CA Inter FM + SM

Statement (i) – INCORRECT C&AG has statutory authority to conduct audit of Government companies under the Comptroller and Auditor-General's (Duties, Powers and Conditions of Service) Act, 1971. However, the C&AG does not "order" a test audit but rather directly performs/conducts the audit. The terminology used is improper; C&AG exercises audit authority by conducting audits themselves, not by ordering others to conduct them.

Statement (ii) – INCORRECT As per SA 700 and Section 142 of the Companies Act 2013, auditors are required to modify their opinion when material misstatements or limitations exist. The auditor must issue a qualified opinion, adverse opinion, or disclaimer of opinion as circumstances warrant. An unmodified opinion is issued only when no material misstatements or limitations are identified. The statement contradicts auditing standards.

Statement (iii) – INCORRECT According to Section 140 of the Companies Act, 2013, the first auditor of a Government company is appointed by the Comptroller and Auditor-General (C&AG), not by the Board. The Board's authority to appoint auditors commences only after the first auditor's term ends, typically at the Annual General Meeting.

Statement (iv) – INCORRECT Section 138 of the Companies Act, 2013 requires every company with a paid-up capital of one crore rupees or more to constitute an internal audit function. Therefore, private companies meeting this threshold are required to appoint an internal auditor. The blanket statement that all private companies are exempt is incorrect.

Statement (v) – INCORRECT Management representations alone cannot substitute for verification. As per SA 330, management representations are audit evidence but must be supplemented by substantive procedures. Physical verification, inspection, and other verification procedures for inventory are mandatory audit procedures that cannot be replaced by written management representations.

Statement (vii) – CORRECT Scrutiny of Bank Reconciliation statement is a recognized audit technique. It verifies the agreement between the cash book and bank statement, identifies discrepancies, detects errors, and confirms the accuracy of bank balances presented in financial statements. It is a substantive procedure regularly performed by auditors.

Statement (viii) – CORRECT The basic objective of audit – to form and express an opinion on whether financial statements are fairly presented in accordance with the applicable accounting framework – remains constant irrespective of entity nature, size, or form. While audit procedures and scope may vary based on these factors, the fundamental objective does not change. This principle is established in SA 200.

Statement (x) – INCORRECT When an LLP is appointed as auditor, not every partner must be individually qualified as an auditor. Section 141 and auditing requirements mandate that at least one partner of the LLP must be eligible and qualified to be an auditor. Only that partner (or qualified partners) acts on behalf of the LLP; other partners need not possess auditor eligibility criteria.

VOUCHING AND VERIFICATION PROCEDURES

(a) RENTAL RECEIPTS

Vouching: Obtain the lease agreement or rent note from landlord containing terms (amount, payment date, period). Cross-check the rent amount and frequency recorded in the rent expense account with the lease terms. Verify that monthly rent entries match the agreed amount and are recorded consistently. Examine the rent receipts issued by the landlord for signature, date, and amount. Trace payment through cheque stubs and bank statements to confirm cheques were presented. Ensure authorization from authorized personnel for rent payments. Review rental expense ledger and reconcile with receipts.

Verification: Conduct physical inspection of the rented premises to confirm it exists and is actively used for business operations. Verify that no arrears of rent are outstanding by confirming with the landlord. Confirm the reasonableness of rent based on location and comparable properties. Check consistency with prior years and investigate any material variations. Verify that rent is paid within reasonable time from the agreed date. Cross-check rental expense with bank deposit records and confirm amounts match.

(b) REPAIR TO ASSETS

Vouching: Obtain work orders, repair quotations, and invoices from vendors containing description of work, dates, and amounts. Verify invoices bear invoice numbers, date, vendor details, and amount claimed. Check whether repairs were approved by authorized person before execution. Cross-check invoice amounts with the purchase ledger and supplier accounts. Examine bills of materials and time sheets to verify costs incurred. Verify payment was made through cheque/bank transfer by inspecting cheques and bank statements. Ensure entries in repairs and maintenance account correspond to supporting invoices.

Verification: Distinguish between repairs and improvements — repairs should be expensed while improvements should be capitalized. Conduct physical inspection of the asset to verify repair work was actually performed. Check reasonableness: repair cost should not be disproportionate to asset value. Review fixed asset register to confirm the asset exists and belongs to the company. Examine prior repairs records to ensure recurring repairs are normal and not indicative of asset obsolescence. Verify that repairs are revenue in nature (not capital expenditure). Check consistency of repair costs with prior years.

(c) WORK-IN-PROGRESS

Vouching: Examine cost sheets or production records supporting WIP valuation. Verify material costs by tracing requisition notes to purchase invoices and stores records. Check labour costs by examining payroll records, time sheets, and production records showing hours allocated. Verify overhead allocation through the overhead distribution ledger and ensure proper apportionment basis. Cross-check WIP figures with raw materials consumption, labour hours, and production output. Reconcile opening WIP with closing WIP using production records and material consumption.

