CA Inter FM + SM

ANSWER TO ANY EIGHT QUESTIONS:

(a) CORRECT - The scope of work of an internal auditor may extend even beyond the financial accounting. Internal auditors examine not only financial records but also operational efficiency, compliance with policies, risk management, and management controls. Unlike external auditors who focus on financial statements, internal auditors have a broader mandate including operational and strategic audit areas.

(b) INCORRECT - An auditor cannot be indifferent to prudence or profitability. While the auditor is not responsible for ensuring profitability, they must verify application of the prudence concept in valuation of assets, recognition of liabilities, adequacy of provisions, and going concern assessment. The auditor also considers appropriateness of accounting policies and compliance with Indian Accounting Standards (Ind AS) which embodies prudence.

(c) CORRECT - Evaluating responses to enquiries is an integral part of the inquiry process. Per SA 500 (Audit Evidence), inquiry involves not merely asking questions but critically evaluating the nature, source, reliability, and consistency of responses received. The auditor must assess whether responses are corroborated by other evidence and whether the respondent has appropriate knowledge.

(d) CORRECT - Internal control questionnaires (ICQs) are a good source for identifying weaknesses in internal control systems. ICQs comprise structured questions about control design and operation. However, they must be supplemented with observation and testing procedures to confirm actual implementation and effectiveness of controls.

(e) CORRECT - Cluster sampling is less effective than random sampling for audit purposes. Cluster sampling involves dividing the population into clusters and randomly selecting entire clusters. Random sampling provides better representativeness as each item has equal chance of selection. For audit populations, random sampling generally yields more reliable and defensible conclusions.

(f) INCORRECT - Errors of duplication do NOT affect the Trial Balance. When the same transaction is posted twice (both debit and credit sides are duplicated equally), the trial balance continues to balance. Such errors affect the accuracy of individual account balances and financial statements but not the agreement of trial balance totals. These are errors of accuracy, not of principle affecting trial balance agreement.

(g) INCORRECT - Substantive procedures DO test the balances of accounts. Substantive procedures include substantive tests of details and substantive analytical procedures specifically designed to test account balances and detect misstatements. They directly address the risk of material misstatement at the assertion level.

(h) INCORRECT - The first auditors of a Government company are NOT appointed by the Board of Directors. Under the Companies Act, 2013, the first auditors of a Government company are appointed by the Central Government, State Government, or the Comptroller and Auditor General (CAG) as applicable. The Board appoints subsequent auditors after the first auditors' term.

(i) CORRECT - The members of XYZ Ltd. can validly lodge a complaint against the auditor for failing to send the auditor's report. Under the Companies Act, 2013, the auditor's report must be placed before the company in general meeting and members have a statutory right to receive copies. Failure by the auditor to ensure members receive the report constitutes a breach of statutory duty.

(j) INCORRECT - Mr. Pawan cannot be appointed as Tax-Consultant of ABC Ltd. where his father is the Managing Director. This appointment violates the principle of independence as enshrined in the Chartered Accountants Act, 1949 and professional ethics. A close family relationship with a key management person creates a threat to independence and objectivity. Such professional engagements are not permitted due to conflict of interest and self-interest threat.

VOUCHING AND VERIFICATION OF SPECIFIC AUDIT ITEMS

(a) Preliminary Expenses

Vouching: Verify from the Certificate of Incorporation and Memorandum/Articles of Association that expenses relate to the preliminary stage before commencement of business operations. Examine original invoices, bills, and payment receipts for all preliminary expenses claimed (registration fees, legal fees, stamp duty, professional fees). Trace payments through bank statements and cheque registers. Cross-check with directors' report to confirm the nature and extent of preliminary expenses. Verify that only eligible expenses are capitalized as per company's accounting policy, not revenue expenses disguised as preliminary expenses.

Verification: Confirm the total amount of preliminary expenses is properly capitalized as intangible assets in the balance sheet. Verify the amortization policy is disclosed in notes to accounts and applied consistently (typically over 5 years or as per company policy). Check that no items have been double-counted. Ensure expenses relate genuinely to preliminary stage and not to ongoing operations. Verify that the expense does not exceed the amount authorized in the Memorandum or approved by directors.

