors which appear in the process of feeding input Serial control may be used in inputting data that are to follow serial sequence. Approaches to Audit in CIS/EDP Environment

Audit around the computer

Audit through the Computer

Black Box Approach

White Box Approach

Audit around the computer (N’98, M’05, and N’10) The auditor views the computer as a black box, does not directly examine the details of the processing aspects. = Useful when: i) ii) iii) iv)

Generalised software packages (reputed vendor), used widely and thoroughly tested e.g. Tally Small organisations having simple operations; Processing = simple Clear audit trail with detailed reports are prepared at key processing points. We can control input of transactions through normal methods, i.e. separation of duties, and management supervision.

≠ Useful if the system has been customised to suit specific needs ≠ Useful for multi unit, multi location companies, having various inter unit transactions Theme: The auditor takes a printout of all vouchers and books of accounts in Tally and checks them, as if the computer does not exist. The Computing System remains a mystery to him Special audit techniques using the computer as an audit tool Since no audit trail, how can the auditor test whether system functioning effectively? Use Computer Assisted Audit Techniques (CAATs) to check the system’s logic/controls and the system generated records Types of CAATs, viz., test pack or test data, controlled processing and audit software or computer audit programmes. Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Why are Computer Aided Audit Techniques (CAAT) required in EDP audit? (M’ 06, N’07, N’11) Computers systems provide less visible evidence than those systems using manual procedures Absence of input documents: Data may be entered directly into the computer systems without supporting documents. In on-line transaction systems, written evidence of individual data entry authorization, e.g., credit limit approval may not be available. In a manual system, you can check signature of the General Manager on the sales invoice for credit approval. In the computer system, there is a pre-inputted credit limit for Mr Agarwal and till the same is breached, no manual intervention is required and system automatically approves Lack of visible transaction trail: In a manual system, for a Sales transaction of Rs 150,000 made on 3 rd August’12, one can examine a host of base documents such as Invoice, Sales Day Book, Party Ledger, Credit Approval Note, and Sales Reports etc. But in an EDP environment, the transaction trail may be existing in the computer system itself. Lack of visible output In EDP systems, processing output may not be printed or only a summary data may be printed Auditor has to check data stored in computer itself There will be no printouts of millions of customer ledger accounts of SBI customers. The auditor would have to check in the system itself Ease of Access to data and computer programmes Data and computer programmes may be tampered with by malicious people at remote locations There is a chance of unauthorized access to data and programmes Key Dimensions: Input/Processing/Output/Access to data or program How use of CAAT helps? Audit Effectiveness (i) If we use the computer, we can test some transactions more effectively for similar cost (ii) If we use the computer , easier to apply analytical review procedures (ARP), transactions or balance details of unusual items We can save time by reviewing EDP controls using CAAT than through other audit procedures CAAT permits effective examination in depth of selected transactions since the auditor constructs the lost audit trail Efficient examination in depth of few transactions/Audit Trail/ARP/Time Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Internal Check (N’06) General Considerations in Framing a System of Internal Check Basic Principle: Mr X cross-checks work of Mr Y; prevention as well as faster detection of error/fraud. Breaking the chain of the work in a manner so that no single person can handle a transaction from the beginning to the end Rotation of jobs without any previous notice, same officer cannot continuously perform a function for a long period Send staff on leave annually- frauds that he successfully concealed would be detected in his absence. Persons having physical custody of assets ≠ Person having access to the books of accounts. Accounting control w.r.t. each important class of assets; Regular Physical Verification. Budgetary Control At year end, suspend trading activities for stock-taking. To be performed by staff from department other than stock section. Division of financial and administrative powers Scalability : System can expand/contract as per change in size of entity Case Study: In a medium size trading organisation the accountant was given additional responsibility of making recoveries from the debtors. When insurance claim of Rs 50,000 was received, he credited the same to the account of a debtor and misappropriated the cash which he had recovered from the said debtor. Pinpoint weaknesses in the internal control system which led to this situation The principles of Internal Check involved here: Breaking the chain of the work in a manner so that no single person can handle a transaction from the beginning to the end Segregation of accounting and custodial functions Weakness in this case: a) The person collecting cash is making entry in books of accounts b) No system of issuing receipts for cash/cheque received c) Normally, supervision by owner in small cos. off-sets weakness in Int. Control but same is lacking Internal Audit Thorough examination of the accounting transactions/system to check i)

whether the accounts are being properly maintained


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ ii) system contains adequate safeguards to check any leakage of revenue or misappropriation of property or assets and iii) operations have been carried out in conformity with management’s plans Internal auditor of the company cannot be its cost auditor- S 233B of Companies Act Independence of Internal Auditor (M’o5) Internal auditor is part of management but evaluates efficiency of management itself at various levels; Independence = necessary for efficient discharge of duties , say if an internal auditor who is an employee of ITC Ltd will not be able to point out the mistakes of the operations /finance/logistics department unless he is independent So internal auditor = responsible directly to the Board of Directors through Audit Committee, can communicate findings directly If internal auditor is made subordinate to lower level, independence = reduced, efficiency = reduced However, Independence of internal auditor < statutory auditor as statutory auditor expresses an opinion on financial statements (f.s.) If external CA firm = internal auditor instead of an employee, independence= more Relationship between the Statutory and the Internal Auditors Internal auditor = integral part of the system of internal control Statutory auditor must examine the internal auditor’s work w.r.t. scope, independence and effectiveness. Also has to opine in CARO 2004 Roles and primary objectives of internal and statutory audit = different, means of achieving = similar Internal auditor’s work = Useful to the statutory auditor in determining the nature, timing and extent (NTE) of audit procedures If efficient, Statutory Auditor may rely on Internal Auditor’s work w.r.t. internal control, verification Difference between the Statutory and the Internal Auditors (M’ 07) STATUTORY AUDITOR Scope determined by statute To opine whether financial statements= true & fair view Responsible directly to the shareholder ≠ Employee of company. Independence = more


INTERNAL AUDITOR Scope determined by management To ensure accounting system = efficient, accurate and discloses material facts. Responsible to management. = Employee of company. Independence = lesser

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Evaluation of Internal Audit! Can the External Auditor rely upon the work of an Internal Auditor? (N’03) SA 610 “Using the Work of Internal Auditors” Factors which external auditor should consider for evaluating the work of the internal auditors a) Size of the internal audit department? Areas covered by it? b) Is the internal auditor independent/objective (IOI)? How independent is the audit function in the company? Whether they any restrictions imposed? Does he have direct access to top management? Are his recommendations viewed seriously by top management and acted upon? c) Is he technically competent? Are he is a member of professional bodies? Trained adequately in the function? Established policies for hiring and training in the company? Compliance with the mandatory/ recommendatory Standards on Internal Audit (SIAs) issued by Internal Audit Standards Board of ICAI? d) Does he do his work with due professional care? Is work planned, supervised, reviewed and documented? Audi t manuals/audit programs/ documentation? e) How is the communication between Internal Auditor and Statutory Auditor? Regular meetings held? Access to internal audit report, critical matter raised etc? Requirements of Companies Audit Report Order (CARO), 2003 (M’12) Clause 4(vii) of CARO, 2003 requires the auditor to comment whether the company has an internal audit system commensurate with the size and nature of the business



Listed on a recognised stock exchange as on the date of the balance sheet

Paid up Capital+Reserves > Rs 50 lacs

Average turnover > Rs 5 cr for 3 yrs preceding the current yr

Case: A company has ` 75 lakhs of paid up Capital and ` 4.5crores of average Annual Turnovers of past three years immediately preceding the financial year under audit. The company does not have any Internal Audit system because the Management does not think it necessary. Comment as an auditor of the above company. As per CARO provisions, an auditor is required to comment on the Company’s internal audit system if its paid up capital and reserves exceeds ` 50 lakhs as at the commencement of the financial year or its average annual turnover exceeds ` 5 crores for consecutive three financial years preceding the financial year concerned, whether the company has an internal audit system commensurate with size and nature of the business. Therefore, in the above case, because company’s paid up capital and reserves exceeds ` 50 lakhs, the auditor has to comment under CARO that the company does not have an internal audit system. Scanner-Chapter 4 True/False (2 marks each) 1) There is direct relationship between detection risk and combined level of inherent and control risk-N’07 2) If internal control is satisfactory, external evidence is more reliable than internal evidence-N’07 3) Internal auditor of the company can also be its cost auditor-N’07 4) SA-400 establishes standards about procedure to be followed to have an understanding of Accounting and Internal Control system-N’08 5) The environment in which internal control operates has no relationship with effectiveness of internal controls-N’08 Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ 6) The overall objective of audit changes in Computer Information System (CIS) environment-N’09 Solution Key: Q 1: False, Q 2: False, Q 3: False, Q4: True, Q 5: False, Q 6: False

Question

Term

Marks

Steps required to assess Internal Audit Function of an enterprise

M’98

8

Auditing through the computer

M’98

6

Comment- Use of computer facilities by a small enterprise may increase the control risk Different types of internal control that you will examine as auditor in a N’98 computer based system Auditing around the computer Vs Auditing with the computer N’98,M’05,N’10

8 8/6

Comment- Installation of computer operating system has created both M’99,M’04 benefits and problems for auditors Comment: A senior assistant of X & Co drew up his audit programme M’99 without evaluating internal controls of T Ltd as the controls were developed by GM-Finance of T Ltd who is himself a CA and has authored some books on Internal Control Explain approaches to EDP auditing N’99, M’02

6/4

Comment- Auditor is entitled to rely upon work performed by others

M’00

4

Comment-Overall objective and scope of an audit does not change in an M’00 EDP environment

6

Examination in Depth

M’00,M’11,

4

Audit Trail

N’00

4

5

7

Doing an audit in an EDP environment is simpler since the trial balance N’00,M’10 4/5 always tallies General considerations in framing a system of Internal Check M’01,M’06,M’12 8 Design and procedural aspects of EDP systems

N’01,N’08

8

Internal Controls in an EDP environment

N’02,M’03

16/8

Can the statutory auditor rely upon work of Internal Auditor

N’03

8

Aims of Internal Control in relation to Financial and Accounting Aspects

N’03

12

Comment: In spite of internal control weakness commented upon by N’03 audit manager, no further tests need to be carried out as Gross Profit % is same as previous year What are the important requirements of Internal Control System at a M’04 Service Bureau Audit Trail in computerised accounting environment N’04

