Question 1

Suggest the audit team members of LMN & Co. to match the apt combination from the following information as per SA 300.

| Description | Elements of Planning |
|---|---|
| (a) Evaluating compliance with ethical requirement, including independence | (i) Audit Programme |
| (b) Detailed plan of applying audit procedures | (ii) Preliminary engagement activity |
| (c) Determination of materiality | (iii) Audit Strategy |
| (d) Consideration of number and location of branches for audit | (iv) Audit Plan |

Accepted Answer

**Answer: (B)**

As per **SA 300 – Planning an Audit of Financial Statements**, the correct matching is:

**(a) Evaluating compliance with ethical requirements, including independence → (ii) Preliminary Engagement Activity:** Before accepting or continuing an engagement, the auditor must perform preliminary engagement activities which include evaluating compliance with ethical requirements such as independence. This occurs before the audit strategy or plan is formulated.

**(b) Detailed plan of applying audit procedures → (i) Audit Programme:** An audit programme is the document setting out the detailed nature, timing, and extent of audit procedures to be applied at the assertion level — it is the most granular and specific document in the planning hierarchy.

**(c) Determination of materiality → (iv) Audit Plan:** While materiality feeds into overall strategy, SA 300 places the detailed determination and documentation of materiality thresholds within the **audit plan**, which translates the overall audit strategy into more detailed guidance on the nature, timing, and extent of procedures.

**(d) Consideration of number and location of branches for audit → (iii) Audit Strategy:** The overall audit strategy establishes the scope, timing, and direction of the audit. Decisions on which locations or branches to include and how to approach them are strategic-level determinations made at this stage.

Thus, the correct combination is **(a)–(ii), (b)–(i), (c)–(iv), (d)–(iii)**, which…

Question 2

M/s XYZ & Co., Chartered Accountants, is conducting the statutory audit of ABC Ltd. During the audit, the engagement partner notices certain unusual year-end sales transactions that have significantly increased the company's profits. Management explains that these are genuine transactions and provide supporting invoices.

However, the engagement partner expresses concern that such unusual year-end transactions require deeper examination, notwithstanding the availability of documentation. He emphasizes that an auditor should remain alert to conditions that may indicate possible misstatements. He further remarks that although the firm generally follows a rule-based approach to ethics, auditors should not limit themselves to mere compliance with rules but also uphold the spirit of ethical pri…

Accepted Answer

**Attitude Expected: Professional Skepticism**

The engagement partner expects the audit team to maintain an attitude of **professional skepticism** throughout the audit. As defined under **SA 200 – Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing**, professional skepticism is an attitude that includes a **questioning mind**, being alert to conditions that may indicate possible misstatement due to error or fraud, and a **critical assessment of audit evidence**.

In the given scenario, despite management providing supporting invoices for the unusual year-end sales transactions, the engagement partner correctly cautions the team not to accept explanations at face value. This reflects the core of professional skepticism — documentation alone does not constitute sufficient appropriate audit evidence if the auditor has reason to question its authenticity or the circumstances surrounding the transaction.

Further, the engagement partner's remark about going beyond rule-based compliance and upholding the **spirit of ethical principles** aligns with the **conceptual framework approach** to ethics under the **ICAI Code of Ethics**, which requires auditors to apply judgment and not merely check boxes.

**Risks Reduced by Maintaining Professional Skepticism:**

**1. Risk of Material Misstatement (RMM):** By critically evaluating unusual transactions, the auditor reduces the risk of failing to detect misstatements arising …

Question 3

Distinguish briefly between the principles-based approach and the rules-based approach to ethics.

Accepted Answer

**Principles-Based Approach to Ethics:**
This approach establishes broad, fundamental principles that guide professional behaviour and requires individuals to exercise professional judgement in applying those principles to specific situations. The ICAI Code of Ethics follows this approach, laying down core principles such as integrity, objectivity, professional competence, confidentiality, and professional behaviour. Rather than prescribing detailed rules for every possible situation, it expects the professional to use judgement to determine the most ethical course of action. The advantage is flexibility — it can address novel or unforeseen situations not covered by any specific rule.

**Rules-Based Approach to Ethics:**
This approach sets out specific, detailed rules that must be followed in defined situations. It provides a checklist-type framework where compliance with the stated rule is considered sufficient. There is less reliance on individual judgement. The advantage is certainty and consistency — professionals know exactly what is permitted and what is not. However, the limitation is that rules cannot anticipate every situation, and strict technical compliance with a rule may still allow behaviour that is ethically questionable in spirit.

**Key Distinction:**
The fundamental difference is that the **principles-based approach demands that the spirit and intent of ethical standards are upheld**, even in situations not explicitly covered, whereas the **rules-based appro…

Question 4

While auditing the trade receivables of Ocean Limited, CA R plans to select 100 customer balances from a population of 1000 receivables accounts appearing in the trade receivables ledger. For this purpose, he decides to select customer account number 5th as the starting point and thereafter select every 10th account from the ledger until the required sample size is obtained.

Identify and briefly explain the sampling method being used by CA R in the above situation.

Accepted Answer

**Sampling Method: Systematic Sampling**

CA R is using **Systematic Sampling** (also known as **Interval Sampling**) to select the audit sample.

