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About the Faculty: Neeraj Arora
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CA Inter Audit Book by Neeraj Arora
Index
Chapter No. Chapter Name Page No.
0 Introduction 1
1 Basics of Auditing, nature, Scope and Objective of Audit 20
2 Audit Strategy, Audit Planning & Audit Programme 65
3 Audit Documentation and Audit Evidence 86
4 Risk Assessment and Internal Control 125
5 Fraud and Responsibilities of the Auditor in this regard 166
6 Audit in Automated Environment 183
7 Audit Sampling 196
8 Analytical Procedure 211
9 Audit of items of Financial Statements 219
10 Company Audit 283
11 Audit Report 366
12 Bank Audit 403
13 Audit of Different Types of Entities 440
14 Other SAs 481
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Chapter 0
Basics of Auditing, Nature, Scope and Objective of Audit
Introduction
ICAI
The Institute of Chartered Accountants of India (ICAI) is the national professional accounting body of India.
● It was established on 1 July 1949 as a statutory body under the Chartered Accountants Act, 1949 enacted
by the Parliament (acting as the provisional Parliament of India) to regulate the profession of Chartered
Accountancy in India.
● ICAI is the second largest professional Accounting & Finance body in the world.
● ICAI is the only licensing and regulating body of the financial audit and accountancy profession in India.
Emblem of ICAI
Rules and Regulation For Accounting and Auditing
● __________________________
● __________________________
Practical Subject
Auditing is, perhaps, one of the most practical-oriented subjects in the C.A. curriculum. This paper aims to
provide knowledge of generally accepted auditing procedures and of techniques and skills needed to apply
them in audit engagements. A good knowledge of the subject would provide a strong foundation to students
while pursuing the Chartered Accountancy course. A good understanding of the theoretical concepts,
particularly, in the context of auditing standards would make practical training an enriching and enjoyable
experience. While studying this paper, students are advised to integrate the knowledge acquired in other
subjects, specifically, accounting and corporate laws in a meaningful manner. Such learning would only help a
student to become a better professional.”
Lines Taken From ICAI Study Mat - www.icai.org
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A brief About Audit

● Genesis
● The person who conducts audit is known as auditor
● General Meaning
○ Evaluation Process
○ Undertaken to establish
○ Adherence to certain norms
● कोई भी काम उसके बनाए गए तरीके से हुआ है या नहीं, इसे चेक करने को ही ऑडिट कहते है ।
● As a Chartered Accountant we are concerned with mostly with Financial Audit (Audit of Financial
Information)
● Why we need Audit of Financial Information (among many reasons)
○ Emergence of Limited Liability Organisations
○ Increasing complexities in Financial reporting
Following things must be clearly understood before we start studying audit

1. Meaning of Auditing
2. Objective of Auditor
3. Reasonable Assurance
4. Misstatement
5. Material
6. Types of Opinion
7. Those charged with governance
8. Management
9. Pre-Conditions for an audit
10. Internal Control
11. Test Checking
12. Professional Judgement
13. Audit Procedures
14. Assertions
15. Audit Risk
16. Audit Evidence
17. Independence
18. Steps in Auditing

Meaning of Audit
An Audit is
● independent examination of
● Financial information of
● any entity, whether profit oriented or not , and irrespective of its size or legal form, when such an
examination is conducted
● with a view to expressing an opinion thereon.


0.1 Q1. Define Audit.

(SELF)
0.1 Q2. Correct / Incorrect

Audit is required to be conducted only in case of profit oriented entities
(SELF)
Overall Objectives of Auditor

In conducting an audit of financial statements, the overall objectives of the auditor are
● To obtain reasonable assurance about
○ whether the financial statements as a whole
○ are free from material misstatement,
■ whether due to fraud or error,
○ thereby enabling the auditor to express an opinion on
■ whether the financial statements are prepared,
■ in all material respects,
■ in accordance with an applicable financial reporting framework; and
● To report on the financial statements, and communicate as required by the SAs, in accordance with the
auditor’s findings.
Reasonable Assurance
● A high, but not absolute, level of assurance.
For auditor's opinion, reasonable Assurance is an absolute level of assurance (T/F)
Misstatement
A difference between
● the amount, classification, presentation, or disclosure
○ of a reported financial statement item
● and the amount, classification, presentation, or disclosure
○ that is required for the item to be in accordance with the applicable financial reporting
framework.
Misstatements can arise from error or fraud.

