CA Inter FM + SM

The following statements are analysed for correctness:

(a) INCORRECT. A more automated business environment does not necessarily mean it is less complex. On the contrary, increased automation often introduces IT-related complexities such as system interdependencies, automated journal entries, access controls, and data integrity risks. As per SA 315 (Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment), the auditor must understand the entity's use of IT, which itself adds layers of complexity — including risks of system failures, unauthorised access, and change management issues. Thus, automation may increase, rather than decrease, the complexity of the business environment.

(b) INCORRECT. As per SA 200 (Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Standards on Auditing), the auditor aims to reduce audit risk to an acceptably low level, not to zero. Absolute assurance is impossible due to inherent limitations of an audit — use of sampling, reliance on management representations, and professional judgment. Audit risk can never be eliminated entirely; therefore, the auditor provides reasonable assurance, not absolute assurance.

(c) CORRECT. As per SA 320 (Materiality in Planning and Performing an Audit), determining materiality requires the exercise of professional judgment. There is no single formula; the auditor considers both quantitative benchmarks (e.g., a percentage of profit before tax, turnover, or total assets) and qualitative factors (nature of the item, user needs). Different auditors may reach different but equally valid conclusions on materiality for the same entity.

(d) INCORRECT. The scope of the internal audit function is not restricted solely to the evaluation of internal controls. As per SA 610 (Using the Work of Internal Auditors), the internal audit function may cover a wide range of activities including: (i) evaluation of risk management processes; (ii) review of governance mechanisms; (iii) review of compliance with laws and regulations; (iv) assessment of operational efficiency and economy; and (v) investigation of fraud. The objectives and scope are determined by management and those charged with governance and are far broader than internal control evaluation alone.

(e) INCORRECT. For accounts payable (a liability), the primary assertion at risk is completeness (i.e., are all payables recorded?), not existence. Testing recorded accounts payable traces from the ledger to source documents, which addresses the existence/valuation assertions — confirming that recorded payables are genuine. However, this direction of testing does not address unrecorded liabilities. To test completeness, the auditor should trace from source documents (invoices, goods received notes, supplier statements) to the ledger. Focusing only on recorded payables creates a significant audit gap regarding omitted liabilities.

(f) INCORRECT. As per Section 139(8) of the Companies Act, 2013, any casual vacancy in the office of an auditor of a company (other than a company whose accounts are subject to audit by the Comptroller and Auditor General of India) shall be filled by the Board of Directors within thirty days. If such vacancy is caused by the resignation of an auditor, such appointment shall also be approved by the company at a general meeting convened within three months. The statement incorrectly attributes this power to the Audit Committee instead of the Board of Directors.

(g) CORRECT. As per SA 500 (Audit Evidence), sufficiency is the measure of the quantity of audit evidence, while appropriateness is the measure of the quality (i.e., relevance and reliability) of audit evidence. The quantity of evidence needed is affected by the auditor's assessment of risks of material misstatement and the quality of evidence obtained. Both sufficiency and appropriateness are interrelated and together determine the adequacy of audit evidence.

(h) INCORRECT. As per SA 701 (Communicating Key Audit Matters in the Independent Auditor's Report), communication of Key Audit Matters (KAM) is a requirement for audits of listed entities, irrespective of whether the audit opinion is modified or unmodified. It is not triggered solely by a modified opinion. In fact, when the auditor expresses a modified opinion under SA 705 (Modifications to the Opinion in the Independent Auditor's Report), the matters giving rise to modification are discussed in a separate 'Basis for Modification' paragraph and are not repeated as KAM. KAM are those matters that, in the auditor's professional judgment, were of most significance in the audit of the financial statements of the current period.

Part (a): Fundamental Principles of Professional Ethics

As per the Code of Ethics issued by ICAI (aligned with IESBA Code), an auditor must adhere to the following five fundamental principles:

1. Integrity: An auditor shall be straightforward and honest in all professional and business relationships. Integrity also implies fair dealing and truthfulness. The auditor must not be associated with information that is false, misleading, or furnished recklessly.

2. Objectivity: The auditor must not allow bias, conflict of interest, or undue influence of others to override professional or business judgements. Objectivity is the state of mind that has regard to all considerations relevant to the task and no other.

3. Professional Competence and Due Care: The auditor has a continuing duty to maintain professional knowledge and skill at the level required to ensure that clients receive competent professional service. This principle has two aspects: (i) Attainment of professional competence, and (ii) Maintenance of professional competence through continuing professional development (CPD). The auditor must act diligently in accordance with applicable technical and professional standards.

4. Confidentiality: The auditor must respect the confidentiality of information acquired as a result of professional and business relationships and must not disclose any such information to third parties without proper and specific authority, unless there is a legal or professional right or duty to disclose. Confidentiality also prohibits using information acquired during audit for personal advantage.

5. Professional Behaviour: The auditor must comply with relevant laws and regulations and avoid any action that discredits the profession. This includes not making exaggerated claims about services offered or denigrating the work of other members.