3

Independence of Internal Auditor

M’05

4

Control Risk

N’05

2


10 4

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Comment=Is there any change of audit approach in audit of N’05 computerised accounts as compared to audit of manual accounts Why are CAAT required in EDP audit/ Advantages of CAATs? M’06,N’07,N’11

8

Internal Checks

6

N’06

10/8/6

Comment: JKT Ltd has Rs 40 lacs Paid up capital, Rs 9.5 lacs reserves N’06,N’08 and turnover of last 3 consecutive years preceding the financial ye ar under audit being Rs 4.9 cr, 4.5 cr and 6 cr but does not have any system of internal audit. In view of management, internal audit system is not mandatory Relationship between Statutory Auditor and Internal Auditor M’07

4

Circumstances where auditing through the computer may be used

M’07

5

Internal Control Questionnaire Vs Internal Control Evaluation

M’07

5

How would you assess the reliability of internal control system in CIS

M’08

6

Comment: Director-Finance of KK Ltd informed their newly appointed statutory auditor that they have sound internal control system implemented by a renowned professional firm and he is satisfied with the efficiency and so statutory auditor should concentrate on verifying only routine books and financial statements Comment- PP Ltd, a garment exporter asked their internal auditor, a practising chartered accountant to conduct physical verification of the year- end inventory and report of such verification was handed over to the statutory auditor. Can he rely on the same Mention any 6 points for good internal control for collection of tuition fee from students of college Internal Controls in CIS environment

M’08

8

M’08

6

M’09

6

M’10

5

Explain the technique of ‘Internal Control Questionnaire’ to facilitate N’10 the accumulation of information necessary for evaluation of internal control Internal Control in Small Business M’11

4

Objectives of Internal Audit

N’11

8

CARO requirements w.r.t. Internal Audit System. Factors to be M’12 considered by auditor to check whether Internal audit commensurate with the size and nature of the business

8


5

4

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Chapter 5: Vouching Short note on Vouching/Comment- ‘In vouching payments, the auditor does not merely check proof that money has been paid away’ (N’05) Vouching = Substantive audit procedure = Verifying the genuineness and validity of a transaction in the primary books of accounts Examination of documentary evidence to support the genuineness Vouching = verifying the genuineness and validity of a transaction ≠merely checking arithmetical accuracy Examination of documentary evidence to support the genuineness Recorded in correct account? correct year

Authorisation for transactions

Vouching

Disclosed per acctg policy/standard ?

Completeness of recording

Vouching = Backbone of auditing; If vouchers ≠proper, financial statements correct



Operating Lease

Finance lease

Recognise expense on straight line basis over the lease term

Disclosure

Risks and rewards incidental to ownership transferred: AS-19

Revised Schedule VI

Asset and Liability @ Present Value of future payments

Assets acquired under finance lease are segregated from assets owned

Payment of Expenses

Authorisation

Accounting for pre-paid component

This accounting year only? ≠ prior period?

Relevance to business; ≠ Personal Expenses

Payment Voucher, supporting documentation

Payment of Taxes (N’11) Base Documents= Assessment order, assessment form, notice of demand and receipted Chillan Interest allowed on advance payments = Income under Interest account Penal interest charged for non-payment= Expense under Interest account Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Salaries and Wages(M’05)

Internal Control

Approval

Computation

Fraud

Dummy Workers?

Attendance

Overtime and piece work

Arithmetical Accuracy

Appointment , promotion, transfer and discharge

Advance to employee

TDS

Disbursemen t of wages

Wages and salary bills

ESIC/Provide nt Fund

Retired Employees included?

Unclaimed wages

Excess Leave

Payment in bank statement

Bankruptcy Dividends When a debtor has been sued for bankruptcy, it is necessary to prove that the debt is due from him to the Official Receiver or Assignee before any amount can be recovered from his estate. Correspondence with the Official Receiver or Assignee to find particulars of part amounts already collected and the balance outstanding at the beginning of the year. Sale of Investments (N’99,M ’06) Is sale of investments approved by Board or other competent authority? Sold through broker, directly or through a bank? Check broker note Sales proceeds, net of expenses and STT Vs Carrying amount (Weighted average Cost= Total Holding Cost/Total Shares* No of Shares Sold) -> Profit & Loss Account Disclosure as per AS-13 Interest, dividends, rentals on investments are to be shown in P& L A/c at Gross Value and TDS as Advance Tax Paid Showing separately profit & Loss on disposal and changes in carrying amount of current and long term investments


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Sale of Assets (N’98) Internal Control? Authority for sale? Basis of sale, whether by auction or by negotiation? Was maximum price obtained? Accounting for sale proceeds! Computation of Profit/Loss on Sale Loans

Loan Balance

Securities

Reconcile Pass Book

Securities deposited as mortgage

Certificate from bank

Registered with Registrar of Companies

Recorded in the Register of charges

Bank Overdraft (N’09)


Approval

Board of Directors

Is limit for borrowing u/s 293 of Companies Act maintained?

Utilisation

Purpose for loan?

Funds used properly?


Clean/against hypothecation or pledge ?

Loan Balance

Reconcile Pass Book

Registered with Registrar of Companies

Certificate from bank

Recorded in the Register of charges

Approval

Board of Directors

Disclosure

Under ‘secured loans’ Nature of security = disclosed

State any six important points to be examined by you, as an auditor, in verifying the correctness of bank balance of an Educational Institution which deposits all its collection/receipt in separate collection account of a bank Ledger

Compare entries in ledger with bank pay-in slips Compare entries in ledger with bank statement and prepare BRS Casting, carry forwards and balancing

BRS

Check for correctness Subsequent clearance (Cheque deposited but not cleared features as an item in BRS on 31.03.12 should be cleared in Apr’12

AUDIT OF PURCHASES



Purchase Requisition (from stores/factory to purchases ) at preapproved re-order points

Accounts Payable dept receive the invoices and process for its payment ; check for accuracy

Purchase Dept negotiates with approved vendors; issued serially prenumbered PO

Good Received Note prepared after Inspection; locked warehouse and access to authroised personnel

Purchases transactions

Examine Purchase book Vs Invoice

Purchase requisitions, purchase orders, receiving reports

Transactions with Related Parties

Cut-off points

Compare with market rates

Analytical Procedures

Variations w.r.t last year

Examine Purchase Invoices Bill of lading, customs clearance, etc. for imported

Sequence of documents

item-wise and location-wise

Subsidies, rebates, duty drawbacks accounted for ?

While conducting the audit of the accounts of a manufacturing company, you discover that the rate of Gross Profit on Sales has sharply risen in comparison to the previous year. State the steps you would take to satisfy yourself



Increase in Selling Price

Reduction in Cost of Manufacturing

Is it increased?

Stock and purchases records w.r.t. large purchases

General/Specific? Why?

Compare with last year

Impact of Automation

Adherence to Cut-off Procedures

Automation of certain manufacturing processes ?

w.r.t Closing stock and workin-progress

Savings in Labour Costs w.r.t last year?

Prescribed procedure followed?

Change in Sales Mix

More profitable lines consistite a greater % of sales?

Manipulating Sales

Are goods on ‘sale or return’ basis included in Sales?

Test-check relevant transaction s? While conducting the audit of accounts of a manufacturing company, you discover that the rate of Gross Profit on Sales has sharply decreased in comparison to the previous year. State the steps you would take to satisfy yourself. What are Potential reasons? Stock valuation Change in stock valuation basis Auditing Mantras for CA IPCC [email protected]

Undervaluation of closing stock or overvaluation of opening stock Change in valuation basis for Opening & Closing Stock

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Purchase Last year purchases included in this year Sales Reversal of fictitious sale recorded last year to boost up profit Sales return Entry passed twice Purchase return Entry not passed whenever goods are returned to suppliers Provision Excess provision for wages or direct expenses? Goods sent out for sale on Not included in closing stock? approval or consignment? Classification Expenses to be charged in P&L wrongly charged to Trading Account. So GP% impacted Insurance claim Received w.r.t. goods lost in transit or destroyed by fire, not credited in Trading Account Purchases Returns (N’98, M’08)

Accounting Basis

Credit Note by party

Stores Record/Goods Outward Book

Recorded in books

Check original Invoice

Any rebate in rates over Original Amt?

Fraud Possibility?

Is amount substantial at beginning or end of year? Possibility of fictitious sales returns in current year for covering bogus sales recorded earlier? To reduce profits , Last yr:

Purchase A/c Dr to Party A/c , This year : Party A/c Dr to Purchase Return

CUT-OFF ARRANGEMENT (M’02, M’03,N’07,N’09,M’11,N’12) If transactions of the Year 2012 are separated from those in the Year 2013, we can correctly ascertain the results of Year 2012


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Purchases, sales and Stock Transaction of Year 2012 separated from Year 2013

Goods purchased where property has passed to client

Included in inventory, Purchase A/C Debited , Vendor credited

Goods Sold

Excluded from inventory, Sales A/C Credited , Customer debited

Auditor to test check a series of samples pertaining to period shortly before and after the cut-off date to assess the accounting in stock etc AUDIT OF LEDGERS General Considerations (i) Is Internal Check= Appropriate? (ii) Tracing the opening balances from the previous year’s records (iii) For receivables and payables, sale or disposal of fixed assets and of inventories, are they disposed during the year? (iv) Postings from subsidiary books (v) If = self-balancing system, is totals of balances in subsidiary ledgers = total of control account? (vi) Checking the closing balances of individual accounts on the balance schedules afterwards from the schedules on to grouping schedules and then into the final accounts; (vii)Checking the totals of ledger accounts, trial balance, schedules and groupings; (viii) Verifying the balances in personal accounts, either with the statements of account or confirmation of balances obtained from the parties; (ix) Verifying the balances in impersonal accounts, viz., those of fixed assets, bank balances, etc. with the schedules containing details of assets and liabilities as well as those of nominal accounts (x) Scrutinizing the accounts generally and Ledger Keeper and Frauds Frauds that can be done by ledger keeper in bought ledger: Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Crediting supplier’s account based on a fictitious invoice (showing that certain goods received whereas in fact no goods have been received) and subsequently misappropriating the payment made against the credit in the supplier’s accounts. Not disclosing a credit note issued by a supplier in respect of return or an allowance and misappropriating an amount equivalent Crediting an amount due to a supplier not in his account but under a fictitious name and misappropriating the amount paid against the credit balance. Frauds that can be done in sales ledger: Teeming and Lading:

