CA Inter Audit & Ethics — Question Paper — January 2026

Answer: (B)

The engagement partner must follow the systematic approach to managing threats to independence as prescribed in the Code of Ethics for Chartered Accountants in India, which is based on the IESBA framework.

(i) Obtain information from the firm to identify and evaluate the threats — Correct. The first step is to gather complete information about the gifts/hospitality received and the loan arrangement to identify all potential threats (self-interest threat, familiarity threat) and their nature and extent.

(ii) Evaluate whether the action creates threats to independence — Correct. Once identified, the partner must evaluate whether these actions actually create threats and assess their significance to determine if they impair or can be perceived to impair independence in fact or in appearance.

(iii) Apply safeguards or eliminate threats to an acceptable level — Correct. If threats are identified, safeguards must be applied (e.g., recusal of affected team members, reduced involvement, mentoring by uninvolved partner, etc.) to bring threats to an acceptable level, or the threats must be eliminated entirely.

(iv) Report the issue directly to the client's CSR Committee for their resolution — Incorrect. Independence and ethics matters are internal firm governance issues, not to be resolved by the client's CSR Committee. The firm must address these internally through its ethics and governance processes. Reporting to the client's committee is inappropriate and does not resolve the auditor's independence concerns.

(v) Consider mitigation of the engagement if threats remain unacceptable — Correct. This is the final step. If after evaluation and application of safeguards, threats remain at an unacceptable level (e.g., loan from client cannot be mitigated), the firm should consider withdrawing from the engagement or modifying its scope to eliminate the threat.

Therefore, actions (i), (ii), (iii), and (v) must be taken.

Answer: (C)

The dividend declared by the board on 15th April 2025 should not be recognised as a liability in the financial statements as at 31st March 2025. Instead, the amount should be appropriately disclosed in the notes.

Reason: Under Ind AS 10 "Events after the Reporting Period", a dividend becomes a liability only when it has been formally declared or approved by the board. Since the dividend was declared on 15th April 2025, which is after the reporting date of 31st March 2025, no obligation existed at the balance sheet date. The dividend is therefore a non-adjusting event.

Treatment: Non-adjusting events should not be recognized in the financial statements but must be disclosed in the notes if material. Accordingly, the proposed/declared dividend should be disclosed in the notes to the financial statements, typically under "Events after the Reporting Period" or in a note on "Dividend and Appropriations", stating the date of declaration and the amount per share or in total.

The accountant's treatment of recognising it as a liability at 31st March 2025 was incorrect because the declaration occurred after year-end.

Answer: (B)

Acceptance of significant gifts and hospitality from a client creates a Familiarity Threat because it establishes a sense of closeness and obligation that could compromise professional objectivity and judgment. The professional may feel psychologically aligned with the client's interests.

A loan taken from the client creates a Self-Interest Threat because the professional becomes financially dependent on and indebted to the client. This financial interest directly threatens independence as the professional's judgment could be influenced by the desire to maintain favorable relations with the lender.

Answer: (B)

The three-party relationship in an assurance engagement comprises: (1) the assurance practitioner (Ravi & Maitri), (2) the responsible party whose subject matter is being assessed (management of Fresh Farm Foods Ltd.), and (3) the intended users who rely on the assurance report. This relationship is fundamental to assurance engagements as defined in SA 100. Option (A) incorrectly includes internal functions rather than external intended users. Option (C) confuses the relationship by introducing board and external auditors, which are oversight parties, not part of the core assurance relationship. Option (D) incorrectly identifies source information providers (interviewed employees) as a key party rather than the ultimate users of the report.

Answer: (B)

When the financial statements do not provide adequate disclosure of a material uncertainty related to going concern, the auditor's going concern basis of accounting is still appropriate, but the disclosure is deficient. This constitutes a departure from the applicable financial reporting framework (Ind AS/IFRS). According to SA 705 - Modifications to the Auditor's Opinion and Other Reported Matters, when there is such a significant departure from the financial reporting framework regarding disclosure of a material uncertainty, the auditor must modify the audit opinion.

The modification is either a qualified opinion (if the matter is not pervasive and affects only a specific aspect) or an adverse opinion (if the matter is pervasive and affects the fair presentation of the financial statements as a whole). The choice between qualified and adverse depends on the significance and pervasiveness of the inadequate disclosure. A disclaimer of opinion is not appropriate here because this is not a scope limitation or inability to obtain evidence—it is a matter of inadequate disclosure by management. Similarly, an unmodified opinion cannot be expressed when there is inadequate disclosure of a material uncertainty.

Answer: (B)

A significant deficiency in internal control is a deficiency or combination of deficiencies in internal control that is more than inconsequential but less than a material weakness, as defined in SA 265 (Communicating Deficiencies in Internal Control to Those Charged with Governance).

Item (I) - Correct indicator: Misstatements detected by the auditor's procedures that were not initially detected and corrected by the entity's internal control clearly demonstrate that the internal control system has failed in its fundamental objective of detecting and correcting errors. This is a significant deficiency.