These five principles are not merely aspirational — they impose a positive duty on the auditor and are the bedrock of the entire audit function.

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Part (b): Procedure for Removal of Auditor before Expiry of Term — Section 140 of the Companies Act, 2013

As per Section 140(1) of the Companies Act, 2013, the removal of an auditor before the expiry of the term requires the following procedure:

Step 1 — Special Notice: A special notice is required for a resolution at an Annual General Meeting (AGM) or Extraordinary General Meeting (EGM) for removing the auditor before expiry of term.

Step 2 — Prior Approval of the Central Government: Before passing any resolution for removal, PQR Ltd. must make an application to the Central Government for prior approval. The auditor cannot be removed without this approval.

Step 3 — Notice to Auditor: The company must give the auditor (CA Raj) a copy of the application made to the Central Government and also give him an opportunity to be heard. The auditor has the right to make representations.

Step 4 — Resolution at General Meeting: Once approval is received from the Central Government, the resolution for removal can be passed at the general meeting of the company.

Step 5 — Filing with ROC: The company must file a statement with the Registrar of Companies (ROC) within 30 days of the meeting, informing them of the removal.

Important Note: Any auditor so removed shall not be re-appointed in that company. This procedure is designed to prevent arbitrary removal of auditors and to safeguard their independence.

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Part (c): Ways in which Theft of Entity's Assets can be Accomplished

As per SA 240 — The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements, misappropriation of assets (including theft) can be accomplished in the following ways:

1. Embezzlement of Receipts: Stealing cash receipts before they are recorded — e.g., stealing cash collected from customers and not entering it into the books at all (also called lapping).

2. Stealing Physical Assets or Intellectual Property: Physically stealing inventory, raw materials, scrap, equipment, or even confidential data and customer information for personal use or to sell outside.

3. Causing Entity to Pay for Goods/Services not Received: Creating fictitious vendors or inflating invoices — payments made to non-existent suppliers or for goods never delivered.

4. Using Entity's Assets for Personal Use: Employees using company vehicles, equipment, or other resources for personal benefit without authorisation.

5. Payroll Fraud: Adding fictitious employees (ghost employees) to the payroll, or continuing payments after an employee's resignation or termination.

6. Theft through Falsification of Records: Manipulating records to conceal theft — e.g., writing off valid receivables, raising fake credit notes, or understating inventory counts.

These amounts are often small and individually immaterial, making detection difficult without proper analytical and substantive procedures.

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Part (d): Objectives of the Auditor Regarding Written Representations

As per SA 580 — Written Representations, the objectives of the auditor in obtaining written representations are:

1. To obtain written representations from management and, where appropriate, those charged with governance (TCWG) that they believe they have fulfilled their responsibility for the preparation of financial statements in accordance with the applicable financial reporting framework.

2. To support other audit evidence: Written representations serve to support other audit evidence relevant to the financial statements or to specific assertions in the financial statements when the auditor determines that such representations are necessary.

3. To respond appropriately to written representations provided by management and, where appropriate, TCWG, or if management or TCWG do not provide the representations requested by the auditor.

It is important to note that written representations do not substitute for other audit evidence. They are a form of audit evidence but are considered less reliable than documentary or external evidence. If management refuses to provide the required written representations, the auditor must disclaim or qualify the audit opinion under SA 705 — Modifications to the Opinion in the Independent Auditor's Report.

India's transition from traditional payment methods to newer digital systems reflects the government's push towards a cashless economy. Two significant newer methods are:

BHIM (Bharat Interface for Money): Launched by NPCI (National Payments Corporation of India) in 2016, BHIM is a mobile application built on the UPI (Unified Payments Interface) framework. It enables peer-to-peer money transfers and merchant payments directly from bank accounts without requiring card details or net banking. Key features include: (a) zero charges for transactions; (b) works on smartphones with 2G internet connectivity; (c) uses mobile number, Aadhaar, or bank account as identifier; (d) simple, user-friendly interface designed for mass adoption. BHIM represents a significant step in financial inclusion as it facilitates digital payments across all income groups and reduces reliance on cards or cheques.

USSD (Unstructured Supplementary Service Data): This is a mobile banking protocol that operates through basic telephony without requiring internet connectivity. Customers dial **code *99#** on their mobile phones to access banking services. Key features include: (a) works on all mobile phones, including feature phones without internet; (b) provides account balance inquiry, fund transfers, mini statements, and bill payments; (c) particularly effective in areas with limited broadband penetration; (d) minimal data consumption, making it cost-effective for rural and semi-urban populations. USSD-based mobile banking is instrumental in bringing banking services to underserved populations.

Both methods strengthen India's digital payment infrastructure by addressing the digital divide and promoting financial inclusion across demographics. While BHIM leverages smartphone technology for the tech-savvy population, USSD ensures basic banking access for all mobile users, complementing each other in the broader vision of a digitally-empowered economy.