X Z

Y

a) Misappropriate amount received from Customer X, b) To prevent detection, money received from Customer Y credited to the account of the X and money received from Customer Z credited to the account of the Y c) Such a practice is continued so that no one account is outstanding for payment for any length of time, which may lead the management to either send out a statement of account to him or communicate with him. Unauthorized credit or fictitious rebate, allowance, discount, etc. in the account of Customer;, misappropriating an amount equivalent when payment received Writing off as bad debt and misappropriating the amount received in payment of the debt. Scrutiny of Ledgers(M’06) Final review of balances before inclusion in Final Accounts- P&L and balance Sheet; hence important Check posting: Cash Book, Journal, Sales Book, Purchase Book etc (after verifying totalling) -> General Ledger -> Trial Balance -> Final Accounts Balances in Income/Exp accounts adjusted: Accrued Expenses, Prepaid Expenses, Accrued Income, Legal provisions What points shall an auditor keep in mind while auditing an account of Bought Ledger having a debit balance? Amount receivable on account of goods returned, rebate allowed by the supplier or advance paid against an order Advance as per recognized trade practice? Subsequently, have goods been received? Is balance recoverable? Provision for bad debts? Is cost of goods purchased wrongly debited to supplier? Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ If the debit balance represents a loan to a director or officer of the company, either jointly or severally with another person or private company in which the director is a partner or a member, disclosure?



Chapter 6: Verification of Assets & Liabilities CAPITAL AND REVENUE EXPENDITURE Capital Expenditure Acquiring fixed assets, benefit of enduring nature of a valuable right etc. Revenue Expenditure Benefits is derived within 1 year or exhausted in the process of earning revenue Comment- Cost of structural alterations amounting to ` 60,000 to self-owned factory premises has been charged to Building Repairs Capital expenditure =

Subsequent expenditure on fixed assets

Beyond previously assessed standards of performance

increases the profitability or capacity

"Structural alteration” = Some significant changes might have taken place in the design of building to provide more strength to the building or expansion in the capacity of the building Adjustment Building A/c Dr To Repairs A/c Provide Depreciation Comment- A Ltd wanted to treat the heavy advertisement expenditure incurred by them to launch a new product as Revenue expenditure. The product did not pick up and the sales were negligible. It is anticipated that no material benefit will accrue in future from such heavy advertisement expenditure Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Advertisement expenditure is generally of revenue nature and thus written off to P&L ≠ Intangible asset as per AS-26 RESERVES Reserves v. Provision (M’01,M’07,M’12) Provisions Charged against revenue to provide for depreciation, renewal or diminution in value of assets or a known liability where amount ≠ substantially accurate or a claim which is disputed

Reserves Created for some definite purpose out of the profits of the company Dividend equalization, replacement of fixed assets, expansion of the organization, Incometax liability for future foreign exchange fluctuation etc

Amounts set apart to meet specific liabilities

Statutory -> Funds for redemption of debentures and development rebate reserve. Created only if profit available

Charge against profit. Provide even if no profit

Appropriation of profit

Specific Reserves To comply with Articles of Association/ Board decision to meet a particular situation; this may arise in the future/created under contractual obligations or legal compulsions such as Income Tax Act VERIFICATION OF ASSETS General Principles Not enough to verify correctness, must verify existence

Valuation of Assets General Principles Regarding Verification of Assets



Cost

Vouching

Difference between Capital & Revenue

Ownership

Valuation

Documents of title ?

Basis

If held by 3rd party, then inspect

If change, then disclosure

Existence

Presentation in Accounts

Physical Inspection

or obtain certificate

Investments

Details

Date/Rate

Long term/short term?

Rate

Schedule

Compare with quotations?

Physical verification

Amt in cheque book counterfoils and bank statements

Cumdividend/ interest/right /bonus.

investment certificate

Compliance with the disclosure

Stock-in-Trade Guidance Note on Audit of Inventories issued by ICAI Obtain sufficient/ appropriate audit evidence w.r.t inventory Auditing Mantras for CA IPCC [email protected]

Accounting in books

CARO, 2003

AS-13

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Evaluate internal controls and then substantive procedures

Examination of records/Valuati on and disclosure of inventories as per AS-2

Attendance at stock-taking

Analytical procedures

3rd party confirmation and management representation

Verification must be done at least yearly, if not more frequently within a year CARO 2003 - Auditor to comment on a) adequacy and reasonableness of physical verification of inventory b) whether accounting was done for discrepancy, if any, observed in such a physical verification What points shall an auditor keep in mind while auditing an account of Bought Ledger having a debit balance? May represent the amount receivable on account of goods returned, rebate allowed by the supplier or advance paid against an order Is advance as per recognised trade practice? Have goods been subsequently received? If long outstanding, is it recoverable? Debit balance due to wrong accounting? Debiting supplier instead of purchases? Disclose maximum account due from the directors/ other officers of the company at any time during the year and debts due from companies under the same management Advance given to a director of a company



Approval

Accounting

Articles of association Section 295 ; if public company, Central Govt approval

Confirmation received

Bank book/cash book entries

AS 18

Related party transaction

Contract /loan agreement terms, interest

Interest charged?

Cash at Bank

Bank Balance

Reconciliation items

Reconcile Pass Book

Subsequent clearance?

Certificate from bank for balance

Outstanding for an unduly long period? writeoff?

Certificate for fixed deposits

Remittances in transit, subsequent credit entry?

Disclosure

Balances/deposits with specific charge

Material blocked balances Foreign banks with exchange control restrictions Banks under moratorium or liquidation

Reverse stale cheques Also if entity maintains a large number of bank accounts, not justified by its size, exercise greater care to check genuineness of banking transactions and balances CARO, 2003 Requirements Auditor to comment on creation of security or charge in respect of debentures issued by the company by creating proper charges on the assets of the company Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ EVENTS OCCURRING AFTER THE BALANCE SHEET DATE (N’98) Explain the meaning of the term “subsequent events” as used in SA 560 (N’01) Events between the date of the financial statements and the date of the auditor’s report, say for YE Mar’13, the news of a major customer defaulting in payment of Rs 5 crores in May’13 Consideration of Subsequent Events by the Auditor Auditor should consider effect of subsequent events on financial statements and auditor’s report Treatment would depend upon whether it is ‘adjusting event’ or ‘non-adjusting event’

Adjusting Events

Nonadjusting events

Subsequent Events

Adjusting events = Provide further evidence of conditions that existed at the date of the balance sheet; Non-adjusting events = Indicative of conditions that arose subsequent to date of the balance sheet Auditor must consider all subsequent events Check whether accounts adjusted/event simply disclosed Consideration of Subsequent Events by the Auditor(M’03) To be done as per SA-560 (in a separate chapter on SA) You are the Auditor of a Manufacturing Company, whose year ends on 31st March. An event occurred after the year ended, but before you complete the audit. The audit report issued by you is dated 20th July. The Sales Ledger balance at 31st March was Rs95, 000. By 20th July Rs65,000 only had been received against this amount as full and final payment SA 560 “Subsequent Events Subsequent realisation has been good, assurance about reliability Auditor to consider actual past experience of collections from debtors


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Calculate how much provision was assessed in respect of bad and doubtful debts having regard to recovery position, due date, legal cases, cheques dishonoured, etc. as on March 31 Revision of provision against outstanding amount required? You are a Principal Auditor of Sri Company Limited which has three branches the accounts of which are subject to audit by qualified branch auditors. One of the branch auditors qualified his report for non-provision of doubtful debts which he considered to be material for the company as a whole. Subsequent to their reporting, but before you could sign the audit report on the accounts of the company as a whole, the management informed you that the debt under the subject-matter of qualification in Branch Auditor’s report had been fully recovered. This is a subsequent event within the meaning of SA 560 Subsequent event would include events between the date of audit report of the component (branch) and the date of signing the audit report of the entity as a whole Auditor should omit qualification as the debt is no more doubtful as it has been recovered in full Substantial vouching of the recovery should be done PRIOR PERIOD AND EXTRAORDINARY ITEMS AND CHANGES IN ACCOUNTING POLICIES AS-5 Scanner CAPITAL & REVENUE EXPENDITURE Question

Term

Marks

Is repairs done to building shortly after purchase=capital/revenue?

