CA Inter FM + SM — Question Paper — November 2020

Answer to True/False Statements (Any Seven out of Eight):

(a) CORRECT. Even if law or regulation prescribes sufficient details of audit engagement items, the auditor must still record them in a written agreement. SA 210 (Agreeing the Terms of Audit Engagements) mandates that the auditor should agree with the client on engagement terms and document them in writing. This written agreement serves to establish mutual understanding, clarify responsibilities, and provide evidence of the engagement scope. Recording in writing is a fundamental requirement regardless of whether regulatory provisions exist.

(b) INCORRECT. The auditor is required to periodically review the audit engagement understanding with the client. As per SA 210, the auditor should communicate with management if circumstances change or if there are modifications to the engagement terms. Periodic review ensures the engagement understanding remains appropriate, relevant, and complete. Non-review of engagement understanding fails to address changing circumstances and potential misunderstandings.

(c) INCORRECT. Dividends are not recognized in the statement of profit and loss as described. Under Ind AS 1 (Presentation of Financial Statements), dividends paid or payable are presented in the statement of changes in equity, not in the profit and loss statement. Additionally, the criterion for recognizing a dividend liability is when the entity has a present obligation (typically when declared/approved by the board), not merely when the amount can be measured reliably. Reliable measurement is a supporting condition, not the primary recognition criterion.

(d) INCORRECT. Under the Limited Liability Partnership Act, 2008, every LLP is required to file the Statement of Accounts within 30 days from the end of the financial year, not 60 days. The Schedule 6 filing requirement specifies 30 days as the deadline. Filing after 30 days constitutes a violation of statutory obligations and invites penalties.

(e) INCORRECT (Both parts are incorrect). Per RBI guidelines on NPA classification, classification is determined based on payment status (days of default), not on availability of security. Security availability is relevant for provisioning purposes, not classification. Additionally, asset classification is borrower-wise and not facility-wise—if one facility of a borrower is classified as NPA, all other facilities of the same borrower must also be classified as NPA, regardless of their individual payment status.

(f) CORRECT. The audit plan is indeed more detailed than the overall audit strategy. As per SA 300 (Planning an Audit of Financial Statements), the overall audit strategy establishes the direction and scope of the audit at a high level, while the audit plan translates this strategy into specific detailed procedures, timing, and responsibilities for addressing the identified risks of material misstatement.

(g) CORRECT. Risks of material misstatement are generally greater for accounting estimates involving significant judgement. Per SA 240 (The Auditor's Responsibilities Relating to Fraud) and SA 330 (The Auditor's Response to Assessed Risks), judgmental matters and estimates are inherently subject to estimation risk and the potential for management bias. The greater the degree of judgment required, the higher the risk of unintentional or intentional misstatement.

(h) INCORRECT. Formal confirmation procedures are not restricted only to assets, liabilities, and their elements. SA 505 (External Confirmations) establishes that confirmation procedures may be used for various assertions including, but not limited to: receivables (assets), payables (liabilities), revenue recognized, services provided, and other transaction items. While confirmations are commonly used for asset and liability assertions, they can extend to revenue, expenses, and other balances when relevant to the audit objectives.

Verification of Provisions by DEF Bank Limited's Statutory Auditor

1. Understand the Regulatory Framework
The auditor must first comprehend the RBI's guidelines on Asset Classification and Provisioning norms, including the Master Circular on Prudential Norms. These norms prescribe mandatory provisions for Non-Performing Assets (NPAs), standard assets, and contingent liabilities. The auditor should review DEF Bank's Provisions Policy to ensure consistency with RBI requirements and previous years' practices.

2. Verify Asset Classification
The auditor should obtain the bank's NPA schedule and verify that assets are correctly classified as Standard, Sub-standard, Doubtful, or Loss based on RBI criteria (primarily, arrears of 90 days or more). Sample test selected loan accounts to confirm classification dates, aging of arrears, and whether accounts meeting NPA criteria have been properly identified. Particularly scrutinize accounts with arrears near the 90-day threshold and advances to related parties.

3. Verify Provision Percentages Applied
The auditor should verify that provisions comply with RBI norms:
- Standard Assets: 0.40% general provision (or as per bank's higher policy)
- Sub-standard Assets: 15% provision
- Doubtful Category I (up to 1 year): 25% provision
- Doubtful Category II (1-3 years): 40% provision
- Loss Assets: 100% provision

Test a sample of accounts in each category to ensure correct percentage application.