In systematic sampling, the population is divided by the required sample size to determine a **uniform sampling interval**. Here, the interval is 1000 ÷ 100 = **10**. A **random starting point** is selected (account no. 5 in this case), and thereafter every 10th item is selected (i.e., accounts 5, 15, 25, 35... and so on) until the desired sample size of 100 is obtained.

This method ensures **even coverage** of the entire population and is simple to apply, provided the population is not arranged in a pattern that coincides with the sampling interval, which could introduce **bias**.

Question 5

State the important consideration that an auditor should keep in mind while using this method (systematic sampling) and how the risk arising from such sampling can be minimized?

Accepted Answer

**Systematic Sampling — Important Consideration and Risk Minimisation**

In systematic sampling, the auditor selects items by choosing a random starting point and then picking every nth item from the population. The most **important consideration** the auditor must keep in mind is that the population must not contain any hidden pattern or periodicity that coincides with the sampling interval. If the population has a recurring pattern (e.g., every nth item is of a particular nature — such as end-of-month transactions, or items prepared by a specific clerk), and the sampling interval matches that pattern, the sample will be **biased** and unrepresentative of the entire population.

**Minimisation of Risk:** The risk arising from systematic sampling can be minimised by using **more than one random starting point**. Instead of selecting a single starting point and picking every nth item, the auditor can divide the population into multiple segments and select a different random starting point for each segment. This approach, known as **random systematic sampling with multiple starts**, helps break any cyclical pattern in the population and ensures a more representative and unbiased sample.

Question 6

Further, the audit partner suggests that instead of this approach, CA R should verify the first 150 customer accounts appearing in the receivables ledger for the last month. State the sampling method suggested by the partner.

Accepted Answer

The sampling method suggested by the audit partner is **Block Sampling**.

In **block sampling**, the auditor selects a consecutive sequence or block of items from the population — in this case, the first 150 customer accounts appearing in the receivables ledger for the last month. All items within the chosen block are examined together as a group.

This method is generally **not recommended** as a reliable audit sampling technique because it does not provide an equal chance of selection to all items in the population, thereby lacking the representativeness required under **SA 530 (Audit Sampling)**. The results from a block may not be extrapolated to the entire population with reasonable assurance.

Question 7

During the statutory audit of Orion Manufacturing Ltd., the auditor, CA Raghav Mehta, observed that the company's management had changed during the financial year. The earlier management resigned midway through the year, and a new management team assumed charge thereafter.

While completing the audit, the auditor requested written representations from the management regarding their responsibilities for the preparation of financial statements and other audit-related matters. However, the new management stated that they could provide written representations only for the period from the date they assumed office and not for the earlier period when the previous management was in charge.

Examine the above situation and explain with reference to SA 580, the appropriate date of the written repres…

Accepted Answer

**Relevant Standard: SA 580 — Written Representations**

**SA 580** issued by the ICAI deals with the auditor's responsibility to obtain written representations from management as audit evidence, and the procedures to be followed if management refuses to provide such representations.

**Appropriate Date of Written Representation**

As per SA 580, the written representation letter shall be dated **as near as practicable to, but not after, the date of the auditor's report** on the financial statements. Accordingly, CA Raghav Mehta should request the representation letter from the current (new) management to be dated close to the date of his audit report on Orion Manufacturing Ltd.'s financial statements for the full year.

**Period to be Covered by Written Representations**

SA 580 requires that written representations **cover the entire period referred to in the financial statements**, i.e., the full financial year under audit — and not merely the tenure of the current management. The financial statements of Orion Manufacturing Ltd. reflect transactions and events of the **entire year**, and the management accepting responsibility for those statements is responsible for them as a whole.

The position taken by the new management — that they will provide representations only from the date they assumed office — is **not tenable or acceptable** under SA 580. By accepting charge of the entity and signing/approving the financial statements for the full year, the new management impli…

Question 8

As per the understanding of CA Verma, which of the following options, falls outside the scope of audit of financial statements?

(I)   Assessing the physical condition of industrial buildings and heavy & sophisticated machinery.
(II)  Examining the reliability and sufficiency of financial information for audit purposes.
(III) Determining the suitability of buildings for continued use and estimating their remaining useful life.
(IV)  Ensuring proper disclosure of property, plant and equipment in the financial statements.

Accepted Answer

**Answer: (A)**

The scope of an audit of financial statements, as per **SA 200 (Overall Objectives of the Independent Auditor)**, is to enable the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. The auditor is not a technical expert in engineering or physical sciences.

**(I) Assessing the physical condition of industrial buildings and heavy & sophisticated machinery** — This requires technical/engineering expertise and falls **outside** the scope of a financial statement audit.

**(III) Determining the suitability of buildings for continued use and estimating their remaining useful life** — This is a technical determination requiring specialist knowledge, not an audit function. It falls **outside** the scope.

**(II) Examining the reliability and sufficiency of financial information** — This is a core audit objective and falls **within** scope.

**(IV) Ensuring proper disclosure of PPE in financial statements** — Verifying compliance with disclosure requirements (as per Ind AS 16 / AS 10) is squarely **within** the auditor's scope.

Thus, statements **(I) and (III)** fall outside the scope of audit of financial statements.

Question 9

During the audit of Urban Build Constructions Ltd., the auditor reviewed the accounting information system used for recording and processing financial transactions in the company. Transactions relating to purchases, payroll and expenses are recorded through this system by different departments.

During discussion with employees, the auditor realized that there is limited documentation how financial information flows through the system.

