CA Inter FM + SM

Answering 8 out of 10 sub-parts:

(i) INCORRECT. A relative of a partner holding securities in the company disqualifies the audit firm from appointment. Section 141(3) of the Companies Act 2013 provides that a person shall not be eligible for appointment as an auditor if they or their relatives hold any securities in the company. The fact that the relative Mr. C holds securities of ₹2,00,000 in XYZ Ltd. disqualifies the firm AB & Co. from being appointed as its auditor.

(ii) INCORRECT. Working papers are the property of the auditor, not the client. Although they contain information about the client's business, they are prepared and owned by the auditor in exercise of their professional work. Per SA 230 (Audit Documentation), the auditor must retain working papers for statutory periods. The client has no ownership rights over them; they may request information but cannot claim ownership of the documentation.

(iii) INCORRECT (the board's refusal is improper). The board of directors cannot refuse to show minute books to auditors. Section 143(1) of the Companies Act 2013 grants auditors the statutory right to access all books, records, and documents of the company at all times. Minute books are essential for audit procedures. Refusing access violates the auditor's legal rights and is an offense under the Act.

(v) INCORRECT. Auditor rotation requirements apply to the company. Section 139 of the Companies Act 2013 mandates auditor rotation for companies having paid-up share capital of ₹5 crores or more at any time during a financial year. Company A has paid-up capital of ₹15 crores, which exceeds the threshold. Being a private limited company does not exempt it from rotation requirements—the exemption applies based on size criteria, not company type.

(vi) CORRECT. The auditor must study the Memorandum and Articles of Association to verify the validity of their appointment. The M&A contain the governance framework, auditor qualification requirements, appointment procedures, and powers. Understanding these is essential to confirm that the appointment is valid and that the auditor meets the company's specific requirements. This is a fundamental audit procedure per SA 300.

(vii) INCORRECT. Teeming and lading (or lapping) is a fraud technique involving misappropriation of cash receipts, not inflation of cash payments. It works by crediting one customer's account with receipts from another customer to conceal the misappropriation of the first receipt. It conceals cash theft through rotation of receipts, rather than inflating payment amounts.

(viii) INCORRECT. The Managing Director cannot appoint the first auditor unilaterally. Section 139(6) of the Companies Act 2013 provides that the first auditor of a company shall be appointed by the Board of Directors within 30 days of incorporation. While the MD may be a board member, the appointment must be a board decision, not the MD's individual act. This ensures collective governance and accountability.

(ix) INCORRECT. Any holding of securities, regardless of amount, disqualifies a person from being an auditor under Section 141(3) of the Companies Act 2013. The ₹950 face value is immaterial; even minimal holdings are disqualifying. The law is absolute—no securities holdings are permitted for an auditor in the company being audited, to preserve independence and avoid conflicts of interest.

(x) INCORRECT. Only members of the Institute of Chartered Accountants of India (ICAI) are qualified to be auditors of Indian companies. Section 141(3) of the Companies Act 2013 specifically restricts auditor appointments to Indian chartered accountants. Membership in ICAEW (Institute of Chartered Accountants of England and Wales) does not confer eligibility for Indian audit appointments unless the person is also an ICAI member.

Vouching and Verification of Specific Items

(a) Refund of General Insurance Premium Paid

The auditor should verify the refund of general insurance premium by obtaining and examining the following:

Existence and Completeness: Obtain the original insurance policy documents and verify the period of cover, the premium amount originally paid, and the cancellation or endorsement notice issued by the insurance company. Check whether the policy was cancelled before the expiry date, giving rise to a refund.

Amount of Refund: Verify the refund amount with the credit note or refund voucher issued by the insurance company. The refund should be on a pro-rata or short-period basis as per the terms of the policy. Trace the receipt of refund amount in the bank statement.

Accounting Treatment: Confirm that the refund has been credited to the Insurance Premium Account or the original expense head, and not treated as income, unless justified. Ensure that no portion of unexpired premium was already carried forward as a prepaid expense — if it was, the refund should reverse that asset.