N’98

4

Is costs of raising a loan=capital/revenue

N’98

4

Z Ltd wanted to treat the heavy advertisement expenditure incurred on M’99 product launch as a Revenue Expenditure. The product did not pick up and the sales were negligible Comment- cost of structural alterations amounting to Rs 60,000 to self- M’01 owned factory premises has been charged to Building Repairs

4

Verify-Deferred Revenue Expenditure

M’01

4

Comment-A company whose accounting year ends on 31st March,2001 has N’01 placed an order with Globe Machinery Ltd, Bombay for machinery costing Rs 20 lacs against cash payment during the month of June’01. The company has added a foot-note to the Balance Sheet as on 31st March’01 showing separately that a capital contract has been entered into which requires the payment of Rs 20 lacs in cash Comment- A company has scrapped a semi-automatic part of a machine (not N’01 entirely written off) and replaced with a more expensive fully automatic part,

4


4

5

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ which doubled the output of the machine. At the same time, the machine was moved to a more suitable place in the factory, which involved the building of a new foundation in addition to the cost of dismantling and reerection. The company wants to charge the whole expenditure to revenue Comment-A company has made additions to its factory buildings by its own workmen, at a cost of Rs 450,000 for wages and materials. The lowest estimate from an outside contractor to carry out the same work was Rs 600,000. The directors contend that as they were fully entitled to employ an outside contractor, it is reasonable to debit the Factory Building Account with Rs 600,000 Comment- A publishing company undertook repairs and overhauling of its machinery at a cost of Rs 2.50 lacs to maintain them in good condition and capitalised the amount as it is more than 25% of the original cost of the machine Comment-Interest on loan borrowed to purchase a machinery which has been installed 2 years back is still debited to Machinery Account Rs 5 lacs paid by a pharma company to the legal advisor defending the patent of a product treated as capital expenditure Verify- Research and Development Costs

N’01

4

N’02

3

N’02

3

N’02

3

M’03

4

N’07

4

What is depreciation of fixed assets and why is it provided? Can a company M’98 change its method of providing depreciation How would you audit the following year-end adjustments made by a manufacturing company a) Provision for outstanding expenses M’99

5

Distinguish between capital expenditure and deferred revenue expenditure DEPRECIATION & RESERVES

4

b) Prepaid Expenses

M’99

4

c) Provision for depreciation

M’99

4

d) Proposed Dividends

M’99

4

Comment-The method of depreciation on plant & machinery is to be charged N’00 from SLM basis to WDV basis from the current year Verify- Provision for Income Tax N’00

4

State briefly the duty of an auditor – No depreciation has been charged for M’01 the year 31st March’01, with respect of a spare bus purchased during the year and kept ready by the company for use as a stand-by on the ground that it was not used during the year. Difference between Depreciation and Fluctuation in value M’01

5

Difference between Reserves and Provision

5

M’01,M’07, M’12 Comment- a company has not provided depreciation on the plea that the N’01 machinery has been maintained in excellent condition and is as good as new


4

4

5


Chapter 7: Company Audit-1 SECTIONS 224.

Appointment and remuneration of auditors

224A

Auditor not to be appointed except with the approval of the company by special resolution in certain cases

225

Provisions as to resolutions for appointing or removing auditors

226.

Qualifications and disqualifications of auditors

227.

Powers and duties of auditors

228.

Audit of accounts of branch office of company

229.

Signature of audit report, etc.

230.

Reading and inspection of auditor’s report

231.

Right of auditor to attend general meeting

232.

Penalty for non-compliance with sections 225 to 231

233.

Penalty for non-compliance by auditor with sections 227 and 229

233A

Power of Central Government to direct special audit in certain cases

233B. Audit of cost accounts in certain cases Qualifications of an Auditor = Chartered Accountant within the meaning of the Chartered Accountants Act, 1949 If firm is appointed such as E&Y/KPMG, all partners practicing in India are qualified for appointment Disqualifications of an Auditor u/s 226(3)



Body Corporate (but LLP is allowed)

Officer or an employee of the company or Partner/Employee of Officer or an employee

Indebted/Guarantee > Rs 1000

Holding any security ; (instrument which carries voting rights)

Disqualified if disqualified for Holding/Subsidiary/Fellow Subsidiary Relevant date for reckoning disqualification is the date of appointment viz the date of resolution passed by the company to effect such appointment APPOINTMENT OF AUDITOR Appointment by shareholders U/s 224(1) at each AGM by Ordinary Resolution Company -> Auditor (within 7 days of appointment /reappointment) Auditor -> Registrar of Companies (RoC) in Form 23B (within 30 days) Appointment of the First Auditor By the Board of Directors within 1 month of company’s registration If BoD doesn’t appoint in 30 days, then shareholders can in General Meeting through Ordinary Resolution (≠ AGM) Tenure = till the conclusion of the first AGM Auditors appointed by BoD may be removed by the company at a General Meeting Auditor can’t be appointed as first auditor simply because his name stated in Articles of Association First Auditors are not required to communicate acceptance of audit to RoC Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Reappointment of retiring auditor @ Each AGM, shall retire and be re-appointed by shareholders by a specific resolution But retiring auditor cannot be deemed to be re-appointed automatically Tenure = till next AGM, hence even if AGM not held in time limits u/s 166 and 210, shall continue office

Not qualified/has attracted disqualification u/s 226(3)

= Unwilling to be re-appointed

Retiring audior not reappointed

Resolution @ AGM appointing somebody else instead of the retiring auditor or specifically that retiring auditor shall not be re-appointed

Notice of intended resolution to appoint some other person in place of the retiring auditor is received by the company that could not be proceeded with due to death, incapacity or disqualification

Filling of a Casual Vacancy u/s 224(6) (N’12) Due to death, resignation, disqualification, dissolution of the firms of auditors etc If a firm such as Deloitte has been appointment and Mr. X, a partner dies; it’s a reconstitution of firm and not a case of casual vacancy

Normal reasons

Board of Directors

Resignation

Shareholders in a General Meeting

Due to


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Auditor’s independence: If the auditor has resigned due to some abuse of authority or financial impropriety, he should get a chance to bring that to shareholders Cases No AGM was held for the year ended 31st March, 2010, in XYZ Ltd., Ninu is the auditor for the previous year, whether she is continuing to hold office for current year or not. U/s 224(1), tenure = from conclusion of one AGM until conclusion of the next AGM. Since AGM is not held within the period prescribed, will hold office till annual general meeting is actually held and concluded. NM & Co., Chartered Accountants were appointed as the auditors of a public limited company in their Annual General Meeting. Various co-operative and term lending institutions held 51% of the paid-up share capital of the company 51% held by various co-operative and term lending institutions Specify provisions of Section 224A criteria for special resolution for appointment of auditor where 25% of shares held by government etc If we assume that the organisations were covered u/s 224A criteria Special resolution = necessary Appointment of NM & Co. = null and void Specify provisions of Section 619 and 619Bcriteria Section 619 and 619Bnot applicable as co-operative and term lending institutions are not covered within the definition of corporation/institution owned by the Central/State Government Comment-Mr.Aditya, a practising chartered accountant is appointed as a “Tax Consultant” of ABC Ltd., in which his father Mr.Singhvi is the Managing Director If CA = appointed as an auditor, should disclose his interest while making the audit report Else= misconduct” under the Chartered Accountants Act, 1949 Since Mr Aditya = “Tax Consultant” and ≠“Statutory Auditor”, not liable to disclose his relationship A, a chartered accountant has been appointed as auditor of Laxman Ltd. In the Annual General Meeting of the company held in September, 2009, which assignment he accepted. Subsequently in January, 2010 he joined B, another chartered accountant, who is the Manager Finance of Laxman Ltd., as partner


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ u/s 226(3) provisions for disqualifications of auditors Any person who is a partner or in employment of an officer or employee of the company will be disqualified If disqualifications attracted after appointment, he shall be deemed to have vacated his office as an auditor A, an auditor of M/s Laxman Ltd., joined as partner with B, who is Manager Finance of M/s Laxman Limited, has attracted clause (3) (c) of Section 226 and, therefore, he shall be deemed to have vacated office of the auditor An auditor became aware of a matter regarding a company, only after he had issued his audit opinion. Had he become aware of the same prior to his issuing the audit re port, he would have issued a different opinion. Auditor entitled u/s 231 to attend any general meeting of the company; to receive all the notices etc. and be heard at any general meeting segment where it concerns them as auditors. Normally auditor considers subsequent events only upto the date of issuance of the audit report. But if directors concealed deliberately a serious fact from the shareholders 9which could have altered audit report) and this came to auditor’s attention after issuance of the audit report, he should exercise this right and bring to shareholder’s notice Companies (Auditor’s Report) Order, 2003 (CARO, 2003) All companies including a foreign company as defined u/s 591 Banking companies, insurance companies and Section 25companies = Exempt Private companies fulfilling certain conditions= Exempt Manufacturing company = company engaged in any manufacturing process as defined in the Factories Act, 1948 Finance company = company engaged in the business of financing, whether by making loans or advances or otherwise, of any industry, commerce or agriculture and includes any company engaged in the business of hire-purchase, lease financing and financing of housing; Investment company = company engaged in the business of acquisition and holding of, or dealing in, shares, stocks, bonds, debentures, debenture stocks, including securities issued by the Central or any State Government or by any local authority, or in other marketable securities of a like nature, etc Exemption(M’05)



Banking company

Insurance company

Section 25 company

Private Ltd Co: Paid-up capital+Reserves (Capital+Revenue) <50 lacs, Turnover <5 cr and outstanding loan from any bank/FI <25 lacs , even if short-ter,

Turnover excludes Sales tax collected or excise duty collected if they are credited separately to sales tax account or excise duty account; Trade discounts Sales return even if the returns are from the sales made in the earlier years. Income received by way of rent or dividend/interest Turnover Includes Commission allowed to third parties; CARO = applicable to a private limited company if, at any point of time, during the financial year covered by the audit report: Paid-up capital and reserves exceed the limit of rupees fifty lakh; Loan outstanding exceeding rupees twenty five lakh, Turnover exceeds rupees five crore. Matters to be Included under CARO, 2003


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Chapter 8: Company Audit-2 Books of Accounts u/s 209 U/s 209, company must maintain proper books of account at its registered office a) b) c) d)

Receipts/payments Sales and Purchases Assets and Liabilities If company engaged in production, processing, manufacturing or mining activities , Cost records (utilisation of material or labour etc) prescribed by CG for that class of company

Board of Directors may decide to keep at some other place but must pass Board Resolution and give notice to RoC within 7 days Must maintain proper books of account relating to transactions effected at the branch office; also arrange to obtain from the branch proper summarized returns, at intervals of not more than three months, for being kept at the registered office Proper books of Accounts u/s 209(3)

True & Fair value

Double Entry system

Accrual Basis ; ≠ Cash Basis

AUDIT OF SHARE CAPITAL General Programme for Verification of Share Capital 1) Authorized capital Verified w.r.t. amount shown in the Memorandum of Association Previous year audited balance sheet may also be seen 2) Issued capital Verify the amount of issued capital w.r.t last year audited balance sheet. Has Central Government issued any notification for conversion of debenture or loan into equity share under section 94A? Auditing Mantras for CA IPCC [email protected]


3) Further issue of capital a) Compliance with conditions of issue contained in MOA and AOA, Prospectus or Statement in lieu of Prospectus, shelf prospectus, red-herring prospectus and information memorandum etc b) First allotment made only when minimum subscription stated in the Prospectus had been subscribed and until then the amount received was kept deposited in a Scheduled bank as required by Section 69 of the Act. c) Brokerage and underwriting commission @ Rates authorized by the Prospectus or AOA d) Compliance with section 81 (dealing with right shares) e) Preliminary contracts, if any, entered into for purchase of a property or business, for creating an organisation for management of the company, etc. as per terms stated in the Prospectus. f) Application for listing to one or more recognised stock exchanges before the expiry of ten weeks from the date of the closing of the subscription list. g) SEBI guidelines followed? Check Compliance reports submitted by lead managers and reports submitted to SEBI h) Internal check on receipt of amounts along with the application i) Verify compliance with legal provision relating to issue of shares at premium (section 78), issue of shares at discount (section 79), and issue of sweat equity shares (section 79A) s 80

Max tenure of preference shares= 20 years

AOA allow such issue?

