CA Inter FM + SM — Question Paper — May 2018

EXAMINATION OF STATEMENTS:

(i) INCORRECT. The auditor cannot reduce audit risk to zero or obtain absolute assurance. Per SA 200, auditors can only obtain reasonable assurance, not absolute assurance. Audit risk comprises inherent risk, control risk, and detection risk. While auditors can minimize detection risk through increased sample sizes and testing procedures, they cannot reduce it to zero due to the inherent limitations of auditing, sampling uncertainty, and the potential for management override of controls. The presence of inherent uncertainty in evidence evaluation makes zero audit risk impossible.

(ii) CORRECT. Materiality is fundamental to auditing. SA 320 establishes that materiality is essential for audit planning and performing procedures. It determines the nature, timing, and extent of audit procedures and enables the auditor to evaluate whether misstatements are significant. Materiality underpins the audit risk model and is critical for reaching audit conclusions on financial statement fairness.

(iii) INCORRECT. External confirmation evidence is not always reliable. While SA 505 (External Confirmations) recognizes confirmations as generally reliable, reliability depends on: (a) the nature of confirmation (positive vs. negative); (b) the third party's independence and objectivity; (c) controls over the confirmation process; (d) the auditor's assessment of the responding party's ability to confirm. Confirmations from related parties, those subject to management pressure, or inadequately controlled processes may not be reliable. Fake confirmations and management involvement can compromise reliability.

(iv) INCORRECT. Under Section 140(4) of the Companies Act, 2013, an auditor who resigns must file Form ADT-4 with the Registrar within 30 days from the date of resignation, not 60 days. The shorter timeframe (30 days) is critical for disclosure of resignation circumstances to the company and registrar.

(v) INCORRECT. A satisfactory control environment is not an absolute deterrent to fraud. SA 240 clarifies that while a strong control environment reduces fraud risk, it does not eliminate it. Fraud can still occur through: (a) management override of controls; (b) collusion between two or more employees; (c) sophisticated schemes bypassing controls; (d) tone at the top not translating to actual implementation. A good control environment is a mitigating factor, not absolute prevention.

(vi) INCORRECT. This statement violates Section 139 of the Companies Act, 2013 on multiple grounds: (a) first auditor appointment must be made by the Board, not by the Managing Director alone—it requires Board approval at a meeting held within 30 days of company incorporation; (b) In this case, the appointment on 31-12-2019 is beyond the 30-day window from incorporation on 01-10-2019 (approximately 92 days), making it a late appointment in violation of statutory requirements. The Managing Director lacks authority for this appointment.

(vii) CORRECT. All NGOs/Not-for-Profit entities registered under the Companies Act, 2013 are permitted to maintain accounts on either cash basis or accrual basis. Per the Companies (Accounts) Rules, 2014, Schedule VI, NGOs have the flexibility to adopt either method based on their operational needs and stakeholder requirements, though accrual basis is generally preferred for larger organizations for better reflection of financial position.

(viii) INCORRECT. In an automated environment, inquiry is NOT the most efficient or effective audit testing method. SA 315 and SA 330 emphasize that in IT environments, the most appropriate procedures include: (a) testing of automated controls and system-generated reports; (b) data analytics and CAATs (Computer Assisted Audit Techniques); (c) testing system configuration and access controls; (d) tracing transactions through system logic. Inquiry has limitations in automated environments because the audit trail is system-generated; reliance on oral/written evidence about automated processes is less effective than testing the controls and outputs directly.

Answer: (B)

CA H and his team members carefully watching the process of counting of finished wooden doors by WT Limited's employees is a classic example of Observation. As per SA 500 (Audit Evidence), Observation consists of looking at a process or procedure being performed by others. Here, the auditor is not performing the count himself but is watching (observing) the client's employees perform the physical stock count — this precisely fits the definition of Observation.

Answer: (D)

Recalculation involves independently re-performing calculations originally done by the entity's personnel to verify mathematical accuracy. Here, the team member re-multiplied the number of finished wooden doors by the value per door — precisely checking the arithmetic accuracy of the client's manual valuation. This is the definition of Recalculation as an audit procedure under SA 500 (Audit Evidence) issued by ICAI.