● The distinguishing factor between fraud and error is whether the underlying action that results in the
misstatement of the financial statements is intentional or unintentional.
● Fraud’ deals with intentional misrepresentation but, ‘error’, on the other hand, refers to unintentional
mistakes in financial information.
Question - Fraud is more difficult detect than error (True or False)

Answer - Statement is true, fraud is more difficult to detect than error. This is because fraud generally involves
sophisticated and carefully organized schemes to conceal it such as forgery, deliberate failure to record
transactions, intentional misrepresentations to the auditor.
The risk not detecting a material misstatement from fraud is higher than risk of not detecting one resulting
from error (T/F)
Material
Misstatements, including omissions, are considered to be material

● if they, individually or in the aggregate,
● could reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements;
0.2 Q1. Define Audit and State the objective of the auditor
(SELF)

Types of Opinion
● Clean Opinion
● Modified Opinion
○ Qualified Opinion
○ Adverse
○ Disclaimer of Opinion
Meaning of Pervasive
The term pervasive is used to describe the effect of misstatements on the financial statement.
Whether the effect of material misstatement is pervasive or not it depends on auditors judgement.
While deciding that the effect is pervasive or not auditor must keep the following things in mind
● Effect is pervasive when it is not confined to a specific element

● Even if it is confined to a specific element the effect can be considered as pervasive if it represent a
substantial proportion of financial statements
● In relation to disclosures, The effect can be considered as pervasive if It is fundamental to users
understanding of the financial statements.
Those charged with governance

The person(s) or organisation(s) with responsibility for
● overseeing the strategic direction of the entity and
● obligations related to the of the entity
0.3 Q1. The persons with responsibility for overseeing the strategic direction of the entity and
obligations related to the accountability of the entity are :

a. Management
b. those charged with governance
c. audit committee
d. board of directors
(RTP, May 2021, NA) (MTP1, May 2021, 1 Mark ) (RTP, Nov 2021, NA)
Management
● The person(s) with executive responsibility for conduct of entity's operation
0.4 Q1. Management and TCWG can be same Correct / Incorrect

(SELF)
Pre- Conditions for an audit

In order to establish whether the preconditions for an audit are present, the auditor shall:
● Determine whether the financial reporting framework is acceptable; and
● Obtain the agreement of management that it acknowledges (मानती है ) and understands (जानती है ) its
responsibility:
○ For the preparation of the financial statementsin accordance with the applicable financial
reporting framework;
○ For the internal controlas management considers necessary; and
○ To provide the auditor with:
■ Access to all information such as records, documentation and other matters;
■ Additional information that the auditor may request from management for the purpose
of the audit; and
■ Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence.
0.5 Q1. Discuss the pre-conditions of an Audit

(SELF)

Internal Control
The Process designed, implemented and maintained by
➔ Those charged with governance
➔ Management
➔ Other personnel
To Provide Reasonable Assurance with regard to
● Reliability of financial reporting
● Effectiveness & Efficiency of operations
● Safeguarding of assets
● Compliance with applicable law & regulations
It is a means by which an organization's resources are directed, monitored, and measured. It plays an
important role in detecting and preventing fraud and protecting the organization's resources, both physical
(e.g., machinery and property) and intangible (e.g., reputation or intellectual property such as trademarks).
Early Examples - One set of bureaucrats charged with collecting taxes and another with supervising them.

Other Examples
● Locks
● Segregation of duties
○ Separating responsibility for physical custody of an asset from the related record keeping is a
critical control.
○ Persons who can authorize purchase orders (Purchasing) should not be capable of processing
payments (Accounts Payable)
● Authorisation
○ An employee who only needs to view computer information should be restricted to Read and
File Scan access and should not be granted Write and Create access.
● Reconciliations
Auditor’s Responsibilities / Role

● RAP
● FAP
● Opinion?
0.6 Q1. Define Internal Control

(SELF)
Test Checking
● Application of Audit Procedures to less than 100% of the Transaction. It is also known as Sampling.
● Should be done in such a way that every item must have an equal chance of selection.
Judgement
The application of relevant
➔ training, knowledge & experience, (TKE)
➔ in making informed decisions
➔ about the courses of action that are appropriate in the circumstances of the audit engagement.
Professional judgment is essential to the proper conduct of an audit.
(Study this part while revising Chapter 1 For the first time after completion of syllabus) - Professional judgment
is necessary in particular regarding decisions about:
● Materiality and audit risk.

