CA Inter FM + SM

Answer: Seven statements answered below

(a) CORRECT – In government and non-business public sector entity audits, the audit objectives, nature of transactions, and authorization frameworks differ fundamentally from commercial enterprises. Traditional financial relationships used in business audits (e.g., gross profit consistency, receivables aging patterns, debt-to-equity ratios) may have limited relevance where entities operate under budget allocation and compliance-based frameworks rather than profit maximization principles. Government audit must adapt procedures to address public accountability rather than investor returns.

(c) INCORRECT – A sales invoice is internal evidence, not external evidence. Internal evidence comprises documents prepared or maintained by the entity itself (invoices, cash memos, ledgers). External evidence originates from third-party independent sources outside the entity's control (bank confirmations, supplier confirmations from vendors, correspondence with external agencies, tax authority documents). Only third-party originated documents qualify as external evidence.

(d) INCORRECT – Under Section 148 of the Companies Act, 2013, any vacancy in the Cost Auditor position due to resignation must be filled within 30 days of occurrence, not 60 days. The company must inform the central government in Form CRA-2 within 45 days of such appointment. The statement misstates the appointment timeline as 60 days, making it incorrect.

(e) INCORRECT – Under AS 19 (Accounting for Leases) and Ind AS 116, a finance lease is identified when the lease term extends to at least 75% or more of the economic life of the underlying asset. A lease term of less than 75% of useful life characterizes an operating lease, not a finance lease. The statement reverses this fundamental classification criterion, rendering it incorrect.

(f) INCORRECT – Block sampling is a non-statistical method involving selection of contiguous items (e.g., all transactions in January), but the statement's characterization is inaccurate. Block sampling does involve judgment in choosing which blocks to examine. While it does not use random number tables, it does possess a structured approach (systematic division of population into blocks). The blanket assertion that it has "no structured approach" and "no judgment" is overstated and incorrect.

(g) CORRECT – "Audit against provision of funds" is a core component of government expenditure audit. It verifies that every expenditure item is covered by proper sanction (general or special) from competent authority, ensuring authorized spending within allocated budgets and preventing unauthorized or ultra vires expenditure. This statement accurately reflects government audit principles.

(h) CORRECT – Where regulatory or governance frameworks mandate that auditors express an opinion on the effectiveness of internal controls over financial reporting (e.g., COSO framework requirements or Companies Act provisions for certain entity categories), the entity must establish, document, and maintain effective internal control systems. The statement correctly identifies the reciprocal requirement: opinion mandates require existence of controls to be opined upon.

Part (a): Auditor's Assumptions About Users of Financial Statements

As per SA 200 (Overall Objectives of the Independent Auditor) and SA 320 (Materiality in Planning and Performing an Audit), an auditor reasonably makes the following assumptions about users of financial statements:

1. Users possess reasonable knowledge of business, economic activities and accounting matters, and will review the financial statements with reasonable diligence.

2. Users understand the nature and limitations of financial information contained in the financial statements and are aware of the limitations inherent in audited financial information.

3. Users are primarily interested in the financial statements for economic decision-making purposes, such as assessing the entity's ability to generate cash flows, liquidity position and solvency.

4. Users rely on the financial statements as a primary source of financial information about the entity and do not seek further assurance beyond the audit opinion.

Part (b): Disclosure of Short-Term Borrowing

As per Part I of Schedule III to the Companies Act, 2013, short-term borrowing must be disclosed separately in the Balance Sheet under current liabilities. The disclosure requirements are:

Short-term borrowing should include: (i) Current portions of long-term borrowings; (ii) Bank overdrafts and cash credit facilities; (iii) Short-term loans from banks and financial institutions; (iv) Other short-term credit facilities availed by the entity.

These amounts should be shown separately with appropriate breakdowns where material, including details of secured and unsecured borrowings. The financial statements should provide information regarding the terms, conditions, interest rates and repayment schedules of material short-term borrowing arrangements.

Part (c): Other Circumstances Indicating Possibility of Fraud

As per SA 240 (The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements), four other circumstances relating to discrepancies in accounting records that indicate the possibility of fraud are:

1. Unusual entries in the general ledger, particularly at the end of the accounting period or in unusual account combinations, without supporting documentation.

2. Missing, forged or altered documents, including missing cheques, invoices, contracts or authorization forms, or documents bearing alterations or signs of tampering.