Answer: (C)

Obtaining information from knowledgeable persons, whether financial or non-financial, inside or outside the entity, is the audit procedure known as Inquiry. As per SA 500 – Audit Evidence, inquiry consists of seeking information from knowledgeable persons within or outside the entity. In this case, CA H sought information from experienced people in the wooden door manufacturing business regarding purchase prices of raw materials and other non-financial information, which precisely defines the procedure of Inquiry.

Answer: (A)

CA H and his team members checking and evaluating the books of accounts and relevant documents of WT Limited in detail is an example of Inspection. As per SA 500 (Audit Evidence), Inspection involves examining records, documents, or tangible assets. Detailed checking and evaluation of books of accounts and relevant documents clearly falls under the audit procedure of Inspection.

Answer: (D)

Asking for written confirmations regarding account balances from Debtors and Creditors constitutes External Confirmation, as defined under SA 505 (External Confirmations). External confirmation is an audit procedure that obtains audit evidence by a direct written response from a third party (the confirming party) in paper, electronic, or other medium. Since the confirmation is sought from parties external to WT Limited (its Debtors and Creditors), this is clearly External Confirmation, not mere Inquiry (which is internal/oral), Inspection (which involves examining records/documents), or Investigation (which is not a standard audit procedure term under SA 500 series).

Answer: (B)

As per SA 230 (Audit Documentation), the purpose of audit documentation is to assist the auditor in planning and performing the audit, supervising and reviewing audit work, retaining a record of matters of continuing significance, enabling quality control reviews under SQC 1, and enabling external inspections. Preparation of Financial Statements is the responsibility of management, not a purpose of audit documentation.

Answer: (C)

As per SA 230 – Audit Documentation, the completion of assembling the final audit file is an administrative process and should be completed within 60 days from the date of the auditor's report. This is not more than 60 days from the date of the audit report (not from the completion of audit).

Answer: (A)

As per SA 505 (External Confirmations), external confirmations are not restricted to account balances only. They can be used to obtain audit evidence across a wide range of areas including — absence of certain conditions (e.g., side agreements), inventories held by third parties, investments held for safekeeping, and loan agreements. Hence, option (A) is the inappropriate (incorrect) statement among the given choices.

Answer: (C)

As per SA 705 (Revised) – Modifications to the Opinion in the Independent Auditor's Report, when the auditor concludes that the accounting policies have not been consistently applied in relation to opening balances, or a change in accounting policy has not been properly accounted for or adequately disclosed, the auditor shall express a qualified opinion or an adverse opinion, depending on the pervasiveness of the matter to the financial statements. A Disclaimer of Opinion is reserved for situations where the auditor is unable to obtain sufficient appropriate audit evidence (scope limitation), which is not the case here. Since the article clerk has already identified and confirmed the inconsistency, CA M shall express a qualified or adverse opinion in accordance with SA 705.

Answer: (C)

Under SA 560 – Subsequent Events, the auditor is required to perform specific procedures to identify events occurring between the date of the financial statements and the date of the auditor's report. The fire in the factory premises after the Balance Sheet date (which did not reflect any conditions existing on the Balance Sheet date) is a non-adjusting subsequent event.

Statement 1 is correct: The auditor must obtain an understanding of procedures management has established to identify subsequent events, and must make inquiries with management and those charged with governance regarding any such events — this is explicitly required under SA 560.

Statement 2 is correct: Inspection of minutes of meetings (shareholders, board, audit committee) held after the date of financial statements, and inquiring about matters discussed at meetings for which minutes are not yet available, is a mandated procedure under SA 560.

Statement 3 is incorrect: SA 560 specifically requires the auditor *to read* the entity's latest subsequent interim financial statements (if any) — not to avoid reading them. Hence Statement 3 is false.

Therefore, both Statements 1 and 2 are correct, and the answer is (C).