Relevant Accounting Treatment: As per Ind AS 38, preliminary expenses qualify as internally generated intangible assets and must meet recognition criteria before capitalization.

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(b) Customs & Excise Duties

Vouching: Obtain duty assessment orders and bills from customs/excise authorities. Examine payment challans and trace payments through bank statements. For imports, verify original customs bills with corresponding import documents, invoices, and shipping papers. For excise duties on manufactured goods, verify with production records and excise department returns. Check if duty drawback claims have been filed and verify supporting documentation. Review correspondence with customs/excise authorities for any disputes or pending assessments.

Verification: Confirm that customs duties on imported goods are capitalized as part of the cost of inventory or fixed assets (as applicable) and not charged directly to P&L. Verify that excise duties are included in the cost of goods manufactured. Check whether any duty reversals or refunds should be accounted for. Ensure duties are correctly apportioned between capital assets and revenue items. Review the cut-off to ensure duties relate to transactions occurring in the current period. Verify compliance with GST law regarding input credit eligibility.

Relevant Standards: Duties and levies form part of cost of purchase/production under Ind AS 2 (Inventories) and Ind AS 16 (Property, Plant & Equipment).

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(c) Floating Assets

Vouching: Floating assets include inventories and trade receivables. For inventories, examine purchase invoices, Goods Receipt Notes (GRNs), and inspection reports. Verify entries in stock registers, bin cards, and perpetual inventory records. For receivables, check sales invoices, delivery notes, and dispatch records. Cross-reference with the debtors' ledger and monthly statements sent to customers. Obtain written confirmations from major customers. Examine correspondence regarding credit terms and any disputes.

Verification: Inventory verification: Observe and participate in physical stock verification at year-end. Verify the valuation on Cost or Net Realizable Value (NRV), whichever is lower as per Ind AS 2. Identify obsolete, damaged, or slow-moving items and assess adequacy of provision. Check the consistency of valuation method with prior years. Receivables verification: Analyze the aging of debtors and examine the adequacy of provision for doubtful debts. Verify that debtors are genuine trade customers and not related parties. Check post-year-end receipts to confirm existence and recoverability. Examine the bad debts written-off and recovery trends. Ensure completeness by comparing with sales records.

Cutoff Verification: Confirm that purchases and sales occurring near year-end are recorded in the correct period.

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(d) Recovery of Bad Debts Written-off

Vouching: Refer to the bad debts written-off register maintained in the prior year(s) and identify which bad debts were recovered during the current year. Obtain the cheque or bank receipt evidencing the recovery and trace it through bank statements. Verify the debtor's identity and confirm the amount recovered matches the ledger record. Examine correspondence from the debtor indicating the reason for recovery (settlement, changed circumstances, etc.). Cross-check the recovery with the accounts receivable subsidiary ledger to ensure the debtor was indeed written-off previously.

Verification: Confirm that the recovered amount genuinely relates to a bad debt written-off in a prior period and not a current year allowance against sales. Verify the accounting treatment: recovery of bad debts previously written-off should be credited to Profit & Loss statement (as Other Income or reversal of bad debts expense), not to the provision for doubtful debts account. Ensure the recovery is not double-counted—check that the original bad debt write-off is not reversed. Examine the timing of recognition to confirm income is recorded in the period cash is received (on receipt basis, as receivables are typically non-existent on the books once written-off). Verify completeness by reviewing bank deposits and post-year-end collections to identify all recoveries. Check tax treatment to ensure bad debt recovery is properly included in taxable income per Income Tax Act.

Relevant Standards: As per Ind AS 109, recovery of previously written-off financial assets should be accounted for as income in the period of receipt.

Part (a): Disclosure Requirements of Current Investments as per Schedule III, Companies Act, 2013

Schedule III, Part II of the Companies Act, 2013 prescribes the disclosure requirements for current investments in the Balance Sheet. The key disclosure requirements are:

Nature and Composition: Current investments must be disclosed by their nature, showing the break-up as follows: government securities, bonds and debentures, shares, mutual fund units, and any other investments. Each category should be separately identified.