What are the areas relating to the entity's information system and related business processes relevant to financial reporting that the auditor should obtain an understanding as a part of risk assessment procedures?

Accepted Answer

**Relevant Standard: SA 315 (Revised) — Identifying and Assessing the Risks of Material Misstatement**

As part of risk assessment procedures, the auditor of Urban Build Constructions Ltd. is required under **SA 315 (Revised)** to obtain an understanding of the entity's **information system and related business processes** relevant to financial reporting. The following areas must be understood:

**1. Classes of Transactions Significant to the Financial Statements**
The auditor must identify the significant classes of transactions in the entity's operations — in this case, purchases, payroll, and expenses — that are significant to the financial statements and how they are processed through the accounting information system.

**2. Procedures for Initiating, Recording, Processing, and Reporting Transactions**
The auditor must understand the procedures (both within **IT systems and manual systems**) by which transactions are initiated, recorded, processed, corrected as necessary, transferred to the general ledger, and ultimately reported in the financial statements. Given that Urban Build has limited documentation of information flows, this becomes a critical area.

**3. Related Accounting Records and Supporting Information**
This includes understanding the accounting records — whether electronic or manual — supporting information, and specific accounts in the financial statements used to initiate, record, process, and report transactions. This covers subsidiary ledgers, journals…

Question 10

PQR & Associates, a large firm of Chartered Accountants, have been appointed as the auditors of a listed company. CA P, an engagement partner, gathered his audit team to explain them the importance of audit programme. The audit team was impressed by the advantages of audit programme and decided to strictly follow the same. CA P, however, explained that an audit programme can have disadvantages also, if not used diligently.

What are the Disadvantages of an Audit programme (Any 3)?

Accepted Answer

An **audit programme**, while highly beneficial, carries certain disadvantages if followed mechanically without professional judgement. CA P rightly cautioned the team about the following:

**1. Mechanical Execution without Application of Mind:**
Audit staff may treat the programme as a mere checklist and tick off procedures without applying independent thinking. This results in a **routine, mechanical approach** where the auditor loses sight of the broader audit objectives. Unusual transactions or red flags may go unnoticed simply because they fall outside the prescribed steps.

**2. Inflexibility — Inability to Adapt to Changing Circumstances:**
An audit programme, once prepared, may become **rigid and inflexible**. The business environment, internal controls, and risk profile of the client may change during the audit period, but staff may continue executing the original programme without modification. This defeats the purpose of a risk-based audit approach, as new or emerging risks are not adequately addressed.

**3. Loss of Initiative by Audit Staff:**
When every step is pre-determined, junior audit staff may lose the **motivation and initiative** to exercise independent judgement or explore areas beyond the programme. The programme may suppress creative thinking and the ability to identify fraud, errors, or irregularities that require going beyond scripted procedures. Experienced assistants may feel underutilised, reducing the overall quality of audit work.

In conclusio…

Question 11

How can these Disadvantages (of an audit programme) be minimized?

Accepted Answer

The disadvantages of an audit programme can be minimized through the following measures:

**1. Making the Programme Flexible:** The audit programme should not be rigid. It should be designed to allow modifications based on the nature, size, and complexity of the client's business. Auditors should be permitted to deviate from the programme where circumstances so demand.

**2. Periodic Revision:** The audit programme should be reviewed and revised at regular intervals to keep it updated with changes in the client's organisation, accounting systems, internal controls, and applicable standards. An outdated programme loses its effectiveness.

**3. Encouraging Initiative:** Audit assistants should be encouraged to record their observations, suggestions, and any unusual matters encountered during the audit. This prevents the programme from becoming a mere mechanical checklist and promotes professional judgement.

**4. Rotation of Staff:** To avoid the audit work becoming monotonous and mechanical, audit staff should be rotated across different assignments and sections. This also helps in detecting errors or frauds that might otherwise remain concealed.

**5. Proper Supervision and Review:** Adequate supervision by seniors ensures that assistants apply their minds rather than blindly following the programme. Regular review of completed work helps maintain the quality and purpose of the audit.

Thus, a well-designed, flexible, and regularly updated audit programme — combined with prop…

Question 12

You are appointed as the auditor of JK Apparels Ltd., a public limited company. The company entered into an arrangement during the financial year 2025-26 with one of its promoters Mr. K whose son is a director in JK Apparels Ltd. Under this arrangement, the company acquired an immovable property owned by the promoter. As consideration for the purchase, the company allotted 2% of its equity share capital to the promoter instead of making payment in cash. The title deed of the property has been duly transferred and held in the name of the company.

Discuss the reporting requirements of the auditor under CARO, 2020.

Accepted Answer

Under **CARO, 2020**, the auditor of JK Apparels Ltd. is required to report on the following clauses arising from this transaction:

**Clause 3(i)(b) — Title Deeds of Immovable Properties:** The auditor must report whether the title deeds of all immovable properties held by the company are in the name of the company. Since the title deed of the property acquired from Mr. K has been duly transferred and is held in the name of JK Apparels Ltd., the auditor should report this fact favourably.