Only fully paid up shares can be redeemed

Source of funds= Profits/Fresh Issue of shares

Source of Premium= Profits/Securities Premium Account

Face Value of shares redeemed to be transferred to CRR

Notice to registrar

Transmission of Shares u/s 109A



Death

Grant of probate or succession certificate of Power of Attorney

Insolvency

Court Order

Transmission

Authorised by Articles? Approved by Board Resolution

Verification of Issue of Bonus Shares

AOA allow such issue?

Ordinary Resolution

Source of funds= Securities Premium Account /Capital Redemption Reserve

Only exisiting shareholders

SEBI Guidelines

Shares- Fully paid up

Cases Comment-The surplus arising from a change in the basis of accounting was set off by X Ltd., against a non-recurring loss. AS 5 on “Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies” Disclose any change in an accounting policy which has material effect Ensure that material items are not offset against each other Not prudent to set off the surplus from a ‘change in accounting basis’ against a ‘non-recurring loss’.


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Comment-Z Ltd. gave a guarantee to the Court for payment of excise dues of ` 10 lakhs for one of its subsidiaries. According to the company, since the guarantee was given on behalf of its subsidiary, no disclosure was required. Z ltd must record a contingent liability of ` 10 lakhs for the guarantee given by it AS-4: Existence and amount of guarantees undertaken are disclosed in financial statements by way of a note, even if remote possibility of loss Thus disclose amount and nature of contingent liability A publishing company undertook repair and overhauling of its machinery at a cost of ` 250 lakhs to maintain them in good condition and capitalised the amount as it is more than 25% of the original cost of the machinery Criteria for capital expenditure= Increase in earning capacity or reduction in the cost of production Quantum of repair expenditure= immaterial If revenue exp treated as capex, profits for the year are inflated Hence auditor must qualify the audit report Inventories of a Car manufacturing company include the value of items, required for the manufacture of a model which was removed from the production line five years back, at cost price. AS 2 on “Valuation of Inventories Has appropriate allowance been made for defective, damaged, obsolete and slow-moving inventories? High likelihood that the said items have been obsolete Necessary to write down the inventory to ‘net realizable value’ Carrying them in inventory at cost leads to inflated profits Hence auditor must qualify the audit report Cairn India’s oil wells were damaged in Iraqi war in November, 2009. Claim was preferred with the Insurance Companies for the total loss. Pending the settlement by the Insurance Companies neither any provision nor any disclosure has been made in 2009-10 accounts. Revised Schedule VI- provisions have to be disclosed as long term and short term provisions with their nature being specified


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ AS 29 on Provisions, Contingent Liabilities and Contingent Assets, create provisions if they can be reliably measured and are probable to result in outflow of resources embodying economic benefits While making provision, consider probability of recovery from the claim lodged Auditor must qualify the report stating quantitative impact on the assets and profit Sundry debtors of a company as a 31-3-10 include ` 10 lakhs from M/s Unreliable Traders, who have been declared as insolvent on 4-4-2010. (N’03) AS 4, “Contingencies and Events Occurring after the Balance Sheet Date Event after balance sheet date but before the date of approval of financial statements by the Board requires adjustments to assets/liabilities as on the date of Balance Sheet in case additional evidence is available in respect of conditions existed on the date of the balance sheet Auditor must qualify the report stating quantitative impact on the assets and profit Directors of Speedway Ltd. declared a final dividend of 30% for 2008-09 in their meeting held on 11-8-2009. (N’03) Interim Dividend Final Dividend

Board can declare Only shareholders can declare based on the recommendation of Board of Directors

Revised Schedule VI- Only disclosure of proposed dividend required in Notes to Accounts Auditor should have qualified his report During the year under audit, A Ltd. credited to the Profit & Loss Account, the entire profit of 5 lakhs on the sale of land not required for its use. You are informed that the directors would like to propose dividend out of the above profit.(N’03) Foster Vs. The New Trinidad Lake Asphalte Co. Ltd Capital profits can be distributed by a company only if certain conditions are fulfilled AS-10 on “Accounting for Fixed Assets” - any gain arising from disposal of fixed assets to be recognised in P&L All profits which can properly be taken to the P&L Account are ‘profit’ u/s 205 In spite of the internal control weakness commented upon by the audit manager, no further tests need to be carried out, as the purchase and sales figure as a percentage of gross profit was same as in the previous year. The audit manager’s comments were in regard to control over purchases and sales.


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Internal control=weak Conduct further audit tests in detail to check since mgmt might have manipulated figures Must carry out substantive procedures (test of details of transactions and balances) rather than drawing their conclusions on analytical procedures GVK Project Ltd was incorporated on 1.7.2010. During the year ended 31.3.2011 there was no manufacturing or trading activity except raising of share capital, purchase of land, acquisition of plant and machinery and construction of factory sheds. Therefore the Chief Accountant of the company contends that for the relevant year there was no need to prepare a statement of profit or loss or any other statement except a Balance Sheet as at 31.3.2010. U/s 210 (3) of the Companies Act, 1956: company must prepare accounts for every financial year starting from date of incorporation Company has undertaken construction of factory shed, acquisition of plant and machine ry.etc. Must provide depreciation Mere fact that there was no manufacturing or trading activity cannot be the basis for not preparing the P&L Chief Accountant’s contention is not correct M/s Marico Ltd. has taken a Group Gratuity Policy from an Insurance Company. During accounting year 2008-09 it received a communication from the said Insurance Company informing that premium amount for the accounting year 2007-08 was less charged by ` 75 lacs on account of arithmetical error on the part of Insurance Company. M/s Marico Ltd. paid the said sum of ` 75 lacs during the accounting year 2008-09 by debiting the same to prior Period Expenses. Error was by Insurance Company and not the company Hence does not qualify as Prior Period item The auditor must ensure that the nature of mistake, i.e., insurance premium as well as amount of ` 75 lacs has been disclosed separately in such a manner that its impact on the current profit or loss can be perceived. The register of members of AP Ltd. has not been written up-to-date and as a result, the balances in the register do not agree with the amount of issued Share Capital. Register of Members = Internal documentary evidence for audit of share capital Must be updated regularly Apply alternative audit procedures if the company fails to update the register


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Qualify audit report if audit evidence ≠ sufficient/ appropriate


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Chapter 9: Special Audit Government Audit (M’02) In India, the function of audit is discharged by the independent statutory authority of the Comptroller and Auditor General through the agency of the Indian Audit and Accounts Department. Legal Framework and Comptroller & Auditor General The auditor of a government company is appointed by C&AG. Has powers u/s 619(3) of the Companies Act, 1956 (a) To decide how the company’s accounts shall be audited by the auditor and to give instructions in this regard (b) To conduct a supplementary or test audit of the company’s accounts by authorised person(s); and arrange for additional information to be provided, by general or special order; (c) Has the right to comment upon or supplement the audit report Comptroller and Auditor General’s — Duties and Powers(N’09)(M’03,N’12) The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 (i)

Compile and submit Accounts of Union and States - Initial and subsidiary accounts rendered to the audit and accounts offices under his control by treasuries, offices or departments

(ii) General Provisions Relating to Audit - It shall be the duty of the C&AG – (a) Audit/report expenditure from Consolidated Fund of India and of each State/UT to ascertain there was sanction for the specific purpose of disbursal of money as per accounts (b) Audit/report transactions of Union/States w.r.t. Contingency Funds and Public Accounts; (c) Audit/report on all trading, manufacturing P&L and BS etc kept in any department of the Union or of a State. (iii) Audit of Receipts and Expenditure - Audit/report receipts and expenditure of any body or authority substantially financed by grants or loans from the Consolidated Fund of India or of any State/UT (iv) Audit of Grants or Loans – Audit fulfilment of conditions attached to grant or loan given for any specific purpose from the Consolidated Fund of India or of any State/UT (v) Audit of Receipts of Union or States - Assessment, collection and proper allocation of revenue payable into the Consolidated Fund of India and of each State /UT (vi) Audit of Accounts of Stores and Stock – Audit/report on the accounts of stores and stock kept in any office or department of the Union or of a State. (vii) Audit of Government Companies and Corporations - Duties and powers of the CAG w.r.t. audit of the accounts of government companies = function (provisions of Companies Act) Powers(N’07) Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ To inspect any an office of accounts under the control of the union or a State Government including office responsible for creation of initial or subsidiary accounts. (ii) To require that any accounts, books, papers and other documents which deal with or are otherwise relevant to the transactions under audit, be sent to specified places. (i)

(iii) To inquire from person in-charge of the office as he may require for preparation of any account or report, which is his duty to prepare C&AG has the power to dispense with any part of detailed audit of any accounts/class of transactions and to apply such limited checks in relation to such accounts or transaction as he may determine EXPENDITURE AUDIT(M’99,M’07)(N’01,N’03,N’06)(N’11) Audit against Rules &Orders(M’08) Is expenditure = in conformity with statutory provisions and financial rules and regulations? Function of audit to examine various rules, orders and regulations to see that: (i)

≠ inconsistent with any provisions of the constitution or any law made thereunder.