Authorization: Check that the cancellation of the policy was duly authorised by the management. Verify correspondence with the insurance company for confirmation of the refund amount.

Cut-off: Ensure the refund is recorded in the correct accounting period in which the cancellation became effective.

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(b) Payment of Taxes

The auditor must vouch tax payments carefully, as these are significant and carry penal consequences for errors. The following steps should be undertaken:

Direct Taxes (Income Tax / TDS): Examine the challans of advance tax and self-assessment tax payments filed with the bank. Verify that challan particulars (PAN, Assessment Year, amount, head of payment) are correct. For TDS, verify Form 26AS/Annual Information Statement to reconcile amounts deducted and deposited. Check due dates to ensure no interest under Section 234B and 234C of the Income Tax Act, 1961 has been incurred unnecessarily.

Indirect Taxes (GST): Verify GST payment challans (PMT-06) and confirm amounts paid are consistent with GSTR-3B returns filed. Cross-check with the electronic cash ledger and electronic credit ledger on the GST portal.

Professional Tax / Other Local Levies: Vouch payment receipts against demands raised by municipal or state authorities. Verify that payments are made before due dates to avoid penalties.

Accounting: Ensure tax payments are correctly classified — advance tax as an asset (advance tax account), TDS payable timely remitted, and current tax expense charged to Profit & Loss Account in accordance with AS 22 – Accounting for Taxes on Income.

Authorisation and Cut-off: All tax payments should be authorised by the finance head/CFO. Verify that provisions made in prior periods are adequate and reconcile with actual payments.

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(c) Sale Proceeds of Junk Material (Scrap Sales)

Sale proceeds from junk/scrap material are highly susceptible to misappropriation due to the informal nature of such transactions. The auditor should exercise special care:

Internal Controls: Evaluate whether the entity has a system for weighment, measurement, or counting of scrap before sale. Check if there is a designated officer supervising scrap disposal and whether separate records (Scrap Register / Scrap Disposal Register) are maintained.

Gate Pass and Weighment Records: Verify the outward gate passes issued for removal of junk/scrap material and cross-check with weighbridge slips or measurement certificates to confirm quantities removed match invoices raised.

Invoices and Collection: Examine the sale invoices raised on the scrap buyer and trace the amounts to the cash book or bank statement to confirm actual receipt. Check that GST has been properly charged and remitted on scrap sales where applicable.

Reasonableness Check: Compare the scrap realisation with prior periods and assess reasonableness in relation to production levels and input consumption. An unusually low amount may indicate suppression of receipts.

Accounting Treatment: Confirm that sale proceeds are credited to the Scrap Sales Account or reduced against manufacturing overhead, consistently with the accounting policy adopted. Ensure the treatment is disclosed appropriately.

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(d) Intangible Assets

Verification of intangible assets involves confirming their existence, valuation, ownership, and proper accounting as per AS 26 – Intangible Assets.

Existence and Identification: Obtain a schedule of all intangible assets (goodwill, patents, trademarks, copyrights, software licences, brands, etc.). Verify the nature of each intangible and determine whether it meets the recognition criteria — identifiable, controlled by the entity, and expected to generate future economic benefits.

Valuation — Cost of Acquisition: For purchased intangibles, verify original purchase agreements, invoices, and payment records. For internally generated intangibles, confirm that only costs incurred in the development phase have been capitalised; research-phase costs must be expensed as per AS 26.

Amortisation: Verify that the amortisation policy is reasonable and consistently applied. AS 26 requires amortisation over the useful life, not exceeding 10 years (rebuttable presumption). Check the amortisation calculations for mathematical accuracy and ensure the charge to the Profit & Loss Account is correctly recorded.

Ownership/Legal Rights: For patents and trademarks, examine registration certificates from the relevant authority (Patent Office / Trade Marks Registry). For software, verify licence agreements in the entity's name.

Impairment: Assess whether there are indicators of impairment (loss of market, obsolescence of technology) and verify that an impairment review has been carried out in accordance with AS 28 – Impairment of Assets if required.

Disclosure: Confirm adequate disclosure of intangible assets in the financial statements — gross block, accumulated amortisation, net block, and amortisation method — as required by Schedule III to the Companies Act, 2013.

