Question 1

HR & Associates are the auditors of a large manufacturing company. The company has recently invested huge amount in Property, Plant and Equipment (PPE) for its new unit. They have added many incidental expenses to the cost of PPE. The junior audit team members are not sure about which costs should be excluded from the cost of PPE. Give examples of costs that should not form part of costs of PPE.

Accepted Answer

According to **Ind AS 16 – Property, Plant and Equipment**, the cost of PPE should include only those amounts that are directly attributable to bringing the asset to the location and condition necessary for its intended use. The following costs should be **EXCLUDED** from the cost of PPE:

**Administrative and General Overhead Costs:** Allocation of general factory administration, head office expenses, and indirect overhead not directly related to acquisition or construction. These should be expensed as incurred.

**Initial Operating Losses:** Any losses incurred during the period when the asset is operational but not yet at full efficiency. For example, if a new manufacturing line produces below-normal output initially, the associated losses should not be capitalized.

**Training Costs:** Costs of training employees to operate the asset should be expensed. While directly related to the asset's use, they are not costs of bringing the asset to working condition.

**Reorganization and Relocation Costs:** Costs incurred after the asset is already in place and operational, such as relocating the PPE to a different location or restructuring operations, should be expensed.

**Opening/Launch Costs:** Advertising, promotional expenses, and other costs of opening a new facility or launching a new product line should be expensed, not capitalized.

**Abnormal Wastage and Inefficiency:** Costs attributable to abnormal material wastage, labor inefficiency, or idle time during commissionin…

Question 2

A professional accountant is expected to comply with the fundamental principles of professional ethics at all times. Explain which fundamental principle governing professional ethics is violated in the following situations?

Accepted Answer

The fundamental principles governing professional ethics under the ICAI Code of Ethics include Integrity, Objectivity, Professional Competence and Due Care, Confidentiality, and Professional Behavior.

(1) **Objectivity Principle Violated**: When a chartered accountant accepts an appointment as auditor of a firm where his sister is a partner, the principle of **Objectivity** is violated. Objectivity requires maintaining independence, impartiality, and unbiased professional judgment. The family relationship creates a direct conflict of interest that impairs the auditor's ability to form objective conclusions and act impartially. Personal loyalties may override professional judgment, compromising the credibility and reliability of the audit.

(2) **Confidentiality Principle Violated**: By disclosing insider information about a client to his friend, the principle of **Confidentiality** is breached. Professional accountants must respect and maintain confidentiality of client information obtained in the course of their work. Information disclosed to unauthorized third parties—regardless of personal relationships—constitutes a violation of the trust placed by the client. Confidentiality obligations cannot be overridden by personal requests or relationships.

(3) **Professional Competence and Due Care Principle Violated**: Failure to inform the client about changes in applicable laws violates the principle of **Professional Competence and Due Care**. This principle requires professi…

Question 3

XY and Associates are auditors of PQR Ltd., which provides electrical components on project basis. The purchases are huge and the auditor wants to make sure that all the purchases made during the period are recorded and there is no understatement or overstatement. For this purpose the audit team have performed procedure like cut-off tests, correct treatment of goods in transit, obtaining written representations and performing analytical procedures. What are the analytical procedures required to be performed to obtain audit evidence as to overall reasonableness of purchase quantity and price?

Accepted Answer

Analytical procedures are audit techniques involving evaluation of financial information through analysis of plausible relationships among financial and non-financial data. Per **SA 520 – Analytical Procedures**, the following analytical procedures should be performed to obtain audit evidence regarding overall reasonableness of purchase quantity and price for PQR Ltd.:

**1. Trend Analysis of Purchase Quantities** — Compare monthly/quarterly purchase quantities with corresponding prior year periods. Calculate percentage variances and investigate significant deviations. For a project-based electrical components manufacturer, purchase quantities must align with project schedules and production requirements. Unusual spikes or drops indicate potential misstatement.

**2. Purchase Price Analysis** — Calculate average purchase price per unit for major purchased items and compare with prior year prices. Identify items with significant price increases or decreases to detect whether changes align with market conditions or indicate potential misstatement. Price trends should reflect industry conditions and supplier relationships.

**3. Purchase to Sales Ratio Analysis** — Calculate ratio of total purchases to sales revenue and compare with prior years. Material deviations may indicate over/under purchasing inconsistent with business activity. For project-based operations, this ratio should remain relatively stable absent significant changes in business volume.

**4. Purchase to Product…

Question 4

LD Ltd. has given below loans to the following borrowers during the financial year 2023-24. Mr. B an auditor wants your guidance regarding additional regulatory information required to be provided under the Companies Act, 2013: [Table showing borrowers: X (Promoter), Y (Director), Z (KMP), A (Related Party), Others, and Total with columns for Maximum Loan granted during 2023-2024 (₹ in Lakh) and Outstanding Loan as at 31/03/24 (₹ in Lakh)]

Accepted Answer

Under the **Companies Act 2013**, loans to various borrower categories require specific regulatory disclosures beyond the loan amounts shown in the table.

**For Loans to Directors (Y)**: Under **Section 182**, loans to directors require **Board approval and shareholder approval in general meeting**. Additional information to disclose includes: (i) rate of interest (not less than CRAR), (ii) security/guarantees provided, (iii) repayment schedule and period, (iv) purpose of loan, (v) approval details and dates, and (vi) any defaults or overdue amounts.

**For Loans to Related Parties (X-Promoter, A-Related Party)**: Under **Section 188-189**, these transactions require: (i) **Board/Audit Committee approval** for all related party transactions, (ii) **shareholder approval** if material (₹100 lakh or more or 10% of annual turnover, whichever is lower), (iii) **relationship details** confirming status as related party, (iv) **terms and conditions** including rate of interest and repayment terms, (v) **certification of arm's length nature** if outside ordinary course of business, and (vi) **justification** if transaction is not in ordinary course.

**For Loans to KMP (Z)**: Similar to directors, **Board approval is essential**. Disclose: (i) relationship to company, (ii) rate of interest, (iii) security details, (iv) repayment schedule, and (v) approval mechanism.