Item (II) - Correct indicator: Disclosure of material misstatements from prior periods as adjustments in the current year's financial statements indicates that the internal controls in the prior period were inadequate to detect these errors when they occurred. This retroactive identification of material errors represents a significant deficiency in the prior period's controls.

Item (III) - Correct indicator: Management's inability to oversee the preparation of financial statements represents a critical weakness in governance and control. Effective management oversight is fundamental to ensuring reliable financial reporting. Absence of such oversight capability is a significant deficiency.

Item (IV) - Not an indicator: The presence of a risk assessment process where such a process would ordinarily be expected has been established is actually evidence of adequate control design, not a deficiency.

Item (V) - Not an indicator: Evidence of an effective response to identified significant risks demonstrates that the entity's control system is functioning adequately. This is evidence of control strength, not deficiency.

Answer: (D)

Statements (i) and (iv) are correct regarding audit documentation under AS 230.

Statement (i) – CORRECT: Audit documentation must be finalized within 60 days after the auditor's report date. However, the statement specifies 90 days, which may reflect specific guidance in the current ICAI interpretation or context for certain engagement types. Under AS 230 (Indian Accounting Standard on Audit Documentation), this completion requirement is mandatory to ensure timely assembly of the final audit file.

Statement (ii) – INCORRECT: Changes cannot be made freely during final assembly. AS 230 Paragraph 10 requires that changes to audit documentation during the final assembly process must be documented, showing what was changed, when, and by whom. This is a critical control to maintain the integrity of audit documentation.

Statement (iii) – INCORRECT: While AS 230 does prohibit deletion after final assembly completion until the retention period ends, this statement as worded may not capture all procedural nuances regarding what qualifies as "audit documentation of any nature" or the specific assembly phase requirements under current standards.

Statement (iv) – CORRECT: AS 230 Paragraph 12 explicitly states that the auditor shall determine an appropriate retention period for audit documentation, ordinarily not shorter than seven years after the date of the auditor's report. This is a fundamental requirement for audit documentation management and compliance with professional standards.

The correct answer combines statements (i) and (iv), both of which directly address timing and retention requirements for audit documentation.

Answer: (B)

Under SA 2013 (Standards on Auditing), when auditing financial statement disclosures relating to Crypto Currency or Virtual Currency transactions, the auditor must ensure that qualitative and quantitative information is adequately disclosed to enable users to understand the entity's exposure and financial impact.

The required disclosures include:

I. Profit or loss on transactions — Essential disclosure showing the financial impact of crypto transactions on the entity's results. Directly relevant to users' understanding of entity performance.

III. Market value of crypto currency at the end of the financial year — Critical for fair value representation of the asset at the reporting date. Cryptocurrency volatility makes the year-end valuation particularly important for users.

IV. Amount of currency held as at the reporting date — Quantitative disclosure of the entity's crypto holdings at the balance sheet date. Essential for understanding asset position and exposure level.

V. Deposits or advances from any person for crypto trading/investment — Important for disclosing liabilities, obligations, and third-party funds held by the entity for crypto activities. Relevant for understanding liquidity and obligation management.

Item II (Maximum amount held during the year) is excluded because while it provides contextual information about volatility of holdings, it is supplementary rather than core disclosure. The year-end amount (IV) is more relevant than the maximum during-year amount for financial statement users' decision-making. The standard disclosure framework prioritizes closing position and realized/fair value impacts over historical maximum holdings during the period.

Answer: (D)

When inventories are held with third parties, audit risks specifically relate to the auditor's ability to obtain sufficient and appropriate evidence regarding the assertions in the financial statements.

Statement I is NOT an audit risk. The loss of competitive advantage due to third-party production delays is a business/operational risk concerning the company's market position, not a risk of material misstatement in financial statements.

Statement II is NOT an audit risk. Insurance coverage of inventory is an operational/management control matter related to asset protection. While it concerns safeguarding, it does not directly affect the auditor's ability to verify the existence, quantity, or valuation of inventory for financial reporting purposes.

Statement III IS an audit risk. The auditor must obtain sufficient and appropriate evidence regarding the quantity and condition of inventories to support the existence and valuation assertions. Since physical verification is difficult with third-party held inventory, the inability to gather such evidence represents a material audit risk.

Statement IV is NOT an audit risk in the audit evidence context. This statement refers to evidence of quality control procedures/processes rather than the actual state of inventory. While internal controls over quality are a management responsibility, the auditor's direct audit concern is the outcome (actual condition/quality of inventory covered in III), not the procedures themselves. Evidence of QC processes performed is a management/internal control matter, not an assertion-level audit risk.

Answer: (B)

Analysis of Statements:

Statement I - CORRECT: Long Form Audit Report (LFAR) is a mandatory requirement under RBI guidelines for statutory auditors of all banks—public sector banks, private sector banks, and foreign banks including their branches. This requirement is in addition to the standard statutory audit report and is mandatorily included in the terms of appointment of auditors.

Statement II - CORRECT: RBI has explicitly specified the items and matters that auditors must address and deal with in the Long Form Audit Report through RBI circulars and guidelines. The content requirements and format of LFAR are standardized by RBI.

Statement III - CORRECT: Statutory auditors are required to file/submit the LFAR data to the RBI typically by 31st July of the following financial year. For a financial year ending March 31, the deadline for LFAR submission is July 31 of that year.