4. Reconcile Provisions with Supporting Schedules
Obtain the Provisions Register and verify:
- Opening balance of provisions by category
- Provisions made during the year with supporting journals
- Recoveries, write-offs, and reversals with appropriate approvals
- Closing balance agreement with General Ledger and Trial Balance
- Mathematical accuracy of all calculations

5. Verify Calculations and Bases
For each provision category, verify the base amount (typically the outstanding loan amount) and confirm the percentage is correctly applied. Review provisions for contingent liabilities (guarantees, letters of credit, commitments) against RBI guidelines.

6. Post-Year-End Review
Review transactions immediately after the balance sheet date to identify any additional NPAs or changes requiring provision adjustments or disclosures. Check if any accounts upgraded from NPA to Standard Asset have been appropriately handled.

7. Verify Regulatory Compliance
Ensure compliance with IRAC (Income Recognition, Asset Classification, and Provisioning) norms, RBI inspection reports, and any compliance directions issued. Verify that specific provisions directed by RBI are separately tracked.

8. Review Disclosures
Verify that financial statements and schedules contain appropriate disclosures of NPAs, provisions by category, movement of provisions, and other contingencies in accordance with RBI requirements and accounting standards. Ensure classification of NPAs as per the prescribed format.

9. Assess Management Intent and Ability
Evaluate whether provisions are adequate given the bank's recovery policies and historical recovery rates. Review board minutes and management policies for evidence of appropriate evaluation of provision adequacy.

10. Audit Evidence and Documentation
Maintain detailed working papers supporting verification of each provision category, including sample testing details, reconciliations, and compliance confirmations.

The audit of cooperative societies involves special features that distinguish it from ordinary commercial audit. The two key aspects are:

1. Audit Classification of Society: Cooperative societies must be classified based on criteria such as membership strength, share capital, area of operation, and nature of activities (credit, consumer, producer, or service cooperative). This classification is critical as it determines the scope, extent, and nature of audit procedures applicable. The classification directly impacts audit materiality levels, sampling methods, testing depth, and the level of detailed verification required. A large cooperative with extensive membership and significant capital operations will warrant more comprehensive audit procedures compared to a small, localized society. The auditor must classify the society appropriately at the commencement of the audit to ensure audit planning, risk assessment, and procedure design are proportionate to the organization's size, complexity, and regulatory obligations. Different classifications may also involve different regulatory requirements and statutory compliances to be verified.

2. Discussion of Draft Audit Report with Managing Committee: A distinctive feature of cooperative society audit is the requirement to discuss the draft audit report and principal audit findings with the managing committee before finalizing the report. This discussion allows the managing committee to provide explanations, context, or clarifications regarding audit observations and identified issues. The auditor should present findings in a manner comprehensible to committee members who may lack technical accounting expertise. The committee's response and representations should be duly considered before finalizing the report. This practice promotes transparency, enhances governance within the cooperative, allows for potential rectification of minor matters, and strengthens stakeholder confidence. Unlike ordinary company audits where such pre-finalization discussion may not be mandatory, this requirement in cooperative audit reflects the democratic and participatory nature of cooperative organizations.

Audit of receipts in Government Audit refers to the systematic examination and verification of all revenue collections—both tax and non-tax—to ensure proper authorization, accurate recording, timely deposit into the treasury, and prevention of revenue leakage.

Nature and Importance:
While audit of expenditure has traditionally been the primary focus, audit of receipts has gained prominence with the expansion of public enterprises and multiple collection centers. Government receipts form the financial lifeblood of public administration, making their verification equally critical. The audit must ensure that all entitled revenues are collected and properly accounted for without leakage or misappropriation.

Types of Receipts Subject to Audit:
Receipts comprise tax receipts (income tax, GST, customs, excise, property tax) and non-tax receipts (user charges, fees, licenses, penalties, interest, dividends from PSUs, rents). Each category requires specific audit procedures based on the nature and complexity of collection mechanisms.