**For Loans to Others**: Disclose rate of interest, security/collateral held, repayment terms, and any special condit…

Question 5

M/s PSR & Associates are the auditors of The Saturn Hotel, a chain of five-star hotels. Since the nature of their business is prone to frauds, the company has appointed internal auditors at internal locations. The company has devised a system of effective and efficient internal controls. The auditors, M/s PSR & Associates, want to use the work of the internal auditors. In order to ensure effectiveness, what kind of coordination should be there between the external auditor and the internal audit function?

Accepted Answer

The coordination between the external auditors (M/s PSR & Associates) and the internal audit function should include the following key elements:

**Assessment of Internal Audit Function**: The external auditor must evaluate the competence, objectivity, scope, and work quality standards of the internal audit function. This assessment should determine whether the internal auditors possess adequate qualifications, audit experience, and technical knowledge, and whether they maintain independence from management interference.

**Planning and Scope Coordination**: The external auditors should communicate with the internal audit function during planning to understand their audit objectives, methodology, resource allocation, and planned audit coverage. This helps identify areas of potential reliance and ensures coordinated coverage without duplication.

**Determination of Reliance**: Based on their assessment, the external auditors should determine the specific nature, extent, and period of the internal auditors' work on which they intend to rely. This decision must be documented and communicated clearly to the internal audit function.

**Supervision and Direct Assistance**: The external auditors should provide appropriate supervision and direct assistance to the internal auditors, particularly for areas involving significant risk or where the internal audit function lacks sufficient expertise. This ensures quality of work on which reliance is placed.

**Review and Evaluation of Work…

Question 6

The management seeks your advice in arriving at the value of inventory to be shown in the financial statements of the company. What should be the value of inventory in accordance with AS-2?

Accepted Answer

The value of inventory in accordance with **AS-2 (Valuation of Inventories)** should be determined based on the fundamental principle that inventories are measured at the **lower of cost and net realizable value (NRV)**.

**Cost of Inventory**: The cost comprises three elements: (1) **Costs of purchase** including import duties, taxes, and freight, less trade discounts and rebates; (2) **Conversion costs** such as direct labour, direct overheads, and production overheads allocated on a reasonable basis; and (3) **Other costs** necessarily incurred to bring inventory to its present location and condition. Cost excludes abnormal waste, administrative overheads unrelated to production, and selling expenses.

**Net Realizable Value (NRV)**: NRV is the **estimated selling price in the ordinary course of business less estimated costs of completion and estimated costs necessary to make the sale**, including distribution and marketing costs. NRV reflects the amount the entity expects to realize from selling the inventory in normal business operations.

**Write-down to NRV**: When cost exceeds NRV, inventories must be written down to NRV. This occurs due to obsolescence, physical deterioration, decline in market prices, or changes in demand. Conversely, if circumstances improve, previous write-downs may be reversed (not below the original cost).

**Cost Allocation Methods**: The standard permits **FIFO (First-In-First-Out), Weighted Average Cost, Specific Identification, Standard Cost…

Question 7

JK Ltd. was having a 'Paper' manufacturing plant and looking at the demand it was of the view that the company will grow continuously in future. But, with the introduction of mobile phones in the market, the plant was shut down completely. The shareholders of the company were of the view that auditor failed to perform their duty and have not informed in them about the company's plans to continue its business, otherwise they might not have suffered the loss. List down the factors giving rise to the inherent limitations due to which auditor cannot provide a guarantee that the financial statements are free from material misstatement due to fraud or error.

Accepted Answer

**Auditor's Role and Inherent Limitations:**

Auditors are responsible for obtaining reasonable assurance about whether financial statements are free from material misstatement, but this does NOT mean they can provide a guarantee. The shareholders' claim that the auditor failed to warn them about business shutdown reflects a misunderstanding of auditor responsibilities.

**Factors Giving Rise to Inherent Limitations:**

**1. Nature of Audit Evidence** - Audit evidence is persuasive rather than conclusive. Auditors cannot obtain absolute certainty; they can only provide reasonable assurance. Evidence gathered through samples cannot guarantee detection of all misstatements.

**2. Limitations of Internal Control Systems** - No system of internal control can completely prevent or detect errors and irregularities. Controls can be circumvented through collusion, management override, or sophisticated concealment techniques.

**3. Management Override of Controls** - Senior management can override established internal controls and circumvent audit procedures. Auditors cannot always detect such overrides, particularly when fraud is perpetrated by those in authority.

**4. Prevalence of Fraud and Collusion** - Fraud involving collusion between two or more parties or management fraud is inherently difficult to detect. Sophisticated fraudsters can conceal their activities effectively.

**5. Subjective Nature of Estimates and Judgments** - Financial statements contain numerous accounting e…

Question 8

Mr. Z, at the time of appointment as an independent director in EF Ltd., a listed company, came to know that the Companies Act, 2013 has increased the greater emphasis on the effective implementation and reporting on internal controls for a listed Company. He wants to know the responsibilities as stated under Companies Act, 2013 with regards to Internal Financial Control for (1) Directors (2) Independent directors and (3) Audit committee as per section 134(5)(e), 149(8) & 177(4) (vii) respectively of the Companies Act, 2013.

Accepted Answer

**Internal Financial Controls - Directors, Independent Directors, and Audit Committee Responsibilities under Companies Act, 2013**

**1. Directors' Responsibilities (Section 134(5)(e)):**

The Board of Directors is statutorily required to establish and maintain internal financial controls commensurate with the size and nature of the business. Under Section 134(5)(e), the Board must include a statement in the Directors' Report confirming that **internal financial controls have been established and are operating effectively throughout the financial year**. This responsibility encompasses: (i) Designing and implementing an internal control framework that provides reasonable assurance regarding the reliability of financial reporting and compliance with applicable laws and regulations; (ii) Monitoring the effectiveness of these controls on an ongoing basis; (iii) Documenting the assessment of internal financial control procedures; and (iv) Ensuring that the scope and nature of internal controls are appropriate given the company's size, complexity, and risk profile.