Remuneration paid to directors in case of a public limited company:

Directors' remuneration in a public limited company must comply with Section 179 of the Companies Act, 2013 and the criteria specified in Schedule V. The auditor's audit procedures include: (1) Examining board resolutions and shareholders' approval documenting authorization of remuneration; (2) Verifying that remuneration does not exceed limits prescribed under Schedule V (such as maximum commission not exceeding 5% of profits or prescribed percentage of turnover); (3) Checking that all components (salary, commission, bonus, perquisites) are properly segregated and disclosed; (4) Confirming compliance with tax withholding obligations and Provident Fund contributions; (5) Reviewing financial statement disclosures to ensure proper reporting of remuneration details including amount paid to each director and nature of benefits. If remuneration exceeds approved limits, the auditor should express a qualified opinion as it represents a breach of statutory requirements.

Payment for acquisition of assets:

When verifying asset acquisitions, the auditor must ensure both authorization and execution are proper. Key audit procedures include: (1) Obtaining and reviewing capital approval from the board of directors or shareholders as per the company's delegation of authority matrix; (2) Examining supporting documents such as purchase invoices, quotations, acceptance certificates, and delivery challan; (3) Verifying physical existence of the asset through inspection or management certification; (4) Confirming proper capitalization as per AS 10 or Ind AS 16, ensuring all directly attributable costs are included and non-capitalisable expenses are expensed; (5) Checking that the transaction is correctly recorded with appropriate debit to fixed asset and credit to cash or creditor; (6) Verifying cut-off to ensure acquisitions in the period are recorded in the correct financial year; (7) Assessing whether any contingent liabilities, warranties, or obligations exist; (8) Testing a sample of significant acquisitions to confirm they represent genuine business operations and are not fictitious or personal assets. The auditor should also verify that capital assets are not capitalised for revenue items.

A qualified opinion:

A qualified opinion is expressed as an "except for" opinion when the auditor believes there is a material misstatement in the financial statements or a scope limitation in audit procedures, but the matter is not pervasive to the financial statements as a whole. This is issued under SA 705 (Modifications to Opinion). A qualified opinion is appropriate when: (1) The scope of audit is restricted (e.g., unable to observe inventory count or directly confirm receivables) but the financial statement impact is material but not pervasive; (2) There is a material disagreement with management regarding an accounting treatment, disclosure, or principle, but the matter is isolated; (3) There is a limitation in obtaining sufficient appropriate evidence, but alternative procedures provide reasonable audit assurance. In expressing a qualified opinion, the auditor must clearly describe the matter in a separate paragraph and modify the opinion paragraph to include "except for" language. A qualified opinion should be distinguished from an adverse opinion (when the matter is pervasive and overall financial statements are significantly misleading) and a disclaimer of opinion (when scope limitations are so significant that adequate opinion cannot be formed).

Fraudulent financial reporting:

Fraudulent financial reporting is an intentional misstatement or omission of amounts or disclosures in financial statements, distinct from unintentional errors. Under SA 240 (The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements), the auditor must maintain professional skepticism and acknowledge that fraud may occur. Common types include: revenue recognition fraud (recording fictitious sales, channel stuffing, or premature revenue recognition), expense understatement (omitting liabilities or expenses), asset inflation (overstating inventory, receivables, or fixed assets), and liability concealment (understating payables or accruals). Auditor procedures to detect fraudulent reporting include: (1) Conducting brainstorming among audit team members to discuss fraud risks; (2) Making inquiries of management, internal auditors, and those charged with governance regarding fraud concerns; (3) Identifying high-risk areas requiring detailed substantive testing; (4) Testing significant and unusual transactions with close scrutiny; (5) Evaluating the tone at the top and entity's control environment; (6) Assessing management override of internal controls; (7) Checking for inconsistencies in documentation or unusual patterns. If fraud is detected or suspected, the auditor must evaluate its implications and communicate to those charged with governance under SA 260 (Communication with Those Charged with Governance) and comply with regulatory reporting requirements.