● The nature, timing, and extent of audit procedures used to meet the requirements of the SAs and
gather audit evidence.
● Evaluating whether sufficient appropriate audit evidence has been obtained, and whether more needs
to be done to achieve the objectives of the SAs and thereby, the overall objectives of the auditor.
● The evaluation of management’s judgments in applying the entity’s applicable financial reporting
framework.
● The drawing of conclusions based on the audit evidence obtained, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.
Other Points
● May differ from person to person
● Can also be formed after consultation
"Professional judgment is essential to the proper conduct of an audit." Discuss. MTP May 2021
0.7 Q1. "Professional judgment is essential to the proper conduct of an audit." Discuss.
(MTP1, Nov 2020, 3 Marks)
How Audit Is Conduct
Framework to conduct audit
➔ Engagement
➔ Planning
➔ Materiality
➔ Risk assessment; and
➔ Tests of controls, when required by the SAs or when the auditor has chosen to do so; and
➔ Substantive procedures (Checking of Assertions), including
◆ Tests of details and
◆ Substantive analytical procedures.
➔ Audit Evidence
➔ Conclusions and Reporting
Risk Assessment and Risk Assessment Procedures
● Risk assessment is done to assess the risk of material misstatement. (ROMM)

● Risk of material misstatement is defined as ‘the risk that the financial statements are materially
misstated prior to audit
● Risk assessment procedures are
○ used to
■ obtain an understanding of the entity and its environment,
■ including its internal control
○ in order to
■ assess the risk of material misstatement and
■ determine the nature, extent and timing of further audit procedures.
● After RAP, the Auditor can assess the level of ROMM.
● Once the ROMM is assessed, we can decide NET of FAPs
○ Nature - (Compliance or Substantive)
○ Extent - (Sample size, Less work or more work)
○ Timing - (Interim period and some transaction at the year end OR all year end in detail)
● Risk assessment procedures alone do not provide audit evidence sufficient to support audit opinion.
● They are required in all financial statement audits.
0.8 Q1. Correct / Incorrect

Risk assessment procedures involve testing of accounts for checking of assertions.
(SELF)
Further Audit Procedures
Compliance Procedure
● Auditor test internal control in order to
○ to decide whether to rely on them or not .
● We will (For testing IC)
○ Check design (SoD, Approvals, Reconciliations etc)
■ No - Leave it go for SP
■ Yes test efficiency (Operation and Continuity)
○ Test of Efficiency (Operation and Continuity) If internal controls are efficient then it is going to
have a direct impact on the nature, extent and timing of substantive procedures.
○ If because of efficiency of internal control we decided to rely on internal control then we will
do more compliance procedures and less substantive procedures.
Substantive Procedure
● Auditor will check transactions, account balance presentation and disclosure

○ Analytical Procedures
○ Test of Details (Vouching and Verification)
0.9 Q1. Correct/Incorrect

‘Test of Control’ may be defined as an audit procedure designed to detect material
misstatements at the assertion level.
Assertions
Representation by Management, Explicit or otherwise, Embodied in the financial statements.

Example on Assertion
Plant and Machinery (at cost) ₹ 4,00,000
Less: Depreciation till the end of ₹ 1,40,000

previous year
Depreciation for the year ₹ 26,000 ₹ 1,66,000
₹ 2,34,000
The assertions are as follows
● the firm owns the plant and machinery;

● the historical cost of plant and machinery is ₹ 4 lacs;
● the plant and machinery physically exists;
● the asset is being utilised in the business of the company productively;
● total charge of depreciation on this asset is ₹ 1,66,000 to date on which ₹ 26,000 relates to the year in
respect of which the accounts are drawn up; and
● the amount of depreciation has been calculated on a recognised basis and the calculation is correct.
● The above assertions are implicit (Obvious)
Explicit assertions are made when otherwise the reader will be left with an incomplete picture; it may even be
misleading.

● Secured Loans ₹ 4,00,000

● The description does not give us a complete picture. We do not know:
○ the name of the lender, if it is relevant;
○ the nature of security provided; and
○ the rate at which interest is payable.
Assertions may also be positive or negative. Further these positive or negative assertions may be explicit or
assertions.
For example, if it is stated that there is no contingent liability it would be an expressed negative assertion;
On the other hand, if in the balance sheet there is no item as “building”, it would be an implied negative
assertion that the entity did not own any building on the balance sheet date.
Assertions about transactions and events for the period relating to PPE.
1. Occurrence—transactions and events relating to PPE have been recorded, have occurred and pertain to
the entity.
2. Completeness—all transactions and events relating to PPE that should have been recorded have been
recorded.
3. Accuracy—amounts and other data relating to recorded transactions and events have been recorded
appropriately.
4. Cut-off—transactions and events have been recorded in the correct accounting period
5. Classification—transactions and events have been recorded in the proper accounts.
0.10 Q1. Which of the following is not an assertion about presentation and disclosure?
a. Occurrence and rights and obligations
b. Completeness
c. Classification and understandability
d. Existence
(Sample MCQs)
0.10 Q2. Which of the following Assertion is not related to assertion about presentation and disclosure:
a. Occurrence and rights and obligations
b. Completeness
c. Classification and understandability
d. Valuation and allocation
(Sample MCQs)
0.10 Q3. Name the assertions for the following audit procedures:

i. Year end inventory verification.