(ii) ≠consistent with requirements of audit and accounts as determined by C&AG. (iii) ≠ in conflict with the orders/rules made by any higher authority. (iv) In case they have not been separately approved by competent authority, the issuing authority possesses the necessary rule-making power. Audit of Sanctions Is each item of expenditure is covered by a sanction, either general or special, accorded by the competent authority, authorising such expenditure? Audit against provision of funds(N’98) Is there provision of funds out of which expenditure can be incurred and does it cross the same? Audit of Receipts



Whether all revenues or other debts due to government have been correctly assessed, realised and credit to government account

Whether adequate regulations and procedures have been framed by the department/agency

whether adequate checks are imposed to ensure the prompt detection and investigation of irregularities, double refunds, fraudulent or forged refund vouchers

Actual Implementation ?

internal procedures adequately secure correct and regular accounting of demands collection and refunds and pursuant of dues up to final settlement

Describe the salient features of Financial Administration of Local Bodies. (i)

Budgetary Procedure: a) Aims at financial accountability, control of expenditure, and to ensure that funds are raised/spent as per rules/regulations and within the limits of sanction and authorisation by law/Council. b) Focus on how to determine the level of taxation, fees, rates, and laying down the ceiling on expenditure, under revenue and capital heads.

(ii) Expenditure Control: At the State and Central level, there is a clear demarcation between the legislature and executive. In the local body, legislative powers are vested in the Council whereas executive powers are delegated to the officers, e.g., Commissioners. Executive wing handles matters of regular revenue and expenditure while legislative wing handles special situations like, reduction in property taxes, refund of security deposits, etc. (iii) Accounting System: Municipal Accounting System is traditionally done under cash system but migrating to accrual system recently The accounting system is characterized by a) b) c) d)

subsidiary and statistical registers for taxes, assets, cheques etc., separate vouchers for each type of transaction, compulsory monthly bank reconciliation, submission of summary reports on periodical basis to different authoritie s

Audit Programme for Local Bodies(M’10)



Check fairness of the contents and presentation of financial , financial control, whether value is being fully received on money spent.

Letter of appointment clearly states the nature and scope of audit? Validity of appointment Local Fund Audit Wing of the State Govt ?

All types of sanctions, either special or general, accorded by the competent authority?

Expenditure = from provision made and = authorized

Expenditure incurred = as per relevant provisions of the law and as per financial rules and regulations framed by the competent authority.

Scrutinise whether large expenditure projects meeting their endobjectives

Audit of Non- Governmental Organisations (NGOs) (N’02,M’04,N’10,N’07,N’05) Knowledge of the NGO’s work, its mission and vision, areas of operations

Legal form of the organisation and its MOA, Articles of Association, rules and Regulation

General

NGO’s Organisation chart,minutes of the Board/Managing Committee

accounting system, procedures, internal controls and internal checks

Vouch transfers from projects/programmes into Reserves with donor’s letters and board resolutions of NGO Assets, liabilities

Grants received into Corpus Fund and Interest Income

Vouch all acquisitions/sale or disposal of assets including depreciation and authorisations

Check Investment Register and physical verification of Investments. Check bank balance, stock etc

Check agreements with donors and grants letters to ensure that funds received have been accounted for

Foreign Contribution (Regulation) Act, 1976 compliance for foreign donations Revenue items

Internal Control over Receipts from Fund raising programmes

Membership Fee, Subscription, Interest and Dividends

Scanner-Chapter 9 Government Audit and Audit of Local Bodies True/False Sl.

Question


Term

Marks

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ No 1 2 3

Government companies are also to be considered for the ceiling on N’07 number of audits. Comptroller and Auditor General of India can be removed by the Prime N’09 Minister of India on the recommendation of his Council of Ministers. While conducting audit of Government companies, the auditors are M’10 paid their Professional Fees as prescribed by the Government.

2 2 2

Solution: 1: True, 2: False, 3: False Question

Term

Short Note- Performance Audit

Marks

M’98, M’00 In carrying out an audit against provision of funds, what aspects would N’98 you consider? As an auditor, how will you react to an expenditure incurred by a N’98 government department which was sanctioned by a fellow officer of the competent authority as the concerned officer was on leave? The assessing officer in order to ensure that there was no loss of N’98 revenue, increased the income of all assesses between 50% and 100%. State your views, if you were entrusted to carry out an audit of receipt of the said assessing department. Short Note – Expenditure Audit of Government Organisations/ M’99, Departments M’07 Discuss the provision of the Constitution of India to safeguard the N’99 independence of the Comptroller and Auditor General of India. An audit of Expenditure is one of the major components of N’01, Government Audit. In the context of Government Expenditure Audit, N’03, write in brief, what do you mean by : a) Audit against rules and orders, N’06 b) Audit of Sanctions, c) Audit against provision of Funds, d) Propriety audit, e) Performance Audit? What role is played by Comptroller and Auditor General of India in the N’01 audit of a Government Company? What do you understand by the term “Government Audit”? M’02

4

Explain in detail the duties of C&AG of India.

M’03, N’12 Describe the salient features of Financial Administration of Local N’04 Bodies. With reference to Government Audit, what do you understand by M’05 “Audit of Commercial Accounts”? Explain Propriety audit in the context of Government Audit. M’06,N’1 1 Short Note – Power of CAG Under Section 619(3) in relation to audit of N’07 Government Company. Short Note – Audit against Rules and Orders M’08

8/10

Short Note – Powers of C&AG in connection with the performance of N’09

5


2 3

3

2.5/5 8 5/8/3

3 3

8 8 8 5 5

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ his duties. Draft an audit programme for conducting audit of accounts of a local M’10 body.

5

Audit of NGOs Question

Term

Marks

Explain the audit procedure for conducting the audit of a Nongovernment Organisation. Mention the important items to be examined by the auditor in the receipt of Income of NGO’s. An NGO operating in Delhi had collected large scale donations for Tsunami victims. The donations so collected were sent to different NGOs operating in Tamil Nadu for relief operations. This NGO operating in Delhi has appointed you to audit its accounts for the year in which it collected and remitted donations for Tsunami victims. Draft audit programme for audit of receipts of donations and remittance of the collected amount to different NGOs. Mention 6 points each, peculiar to this situation, which you will like to incorporate in your audit programme for audit of said receipts and remittances of donations. State any five special points which you, as an auditor, would look into, while examining the income and collection of fund by an NGO engaged in providing relief work for flood victims.

N’02

16

M’04, N’10 N’05

10/4

N’07

5

12

Miscellaneous Audits True/False Sl. Question Term No 1 A company running a departmental store and having total turnover of N’07 Rs. 100 crores during the financial year 2006-07, need not get its branch audited whose turnover is 1.9 crores during the same year

Marks 2

Solution: 1: True Question

Term

What is the ideal approach while carrying out the audit of incomplete M’98, records? M’01, N’02, N’03 Mention the important items to be examined while conducting audit of M’98, a hospital? N’08, M’11, N’12 Auditing Mantras for CA IPCC [email protected]

Marks 8/12

16/6/8

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Mention the important items to be examined while conducting audit of N’98, a cinema? N’06, M’11 Mention the important items to be examined while conducting audit of M’99 a Charitable Institute running a dispensary in a small village which charges Re. 1 per patient per visit irrespective of the disease. Mention 8 special points you would consider while conducting audit of N’99, a club. N’10 Mention the special points involved in the audit of an Educational M’00, Institution. N’04, M’12 Mention the important items to be examined while conducting audit of N’00 a Charitable Institute running hostels for students pursuing C.A. and which charges only Rs. 500 per student for this lodging/boarding. Mention 8 special points you would consider while conducting audit of M’02, a Recreation club with facilities for indoor games and in-house eating. N’11 Mention any eight special points you would look into in the audit of a M’03 partnership firm. Mention the important items to be examined while conducting audit of M’05, a hotel. N’09 Medical Council of India organised a 3-day International conference of M’05 Doctors in Delhi. You are asked to audit the accounts of the conference. Draft an audit programme for audit of receipt of participation fees from delegates to the conference. Mention any six points. Mention any four special points you would look into in the audit of an N’05 amusement park. How the audit is advantageous to Sole Trader? M’06

8/10

Mention any six important points to be examined by you, as an M’08 auditor, in verifying the correctness of bank balances of an Educational Institution which deposits all its collection/ receipt in separate collection account of a bank. As an auditor how would you react to the following situation – The N’08 Central Government sanctioned Rs. 20 lacs as Grant to a hospital for the purchase of certain equipments and paid Rs. 10 lakhs as advance. The hospital took Rs. 10 lacs as income in the Profit and Loss account for the year. Short note – Audit of Expenditure in Government Audit M’11

6


16

8 16/8

16

16/8 8 10/5 6

4 8

6

4



CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ Chapter 10: Standards on Auditing Sl 1

SA SA 200

2 3 4 5

SA 210 SA 220 SA 230 SA 240

Title Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing Agreeing the Terms of Audit Engagements Quality Control for an Audit of Financial Statements Audit Documentation The Auditor’s responsibilities Relating to Fraud in an Audit of Financial Statements

6

SA 250

Consideration of Laws and Regulations in An Audit of Financial Statements

7 8

SA 260 SA 265

9 10 11

SA 299 SA 300 SA 315

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31

SA 320 SA 330 SA 402 SA 450 SA 500 SA 501 SA 505 SA 510 SA 520 SA 530 SA 540 SA 550 SA 560 SA 570 SA 580 SA 600 SA 610 SA 620 SA 700 SA 705

Communication with Those Charged with Governance Communicating Deficiencies in Internal Control to Those Charged with Governance and Management Responsibility of Joint Auditors Planning an Audit of Financial Statements Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment Materiality in Planning and Performing an Audit The Auditor’s Responses to Assessed Risks Audit Considerations Relating to an Entity Using a Service Organization Evaluation of Misstatements Identified during the Audits Audit Evidence Audit Evidence – Specific Considerations for Selected Items External Confirmations Initial Audit Engagements-Opening Balances Analytical Procedures Audit Sampling Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures Related Parties Subsequent Events Going Concern Written Representations Using the Work of Another Auditor Using the Work of Internal Auditors Using the Work of an Auditor’s Expert Forming an Opinion and Reporting on Financial Statements Modifications to the Opinion in the Independent Auditor’s Report

32

SA 706

33

SA 710

34

SA 720

Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report Comparative Information – Corresponding Figures and Comparative Financial Statements The Auditor’s Responsibility in Relation to Other Information in Documents Containing Audited Financial Statements