**2. Independent Directors' Responsibilities (Section 149(8)):**

Independent Directors have a specific statutory duty regarding internal financial controls. Under Section 149(8), Independent Directors must **ensure the highest standards of ethical behavior and integrity**—this includes actively ensuring that proper internal financial controls are established and maintained. Their responsibilities include: (i) Particip…

Question 9

JK Ltd. was having a manufacturing plant and looking at the demand it was of the view that the company will grow continuously in future. But, with the introduction of mobile phones in the market, the plant was shut down completely. The shareholders of the company were of the view that auditor failed to perform their duty and have not informed to them about the company's inability to continue its business, otherwise they might not have suffered the loss. List down the factors giving rise to the inherent limitations due to which auditor cannot provide a guarantee that the financial statements are free from material misstatement due to fraud or error.

Accepted Answer

**Inherent Limitations of Audit** are limitations that exist in the very nature of the audit process itself, preventing auditors from providing absolute assurance about financial statements. These arise from factors beyond the auditor's control, even when an audit is properly conducted.

**Factors Giving Rise to Inherent Limitations:**

**1. Management Override of Controls** - Management has the unique ability to override internal controls and direct employees to record incorrect transactions. Auditors cannot guarantee detection of management-initiated fraud because those in authority can circumvent controls.

**2. Fraud by Collusion** - When multiple employees or management collude to perpetrate fraud, auditors cannot reliably detect it. Collusive schemes can evade even well-designed internal controls and audit procedures.

**3. Selective Disclosure and Management Representations** - Auditors are dependent on management's disclosures and representations. Where management is dishonest or selective in what it discloses, auditors cannot independently verify all information without incurring disproportionate costs.

**4. Persuasive Rather Than Conclusive Evidence** - Much audit evidence is persuasive in nature, not conclusive. Auditors work on a sampling/test basis and cannot examine every transaction. Fraudulent transactions could exist in untested items.

**5. Limitations of Audit Procedures** - Standard audit procedures may not detect sophisticated fraud mechanisms. Auditors …

Question 10

CA. B, an auditor, after the completion of busy audit season, was occupied in assembling of final audit files of one of his client. First of all, he started preparing various documents of that client and then kept those documents in various folders. He was preparing documents as well as audit file in paper form because he believed that it is mandatory. He could complete documentation as well as assembling of audit file after three months from the date of audit report. Generally, he retains audit file of the clients for 4 years from the date of audit report. Check the validity of the action of CA B.

Accepted Answer

The actions of CA. B are examined below in light of **SA 230 – Audit Documentation** issued by the ICAI:

**(a) Preparing documents and keeping them in folders:**
CA. B started by preparing various documents and placing them in folders as part of assembling the final audit file. This action is **valid**. SA 230 requires the auditor to assemble audit documentation in an audit file and complete the administrative process of assembling the final audit file on a timely basis after the date of the auditor's report. Organising documents in folders is a standard part of this process.

**(b) Belief that documentation must be in paper form only:**
CA. B believed that it is **mandatory** to maintain audit documentation in paper form only. This belief is **incorrect and not valid**. SA 230 does not prescribe any specific medium for audit documentation. It explicitly provides that audit documentation may be maintained in **paper form, electronic form, or other media** (or a combination thereof). CA. B is therefore free to maintain documentation in electronic form as well; insisting only on paper form is a misunderstanding of SA 230.

**(c) Completing documentation and assembling audit file three months after audit report:**
CA. B completed the assembly of the final audit file **three months (approximately 90 days)** after the date of the audit report. This action is **not valid**. SA 230 requires that the auditor shall complete the assembly of the final audit file on a **timely basis**, …

Question 11

B Ltd. is a company manufacturing bed-sheets and pillow covers. They have appointed M/s C & Co., Chartered Accountants, as their auditors. The auditor is establishing audit strategy with his team members. As the work progressed, they came to know that the company has diversified its business and now they are also planning to manufacture wooden furniture. The auditor, in his professional judgement, considers this to be a significant factor in directing the engagement team's efforts. Give examples of factors that, in auditor's professional judgement, are significant in directing the engagement team's efforts.

Accepted Answer

In audit planning, the auditor must identify significant factors that direct the engagement team's efforts. These factors help allocate appropriate resources, determine the scope of audit procedures, and assess overall audit risk.

**Examples of Significant Factors:**

1. **Changes in Business Operations and Scope**: The diversification from textile manufacturing (bed-sheets and pillow covers) to wooden furniture manufacturing represents a substantial change in the entity's business. The engagement team must understand new production methodologies, supply chains, inventory management systems, and cost structures specific to furniture manufacturing. This change requires the team to acquire industry-specific knowledge and identify new risks and control areas.

2. **Regulatory and Legal Environment Changes**: Different business segments are subject to different regulatory requirements. Furniture manufacturing is subject to distinct labor laws, environmental regulations, health and safety standards, and quality certifications compared to textile manufacturing. The auditor must direct the team to focus on compliance procedures specific to each business segment.

3. **Risk Assessment and Identification**: The new business line introduces different risk profiles—supplier risks, raw material sourcing risks, pricing volatility, market risks, and technological risks in furniture production. These identified risks direct the team to focus on high-risk areas requiring enhanced audit proc…

Question 12

CA B, an auditor, after the completion of busy audit season, was occupied in assembling of final audit files of one of his client. First of all, he started preparing various documents of that client and then kept those documents in various folders. He was preparing documents as well as audit file in paper form because he believed that it is mandatory. He could complete documentation as well as assembling of final audit file of that client after three months from the date of audit report. Generally, he retains audit file of the clients for 4 years from the date of audit report. Check the validity of the action of CA B.

Accepted Answer

The actions of CA B need to be examined in light of **SA 230 – Audit Documentation** issued by the ICAI.