Answer: (C)

Section 52 of the Companies Act, 2013 prescribes the permissible applications of Securities Premium Account. The company may apply the amount credited to this account only for the purposes specified in Section 52(3), which include: (1) issuing bonus shares to members, (2) writing off preliminary expenses, discount on debentures, and expenses/commissions on issue of shares or debentures, and (3) writing off the premium payable on redemption of debentures or preference shares.

Option (C) is the correct answer. When preference shares are to be redeemed and a premium is payable on such redemption, the Securities Premium Account can be applied to cover this premium portion, thereby reducing the burden on distributable profits.

Options (A), (B), and (D) are incorrect. Loss on revaluation of assets cannot be adjusted against Securities Premium Account; Securities Premium Account cannot be used to pay dividends (dividends are paid only from profits available for dividend); and the account cannot be applied as working capital for general business operations. These restrictions exist to protect the capital nature of the Securities Premium Account.

Answer: (C)

The attribute highlighted is Periodic Review. The question specifically mentions that the audit programme must be kept under "recurrent assessment" along with the client's operations and internal controls. This directly refers to the principle of Periodic Review—the attribute that requires auditors to review and update the audit programme at regular intervals to ensure its continued relevance, effectiveness, and alignment with the client's evolving business environment and control structure.

Periodic Review ensures that the audit programme remains a dynamic and useful tool rather than becoming static or obsolete. As client operations change, new risks emerge, and internal controls are modified or strengthened, the audit programme must be reassessed to maintain its utility. This is a fundamental principle of audit planning and programme design to ensure that audit procedures remain appropriate and sufficient to address current audit objectives and identified risks.

Option (A) Static Review would mean the programme remains unchanged and fixed. Option (B) Mechanical Review refers to executing procedures without professional judgment. Option (D) Obsolete Review describes outdated procedures, which is contrary to the concept of recurrent assessment.

Answer: (C)

Professional Skepticism is not a fundamental principle under the Code of Ethics. The five fundamental principles laid down in the Code of Ethics for Chartered Accountants are: (1) Integrity — being straightforward and honest in professional dealings; (2) Objectivity — not allowing bias to override professional judgment; (3) Professional Competence and Due Care — maintaining professional knowledge and skill; (4) Confidentiality — respecting confidentiality of information; and (5) Professional Behaviour — complying with applicable laws and regulations. While professional skepticism is a critical quality that auditors must exercise during audit procedures (as outlined in SA 200 and SA 240), it is a characteristic or attitude expected of auditors rather than a fundamental principle of the Code of Ethics itself.

Answer: (D) A current year profit turning to loss only after providing depreciation is not a going concern indicator. Depreciation is a non-cash accounting charge; a company can remain operationally profitable and cash-generative despite reporting an accounting loss due to this non-cash expense. Such a scenario alone does not cast significant doubt on the entity's ability to continue as a going concern, provided it can still generate adequate cash flows and meet its payment obligations. In contrast, options (A), (B), and (C) are all recognized going concern indicators under SA 570: (A) Loss of key management without replacement undermines operational continuity and management's decision-making capability; (B) Adverse key financial ratios (deteriorating liquidity, solvency, or profitability metrics) indicate structural financial distress; (C) Inability to pay creditors on due date signals an immediate liquidity crisis and insolvency risk. The distinction in option (D) lies in the emphasis on non-cash items—accounting losses from depreciation do not directly threaten the entity's going concern status if cash generation remains adequate.

Answer: (C)

As per Section 143(12) of the Companies Act, 2013, when an auditor discovers fraud during the course of an audit, the auditor must immediately report the same to the Audit Committee/Board of Directors. This is the primary and mandatory reporting obligation for all cases of fraud detected. The Audit Committee is the first body to be informed of any fraudulent transactions. Additionally, if the fraud amount exceeds the prescribed materiality threshold (₹1 crore for public companies or ₹25 lakhs for private companies), the auditor must then report to the Central Government, but this is done through a direction issued by the Audit Committee. In the given case, the fake invoices aggregating ₹75 lakhs must first be reported to the Board/Audit Committee.