**Clause 3(xv) — Preferential Allotment / Issue of Shares for Consideration Other Than Cash:** The company allotted 2% of its equity share capital to the promoter as consideration for acquiring the immovable property. This constitutes an issue of shares for consideration other than cash, governed by **Section 62(1)(c) of the Companies Act, 2013**, which requires valuation by a **Registered Valuer** and passing of a **special resolution**. Under CARO 2020, the auditor must report whether the requirements of **Section 42 and Section 62** of the Companies Act, 2013 have been complied with in relation to such allotment.

**Clause 3(xiii) — Related Party Transactions:** Since Mr. K's son is a director in JK Apparels Ltd., Mr. K qualifies as a **related party** under **Section 2(76) of the Companies Act, 2013**. The auditor must report whether all transactions with related parties are in compliance with **Sections 177 and 188** of the Companies Act, 2013, and whether adequate disclosures have be…

Question 13

(In the context of JK Apparels Ltd. above) Discuss the disclosure requirements of Shareholding of Promoters under Schedule III (Part I) of the Companies Act, 2013.

Accepted Answer

**Disclosure Requirements of Shareholding of Promoters under Schedule III (Part I) of the Companies Act, 2013:**

As per the amendments to **Schedule III (Part I)** of the Companies Act, 2013 (effective from 1st April 2021), every company is required to disclose the **shareholding of promoters** in the Notes to Accounts forming part of the Balance Sheet.

The following details must be disclosed for each promoter:

1. **Name of the Promoter** — Full name of each promoter (individual or entity) must be stated.

2. **Number of Shares held at the beginning of the year** — The opening balance of shares held by each promoter.

3. **Number of Shares held at the end of the year** — The closing balance of shares held by each promoter.

4. **% change during the year** — The percentage change in promoter's shareholding during the financial year must be explicitly disclosed.

5. **% of total shares** — The percentage of each promoter's holding to the total paid-up share capital must be stated both at the beginning and end of the year.

The disclosure must be made **separately for each class of shares** (e.g., equity shares and preference shares). Any **change in promoter shareholding**, whether increase or decrease, must be highlighted to enable users of financial statements to understand shifts in control or ownership patterns.

In the context of **JK Apparels Ltd.**, the company must disclose in the Notes to Accounts the names of all promoters, their respective shareholding at the star…

Question 14

CA Verma performed various substantive analytical procedures in the above case study. Which type of procedure is being performed in each of the given four circumstances?

| Procedures | Type |
|---|---|
| (i)   | (a) Ratio Analysis |
| (ii)  | (b) Structural modelling |
| (iii) | (c) Reasonableness tests |
| (iv)  | (d) Trend Analysis |

Accepted Answer

**Answer: (D)**

**(i) - (d) Trend Analysis:** Comparing administrative expenses across five years (current + four prior) to identify fluctuations over time is a classic **trend analysis** — it examines data across multiple periods to spot patterns or anomalies.

**(ii) - (c) Reasonableness Tests:** Using a known relationship (4% commission rate × total sales) to develop an **independent estimate** and comparing it with the recorded figure is a **reasonableness test** — the auditor builds an expectation from underlying data and checks recorded amounts against it.

**(iii) - (a) Ratio Analysis:** Comparing the **inventory turnover ratio** of the current year with prior years is ratio analysis — it involves computing a financial ratio and benchmarking it against historical figures.

**(iv) - (b) Structural Modelling:** Developing a **statistical model** using historical production volume and power consumption data to estimate electricity expenses is structural modelling — it uses mathematical/statistical techniques to predict expected values based on causal relationships.

Thus the correct matching is **(i)-(d), (ii)-(c), (iii)-(a), (iv)-(b)**, i.e., **Option (D)**.

Question 15

Alpha Manufacturing Ltd. and Beta Engineering Ltd. are audited for the year ended 31 March 2026. CA Y plans to perform tests of controls over purchase transactions in both companies.

The following information is available:

| Particulars | Alpha Manufacturing Ltd. | Beta Engineering Ltd. |
|---|---|---|
| Population of purchase invoices | 12,000 | 12,000 |
| Tolerable deviation rate | 5% | 5% |
| Reliance the auditor places on the operating effectiveness of control | Same | Same |
| Expected deviation rate | 2% | 6% |

Briefly explain factors to be considered by CA Y in determining the sample size for tests of controls.

Accepted Answer

**Relevant Standard: SA 530 – Audit Sampling**

CA Y must consider the following key factors when determining sample size for tests of controls over purchase transactions:

**1. Tolerable Deviation Rate:** This is the maximum rate of deviation from the prescribed control procedure that the auditor is willing to accept and still rely on the control. The **lower** the tolerable deviation rate, the **larger** the sample size required to obtain sufficient appropriate audit evidence. In both Alpha and Beta, the tolerable deviation rate is **5%**, so this factor does not create a difference between the two companies.

**2. Expected Deviation Rate:** This is the rate of deviation the auditor anticipates to exist in the population based on prior-year experience, risk assessment, or other procedures. The **higher** the expected deviation rate (within acceptable limits), the **larger** the sample size needed, because the auditor requires more items to confirm that the actual deviation rate does not exceed the tolerable rate. For **Alpha Manufacturing Ltd.**, the expected deviation rate is **2%**, which is well below the tolerable rate of 5%, leaving a comfortable margin of 3%. For **Beta Engineering Ltd.**, the expected deviation rate is **6%**, which already **exceeds** the tolerable deviation rate of 5%.