**(a) Preparation of documents in paper form only:**
CA B believed that maintaining audit documentation in **paper form is mandatory**. This belief is **incorrect**. SA 230 does not restrict the form of audit documentation. The auditor may maintain audit files in **paper form, electronic form, or any other storage media**. There is no mandatory requirement to use only paper form. Hence, this action/belief of CA B is **not valid**.

**(b) Completion of final audit file assembly after three months from the date of audit report:**
SA 230 requires the auditor to complete the assembly of the final audit file on a **timely basis after the date of the auditor's report**. The standard provides that an appropriate time limit within which to complete the assembly of the final audit file is ordinarily **not more than 60 days** after the date of the auditor's report. CA B completed the assembly **after three months (approximately 90 days)**, which clearly exceeds the prescribed 60-day limit. Hence, this action of CA B is **not valid**.

**(c) Retention of audit file for 4 years from the date of audit report:**
SA 230 requires the auditor to adopt appropriate procedures for **maintaining the confidentiality, safe custody, integrity, accessibility, and retrievability** of audit documentation. The standard further specifies that audit documentation shall be retained for a period of **at…

Question 13

B Ltd. is a company manufacturing bed-sheets and pillow covers. They have appointed M/s C & Co., Chartered Accountants, as their auditors. The auditor is establishing audit strategy with his team members. As the work progressed, they came to know that the company has diversified its business and now they are also planning to manufacture wooden furniture. The auditor, in his professional judgement, considers this to be a significant factor in directing the engagement team's efforts. Give examples of factors that, in auditor's professional judgement, are significant in directing the engagement team's efforts.

Accepted Answer

**Significant Factors in Directing Audit Engagement Team's Efforts** refer to circumstances that, in the auditor's professional judgement, influence the overall audit strategy and the nature, timing, and extent of audit procedures. These factors help identify areas requiring greater audit focus and resource allocation.

**Examples of Significant Factors:**

**1. Changes in Business Operations and Diversification** — When an entity diversifies into new business lines (as in B Ltd.'s case, expanding from bed-sheets and pillow covers to wooden furniture manufacturing), it introduces new operational risks, different production processes, distinct accounting treatments, and unfamiliar regulatory requirements. The auditor must assess controls and risks in the new segment separately.

**2. Introduction of New Products or Services** — Manufacturing wooden furniture involves different raw materials, supply chain dynamics, inventory management practices, and valuation methods compared to textile manufacturing. This creates new areas of audit concentration.

**3. Expansion into New Geographical Locations or Markets** — New factories, warehouses, or sales outlets introduce different regulatory environments, local tax implications, and control environments that require specialized audit attention.

**4. Changes in Accounting Systems or Information Technology** — If B Ltd. implements new ERP systems or accounting software to handle the new business line, auditors must assess system reliabi…

Question 14

APR & Associates, a Chartered Accountant firm, are appointed as the auditors of Time Ltd. and Bakers Ltd. The volume and nature of business of both the companies are entirely different. CA is the engagement partner for Bakes Ltd. CA P is the engagement partner for Time Ltd. CA R formulates an Audit Programme for conducting the audit of Bakers Ltd. He suggests CA P to use the same audit programme for Time Ltd. But CA P is of the opinion that this audit programme will not be verified for the audit of Time Ltd.

In light of the above, mention the matters that should generally be considered while preparing an Audit Programme for Time Ltd. ?

Accepted Answer

An audit programme is a detailed plan of audit procedures to be performed during an audit engagement. It cannot be standardized across different entities due to their unique characteristics. The following matters should generally be considered while preparing an Audit Programme for Time Ltd.:

**1. Nature and Volume of Business** — Since Time Ltd. has an entirely different nature and volume of business compared to Bakers Ltd., the audit programme must be specifically designed to reflect Time Ltd.'s operational characteristics, product lines, service offerings, and scale of operations. This directly impacts the areas requiring detailed testing and the extent of substantive procedures.

**2. Risk Assessment and Materiality** — The auditor must assess the risks of material misstatement specific to Time Ltd. based on SA 315. Different businesses have different risk profiles. Materiality and performance materiality thresholds will differ based on Time Ltd.'s financial position, profitability benchmarks, and key performance indicators relevant to its industry.

**3. Understanding of Entity and Environment** — A thorough understanding of Time Ltd.'s business environment, industry characteristics, regulatory framework, competitive position, and strategic objectives is essential. This understanding drives the nature, timing, and extent of audit procedures as per SA 300.

**4. Internal Control Structure** — The nature, design, and operating effectiveness of Time Ltd.'s internal control…

Question 15

ABC & Co. are in the business of manufacturing toys. The stock taking process has been done by the company as on 31.3.2024. The company has used FIFO method for valuation of its inventories. The cost of inventory as on 31.3.24 is ₹ 23,25,000/- and the net realizable value of the inventory on the same date is ₹ 25,24,000/-.

The cost of inventory includes the following:
(1) Material purchase cost – ₹ 23,05,000/-
(2) Allocated transport cost: ₹ 18,000/-
(3) Abnormal wastage – ₹ 2,000/-

Accepted Answer

**Applicable Standard: AS 2 – Valuation of Inventories**

As per **AS 2 (Valuation of Inventories)**, inventories must be valued at the **lower of cost or net realisable value (NRV)**.

**Treatment of Abnormal Wastage:**

AS 2 specifically excludes **abnormal amounts of wasted materials** from the cost of inventories. Such costs are not incurred in bringing inventories to their present location and condition in the normal course of production — they are period costs to be expensed in the period in which they are incurred.

Therefore, the **abnormal wastage of ₹2,000** included by ABC & Co. in the cost of inventory is **incorrectly included** and must be excluded.

**Corrected Cost of Inventory:**

Material purchase cost and allocated transport cost are legitimate cost components under AS 2 (being purchase cost and costs of bringing inventory to its present location). However, abnormal wastage must be removed.