Objectives of Audit of Receipts:
First, to verify that all eligible revenues have been assessed and collected in accordance with applicable laws and regulations. Second, to ensure that receipts are properly recorded in the books of accounts with supporting documentation. Third, to confirm that collections are deposited promptly and in full into the designated government treasury or bank account, preventing unauthorized retention. Fourth, to detect and report any irregularities, unauthorized deductions, or revenue leakages. Fifth, to verify compliance with statutory provisions and administrative instructions governing receipt collection.

Key Audit Procedures:
The auditor must examine assessment records to verify correct identification of assessees and application of applicable rates and rules. Source documents (receipts, challans, permits) must be verified for authenticity and proper authorization. Reconciliation of collections with treasury deposits ensures nothing is diverted. Testing of transactions on a sample basis validates that procedures are followed consistently. Verification of exemptions and concessions granted ensures they are authorized and justified. The auditor must also review compliance with procedural timelines—e.g., for tax remittance within prescribed periods.

Distinct Challenges:
Audit of receipts is more complex than expenditure audit due to: multiple dispersed collection centers across regions; diverse types of receipts requiring specialized knowledge (e.g., customs procedures, tax assessment rules); involvement of individual assessees whose behavior is less predictable; longer time gaps between assessment and collection; and the need for technical expertise in revenue law. The absence of a central collection point complicates verification and deposit tracing.

Conclusion:
Audit of receipts is fundamental to ensuring public fund integrity and preventing revenue shortfall. Modern government audit must give equal emphasis to receipts as to expenditure, supported by specialized audit teams and detailed procedural guidelines.

Types of Revenue Grants to Local Bodies:

1. Unconditional/General Grants - Grants provided without any restrictions or conditions. Local bodies have complete discretion in their utilization for meeting revenue expenditure. These enhance the financial flexibility of local bodies.

2. Conditional/Specific Grants - Grants linked to specific purposes, schemes, or objectives. The local body must utilize these funds only for the stated purpose and in accordance with conditions prescribed by the grantor. These ensure funds are deployed as per grantor's priorities.

3. Matching Grants - Grants provided on a matching basis where the local body must contribute a specified percentage of total project cost from its own resources. This encourages fiscal responsibility and ensures local stake in implementation.

4. Ad-hoc/Discretionary Grants - Grants given at the discretion of higher authorities (central or state) for specific situations, emergencies, or unforeseen circumstances. These are temporary in nature and not recurring regularly.

5. Statutory Grants - Grants mandated by law or constitutional provisions. In India, Finance Commission recommendations provide statutory grants to local bodies for revenue deficit reduction as per Articles 243G (Municipalities) and 243W (Panchayats). These are regular and predictable.

6. Performance-based Grants - Grants linked to achievement of specified performance indicators or targets such as revenue collection, service delivery, or implementation of schemes. These incentivize efficiency and accountability.

7. Block Grants - Grants allocated for a block of related activities/services with some flexibility in allocation among components, though overall usage remains specified.

These grants serve crucial purposes: reducing revenue deficits, funding essential services like water supply and sanitation, implementing developmental schemes, and enabling local bodies to deliver services effectively.

The audit function of the CAG while examining various rules, regulations and orders serves as a critical mechanism of accountability in government. The primary functions are:

Verification of Authority: The audit examines whether every financial transaction has been authorized by law, rules, or properly delegated orders. Each transaction must have legal backing and must be within the scope of authority granted to the officer executing it.

Compliance with Regulatory Framework: The CAG verifies that all transactions have been executed strictly in accordance with the applicable budgetary provisions, financial rules, and standing orders issued by the government. This ensures that no authority has exceeded its prescribed limits or overstepped the boundaries defined in rules.

Examination of Regularity and Propriety: The audit checks not only the legality of transactions but also their regularity—whether they were executed according to prescribed procedures and in the proper manner. The CAG ensures that public funds have been spent with regard to both authority and propriety, meaning the expenditure represents a prudent and appropriate use of public resources.

Verification of Delegated Powers: Since administrative authority is often delegated through orders and rules, the audit examines whether actions taken were within the scope of delegated powers and whether the delegation itself was properly authorized. This prevents misuse or abuse of authority.

Ensuring Accountability: By examining compliance with rules and orders, the CAG fulfills its constitutional mandate to hold the executive accountable to Parliament and the public, ensuring that government officials act within their prescribed authority and follow established procedures.

The ultimate objective is to provide assurance that public money is managed in accordance with the law and with proper observance of all applicable rules, regulations, and orders.