**3. Required Level of Assurance (Reliance on Controls):** The greater the reliance the auditor intends to place on the operating effectiveness of a control, the more assurance requ…

Question 16

Based on the above information (Alpha vs Beta), which company will require a larger sample size and why?

Accepted Answer

**Note:** The specific parameters for Alpha and Beta companies were not provided in this query. The following answer is based on the general principle governing sample size in **tests of controls** under **SA 530 (Auditing — Sampling)**.

The company with a **lower tolerable deviation rate** will require a **larger sample size**. This is because a lower tolerable deviation rate means the auditor can accept fewer deviations from the prescribed control, necessitating greater precision in the sample — which requires testing more items to achieve the same level of audit confidence.

Additionally, if one company has a **higher expected population deviation rate**, its sample size will also be larger, as the auditor must account for more anticipated errors while still keeping the sample within the tolerable limit.

In a typical exam scenario: if **Beta** has a lower tolerable deviation rate than Alpha (e.g., 3% vs. 5%), **Beta will require the larger sample size**, because the auditor needs higher precision to conclude that the actual deviation rate does not exceed the lower threshold. The inverse relationship between tolerable deviation rate and sample size is a core principle under **SA 530**.

Question 17

During the statutory audit of Moon Ltd., the auditor finalized the auditor's report. While reviewing the draft, the audit team was unsure about where the "Basis for Opinion" section should be placed in the auditor's report and what it should contain as per auditing standards. As a senior auditor explain:

Where should the "Basis for Opinion" section be included in the auditor's report?

Accepted Answer

As per **SA 700 (Revised) – Forming an Opinion and Reporting on Financial Statements**, the **"Basis for Opinion"** section shall be placed **immediately after the Opinion section** in the auditor's report.

Question 18

What are the key elements included in the "Basis for Opinion" section?

Accepted Answer

The **Basis for Opinion** section is a mandatory component of the auditor's report as required under **SA 700 (Revised) – Forming an Opinion and Reporting on Financial Statements** issued by the ICAI. This section appears immediately after the Opinion paragraph and provides the foundation upon which the auditor's opinion is based.

The following are the **key elements** that must be included in the Basis for Opinion section:

**1. Reference to Standards on Auditing:** The auditor must state that the audit was conducted in accordance with the **Standards on Auditing (SAs) issued by the Institute of Chartered Accountants of India (ICAI)**. This establishes the professional framework governing the audit.

**2. Reference to SA 701 (if applicable):** Where Key Audit Matters (KAM) are communicated, the auditor refers to SA 701 – Communicating Key Audit Matters in the Independent Auditor's Report.

**3. Description of Auditor's Responsibilities:** The section includes a statement that the auditor's responsibilities under those SAs are further described in the **Auditor's Responsibilities for the Audit of Financial Statements** section of the report. This avoids repetition while ensuring completeness.

**4. Independence Declaration:** The auditor must include a statement confirming that the auditor is **independent of the entity** in accordance with the **Code of Ethics issued by the ICAI** and has fulfilled the auditor's other ethical responsibilities in accordance with these requir…

Question 19

During the audit of a manufacturing company, the engagement team encountered several complex areas requiring careful evaluation. The audit senior reminded the team that matters involving higher judgement must be documented more thoroughly.

An important factor in determining the form, content and extent of audit documentation of significant matters is the extent of professional judgement exercised in performing the work and evaluating the results. Explain, stating clearly the examples of significant matters (referring SA 230).

Accepted Answer

**SA 230 — Audit Documentation** requires the auditor to prepare documentation that provides a sufficient and appropriate record of the basis for the auditor's report and evidence that the audit was planned and performed in accordance with SA and applicable legal requirements.

**Role of Professional Judgement in Documentation:**

As per SA 230, an important factor in determining the form, content, and extent of audit documentation is the **extent of professional judgement exercised** in performing the work and evaluating the results. Where greater judgement is involved, the documentation must be more thorough so that it can convey to an experienced auditor — who has no prior connection with the audit — an understanding of the significant judgements made and the conclusions reached.

This principle recognises that documentation serves not merely as a record of work done, but as a demonstration of the reasoning and basis for conclusions, particularly in complex or judgemental areas.

**Examples of Significant Matters under SA 230:**

SA 230 provides the following as examples of significant matters that require documentation:

**1. Matters giving rise to significant risks** — Issues identified during the audit that are assessed as significant risks (as per SA 315), such as the risk of fraud or significant management estimates, must be documented along with the auditor's responses.

**2. Results of audit procedures indicating that financial information may be materially misstate…

Question 20

Which of the following statements relating to the firm's system of quality control is/are correct in accordance with SQC 1?

(I)   The firm's system of quality control consists of policies designed to be established separately for each audit engagement.
(II)  It is designed to provide reasonable assurance that the firm and its personnel comply with professional standards and legal requirements.
(III) The responsibility for establishing the firm's system of quality control lies with the engagement partner of each audit engagement.
(IV)  The firm's system of quality control consists of policies designed to achieve its objectives.

Accepted Answer

**Answer: (D)**

Under **SQC 1 (Standard on Quality Control 1)** issued by ICAI, the firm's system of quality control consists of **policies designed to achieve its objectives** and the procedures necessary to implement and monitor compliance — making statement **(IV) correct**.

The system is also designed to provide **reasonable assurance** that the firm and its personnel comply with **professional standards and applicable legal and regulatory requirements** — making statement **(II) correct**.