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ 1. SA 200 - Overall objectives of the Independent Auditor and the conduct of an Audit in accordance with Standards on Auditing Scope •

Establishes the Independent Auditor’s Overall Responsibilities when Conducting an Audit of Financial Statements in Accordance with SAs • Explains the Nature and Scope of an Audit so that the Independent Auditor can Meet those Objectives • Explains the Scope, Authority and Structure of the SAs Requirements of Auditors • Ethical Requirements • Professional Skepticism • Professional Judgment • Sufficient Appropriate Audit Evidence and Audit Risk • Complying with SAs Relevant to the Audit Question What are the basic principles governing an audit as laid down in AAS 1 (SA 200)? Explain in brief. (10 Marks)(PE-II Nov 2006) Answer

D

R I

I S

SA200 A

C P

O

1. Documentation (a) He should document matters relating to audit (maintain Working Papers) to act as a conclusive proof of the fact that audit was carried in accordance with the basic principles 2. Integrity, Objectivity & Independence (IOI): (a) Auditor should be straightforward, honest and sincere in his professional work (b) He should be fair and impartial 3. Skill & Competence Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ (a) He should perform work with due professional care (b) Audit should be performed by persons having adequate training, experience and competence (c) Updated with latest developments in the field 4. Confidentiality (a) He should maintain confidentiality of information acquired during his work (b) He should not disclose any such information to a third party without specific permission of client or unless it is his legal or professional duty to do so. 5. Others performing the work (a) The auditor can delegate work to assistants or use work performed by other auditors and experts. But he will continue to be responsible for his opinion in financial information. Direct, supervise and review work delegated to assistants (b) Must mention fact of reliance on branch auditors appointed under the Companies Act, 1956 6. Planning (a) He should plan his work to conduct audit in effective and timely manner (b) Plans should be based on knowledge of client’s business, accounting system, policies and internal control (c) Plans should be further developed and revised during audit if circumstances require so 7. Audit evidence (a) Auditor should obtain sufficient and appropriate audit evidence by performing compliance and substantive procedures (b) Evidences enable the auditor to draw reasonable conclusion (c) Compliance procedures mean the tests designed to obtain reasonable assurance that internal controls have been properly designed and operating effectively throughout the year (d) Substantive procedures are performed to obtain evidence as to the completeness, accuracy and validity of data produced by the accounting system They are of two types: i. test of details of transactions and balances ii. analysis of significant ratios and trends 8. Internal control and Accounting System (a) Internal control system ensures that the accounting system is appropriate to nature/size of business and records all the accounting information (b) The auditor should understand the accounting system and related internal controls adopted by the management (c) He should study and evaluate internal controls system to determine the nature, timing and extent (NTE) of other audit procedures


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ 9. Reporting of Audit Conclusions (a) The audit report should contain clear written expression of opinion on the financial statements (b) His report is on whether: The financial information has been prepared using acceptable accounting policies which have been consistently applied; The financial information complies with relevant regulation and statutory requirements; There is adequate disclosure of all material matters (c) The report should be as per legal requirement. When other than clean opinion is given, the audit report should state the reasons thereof Clean report/qualified opinion/adverse opinion/ disclaimer of opinion/reservation of opinion on any matter DISCO-PAIR

SA 210: Agreeing the Terms of Audit Engagements Scope This S.A deals with the Auditor’s Responsibility in Agreeing with the Terms of Audit Engagement with Management and See Whether any of the Preconditions of the Management Restricts his Scope. Objective The Objective of the Auditor is to Accept or continue an Audit Engagement Only when the basis upon which it is to be Performed has been Agreed, through: i) Establishing whether the Preconditions for an Audit are Present; and ii) Confirming that there is a Common Understanding between the Auditor and Management and, where Appropriate, those Charged with Governance of the terms of the Audit Engagement. In Order to establish whether the Preconditions for an Audit are Present, the Auditor shall: • •

Determine whether the Financial Reporting Framework to be Applied in the Preparation of the FS is Acceptable; and Obtain the Agreement of Management that it Acknowledges and Understands its Responsibility: a) For the Preparation of the FS in Accordance with the Applicable Financial Reporting Framework, including where Relevant their Fair Presentation; b) For such Internal Control as Management Determines is Necessary to Enable the Preparation of FS that are Free from Material Misstatement, whether Due to Fraud or Error;

Acceptance of a Change in the Terms of the Audit Engagement



Reasonable justification for change

NO

YES

DO NOT ACCEPT

ACCEPT

Acceptance of a Change in the Terms of the Audit Engagement

Permitted by the management to continue the original audit engagement

NO

YES

Withdraw from the audit engagement and Determine whether there is any obligation, either contractual or otherwise, to report the circumstances to other parties,

Continue

SA 220- Quality control for an Audit of Financial Statements

Engagement Partner (EP) shall take Overall Responsibility for the Overall Quality of each Audit Engagement

,EP shall Remain Alert for Non Compliance with Relevant Ethical Requirement by Members of the Engagement Team

Quality Control Procedures Requirements Ensure that apppropriate procedures regarding the Acceptance & Continuance of Client Relationship & Audit Engagements have been Followed Auditing Mantras for CA IPCC [email protected]

Ensure performance of the audit engagement in compliance with professional standards and regulatory and legal requirements

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ SA 230: Audit Documentation Scope of this SA This SA Deals with the Auditor’s Responsibility to Prepare Audit Documentation for an Audit of Financial Statements Overall Objectives of the auditor :

Sufficient and Appropriate Record of the basis for the Auditor’s Report

Evidence that the Audit was Planned and Performed in Accordance with SAs and Applicable legal and Regulatory Requirements

Prepare Documentation that Provides Results of the Audit Procedures Performed, and the Audit Evidence Obtained

Significant matters Arising during the Audit and the Conclusions Reached

Ownership of Audit Documentation • •

SQC 1: Unless otherwise specified by law or Regulation, Audit Documentation is the Property of Auditor. He may at his Discretion, make portions or extracts from, audit Documentation available to Clients, provided such Disclosure does not undermine the validity of the work Performed, or, in the Case of Assurance Engagements, the Independence of the Auditor or of his Personnel.

Question 1 What are audit working papers? Discuss various contents of Permanent Audit File and Current File? (8 Marks) (PE-II May 2007) • •

Working Papers are Papers Prepared and Obtained by the Auditor and Retained by him, in connection with the Performance of his audit. Working Papers are the Property of the Auditor. Working Papers should Record the Audit Plan, the Nature, Timing and Extent of Auditing Procedures Performed, and the Conclusions drawn from the Evidence Obtained. In Case of Recurring audits, Auditors generally prepare two types of Audit Files.

Permanent Audit file Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ a) Information Concerning the legal and Organisational Structure of the Entity. b) Extracts or Copies of important legal Documents, Agreements and Minutes Relevant to the Audit. c) A Record of the study and Evaluation of the Internal Controls Related to the Accounting System. d) Copies of Audited Financial Statements for Previous Years. e) Analysis of Significant Ratios and Trends. f) Copies of Management letters Issued by the Auditor, if any g) Record of Communication with the Retiring Auditor, if any, before Acceptance of the Appointment as Auditor. h) Notes Regarding Significant Accounting Policies. i) Significant Audit Observations of Earlier Years. Current Audit file a) Correspondence Relating to Acceptance of Annual Reappointment. b) Extracts of Important Matters in the Minutes of Board Meetings and General Meetings, as are Relevant to the Audit. c) Evidence of the Planning Process of the Audit and Audit Programme. d) Analysis of Transactions and Balances. e) A Record of the Nature, Timing and Extent of Auditing Procedures Performed and the Results of such Procedures. f) Evidence that the work Performed by Assistants was Supervised and Reviewed. g) Copies of Communications with other Auditors, Experts and Other third Parties. h) Copies of Letters or Notes Concerning Audit Matters Communicated to or Discussed with the Client. i) Letters of Representation or Confirmation Received from the Client. j) Conclusions Reached by the Auditor Concerning Significant Aspects of the Audit. Question 2 Should branch auditor of a company comply with the request of the principal auditor of the company to give photocopy of the working papers pertaining to the branch audit? Explain. Answer



Working Papers are the Property of the Auditor. He may at his Discretion, make Available Portions or Extracts from his working Paper to his Client

An Auditor is not required to provide the Clients or other Auditors’ Access to his working Papers

In the Case of a Company, the Main Auditor has, to Consider the Report of the Branch Auditor and has a Right to Seek Clarification and to Visit the Branch

But he cannot ask for the copy of Working Paper and therefore, the Branch Auditor is under no Compulsion to Give Photocopies of his Working Paper to the Principal Auditor

SA 240 - The auditor’s responsibilities relating to Fraud in an Audit of Financial Statements

Should recognize the possibility that a Material Misstatement due to Fraud could exist, notwithstanding the Auditor’s past Experience

Professional Skepticism

Key Requirements

Unless Doubtful Situations are Present, the Auditor may Accept Records and Documents as Genuine.

Where Responses to Inquiries of Management or those Charged with Governance are Inconsistent, the Auditor shall investigate the Inconsistencies

Ask TCWG about Knowledge of any Fraud Affecting the Entity

What are Management’s Processes for Identifying & Responding to the Risks of Fraud

Auditor's role?

Unusual or Unexpected Relationships while performing ARP?


If auditor identifies a misstatement; the auditor shall re-evaluate the assessment of the risks of material misstatement due to fraud and its resulting impact on the nature, timing

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ SA 250 - Consideration of Laws & Regulations in an Audit of Financial Statements

To obtain sufficient appropriate audit evidence regarding compliance with

Audit procedures to help identify instances of non-compliance

Objectives

Respond appropriately to non-compliance or suspected non-compliance with laws

The auditor is not responsible for preventing non compliance and cannot be expected to detect non-compliance with all laws and regulations: That is management's responsibility

Obtain a general understanding of The legal and regulatory framework

Obtain sufficient appropriate audit evidence regarding compliance

Requirements of this SA

Inquiring of management & Inspecting correspondence, if any, with the relevant licensing or regulatory authorities

Those laws and regulations having a direct effect on the determination of material amounts and disclosures in the FS such as tax and labour laws


Obtain written representation that all known instances of non-compliance or suspected non-compliance with laws and regulations have been disclosed to the auditor

Other laws and regulations that do not have a direct effect on the determination of the amounts and disclosures in the FS, but compliance with which may be fundamental to the operating aspects of the business


If precluded by management or T.C.W.G from obtaining sufficient appropriate audit evidence; qualified opinion or disclaimer

If the auditor concludes that the non-compliance has a material effect on the FS; qualified or adverse opinion

If has identified or suspects non-compliance with laws and regulations; responsibility to report the identified or suspected non-compliance to parties outside the entity.