Corrected Cost = ₹23,25,000 − ₹2,000 = **₹23,23,000**

**Comparison with NRV:**

NRV = ₹25,24,000; Corrected Cost = ₹23,23,000

Since Cost (₹23,23,000) < NRV (₹25,24,000), inventory is valued at **cost**.

**Conclusion:** The inventory of ABC & Co. should be valued at **₹23,23,000** as on 31.3.2024. The company has overstated inventory by ₹2,000 by incorrectly including abnormal wastage in cost. This overstatement must be corrected, and ₹2,000 should be charged to the Profit & Loss Account as a period cost.

Question 16

APR & Associates, a Chartered Accountant firm, are appointed as the auditors of Time Ltd. and Bakes Ltd. The volume and nature of business of both the companies are entirely different. CA R is the engagement partner for Bakes Ltd. CA P is the engagement partner for Time Ltd. CA R formulates an Audit Programme for conducting the audit of Bakes Ltd. He suggests CA P to use the same audit programme for Time Ltd. But CA P is of opinion that this audit programme will not be useful for the audit of Time Ltd.

In light of the above, mention the matters that should generally be considered while preparing an Audit Programme. If CA P correct in emphasizing for a different Audit Programme for Time Ltd.?

Accepted Answer

**CA P is absolutely correct** in emphasizing that a separate and distinct Audit Programme should be prepared for Time Ltd. Since the volume and nature of business of both companies are entirely different, a common audit programme cannot serve the purpose of an effective audit for both entities.

**Meaning of Audit Programme:** An Audit Programme is a detailed plan of the audit work to be performed, specifying the procedures to be followed in verification of each item in the financial statements. It is prepared keeping in mind the specific nature, size, and complexities of the entity under audit.

**Matters Generally Considered While Preparing an Audit Programme:**

**1. Nature and Size of the Business:** The audit programme must reflect the specific industry in which the entity operates, the scale of operations, and the complexity of transactions. What is relevant for Bakes Ltd. (a bakery/food business) may be entirely irrelevant for Time Ltd. (possibly a manufacturing or trading concern).

**2. Volume of Transactions:** The extent of checking — whether 100% verification or sampling — depends on the volume of transactions. A high-volume business requires a different approach compared to a low-volume one.

**3. Internal Control System:** The effectiveness and adequacy of the internal control system of the entity directly influences the nature, timing, and extent of audit procedures to be included in the programme. A strong internal control system may allow reduced substantive…

Question 17

ABC & Co. are in the business of manufacturing toys. The stock taking process has been done by the company as on 31.3.2024. The company has used FIFO method for valuation of its inventories. The cost of inventory as on 31.3.24 is ₹25,25,000/- and the net realizable value of the inventory on the same date is ₹25,24,000/-

The cost of inventory includes the following:
(1) Material purchase cost - ₹25,05,000/-
(2) Allocated transport cost - ₹18,000/-
(3) Abnormal wastage - ₹2,000/-

Accepted Answer

**Applicable Standard: AS 2 – Valuation of Inventories**

As per **AS 2**, inventories shall be valued at the **lower of cost and net realisable value (NRV)**.

**Step 1 – Determination of Correct Cost**

The cost of inventory as stated by ABC & Co. is ₹25,25,000. However, this figure includes **abnormal wastage of ₹2,000**. Under **AS 2**, abnormal amounts of wasted materials and other production costs are specifically **excluded from the cost of inventories** and are recognised as an expense in the period in which they are incurred.

Accordingly, the **corrected cost of inventory** is computed as:

Cost as reported: ₹25,25,000
Less: Abnormal wastage (to be excluded): ₹2,000
**Correct Cost = ₹25,23,000**

Note: **Material purchase cost (₹25,05,000)** and **allocated transport cost (₹18,000)** are legitimate components of cost under AS 2, as transport/freight costs are part of the cost of purchase (costs incurred in bringing the inventory to its present location and condition).

**Step 2 – Comparison with NRV**

| Particulars | Amount (₹) |
|---|---|
| Correct Cost of Inventory | 25,23,000 |
| Net Realisable Value (NRV) | 25,24,000 |
| **Lower of Cost or NRV** | **25,23,000** |

Since the corrected cost (₹25,23,000) is **lower than NRV** (₹25,24,000), the inventory shall be valued at **₹25,23,000**.

**Step 3 – Treatment of Abnormal Wastage**

The abnormal wastage of **₹2,000 shall be charged to the Statement of Profit & Loss** for the year ended 31.3.2024 and shall not form …

Question 18

XY and Associates are auditors of PQR Ltd, which provides electrical components on project basis. The purchases are huge and the auditor wants to make sure that all the purchases made during the period are recorded and there is no understatement or overstatement. For this purpose the audit team have performed procedures like cut-off tests, correct treatment of goods in transit, obtaining written representations and so on, performing analytical procedures. What are the analytical procedures required to be performed to obtain audit evidence as to overall reasonableness of purchase quantity and price?

Accepted Answer

**Analytical Procedures for Overall Reasonableness of Purchases—Quantity and Price**

Analytical procedures, as outlined in **SA 520 (Analytical Procedures)** and **SA 330 (The Auditor's Responses to Assessed Risks)**, are essential to obtain audit evidence regarding the overall reasonableness of purchase volumes and prices. These procedures help identify completeness, understatement, and overstatement risks.

**Procedures for Purchase Quantity Verification:**

Compare current period purchase quantities with prior year quantities to identify significant deviations and unusual trends. Analyze purchase quantities in relation to production levels, sales volumes, and inventory movements—purchases should correlate logically with these operational metrics. Supplier-wise purchase analysis identifies unusual concentration or sporadic orders from new or existing suppliers. Trend analysis of seasonal purchases, if applicable, ensures consistency with historical patterns. Budget vs. actual comparison reveals variances between planned and actual purchases, highlighting potential gaps or excess procurement.