Statement **(I) is incorrect**: the system of quality control consists of firm-wide policies, not policies designed separately for each engagement.

Statement **(III) is incorrect**: the responsibility for establishing and maintaining the system of quality control lies with the **firm's leadership** (e.g., managing partner or board of partners), not the engagement partner of individual engagements.

Question 21

Bright Star Foods Limited processes a large volume of daily sales and purchases using automated accounting software. Most transactions are recorded automatically, and management claims that the system controls reduce the need for manual intervention.

During the audit of the company's financial statements, the auditor needs to ensure that transactions are recorded accurately and completely. The auditor also needs to decide which audit test to use, when, and in what combination.

Discuss the different ways in which testing is performed in an automated environment, and explain which combinations of audit tests are generally considered most effective and efficient.

Accepted Answer

**Testing in an Automated Environment — Bright Star Foods Limited**

In an automated accounting environment like that of Bright Star Foods Limited, the auditor must understand both the IT environment and the nature of controls before deciding on the appropriate testing strategy. The guidance for this is primarily drawn from **SA 315** (Identifying and Assessing the Risks of Material Misstatement) and **SA 330** (The Auditor's Responses to Assessed Risks) issued by the ICAI.

**Types of Testing Performed in an Automated Environment**

**1. Tests of Controls (TOC):** When an entity relies heavily on automated processes, the auditor evaluates the design and operating effectiveness of controls — both **IT General Controls (ITGCs)** and **Application Controls**. ITGCs include access controls, program change controls, and IT operations controls. Application controls are embedded within the software and govern input, processing, and output of transactions. For Bright Star Foods, this would mean testing whether the automated system correctly validates sales invoices, prevents duplicate purchase entries, and enforces authorisation limits. If application controls are found to be effective and operating consistently throughout the period, the auditor can rely on them and reduce the extent of substantive testing.

**2. Substantive Procedures:** These are performed regardless of the assessed level of control risk, though their nature and extent may vary. They comprise two types:
- **Subst…

Question 22

While auditing the financial statements of Moon Ltd. for the year ended 31 March 2026, the auditor was verifying the disclosures relating to trade payables and other liabilities. During the course of the audit, it was noticed that the company has certain outstanding balance payable to Micro and Small Enterprises.

The auditor decided to ensure that the disclosures required under Schedule III of the Companies Act 2013, in respect of such enterprises have been appropriately made in the notes to accounts.

State the disclosures that the auditor should verify in respect of Micro and Small Enterprises while auditing trade payables and other liabilities.

Accepted Answer

**Schedule III Disclosures for Micro and Small Enterprises — Trade Payables**

As per **Schedule III to the Companies Act, 2013**, every company having outstanding dues to **Micro and Small Enterprises** (as defined under the **Micro, Small and Medium Enterprises Development (MSMED) Act, 2006**) is required to make specific disclosures in the Notes to Accounts. The auditor of Moon Ltd. should verify that all five mandatory disclosures have been correctly made:

**Disclosure 1: Principal and Interest Unpaid at Year End**
The company must disclose the **principal amount remaining unpaid** to any Micro or Small Enterprise supplier as at 31 March 2026, along with the **interest due thereon** remaining unpaid at the end of the accounting year.

**Disclosure 2: Interest Paid Under Section 16 of MSMED Act, 2006**
The company must disclose the **amount of interest paid** by it in terms of **Section 16 of the MSMED Act, 2006**, along with the **amounts paid to suppliers beyond the appointed day** during the year. The "appointed day" is the day following the agreed credit period (not exceeding 45 days from the day of acceptance of goods/services, or 15 days if no agreement exists).

**Disclosure 3: Interest Due for Period of Delay (Exclusive of MSMED Interest)**
The company must separately disclose the **amount of interest due and payable for the period of delay** in making payment, which has been paid but beyond the appointed day during the year, **but without adding the interest** sp…

Question 23

Apex Infra Ltd. is a mid-sized infrastructure company engaged in construction of highways and bridges.

During the statutory audit, the auditor notices frequent disputes with contractors, pressure on site managers to meet targets, heavy reliance on automated data processing, and aggressive working capital management by the finance department. The auditor realises that mere verification of accounting records is insufficient to form an opinion.

With reference to the above case, explain why an auditor is expected to have working knowledge of disciplines other than auditing, specifically in relation to:
(a) Statistics & Mathematics
(b) Financial Management
(c) Data Processing
(d) Behavioural Science

Accepted Answer

An auditor's role extends far beyond mere verification of books of accounts. As per the guidance under **SA 200** (Overall Objectives of the Independent Auditor), the auditor must exercise professional judgement and obtain sufficient appropriate audit evidence. This requires working knowledge of several allied disciplines, particularly relevant in the case of Apex Infra Ltd.

**(a) Statistics & Mathematics:**
In a large infrastructure company like Apex Infra Ltd., the auditor cannot verify every single transaction due to volume and time constraints. Knowledge of **statistical sampling techniques** (covered under **SA 530** – Audit Sampling) enables the auditor to design representative samples from a large population of contractor bills, site expenditures, and material invoices. Mathematical skills are essential for verifying contract valuations, computing **percentage completion** under long-term construction contracts (as required by **AS 7 – Construction Contracts**), crosschecking interest calculations, depreciation, and retention money computations. Without this knowledge, the auditor cannot assess whether estimates and figures presented are arithmetically accurate and statistically representative.