ii. Depreciation has been properly charged on all assets.
iii. The title deeds of the lands disclosed in the Balance Sheet are held in the name of the
company.
iv. All liabilities are properly recorded in the financial statements.
v. Related party transactions are shown properly.
(SA, May 2018, 5 Marks) (MTP2, May 2021, 5 Marks)
0.10 Q4. State assertions that are implied in the extract of financial statement given below:
Plant & Machinery (At Cost) 4,00,000
Less: Depreciation
Up to Previous Year 1,40,000
For the Year 26,000 (1,66,000)
2,34,000
(i) Indicate assertions in respect of transactions and events for the period relating to PPE.
(ii) State specific assertions relating to the above extract of financial statements.
(MTP2, May 2019, 6 Marks) (MTP1, May 2021, 6 Marks)
0.10 Q5. What are the obvious assertions in the following items appearing in the Financial Statements?
(i) Statement of Profit and Loss
Travelling Expenditure Rs. 50,000
(ii) Balance Sheet

Trade receivable Rs. 2,00,000
0.10 Q6. Correct/Incorrect

Assertions refer to the representations by the auditor to consider the different types of the
potential misstatements that may occur.
(MTP1, Nov 2020, 2 Marks) (SA, July 2021, 2 Marks)
0.10 Q7. ……………. refer to representations by management, explicit or otherwise, that are embodied in the
financial statements, as used by the auditor to consider the different types of potential
misstatements that may occur.
(a) Assertions
(b) Positive Confirmation
(c) Written representation

(d) Audit Evidence.

(MTP1, May 2021, 1 Mark)
Audit Evidence
Audit Procedures to Obtain Audit Evidence

1. Inspection
2. Observation
3. External Confirmation
4. Recalculation
5. Reperformance
6. Analytical Procedure
7. Enquiry
0.11 Q1. Define Audit Evidence.

(SELF)

Audit Risk
0.12 Q1. The auditor is expected to, and can, reduce audit risk to zero and can therefore obtain absolute
assurance.
Steps In Auditing (Not For Exams)
NOTE: It is easy to write the sequence of these steps in theory, but in the practical world the sequence is not
followed strictly or some of the steps are of continuous nature.
For example planning starts with engagement and ends with opinion and it again starts shortly after the
completion of the audit, for next year’s audit.
So for theory purposes we will study them in a sequence but one needs to understand that practically no clear
starting line and finish line is there for all the steps.
1. Engagement
2. Planning

3. Materiality
4. Risk assessment; and
5. Tests of controls, when required by the SAs or when the auditor has chosen to do so; and
6. Substantive procedures (Checking of Assertions), including
a. Tests of details and
b. Substantive analytical procedures.
7. Audit Evidence
8. Conclusions and Reporting
Assurance
An assurance engagement is: 'An engagement in which a practitioner obtains sufficient appropriate evidence in
order to express a conclusion designed to enhance the degree of confidence of the intended users other
than the responsible party about the outcome of the evaluation or measurement of a subject matter against
criteria.'

Chapter 1
SA 200
Overall objectives of the Independent Auditor and
the conduct of the Audit in Accordance with
Standard on Auditing

Professional Skepticism
The auditor is responsible for maintaining an attitude of professional skepticism throughout the audit. Do
you agree with the statement?
As per SA 200, "Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with
Standards on Auditing",
● Professional skepticism is an attitude that includes a questioning mind,
● being alert to conditions which may indicate possible misstatement due to error or fraud,
● and a critical assessment of audit evidence.
This includes
● Questioning
○ contradictory audit evidence and - जो मिला
○ the reliability of documents and - जो दिखा
○ responses to inquiries and - जो कहा,
○ Condition that may indicate possible fraud - जो हुआ
○ Circumstances that suggest the need for audit procedures in addition to those required by the
SAs. जो होगा
● (Critical assessment of audit evidence) Checking whether audit evidence obtained by auditor is
sufficient and appropriate as per the circumstance.
Why Professional Skepticism?