**Procedures for Purchase Price Verification:**

Perform unit price analysis by comparing prices per unit of material across suppliers and periods. Identify price variations from standard rates or contracts to detect understatement (possible under-invoicing) or overstatement (inflated pricing). Calculate average prices and identify outliers significantly above or below average, invest…

Question 19

CA Q is the engagement partner for the audit of a Departmental store. As a part of the risk assessment procedure, he wants to make inquiries of management and others within the entity. What kind of information can the auditor get by inquiring from the following?

Accepted Answer

An auditor performs risk assessment procedures including inquiries of management and personnel within the entity to gain understanding of the entity and its environment, including internal controls. The information obtained helps identify and assess risks of material misstatement. Here is the information obtainable from each category:

**(i) Internal Audit Personnel:** Internal audit personnel possess knowledge of the entity's internal risks and control deficiencies. Inquiries can reveal areas identified as high risk within the entity, results and recommendations from recent internal audits, control procedures implemented to address identified weaknesses, assessments of the effectiveness and design of internal controls, fraud risks identified and any instances of non-compliance detected, and the impact of organizational changes or system modifications on the control environment. This helps the auditor understand management's response to control issues and assess the control culture.

**(ii) In-house Legal Counsel:** Legal counsel has insights into legal and regulatory risks affecting the entity. Inquiries can provide information about actual or potential litigation and claims against the entity, existence of contingent liabilities or unresolved disputes, compliance with applicable laws and regulations in the industry, terms and conditions of significant contracts and licenses that may be onerous, potential violations or non-compliance with regulatory requirements, and the pro…

Question 20

CA O is the engagement partner for the audit of a Departmental store. As a part of the risk assessment procedure, he wants to make inquiries of the management and others within the entity. What kind of information can the auditor get by inquiring from the following?

Accepted Answer

As per **SA 315 (Revised 2019)** - Identifying and Assessing the Risks of Material Misstatement, auditors make inquiries from management and others within the entity to obtain information relevant to risk assessment. Different personnel provide insights into specific operational and control areas:

**(i) Internal Audit Personnel:** The auditor can obtain information about internal audit's findings, recommendations, and observations regarding internal control deficiencies. They can provide details on audit scope, focus areas, and management's responses to audit findings. This helps the auditor understand areas of concern, control weaknesses, and previously identified risks within the organization.

**(ii) In-house Legal Counsel:** The legal counsel can provide information about pending or threatened litigation, claims, and legal disputes. They offer insights into the entity's compliance with laws and regulations, including environmental, labor, and regulatory matters. Information about non-compliance issues, contract disputes, and legal contingencies is obtained from this source.

**(iii) Marketing or Sales Personnel:** Personnel in marketing and sales can provide information about sales trends, patterns, and volume changes. They can communicate details about product returns, credits, customer complaints, and disputes. Information regarding unusual or complex transactions, promotional activities, and market conditions affecting the entity's business is gathered from this group…

Question 21

CA Z, the auditor of MNO Ltd., during the course of audit, assesses a risk of material misstatement regarding the litigation and claims involving the company. CA Z is not convinced with the management's explanations regarding the status of the litigations or claims. It is considered unusual that the entity's external legal counsel will respond appropriately to a letter of general enquiry. The auditor sent a letter of specific enquiry requesting the entity's external legal counsel to communicate directly with the auditor. List out the inclusions in the letter of specific enquiry?

Accepted Answer

In auditing litigations and claims, when management's representations are questioned or when a general enquiry is deemed inappropriate, auditors send a letter of specific enquiry directly to the entity's external legal counsel. This letter seeks direct communication and must include the following key inclusions:

**1. Identification of Entity and Auditor** - Clear identification of the client entity (name, address, principal business), period of audit, and complete details of the auditor conducting the audit to ensure the lawyer responds to the correct party.

**2. List of Pending and Threatened Litigations** - A detailed enumeration of all pending litigations and threatened litigations known to management, including case names, parties involved, court/forum, and dates of filing or occurrence.

**3. Description of Claims and Assessments** - Specification of all claims and assessments, including tax assessments, regulatory claims, labor disputes, or other claims against the entity.

**4. Scope of Enquiry Regarding Omissions** - A statement requesting the lawyer to provide information about any pending or threatened litigations, claims, or assessments not listed in the letter, to ensure completeness.

**5. Request for Assessment of Legal Outcomes** - Specific request for the lawyer's professional assessment regarding: (a) the probability of unfavorable outcome (probable/possible/remote); (b) the estimated financial exposure or range of potential loss; (c) the expected timeframe…

Question 22

CA Z, the auditor of MNO Ltd., during the course of audit, assesses a risk of material misstatements regarding the litigation and claims involving the company. CA Z is not convinced with the management's explanation regarding the status of the litigation or claims. It is considered unlikely that the entity's external legal counsel will respond appropriately to a letter of general enquiry. The auditor sent a letter of specific enquiry requesting the entity's external legal counsel to communicate directly with the auditor. List out the conclusions in the letter of specific enquiry? In certain circumstances the auditor may judge it necessary to meet with entity's external legal counsel to discuss the likely outcome of the litigations or claims. What will be auditor's reporting responsibility …

Accepted Answer

**Part (a): Conclusions to be Included in Letter of Specific Enquiry**

Under SA 501 (Audit Evidence - Specific Considerations for Selected Items), the letter of specific enquiry to the entity's external legal counsel should request the following conclusions to be communicated directly to the auditor:

1. **Status of Litigation, Claims and Assessments** - Information regarding the current status (pending, threatened, under discussion, or settled) of all known or probable litigation, claims and assessments involving the entity.

2. **Opinion on Likelihood of Unfavorable Outcome** - The external legal counsel's professional opinion on the likelihood of an unfavorable outcome in each matter, and the entity's view of the probable outcome.

3. **Estimated Financial Exposure** - An estimate of the financial exposure (the amount that may need to be paid or provided for) relating to each litigation or claim. If an estimate cannot be made, a statement to that effect should be provided.

4. **Completeness of Disclosures** - Whether the entity's disclosure of litigation, claims and assessments in the financial statements (including notes) is complete. This includes confirmation that no matters have been omitted that should have been disclosed.