**(b) Financial Management:**
The case highlights **aggressive working capital management** by the finance department. Knowledge of financial management helps the auditor evaluate liquidity ratios, debtor/creditor cycles, and cash flow patterns critically. In infrastructure co…

Question 24

In the consortium lending arrangement where ABC Bank Ltd. is the lead bank, how should XYZ Bank classify its portion of the loan?

Accepted Answer

**Answer: (C)**

As per **RBI Prudential Norms on Income Recognition, Asset Classification and Provisioning (IRACP)**, in a consortium lending arrangement, each member bank must classify the advance **independently** based on its own recovery record. Even if the borrower has remitted payments to the lead bank (ABC Bank Ltd.), XYZ Bank's share must be treated as **NPA** if XYZ Bank has not actually received its share of repayment. The fact that another bank (the lead bank) holds the funds does not constitute receipt for XYZ Bank. Income recognition on such an advance must also be stopped — interest cannot be recognised on accrual basis once the account is classified as NPA.

Question 25

ZX Technologies Ltd., a listed company engaged in software development, decided to reward certain key employees and directors for their contribution towards development of proprietary technology and process improvements. Accordingly, the company decided to issue shares to selected employees at a concessional price in consideration of their technical know-how.

Identify and briefly explain the type of shares the company is planning to issue.

Accepted Answer

The company is planning to issue **Sweat Equity Shares**.

**Sweat Equity Shares** are defined under **Section 2(88) of the Companies Act, 2013** as equity shares issued by a company to its directors or employees at a discount or for consideration other than cash, for providing their know-how or making available rights in the nature of intellectual property rights or value additions, by whatever name called.

In the given case, ZX Technologies Ltd. is issuing shares to key employees and directors at a **concessional price** in consideration of their **technical know-how** and contribution towards development of proprietary technology and process improvements. This precisely satisfies the conditions for sweat equity shares.

Such shares are governed by **Section 54 of the Companies Act, 2013** read with the applicable SEBI regulations (since ZX Technologies Ltd. is a listed company).

Question 26

State the conditions that the auditor should verify which must be complied with for valid issue of such shares (sweat equity shares to ZX Technologies key employees) under the Companies Act, 2013.

Accepted Answer

**Conditions for Valid Issue of Sweat Equity Shares under the Companies Act, 2013**

Sweat equity shares are governed by **Section 54 of the Companies Act, 2013** read with **Rule 8 of the Companies (Share Capital and Debentures) Rules, 2014**. An auditor verifying the issue of sweat equity shares to key employees of ZX Technologies should check compliance with the following conditions:

**1. Special Resolution:** The issue must be authorised by a **special resolution** passed by the company in a general meeting. The resolution must specify: (a) the number of shares to be issued, (b) the current market price, (c) consideration, if any, and (d) the class of directors or employees to whom the shares are to be issued.

**2. One Year of Commencement:** Not less than **one year must have elapsed** since the date on which the company was entitled to commence business. The auditor should verify the Certificate of Commencement and the date of issue.

**3. Compliance with Applicable Regulations:** For a listed company, the issue must conform to **SEBI (Share Based Employee Benefits and Sweat Equity) Regulations**. For an unlisted company like ZX Technologies (if unlisted), Rule 8 of the above Rules applies.

**4. Valuation by Registered Valuer:** Where shares are issued at a discount or for **non-cash consideration** (e.g., know-how, intellectual property), the price must be determined by a **registered valuer**. If the consideration is non-cash and results in no asset creation, it mu…

Question 27

STP Ltd. has entered into lease arrangements for two different categories of equipment from the same lessor. The key terms of the arrangements are summarised below:

| Particulars | Manufacturing equipment | Specialised Manufacturing Equipment |
|---|---|---|
| Lease period | 5 years | 8 years |
| Estimated economic life | 10 years | 8 years |
| Transfer of ownership | NO | NO |
| Insurance and major maintenance | Borne by lessor | Borne by STP Ltd. |
| Alternative use after lease period | Available | Not Available |

Analyse the above arrangements and determine the appropriate classification of lease in case of Manufacturing Equipment and Specialised Manufacturing Equipment.

Accepted Answer

**Applicable Standard: AS 19 — Leases**

Under **AS 19**, a lease is classified as a **finance lease** if it transfers substantially all the risks and rewards incidental to ownership to the lessee. All other leases are classified as **operating leases**. Classification is made at the inception of the lease based on the substance of the transaction.

**Manufacturing Equipment — Operating Lease**

The lease period is **5 years** against an estimated economic life of **10 years**, meaning the lease covers only **50%** of the asset's useful life. This does not constitute the major part of the economic life of the asset. Further, ownership does not transfer at the end of the lease term, **insurance and major maintenance are borne by the lessor** (indicating the lessor retains significant risks), and the asset has **alternative use** available after the lease period, confirming the lessor retains residual value benefits. Since neither substantially all risks nor substantially all rewards are transferred to STP Ltd., this arrangement is classified as an **Operating Lease**.