Valuation Method: Current investments are valued at cost or market value, whichever is lower. The basis of valuation must be clearly disclosed in the notes to accounts.

Tabular Format: Disclosure should follow a standard format showing: (1) opening balance at the beginning of the year, (2) additions during the year, (3) disposals/sales during the year, and (4) closing balance at the end of the year for each category of investments.

Unrealized Loss: If the market value of any investment falls below cost, the depreciation in value must be separately disclosed as an adjustment to the cost basis, typically shown as a reduction from cost.

Related Party Disclosure: Investments in related parties (subsidiaries, associates, joint ventures, key management personnel) must be specifically identified and separately disclosed with the name of the related party and nature of relationship.

Interest Accrued: Any interest accrued but not yet received on bond investments and similar instruments should be separately shown.

Security-wise Details: For significant investments, security-wise details (e.g., name of company shares, ISIN number for bonds) should be disclosed.

The disclosure ensures users can assess liquidity, fair valuation, and investment risk concentration.

Part (b): Significant Matters in Audit Note Book

The Audit Note Book (working papers) should record all significant matters observed during the audit course. Key matters include:

Queries and Management Responses: All material queries raised on accounting treatments, compliance, or verification should be documented along with management's clarifications and supporting evidence.

Accounting Treatment Disagreements: Points where the auditor disagreed with management's accounting treatment, the audit team's view, and how the matter was resolved must be clearly recorded.

Contingent Liabilities: All identified contingent liabilities, pending litigations, guarantees, and possible obligations that may arise should be documented with management's disclosures.

Estimation Uncertainties: Significant accounting estimates used (bad debt provisions, depreciation rates, inventory obsolescence, etc.), the basis, management's assumptions, and auditor's review/challenge should be recorded.

Related Party Transactions: All material related party transactions identified, their commercial rationale, pricing justification, and compliance with corporate governance norms.

Accounting Policy Deviations: Any changes in accounting policies or deviations from the stated policies should be documented along with impact analysis.

Errors and Irregularities: All detected errors (whether adjusted or immaterial), fraud indicators, unauthorized transactions, or irregularities, however minor.

Post Balance Sheet Events: Events occurring after the balance sheet date but before audit completion that require adjustment or disclosure.

Going Concern Assessment: Auditor's findings regarding the entity's ability to continue as a going concern and evidence supporting the conclusion.

Control Weaknesses: Significant deficiencies or weaknesses in internal controls observed, their risk impact, and management's remedial actions.

Unusual or Significant Transactions: High-value, unusual-nature, or complex transactions requiring special audit attention and verification steps performed.

Analytical Review Findings: Results of analytical procedures, significant variances from expectations, and audit steps performed to resolve variances.

Verification Details: Key verification steps (confirmation replies, bank reconciliations, physical verification results, sampling basis and results) for material balances.

Part (c): Use of Flowcharts in Internal Control Evaluation

Flowcharts are graphic representations of process flows using standardized symbols to depict the sequence of operations, decision points, and data/document flows within an organization. Their use in internal control evaluation includes:

Process Visualization: Flowcharts clearly depict the entire transaction cycle from initiation to final recording, helping auditors understand the operational flow and identify control points where transactions are authorized, approved, recorded, and reconciled.

Control Point Identification: They facilitate identification of specific points where preventive or detective controls operate, such as approval gates, segregation of duties, reconciliation steps, and exception handling.

Weakness Detection: By tracing the complete flow, auditors can identify control gaps (missing approvals, lack of segregation of duties, absence of reconciliations) and design effective audit procedures.

Standardized Communication: Using standard flowchart symbols (start/end ovals, process rectangles, decision diamonds, data parallelograms, arrows for flow), audit findings are consistently communicated across the audit team and management.

Documentation and Reference: Flowcharts serve as permanent audit documentation for understanding the control environment and can be referenced in future audits for comparative analysis.

Risk Assessment: They help in assessing inherent risks at each transaction cycle stage and designing appropriate control testing procedures.

Compliance Verification: Flowcharts enable verification of whether the actual process follows the documented procedures and policies.