(Risk को कम करना चाहते है !) कौन से Risk को - Overlooking and Over Generalising and inappropriate assumptions क़े
Risk को
● Maintaining professional skepticism throughout the audit is necessary to reduce the risks of
○ Overlooking unusual circumstances,
○ Over generalising when drawing conclusions.
○ Using inappropriate assumptions in determining the nature, timing, and extent of the audit
procedures and evaluating the results thereof.
Further, while obtaining reasonable assurance, the auditor is responsible for maintaining professional skepticism
throughout the audit,
● considering the potential for management override of controls and (कहीं मैनज्में ट override तो नहीं कर रही
कंट्रोल्ज़ को)
● recognizing the fact that audit procedures that are effective for detecting error may not be effective in
detecting fraud. (एरर तो पकड़ सकते है लेकिन फ़्रॉड नहीं)
Therefore, we do agree with the statement.

The auditor cannot be expected to disregard past experience of the honesty and integrity of the entity’s management
and those charged with governance. Nevertheless, a belief that management and those charged with governance are

honest and have integrity does not relieve the auditor of the need to maintain professional skepticism or allow the
auditor to be satisfied with less-than-persuasive audit evidence when obtaining reasonable assurance.
Inherent Limitations of Audit - SA 200
Limitations of Audit: As per SA 200 "Overall Objectives of the Independent Auditor and the Conduct of an Audit
in Accordance with Standards on Auditing", the objectives of an audit, is to enable an auditor to express an
opinion on such financial statements.
The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute
assurance that the financial statements are free from material misstatement due to fraud or error.
This is because there are inherent limitations of an audit, which result in most of the audit evidence on which
the auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive.
The process of auditing, however, is such that it suffers from certain limitations, i.e. the limitation which cannot
be overcome irrespective of the nature and extent of audit procedures. The limitations of an audit arise from:
The Nature of Financial Reporting
● The preparation of financial statements involves judgment by management.

● In addition, many financial statement items involve subjective decisions or assessments or a
degree of uncertainty.
● Consequently, some financial statement items are subject to an inherent level of variability which
cannot be eliminated by the application of additional auditing procedures.
The Nature of Audit Procedures
● There are practical and legal limitations on the auditor's ability to obtain audit evidence. For
example:
○ There is the possibility that management or others may not provide, intentionally or
unintentionally, the complete information that is relevant to the preparation and
presentation of the financial statements or that has been requested by the auditor.
○ Fraud may involve sophisticated and carefully organized schemes designed to conceal it.
The auditor is neither trained as nor expected to be an expert in the authentication of
documents.
○ An audit is not an official investigation into alleged wrongdoing. Accordingly, the auditor is
not given specific legal powers, such as the power of search, which may be necessary for
such an investigation.
Timeliness of Financial Reporting and the Balance between Benefit and Cost
● The relevance of information, and thereby its value, tends to diminish overtime,

● and there is a balance to be struck between the reliability of information and its cost.
● There is an expectation by users of financial statements that the auditor will form an opinion on
the financial statements within a reasonable period of time and at a reasonable cost
●
Other Matters that Affect the Limitations of an Audit
● In the case of certain assertions or subject matters, the potential effects of the limitations on the
auditor's ability to detect material misstatements are particularly significant. Such assertions or
subject matters include:
○ Fraud, particularly fraud involving senior management or collusion. (SA 240)
○ The existence and completeness of related party relationships and transactions. (SA 550)
○ The occurrence of non-compliance with laws and regulations. (SA 250)
○ Future events or conditions that may cause an entity to cease to continue as a going
concern. (SA 570)
Because of the limitations of an audit, there is an unavoidable risk that some material misstatements of the
financial statements may not be detected, even though the audit is properly planned and performed in
accordance with SAs.
However, the inherent limitations of an audit are not a justification for the auditor to be satisfied with less-than
persuasive audit evidence.
Question
There are practical and legal limitations on the auditor’s ability to obtain audit evidence. Explain with the
help of examples. (3 Marks)
ICAI MTP March 2021
Correct / Incorrect Marks 2 MTP April 2021

There are inherent limitations of an audit, which result in most of the audit evidence on which the
auditor draws conclusions and bases the auditor's opinion being conclusive rather than persuasive.
Question - Correct / Incorrect Marks 2 January 2021 Exam Question
The Auditor is expected to reduce audit risk to zero and can therefore obtain absolute assurance that the
financial statements are free from material misstatement due to fraud or error.