SA 260 - Communication with Those Charged with Governance Communicate with TCWG the responsibilities of the auditor in relation to the financial statement audit; audit of the F.S. does not relieve management or TCWG of their responsibilities.

Obtain from TCWG information relevant to the audit

Objectives Provide TCWG with timely observations arising from the audit

Promote effective two-way communication between auditor and T.C.W.G

Auditor’s Responsibilities = forming and expressing an opinion on the F.S.

Planned Scope & Timing of the Audit

Matters to be Communicated Significant Findings from the Audit (Accounting practices , Material weaknesses in internal control etc, Written representations the Auditing Mantras for CA IPCC auditor is requesting [email protected]

Declaration about compliance with relevant ethical requirements regarding independence


SA 299 - Responsibility of Joint Auditors Deals with the Auditor’s responsibility to conduct audit jointly where two or more practicing firms are appointed to conduct audit of a single entity In respect of audit work divided among the JAs each JA is responsible only for the work allocated to him, whether or not he has prepared a separate report JAs are jointly and severally responsible for:

Audit work which is not divided

Decisions taken by all the JA concerning the NTE of audit procedures;

For examining that the FS comply with the disclosure requirements of the relevant statut

Normally, the JAs are able to arrive at an agreed report. However, where the JAs 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.


Matters which are brought to the notice of the JAs by any one of them and on which there is an agreement among the JAs

Ensuring that the audit report complies with the requirements of relevant statute.

A JA is not bound by the views of the majority of the JAs regarding matters to be covered in the report and should express his opinion in a separate report in case of a disagreement.


Auditor should be individually responsible for?

- Type of work alloted to him. -documents & records

- Components alloted to him for audit purpose. Types of Responsibilities? - Work not divided Auditor should be jointly responsible for?

-Disclosure not given in audit report

-non compliance with Applicable FRF.

APPENDIX (MAY 2013 PAPER) May 2013 Question No.1 is compulsory. Attempt any five questions from the remaining six questions. Question 1 (a)

Discuss with reference to SAs: i. ii.

(b) iii. iv.

The auditor shall communicate all significant findings with those charged with Governance.(5 Marks) Factors effecting form, contents and extent of audit. (5 Marks) Discuss the following: Is surprised checks desirable in audit, if so give important recommendations? (5 Marks) Inquiry is one of the audit procedures to obtain audit evidence. (5 Marks)

Answer (a) (i) As per SA-260 “Communication with Those Charged with Governance”, the auditor shall communicate the following significant findings from the audit, with those charged with governance: (a) The auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting policies, accounting estimates and financial statement disclosures. When applicable, the auditor shall explain to those charged with governance why the auditor considers a significant accounting practice that is acceptable under the applicable financial reporting framework, not to be most appropriate to the particular circumstances of the entity; (b)

Significant difficulties, if any, encountered during the audit;

(c)

Unless all of those charged with governance are involved in managing the entity:


CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ (i)

Significant matters, if any, arising from the audit that were discussed, or subject to correspondence with management; and

(ii)

Written representations the auditor is requesting; and

(d) Other matters, if any, arising from the audits that, in the auditor’s profe ssional judgment, are significant to the oversight of the financial reporting process. (ii) As per SA-230 on “Audit Documentation”, the form, content and extent of audit documentation depend on the following factors: 1. 2. 3. 4. 5. 6.

7.

The size and complexity of the entity. The nature of the audit procedures to be performed. The identified risks of material misstatement. The significance of the audit evidence obtained. The nature and extent of exceptions identified. The need to document a conclusion or the basis for a conclusion not readily determinable from the documentation of the work performed or audit evidence obtained. The audit methodology and tools used.

(b) (i) The need for and frequency of surprise checks is obviously a matter to be decided having regard to the circumstances of each audit. It would depend upon the extent to which the auditor considers the internal control system as adequate, the nature of the clients’ transaction, the locations from which he operates and the relative importance of items l ike cash, investments, stores etc. However, wherever feasible a surprise check should be made at least once in the course of an audit. The following are the important recommendations: (1)

Surprise checks should be considered as a desirable part of each audit.

(2) The areas over which surprise checks should be employed would depend upon the circumstances of each audit but should normally include: a) Verification of cash and investments. b) Test-verification of stores and stocks and the records relating thereto. c) Verification of books of prime entry and statutory registers normally required to be examined for the purposes of audit. (3) The frequency of surprise checks may be determined by the auditor in the circumstances of each audit but should normally be at least once in the course of an audit. (4) The results of the surprise checks should be communicated to the management if they reveal any weakness in the system of internal control or any fraud or error or deficiency in the maintenance of records. (5) The auditor should satisfy himself that adequate action is taken by the management on the matters communicated by him. (6) It is not necessary in all cases for the results of the surprise checks to be included in the auditors’ report on the accounts. They should, however, be included if in the opinion of the auditor they are material and affect a true and fair view of the accounts on which he is reporting. Auditing Mantras for CA IPCC [email protected]

CA IPCC | Auditing & Assurance http://www.auditingmantras.com/ (ii) Inquiry consists of seeking information of knowledgeable persons, financial and nonfinancial, within the entity or outside the entity. Inquiry is used extensively throughout the audit in addition to other audit procedures. Inquiries may range from formal written inquiries to informal oral inquiries. Evaluating responses to inquiries is an integral part of the inquiry process. Responses to inquiries may provide the auditor with information not previously possessed or with corroborative audit evidence. Alternatively, responses might provide information that differs significantly from other information that the auditor has obtained, for example, information regarding the possibility of management override of controls. In some cases, responses to inquiries provide a basis for the auditor to modify or perform additional audit procedures. Although corroboration of evidence obtained through inquiry is often of particular importance, in the case of inquiries about management intent, the information available to support management’s intent may be limited. In these cases, understanding management’s past history of carrying out its stated intentions, management’s stated reasons for choosing a particular course of action, and management’s ability to pursue a specific course of action may provide relevant information to corroborate the evidence obtained through inquiry. In respect of some matters, the auditor may consider it necessary to obtain written representations from management and, where appropriate, those charged with governance to confirm responses to oral inquiries. Question 2 Comment on any eight of the following: (8 x 2 = 16 Marks) (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) (x)

PQR Ltd. Include underwriting commission and stamp duty as preliminary expenses. AGM is not held in time, auditor automatically vacates his office. Selling and distribution cost included in the cost of inventories. Internal check is part of internal control system. Company can provide lower rate of depreciation than prescribed by Schedule XIV of the Companies Act; 1956. Compliance procedures are tests designed to obtain audit evidence as to completeness, accuracy and validity of data produced by accounting system. ABC Ltd. having turnover of ` 100 crores during financial year 2011-12, need not get its branch audited whose turnover is ` 1.5 crores during the same year. Computer software which is the integral part of the related hardware can be treated as intangible assets or fixed assets? CARO, 2004 does not apply to a foreign company. Define shortly arm's length transaction.

Answer i)

ii)

The expenditure incidental to the creation and floating of a company includes stamp duties, registration fees, legal costs, accountant’s fees, cost of printing, etc. Underwriting commission and brokerage paid for shares and debentures should not be included under the head preliminary expenses. Therefore, PQR Ltd should include stamp duty as preliminary expense but exclude underwriting commission. Section 224(1) provides that an auditor is appointed for a particular period, i.e., from conclusion of one annual general meeting until conclusion of the next annual general



iii)

iv)

v)

vi)

vii)

viii)

ix) x)

meeting. In case the annual general meeting is not held within the period prescribed, the auditor will continue in office till the annual general meeting is actually held and concluded. Therefore, auditor shall continue to hold office till the conclusion of the annual general meeting. Auditor’s office is not vacated automatically if AGM is not held in time. As per AS-2 on Valuation of Inventories, in determining the cost of inventories, it is appropriate to exclude selling and distributions costs and recognize them as expenses in the period in which they are incurred. Therefore, it is not appropriate to include selling and distribution cost in the cost of inventories. Internal check has been defined as “checks on day-to-day transactions which operate continuously as part of the routine system whereby the work of one person is proved independently or is complementary to the work of another, the object being the prevention or early detection of errors or fraud”. Internal check is 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. It is permissible for the entity to charge deprecation on its assets at rate different from schedule XIV rates provided those rates are higher than the schedule rates based on technical estimation or otherwise allowed under Section 205 of the Act. The rates as contained in Schedule XIV are minimum rates and therefore a company cannot provide lower rate of depreciation than prescribed by Schedule XIV of the Companies Act, 1956. Compliance procedures are tests designed to obtain reasonable assurance that those internal controls on which audit reliance is to be placed are in effect. Here auditor is concerned with assertions that the control exists and is operating effectively. As per rules to section 228 (4) of the companies (Branch Audit exemption) Rules 1961, where the aggregate value of goods sold by a branch office does not exceed ` 2 lakhs or 2% of the average of the total turnover of the company, whichever is higher, the branch shall be exempted from audit. Hence the branch in question is not required to be audited. As per AS-26 on Intangible Assets, computer software for a computer controlled machine tool that cannot operate without that specific software is an integral part of the related hardware and it is treated as a fixed asset. Therefore, computer software which is the integral part of the related hardware should be treated as fixed asset. CARO, 2003 applies to all companies including foreign companies except Banking, Insurance, Sec. 25 Companies and Private Ltd. Companies subject to certain conditions. Arm’s length transaction - A transaction conducted on such terms and conditions as between a willing buyer and a willing seller who are unrelated and are acting independently of each other and pursuing their own best interests.


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