5. **Limitations on Response** - Any limitations on response due to attorney-client privilege, confidentiality restrictions, or other factors that prevent full disclosure of information.

**Part (b): Auditor's Reporting Responsibility When Manage…

Question 23

In certain circumstances the auditor may judge it necessary to meet with the entity's external legal counsel to discuss the likely outcome of the litigations or claims. What will be auditor's reporting responsibility if the management refuses to give permission to the auditor to communicate or meet with the external legal counsel?

Accepted Answer

When management refuses permission to the auditor to communicate or meet with the entity's external legal counsel regarding pending litigations or claims, this constitutes a **limitation on audit scope**. The auditor's reporting responsibility in such circumstances is governed by **SA 705 (Modifications to the Opinion in the Independent Auditor's Report)** and the overall requirement under **SA 200 (Overall Objectives of the Independent Auditor)** to obtain sufficient appropriate audit evidence.

**Assessment and Alternative Procedures:**
First, the auditor must assess whether they can obtain sufficient appropriate evidence through alternative procedures. These may include: (i) reviewing correspondence with legal advisors already received; (ii) examining management's files and minutes of meetings; (iii) reviewing board minutes and legal consultations; (iv) making detailed inquiries of management's internal legal counsel or compliance department; (v) reviewing management representations in writing; (vi) examining invoices from external counsel; and (vii) reviewing court orders or notices received.

**When Alternative Procedures Are Insufficient:**
If, despite attempting alternative procedures, the auditor cannot obtain sufficient appropriate evidence regarding the existence, nature, financial effect, and disclosures relating to litigations and claims, a scope limitation exists. In such cases, the auditor must consider the materiality and pervasiveness of the potential misstate…

Question 24

The management seeks your advice in arriving at the value of inventory to be shown in the financial statements of the company. What should be the value of inventory in accordance with AS-2?

Accepted Answer

As per AS-2 (Valuation of Inventory), inventory should be valued at the **lower of cost or net realizable value (NRV)**. This is the fundamental principle guiding inventory valuation in financial statements.

**Cost of Inventory** comprises: (a) **Cost of purchase** – including invoice price, import duties, taxes, transport, handling, and other costs directly attributable to acquiring inventory, less trade discounts and rebates; (b) **Cost of conversion** – for manufactured goods, including direct materials, direct labour, and production overheads allocated based on normal production capacity (not abnormal idle capacity); (c) Exclusions – administrative and selling costs are excluded from inventory cost.

**Net Realizable Value (NRV)** is calculated as: Estimated selling price less estimated costs of completion and estimated selling/distribution costs.

**Selection of the lower amount**: The entity must compare cost and NRV for each item or group of similar items, then select whichever is lower for balance sheet presentation. This ensures inventory is not overstated. If NRV falls below cost due to obsolescence, damage, or market decline, inventory must be written down to NRV.

**Method of cost determination**: When individual item identification is impracticable, standard methods are adopted – **First-In-First-Out (FIFO)**, **Weighted Average Cost (WAC)**, or **Specific Identification**. The method selected should be applied consistently year-on-year unless circumstances chan…

Question 25

PQ & Co. want to diversify the business and for that purpose they want to raise money by issuing shares to the general public. The face value of the shares is ₹ 100 but the directors of the company propose to issue the shares at a discounted rate of ₹ 95; so as to receive more response. The statutory auditor, however, objects to the same as it is not allowed as per the Companies Act, 2013. State the provisions of Section 53 of the Companies Act, 2013 with reference to shares issued at a discount and the consequences where the company fails to comply with the provisions of this section.

Accepted Answer

**Section 53 of the Companies Act, 2013 - Provisions Regarding Share Issuance at Discount:**

Section 53 provides that **a company shall not issue shares at a discount to their face value**. This is an absolute prohibition applicable to all classes of shares (equity or preference) and to all companies registered under the Companies Act, 2013. The prohibition is categorical and does not permit any exception for share capital.

**Exception - Section 54:**
While Section 54 permits the issue of **debentures at a discount** (subject to authorization by special resolution), this exception applies only to debentures and NOT to shares. Under the Companies Act, 1956, there existed a limited exception allowing shares to be issued at a discount within 12 months of incorporation if authorized by special resolution, but this exception was deliberately removed in the Companies Act, 2013, making the prohibition on share discount absolute and unconditional.

**Rationale:**
The prohibition protects creditors and shareholders by ensuring that the company receives full share capital and maintains the integrity of the capital structure. It prevents fraudulent reduction of capital and ensures transparency in share valuation.

**Consequences of Non-Compliance:**

1. **Validity of Shares**: The shares issued at a discount are **void ab initio** (void from the beginning). The allotment is illegal and unenforceable.

2. **Personal Liability of Directors**: The directors who authorize or permit the is…

Question 26

M/s PSR & Associates are the auditors of The Saturn Hotel, a chain of five-star hotels. Since the nature of their business is prone to frauds, the company has appointed internal auditors at various locations. The company has also devised a system of effective and efficient internal controls. The auditors, M/s PSR & Associates, want to use the work of the internal auditors. In order to ensure effectiveness, what kind of coordination should be there between the external auditor and the internal audit function?

Accepted Answer

**Coordination between External Auditors and Internal Audit Function** should be structured as per **SA 610 (Using the Work of Internal Auditors)**. For The Saturn Hotel, effective coordination requires the following:

**1. Assessment of Internal Audit Function:** The external auditor must evaluate the competence, objectivity, and scope of the internal audit function. The internal auditors should possess adequate technical knowledge of audit procedures, accounting standards, and fraud detection techniques relevant to hospitality industry risks. Objectivity requires that internal auditors maintain independence in their reporting and have appropriate organizational status (preferably reporting to the Audit Committee rather than operational management).

**2. Communication of Audit Plans:** Both auditors should communicate their planned audit scope, timing, and risk areas upfront. The external auditor should understand the internal auditors' audit plan to identify opportunities to rely on their work and avoid duplication of effort. This is particularly important for hotels where fraud risks exist in areas like cash handling, guest payments, and inventory of valuables.