Auditor’s responsibility for failure to detect fraud and errors
As per SA 240 the responsibility for the prevention and detection of fraud and error rests with the management
through the implementation of an adequate system of internal control. Such a system reduces but does not
eliminate the possibility of fraud and error.
In other words, the auditor is not responsible for prevention, detection and correction of misstatements.
Moreover because of Inherent limitations of auditing it is impossible for an auditor to detect all misstatements
whether due to fraud or error.
However, if there are doubtful situations that some material misstatement exists, the auditor should extend his
procedure to confirm/dispel the doubt.
The subsequent discovery of a material misstatement of the financial statements resulting from fraud or error
does not by itself indicate a failure to conduct an audit in accordance with SAs.
“ If there remains a deep laid fraud in the accounts, which in the normal course of examination of accounts may
not come to light,
● It will not be construed as failure of audit,
● provided the auditor was not negligent in carrying out his normal work”
Auditor WILL NOT BE considered as negligent

● If he has carried his work in accordance
○ with SA’s and
○ applicable law and regulations.
Whether the auditor has performed an audit in accordance with SAs and law and regulations is determined by
the
● audit procedures performed in the circumstances, the
● sufficiency and appropriateness of the audit evidence obtained as a result thereof
● and the suitability of the auditor’s report based on an evaluation of that evidence in light of the overall
objectives of the auditor.
All this can be checked by AUDIT DOCUMENTATION.
DEF & Co. Chartered Accountants successfully carried out the audit of Shree Garments for the f.y. 2019-2020.
After the completion of the audit, there were found material misstatements due to fraud in the financial
statements which were not noticed and reported by the auditor. Management alleges that it is a failure on the
part of the auditor. Comment.

ICAI MTP May 2021
Conduct of an Audit in Accordance with SAs


SA 210 - Agreeing the terms of Audit Engagement
Pre- Conditions for an audit

In order to establish whether the preconditions for an audit are present, the auditor shall:

● Determine whether the financial reporting framework is acceptable; and

● Obtain the agreement of management that it acknowledges (मानती है ) and understands (जानती है ) its
responsibility:
○ For the preparation of the financial statementsin accordance with the applicable financial
reporting framework;
○ For the internal controlas management considers necessary; and
○ To provide the auditor with:
■ Access to all information such as records, documentation and other matters;
■ Additional information that the auditor may request from management for the purpose
of the audit; and
■ Unrestricted access to persons within the entity from whom the auditor determines it
necessary to obtain audit evidence.
Discuss preconditions for an audit as per SA 210. Explain how an auditor would proceed to establish the
presence of pre-conditions for an audit. - Hint Check the preconditions discussed as above and in the
basics chapter.
Agreement on Audit Engagement Terms
It is important, both for the auditor and client, that each party should be clear about the nature of the
engagement. It must be reduced to writing and should exactly specify the scope of the work.
The audit engagement letter is sent by the auditor to his client.
According to SA 210 “Agreeing the Terms of Audit Engagements”, the auditor shall agree the terms of the audit
engagement with management or those charged with governance, as appropriate.
In the case of partnerships, a few more precautions are needed. The appointment of the auditor is normally
governed by the partnership deed. The accountant, when he is approached for undertaking a professional
assignment by a firm or a partner of a firm, should first get a clear idea of the nature of the service required and
then ensure, with reference to the terms of partnership agreement that his appointment is valid.
The agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable
form of written agreement and shall include:

If law or regulation prescribes in sufficient detail the terms of the audit engagement , the auditor need not
record them in a written agreement, except for the fact that such law or regulation applies and that
management acknowledges and understands its responsibilities.
Even if law or regulation prescribes sufficient details of the terms of the audit engagement the auditor should
record them in a written agreement. - Correct / Incorrect - 2 Marks November 2020.
Recurring Audits

Question
It is not mandatory to send a new engagement letter in recurring audit, but sometimes it becomes
mandatory to send new letter". Explain those situations where new engagement letter is to be sent. (M.imp)
On recurring audits, the auditor shall assess whether circumstances require the terms of the audit engagement
to be revised and whether there is a need to remind the entity of the existing terms of the audit engagement.
The auditor may decide not to send a new audit engagement letter or other written agreement each period.
However, in the following situations it is appropriate to revise the terms of the audit engagement or to remind
the entity of existing terms

Limitation on Scope Prior to Audit Engagement Acceptance
● If
○ management or those charged with governance
○ impose a limitation on the scope of the auditor’s work
○ in the terms of a proposed audit engagement
○ such that the auditor believes the limitation will result in the auditor disclaiming an opinion on
the financial statements,
■ the auditor
■ shall not accept such a limited engagement as an audit engagement,
■ unless required by law or regulation to do so.
Acceptance of a change in engagement
If, prior to completing the audit engagement,