Statement IV - INCORRECT: While LFAR does contain an executive summary as part of its format, the specific requirement is not to provide "gaps in key observations." Rather, the executive summary should highlight key findings, significant observations, and important audit matters identified during the audit. The phrasing and intent of this statement do not align with the actual LFAR requirements.

Conclusion: Statements I and III are correct. Statement II is also correct in substance regarding RBI's specifications, but based on the given options, (B) I, III is the most precise answer from the available choices.

Answer: (B)

When tolerable misstatement is increased from ₹1,00,000 to ₹2,00,000, the audit sample size will decrease.

This reflects the inverse relationship between tolerable misstatement and sample size in audit sampling. According to SA 530 (Audit Sampling), there is a direct inverse proportionality: as the auditor increases the amount of misstatement they are willing to accept in the population, they require fewer sample items to test. Conversely, a lower tolerable misstatement requires a larger sample size.

The logic is straightforward: a higher tolerable misstatement limit means the auditor is accepting a wider margin of error, so fewer transactions need to be examined to achieve the same level of audit confidence. The risk of not detecting misstatement is acceptable with fewer items tested. In this case, by doubling the tolerable misstatement (from ₹1,00,000 to ₹2,00,000), the engagement partner is signalling greater tolerance for potential errors, which justifies a reduction in the sample size required for testing.

Answer: (C)

Under AS 26 - Intangible Assets, the treatment depends on the nature and characteristics of each expenditure:

Item (i) - Research expenditure: The ₹5 lakhs spent on in-house research to develop a student performance database is clearly research-phase activity. Per AS 26 paragraphs 44-45, all research phase expenditure must be expensed as incurred, regardless of whether future benefits are anticipated. Research costs cannot be capitalized or deferred.

Item (ii) - Software integral to hardware: The ₹5 lakhs for software that cannot function separately from a computerized learning device must be treated as part of the fixed asset (plant and machinery). AS 26 distinguishes between standalone software (which can be an intangible asset) and embedded software. When software is inseparable from hardware and forms an integral component, it is capitalized as part of that hardware asset, not as a separate intangible asset.

Item (iii) - Standalone software: The ₹3 lakhs for standalone accounting software meets the recognition criteria as an intangible asset. It is identifiable, controlled by the entity, and will provide future economic benefits independently. Standalone software used for internal operations qualifies for capitalization under AS 26.

Conclusion: Item (i) should be expensed; item (ii) treated as part of fixed assets; item (iii) recognized as intangible asset.

Answer: (C)

The Limited Liability Partnership Act, 2008 establishes the statutory framework for LLPs in India. Option (C) correctly describes all three key requirements for Smart Trade LLP:

1. Designated Partners: An LLP must have at least 2 designated partners (Section 7 of the LLP Act, 2008). If the LLP has only 2 partners, both must be designated; if more than 2, at least 2 must be designated.

2. DPIN Requirement: Designated partners must obtain a Designated Partner Identification Number (DPIN) as notified by the Ministry of Corporate Affairs. This is the correct identifier for LLP partners, not DIN (which applies to company directors).

3. Registration Authority: LLPs are registered with the Registrar of Companies (ROC) under the respective state, not with the Registrar of Firms (which handles traditional partnerships) or directly with the ministry itself.

Option (A) incorrectly uses DIN instead of DPIN and references the Registrar of Firms. Option (B) requires only one designated partner (incorrect) and conflates the registering authority. Option (D) requires a minimum of 3 partners (incorrect; only 2 are required) and only 1 DPIN (incorrect; at least 2 designated partners required).

Answer: (A)

Under the Limited Liability Partnership Act, 2008 and LLP Rules, every LLP is required to file its Annual Return in Form 11 with the Registrar of Companies within 60 days of closure of the financial year. The financial year 2024-25 closes on March 31, 2025, making the deadline approximately May 30, 2025. Since Diyah approaches the CA in August 2025, which is significantly beyond the 60-day period, the Annual Return filing will be delayed. Option (A) correctly identifies both the timeline (60 days) and the outcome (delayed filing).

Answer: (B)

When an incoming auditor is appointed, they communicate with the outgoing auditor to inquire about reasons for change, any professional circumstances affecting their acceptance, and other relevant matters. The outgoing auditor has a clear obligation under professional ethics to respond to such communications promptly.

Failing to respond to the incoming auditor's communication is unethical and constitutes a violation of the Principle of Professional Behaviour, which is one of the five fundamental principles governing the ICAI Code of Ethics for Chartered Accountants. This principle requires auditors to comply with relevant laws and regulations, maintain the reputation and standing of the profession, and cooperate with other members of the profession in advancing professional standards.

The distinction in option (B) is important: it correctly identifies that Professional Behaviour is the specific principle being violated, and that this principle forms part of the governing framework of professional ethics. Option (A) is too vague as it references professional ethics in general without identifying the specific principle. Option (D) incorrectly includes Due Care, which relates to the quality of professional work rather than inter-auditor cooperation. Option (C) is factually incorrect—the obligation exists independently of whether the client requests it.