**3. Regular Review Meetings:** Periodic coordination meetings should be held to discuss audit progress, preliminary findings, control weaknesses identified, and follow-up on previously reported observations. These meetings facilitate alignment on fraud risk assessment and high-risk areas requiring focused attenti…

Question 27

CA is auditor of LM Ltd. Before commencing with current year's audit, he initiated planning for the audit. Planning includes the need to consider certain matters, prior to the identification and assessment of the risk of material misstatements. Enumerate such matters.

Accepted Answer

According to SA 300 (Planning an Audit of Financial Statements), the auditor must consider the following preliminary matters before commencing the audit and prior to identification and assessment of the risk of material misstatement:

**Understanding the Entity and Its Environment** — The auditor must gain knowledge of the entity's business nature, operational activities, organizational structure, ownership and governance structure, and the financial reporting framework applicable to the entity. This includes understanding the industry in which the entity operates and economic factors affecting it.

**Understanding Accounting Policies and System of Internal Control** — The auditor needs to understand the accounting policies adopted by the entity, the accounting standards followed, the system of internal control implemented, and the IT systems and applications used for maintaining accounting records.

**Identification of Applicable Laws and Regulations** — The auditor must identify the laws and regulations that are applicable to the entity, such as statutory requirements, tax laws, industry-specific regulations, and compliance obligations relevant to the entity's operations and financial reporting.

**Determining Materiality and Performance Materiality** — The auditor should determine overall materiality, performance materiality, and specific materiality thresholds for individual accounts or transaction classes. This helps in planning the nature, timing, and extent of audit pr…

Question 28

CA E is auditor of LM Ltd. Before commencing with current year's audit, he initiated planning for the audit. Planning includes the need to consider certain matters, prior to the identification and assessment of the risk of material misstatements. Enumerate such matters.

Accepted Answer

As per **SA 300 (Planning an Audit of Financial Statements)**, the following matters must be considered by the auditor during the audit planning phase, prior to identification and assessment of risks of material misstatement:

**1. Understanding the Entity and Its Environment**
The auditor must obtain knowledge of the client's business, industry, regulatory environment, and organizational structure. This includes understanding the nature of the client's operations, the client's ownership and governance structure, sources of funding, and the client's objectives and strategies.

**2. Understanding the Applicable Financial Reporting Framework**
The auditor must understand the applicable financial reporting standards under which the financial statements are prepared (e.g., Ind AS, Companies Act 2013) and relevant regulatory requirements that affect the preparation and presentation of financial statements.

**3. Understanding the Accounting System and Internal Control Environment**
The auditor must gain an understanding of the client's accounting system, the design and effectiveness of relevant controls, and the accounting policies applied by the entity. This helps identify areas of complexity and inherent risk.

**4. Preliminary Assessment of Materiality**
The auditor must establish preliminary judgments about materiality levels at the financial statement level and performance materiality to determine the scope and nature of audit procedures, even before detailed risk assessment.…

Question 29

The management of PQ Ltd. changed during the period under audit. Mr. G an auditor, at the time of receiving written representation on the management's responsibilities from the new management, was in a dilemma related to the date of and period(s) covered by the written representation. Further, new management was of the view that they can give written representation from the date they took over and not for the prior period when old management were managing affairs of the company. Guide the auditor & the management in this respect.

Accepted Answer

**The Dilemma:** When management changes during the audit period, uncertainty arises about whose responsibility it is to provide written representations for prior periods and whether new management can represent for periods they did not manage.

**Regulatory Framework:** Per **SA 580 (Written Representations)**, the auditor must obtain written representations from management responsible for financial reporting. These representations should cover the entire period under audit, as they relate to the auditor's responsibility for the financial statements as a whole.

**Guidance to the Auditor:**

**1. Representations should cover the entire audit period** – The management representation letter must address all significant matters throughout the period under audit, regardless of when management changed. The auditor reports on the financial statements for the entire period and therefore requires representations for that complete period.

**2. Obtain representations from new management** – New management, being responsible for the current financial statements, should provide representations. However, distinguish their representations into two categories: (a) matters from their assumption date onwards (direct knowledge), and (b) matters prior to their appointment (based on inquiry and review).

**3. Preferably seek representations from old management** – For matters during the old management's tenure, the auditor should attempt to obtain representations directly from the predecessor …

Question 30

The management of PQ Ltd. changed during the period under audit. Mr. G an auditor, at the time of receiving written representation on the management responsibilities from the management, was in a dilemma related to the date of and period(s) covered by the written representation. Further, new management was of the view that they can give written representation from the date they took over and not for the prior period when old management were managing affairs of the company. Guide the auditor & the management in this respect.

Accepted Answer

**Written Representations – Date and Period Coverage Under Changed Management**

**SA 580 – Written Representations** establishes that written representations are audit evidence comprising statements by management. The key issue concerns the appropriate date and period coverage when management changes during the audit period.

**Date of Written Representation:**
As per SA 580, the representation letter's date should be as close as possible to the auditor's report date, but not after it. When management changes, the new management naturally dates the letter from their tenure onwards. However, this does not diminish the requirement to cover the entire audit period. The auditor must obtain representations before concluding the audit.

**Period Covered by Written Representations:**
Written representations must cover the **entire financial period under audit**, regardless of management changes. The financial statements present results for the full period, and representations must correspondingly cover this entirety. This is a fundamental requirement under SA 580 and cannot be circumvented by management transitions.

**Guidance to the Auditor:**

1. **Insist on full-period coverage:** The auditor must require representations addressing the entire audit period. Accepting representations only from the new management's assumption date is insufficient.

2. **Obtain dual representations if necessary:** The auditor may obtain separate letters from outgoing and incoming management. The ou…

CA Inter Audit & Ethics

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Write it like this

1The skeleton

2Examiner-rewarded phrases

3Common trap

Worked Solution

Write it like this

1The skeleton

2Examiner-rewarded phrases

3Common trap