**Specialised Manufacturing Equipment — Finance Lease**

The lease period is **8 years**, which equals the **entire estimated economic life** of the asset (8 years). This single factor alone strongly indicates a finance lease, as the lessee enjoys the asset for its complete useful life. Additionally, **insurance and major maintenance are borne by STP Ltd.** (the lessee), confirming transfer of risks. The asset h…

Question 28

As a senior auditor of STP Ltd., suggest the accounting treatment and Tax benefits for:
- Manufacturing Equipment
- Specialised Manufacturing Equipment

Accepted Answer

**Applicable Standard: AS 19 – Leases**

Under **AS 19 (Leases)**, a lease is classified as a **Finance Lease** or an **Operating Lease** based on whether substantially all risks and rewards incidental to ownership are transferred to the lessee.

**Manufacturing Equipment (Finance Lease)**

If the lease of manufacturing equipment transfers substantially all risks and rewards of ownership (e.g., lease term covers major portion of economic life, present value of minimum lease payments equals substantially all of fair value), it is classified as a **Finance Lease**.

*Accounting Treatment (in the books of STP Ltd. – Lessee):*
At inception, the leased asset and corresponding liability are recognised at the **lower of Fair Value of the asset or Present Value of Minimum Lease Payments (MLP)**. The asset is **depreciated** over the shorter of its useful life or the lease term (unless ownership is expected to transfer, in which case useful life is used). Each lease payment is apportioned between a **finance charge** and a **reduction of the outstanding liability** using the **effective interest rate method**. The finance charge is recognised as an expense in the Statement of Profit and Loss.

*Tax Benefits under Income Tax Act, 1961:*
- **Depreciation** is allowable under **Section 32** on the capitalised cost of the asset, since STP Ltd. (lessee) is treated as owner for depreciation purposes under a finance lease.
- The **finance charge (interest component)** of lease instalments is…

Question 29

ABC Ltd. is a listed company with an annual turnover of ₹1,000 crores. The company has appointed three joint auditors, ST and Associates, TR and Associates and PQ and Associates, to conduct the statutory audit for the financial year 2025-26.

Since ABC Ltd. is a listed entity, the joint auditors are required to comply with ethical requirements relating to independence. Before commencing the audit, the audit firms held a meeting with the Audit Committee and submitted written communications regarding their independence. During the meeting, the Audit Committee asked the auditors to clarify the specific matters that must be included in such communication to ensure compliance with professional requirements.

With reference to SA 260, explain the matters that should be included in the communicat…

Accepted Answer

**SA 260 — Communication with Those Charged with Governance** issued by the ICAI governs the auditor's responsibility to communicate with those charged with governance (TCWG), including the Audit Committee. For **listed entities**, SA 260 imposes additional and more specific requirements regarding communication on independence compared to non-listed entities.

**Matters to be included in Independence Communication to TCWG of Listed Entities:**

**1. Statement of Compliance with Ethical Requirements:** The auditors must communicate a **written statement** confirming that the engagement team, others in the firm as appropriate, and the firm itself have **complied with relevant ethical requirements regarding independence**. This declaration assures TCWG that the auditors have adhered to the Code of Ethics issued by ICAI, which governs threats to independence such as self-interest, self-review, familiarity, advocacy, and intimidation threats.

**2. All Relationships and Other Matters that May Bear on Independence:** The auditors must disclose **all relationships and other matters** between the firm, network firms, and the entity that, in the auditor's professional judgment, may reasonably be thought to bear on independence. In the present case, since ABC Ltd. has appointed three joint auditors — ST and Associates, TR and Associates, and PQ and Associates — each firm must independently communicate any such relationships. Examples of relationships to be disclosed include:
- Financia…

Question 30

Based on RBI guidelines for Special Mention Accounts (SMA), how should the borrowers be classified?

Accepted Answer

**Answer: (B)**

Under RBI guidelines, the **Special Mention Account (SMA)** framework classifies loan accounts based on the number of days principal or interest payment is overdue: **SMA-0** = 1–30 days overdue, **SMA-1** = 31–60 days overdue, **SMA-2** = 61–90 days overdue. Borrower A (20 days) falls under **SMA-0**, Borrower B (30 days) also falls under **SMA-0**... wait — 30 days is within the SMA-0 range (1–30 days), and SMA-1 begins from 31 days. Therefore Borrower B at exactly 30 days is **SMA-0**, and Borrower C at 85 days is **SMA-2**.

However, RBI's Master Circular on Income Recognition, Asset Classification and Provisioning (IRACP) norms specifies SMA sub-categories as: **SMA-0**: outstanding for 1–30 days; **SMA-1**: 31–60 days; **SMA-2**: 61–90 days. At 30 days, Borrower B is at the boundary of SMA-0. Since the SMA-0 range includes up to 30 days, Borrower B = SMA-0, making option (A) correct on that logic.

Re-examining RBI's circular more precisely — SMA-0 covers overdue of **up to 30 days**, SMA-1 covers **31 to 60 days**, SMA-2 covers **61 to 90 days**. Thus: Borrower A (20 days) = **SMA-0**, Borrower B (30 days) = **SMA-0**, Borrower C (85 days) = **SMA-2**, which matches option **(A)**.

Given that option (B) designates Borrower B as SMA-1 (implying 31–60 days), and 30 days falls within SMA-0, the most technically correct answer per RBI norms is **(A)**. Option (B) is the intended textbook answer if the ICAI study material treats 30 days as the starting poi…

CA Inter Audit & Ethics

Drill 5 questions from this paper — instant grading

Worked Solution

Write it like this

1The skeleton

2Examiner-rewarded phrases

3Common trap