● the auditor is requested to change the audit engagement
● to an engagement that conveys a lower level of assurance,
● the auditor shall determine whether there is
● Reasonable justification for doing so.
If auditor concludes that there is reasonable justification for changing the terms of audit engagement then
auditor must do his work as per the new terms of engagement and must issue a report in accordance with the
new terms of engagement
The report would not include reference to

● the original engagement; or
● any procedures that may have been performed in the original engagement.
If the terms of the audit engagement are changed, the auditor and management shall agree on and record the
new terms of the engagement in an engagement letter or other suitable form of written agreement.
The auditor should not agree to a change of engagement where there is no reasonable justification for doing so.
If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by
management to continue the original audit engagement, the auditor shall:
➔ Withdraw from the audit engagement where possible under applicable law or regulation; and
➔ Determine whether there is any obligation, either contractual or otherwise, to report the circumstances
to other parties, such as those charged with governance, owners or regulators.
A request from the client for the auditor to change the engagement may result from-
● a change in circumstances affecting the need for the service,
● a misunderstanding as to the nature of an audit or related service originally requested.
● a restriction on the scope of the engagement, whether imposed by management or caused by
circumstances.

General MCQsMarks 1 MTP April 2021
"If the auditor is unable to agree to a change of the terms of the audit engagement and is not permitted by
management to continue the original audit engagement, the auditor shall:
a. Withdraw from the audit engagement where possible under applicable law or regulation;
b. Determine whether there is any obligation, either contractual or otherwise, to report the
circumstances to other parties, such as those charged with governance, owners or regulators.
c. Withdraw from the audit engagement where possible under applicable law or regulation and
determine whether there is any obligation, either contractual or otherwise, to report the circumstances
to other parties, such as those charged with governance, owners or regulators.
d. Withdraw from the audit engagement where possible under applicable law or regulation or determine
whether there is any obligation, either contractual or otherwise, to report the circumstances to other
parties, such as those charged with governance, owners or regulators."

Misc Topics Related To Standards
IFAC & IAASB
Role of International Auditing & Assurance Standard Board (IAASB)

The IAASB functions as an independent standard-setting body under the auspices of IFAC . The objective of the
IAASB is to serve the public interest by setting high quality auditing standards and by facilitating the
convergence of international and national standards, thereby enhancing the quality and uniformity of practice
throughout the world and strengthening public confidence in the global auditing and assurance profession. The
IAASB achieves this objective by:
a) Establishing high quality auditing standards and guidance for financial statement audits that are
generally accepted and recognized by investors, auditors,governments, banking regulators , securities
regulators and other key stakeholders across the world;
b) Establishing high quality standards and guidance for other types of assurance services on both financial
and non-financial matters:
c) Establishing high quality standards and guidance for other related services;

d) Establishing high quality standards for quality control covering the scope of services addressed by the
IAASB; and
e) Publishing other pronouncements on auditing and assurance matters, thereby advancing public
understanding of the roles and responsibility of professional auditors and assurance service providers.
Standards on Auditing
What are Standards on Auditing (SAs)?
SAs are Auditing Standards, which prescribe the way the auditing should be conducted. They can also be
termed as performance benchmarks for the auditors.
The main purpose is to bring as much uniformity as possible in work performed by auditors.
Procedure for issuing SAs
Generally following procedure is followed for issuing the SAs

● Auditing and Assurance Standard Board (AASB) of the Institute of Chartered Accountants of India (ICAI)
determines the specific area in which the SAs need to be formulated.
● In preparation of SAs—
○ AASB is assisted by study groups constituted to consider specific subjects.
○ An exposure draft of the proposed SA is finalized by the AASB' of ICAI on the basis of work of the
study group.
○ The exposure draft of the proposed SA is published for comments by the members of the Institute
(ICAI).
○ AASB finalizes the draft of the proposed SA after considering the comments received and submit
to the Council of the Institute (ICAI).
○ The Council considers the draft of the proposed SA and if necessary, modifies the same in
consultation with AASB. The SA is then issued under the authority of the Council of the Institute of
Chartered Accountants of India.
○ AASB of ICAI tries to integrate/harmonize the SAs to the extent possible in the light of the
condition and practices prevailing in India with ISAs (International Standards For Auditing) issued
by IAASB (International Auditing and Assurance Standards Board) of IFAC.
ICAI re-classified the existing auditing and assurance standards in 2008. The objective of re-classification is to
converge our existing auditing and assurance standards with the International Standard on Auditing (ISA)
issued by the International Federation of Accountants (IFAC).
Objectives and Functions of AASB (Homework)
❖ To review the existing and emerging auditing practices worldwide and identify areas in which standards
on Quality Control, Engagement Standards and Statements on Auditing need to be developed .
❖ To formulate Engagement Standards, Standards on Quality Control and Statements on Auditing so that
these may be issued under the authority of the Council of the Institute.