3. Unusual discrepancies between the general ledger and subsidiary records or reconciliations, including reconciling items that do not clear, or differences that cannot be readily explained.

4. Unusual transactions with related parties, particularly those that are not in the ordinary course of business, lack commercial substance, or involve unusual terms and conditions not previously known to the auditor.

Part (d): Two Approaches to Comparative Information Reporting

There are two broad approaches to auditor's reporting responsibilities for comparative information as per SA 710 (Comparative Information—Corresponding Figures and Comparative Financial Statements):

Approach 1: Single Engagement Approach – The auditor has been engaged to audit both the current and prior period financial statements. Both years are audited by the same auditor with the same level of professional skepticism and audit procedures.

Approach 2: Single Period Engagement Approach – The auditor has been engaged to audit only the current period financial statements. The prior period financial statements were audited by a predecessor auditor or not audited, presented as comparative figures only.

Essential Audit Reporting Differences:

1. Scope of Audit Opinion: Under single engagement approach, the audit report covers both periods with equal responsibility. Under single period approach, the opinion relates only to the current period; prior period figures are not audited by the current auditor.

2. Audit Report Language: Single engagement approach uses "we have audited" for both periods. Single period approach requires appropriate disclosure that prior period was audited by predecessor auditor or specifies the nature of review performed.

3. Audit Procedures: Single engagement requires full audit procedures for both periods. Single period approach involves reviewing the predecessor's working papers and audit adjustments for consistency and appropriateness.

Part (a): Audit Evidence

Audit evidence comprises information used by the auditor to draw conclusions on which the audit opinion is based. The junior assistant's view is incorrect. Audit evidence is not limited to accounting records alone. It includes information from accounting records combined with other corroborating information obtained through various audit procedures.

Information contained in the Accounting Records (Examples):

Example 1: Journal entries and General Ledger accounts that record all transactions with date, amount, accounts involved, and supporting narration. These primary records are tested through procedures like vouching to supporting documents and cross-verification with subsidiary records.

Example 2: Subsidiary records such as the Debtors Ledger showing individual customer balances, Creditors Ledger showing supplier balances, and Inventory Registers detailing stock movements and valuations. These provide supporting details for amounts shown in the General Ledger.

Other Information that Authenticates the Accounting Records (Examples):

Example 1: Bank statements received directly from banks (external confirmations) providing independent third-party evidence of cash transactions, balances, and reconciling items. This authenticates the cash book and bank reconciliation statement prepared by the entity.

Example 2: Physical inspection and count of fixed assets such as land, building, machinery, and furniture to verify their actual existence, condition, and ownership. This procedure authenticates the Fixed Asset Register and helps identify obsolete or impaired assets not fully reflected in the accounting records.

The auditor combines both types of evidence—testing accounting records through substantive procedures and obtaining external confirmations, physical evidence, and third-party documents—to gather sufficient appropriate audit evidence supporting the audit opinion.

Part (b): Management Responsibilities Section in Auditor's Report

The section titled 'Responsibilities of Management for the Financial Statements' in the auditor's report explains the foundation on which the audit is conducted. It communicates to stakeholders that management bears primary responsibility for the financial statements, not the auditor. This section clarifies the respective roles and responsibilities, preventing misunderstandings about the scope and limitations of an audit.

Management's Responsibilities include:

Management is responsible for: (1) Preparing and presenting financial statements in accordance with the applicable accounting framework (Indian Accounting Standards or AS); (2) Maintaining fair presentation of the financial position, performance, and cash flows; (3) Assessing the entity's ability to continue operations on a going concern basis; (4) Designing, implementing, and maintaining effective internal control systems to prevent and detect fraud and irregularities; and (5) Ensuring compliance with applicable laws and regulations.

SA 210 Requirement for Auditor:

Standard on Auditing (SA) 210 'Agreeing the Terms of an Audit Engagement' requires the auditor to obtain written agreement from management on their responsibilities before commencing the audit. Specifically, the auditor must: (1) Ensure management acknowledges responsibility for preparing and fairly presenting the financial statements in accordance with the applicable accounting framework; (2) Confirm management's understanding that the audit provides reasonable assurance (not absolute assurance) that financial statements are free from material misstatement; (3) Obtain management's acknowledgment regarding their responsibility for designing controls to prevent and detect fraud; and (4) Document this agreement in the audit engagement letter.

This documented understanding ensures clarity regarding the audit scope, reduces the expectation gap, and provides evidence of agreement on responsibilities before the audit engagement commences.