Verification: Conduct physical count of work-in-progress items at year-end and verify quantities against records. Assess valuation method used (FIFO/LIFO/weighted average) for consistency with prior years and appropriateness. Verify that obsolete or slow-moving items are identified and written down. Check allocation of material, labour, and overhead costs is accurate and follows the accounting policy. Trace opening WIP, additions, and closing WIP through production records. Verify movement between raw materials → WIP → finished goods is logical. Inspect the working of cost calculations for mathematical accuracy.

(d) INSURANCE CLAIMS

Vouching: Obtain the original insurance policy and verify coverage details, premium paid, and insured amount. Examine claim documents and loss assessment reports supporting the claim amount. Verify claim submission correspondence and dates from insurance company records. Check whether claim was authorized by appropriate management level. Examine insurance company correspondence confirming receipt and settlement status of claim. Verify receipt of claim amount through bank statements and cheques. Cross-check claim entries in claims received account or relevant ledger.

Verification: Confirm the existence and ownership of the insured asset at the time of loss. Verify the claim amount is within policy limits and covers the actual loss/damage incurred. Conduct physical inspection of the asset or damage site (if applicable) to substantiate the loss. Verify the claim amount against independent damage assessment or professional valuation. Check whether the claim relates to a covered event under the policy terms. Confirm settlement by the insurance company by verifying bank credits. Ensure the claim is recorded in the correct accounting period (period of loss, not period of settlement). Verify no duplicate claims have been submitted.

Fundamental Accounting Assumptions form the foundation of financial statement preparation as per AS 1 (Disclosure of Accounting Policies). The three assumptions are: (1) Going Concern — assumes the entity will continue operations for the foreseeable future, justifying asset valuation at historical cost rather than liquidation value; (2) Accrual Basis — income and expenses are recognized when earned or incurred, not when cash is received or paid, ensuring proper matching of revenues and expenses; and (3) Consistency — the same accounting policies and methods are applied consistently from period to period, facilitating comparability of financial statements over time. These assumptions underpin reliable financial reporting and are fundamental to the audit process.

Methods to obtain Audit Evidence are detailed in SA 500 (Audit Evidence). The principal methods include: (1) Inspection — examining records, documents, and tangible assets physically; (2) Observation — watching a process or control activity being performed; (3) Confirmation — obtaining direct written responses from third parties regarding account balances or transactions; (4) Recalculation — verifying mathematical accuracy of records and reports; (5) Reperformance — independently executing audit procedures or controls to verify effectiveness; (6) Analytical Procedures — evaluating financial information through analyzing relationships and trends between data; and (7) Inquiry — seeking information from knowledgeable employees and management. Different methods provide varying levels of audit assurance, and auditors combine multiple methods for sufficient appropriate evidence.

Importance of Working Papers is emphasized in SA 230 (Audit Documentation). Working papers serve as: (1) Evidence of work performed — documenting scope, timing, and nature of audit procedures executed; (2) Support for audit opinion — providing factual basis for audit conclusions and the audit report; (3) Quality control tool — enabling review and supervision by senior audit staff during the engagement; (4) Professional standards compliance — meeting regulatory and ICAI requirements for audit documentation; (5) Legal protection — serving as evidence in legal proceedings or professional disputes; (6) Reference for future audits — enabling efficient planning and understanding of prior year findings; and (7) Institutional records — maintaining continuity of knowledge and audit approach. Proper working papers are essential for demonstrating audit compliance and defending the audit work.

Random Sampling is governed by SA 530 (Audit Sampling). It is a selection method where each item in the population has an equal and known chance of being selected, eliminating selection bias. Methods include simple random sampling (using random number tables or computer generation) and systematic sampling (selecting every nth item). Advantages are: elimination of bias, scientific basis allowing statistical conclusions, quantifiable risk assessments, and professional objectivity. Disadvantages include higher implementation cost and complexity. Sample size is determined based on desired confidence level, tolerable error rate, and population materiality. Random sampling allows the auditor to express conclusions about the entire population based on sample results with measurable precision.

Defalcation of Cash refers to fraudulent misappropriation or embezzlement of cash by employees or others with access, addressed under SA 240 (The Auditor's Responsibilities Relating to Fraud in an Audit). Common schemes include: (1) suppression of cash receipts — recording lower amounts or not recording collection at all; (2) fictitious cash disbursements — creating false vouchers and manipulated payment records; (3) manipulation of bank reconciliations — adjusting reconciling items to conceal shortfalls; (4) cash lapping — misappropriating cash from one customer and covering with subsequent collections; and (5) direct theft from safe or cash register. Detection involves detailed cash reconciliations, surprise cash counts, customer confirmations, bank confirmations, detailed vouching of payments, and scrutiny of unusual reconciling items. Strong internal controls including segregation of duties, authorized approval systems, rotation of duties, and regular independent verification are essential preventive measures.