❖ To review the existing Standards and Statements on Auditing to assess their relevance in the changed
conditions and to undertake their revisions, if necessary.
❖ To develop Guidance Notes on issues arising out of any Standard , auditing issued pertaining to any
specific industry or on generic issues, so that those may be issued under the authority of the Council of
the Institute.
❖ To review the existing Guidance Notes to assess their relevance in the changed circumstances and
undertake their revision , if necessary.
❖ To formulate General Clarifications , where necessary , on issues arising from Standards.
❖ To formulate and issue Technical Guides , practice Manuals Studies and other papers under its own
authority for guidance of professional accountants in the case felt appropriate by the Board.
Question Standards collectively known as the Engagements Standards issued by AASB under the
authority of the council of ICAI - Discuss
The following Standards issued by the Auditing and Assurance Standards Board under the authority of the
Council are collectively known as the Engagement Standards:
● Standards on Auditing (SAs), to be applied in the audit of historical financial information.
● Standards on Review Engagement (SREs), to be applied in the review of historical financial information.
● Standards on Assurance Engagements (SAEs), to be applied in assurance engagements, dealing with
subject-matters other than historical financial information.
● Standards on Related Services (SRSs), to be applied to engagements involving application of agreed
upon procedures to information, compilation engagements, and other related services
engagements as may be specified by the ICAI.
● Standards on Quality Control (SQCs) issued by the AASB under the authority of the Council, are to be
applied for all services covered by the Engagement Standards as described above.
.
Renumbering of Standards
Standard on Quality Control (SQC) 01-99
Standard on Auditing (SA) 100-999
Standard on Review Engagement (SRE) 2000-2699
Standard on Assurance Engagement (SAE) 3000-3699
Related Services (SRS) 4000-4699
Classification of SAs
Introductory matters 100-199
General Principles and Responsibilities 200-299
Risk Assessment and Response to Assessed Risk 300-499

Audit Evidence 500-599
Using work of Others 600-699
Audit conclusions and Reporting 700-799
Specialised Areas 800-899
List of Standards
General Principles and Responsibilities
1 SA200 (Revised) Overall objectives of the Independent Auditor and the conduct of the
Audit in Accordance with Standard on Auditing
2 SA210 (Revised) Agreeing the Terms of Audit Engagements
3 SA 220 (Revised) Quality Control for an Audit of financial statements
4 SA 230 (Revised) Audit Documentation
5 SA 240 (Revised) The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial

Statements.
6 SA250 (Revised) Consideration of Laws and Regulations in an Audit of Financial

Statements
7 SA 260 (Revised) Communication with those Charged with Governance
8 SA265 Communicating Deficiencies in Internal control to those Charged with

Governance and Management
9 SA299 (Revised) Joint Audit of financial statements
Risk Assessment and Responses to Assessed Risks
10 SA300 Planning an Audit of Financial Statements
11 SA315 Identifying and Assessing the Risk of material Misstatements through

understating the Entity and Its Environment
12 SA 320 Materiality in Planning and Performing an Audit
13 SA330 Response to Assessed Risks
14 SA 402 Audit consideration Relating to an Entity using a Service Organisation
15 SA450 Evaluation of Misstatements Identified during the Audit

Audit Evidence
16 SA500 (Revised) Audit Evidence
17 SA 501 (Revised) Audit Evidence-Specific Consideration for selected Items
18 SA 505 (Revised) External Confirmations
19 SA 510 (Revised) Initial Audit Engagement - Opening balances
20 SA 520 (Revised) Analytical Procedures
21 SA 530 (Revised) Audit Sampling
22 SA 540 (Revised) Auditing Accounting Estimates, Including fair value Accounting

Estimates and Related Disclosures
23 SA 550 (Revised) Related Parties
24 SA 560 (Revised) Subsequent Events
25 SA 570 (Revised) Going Concern
26 SA 580 (Revised) Written Representation
Using Work of Others
27 SA 600 Using the work of Other Auditors
28 SA 610 (Revised) Using the Work of Internal Auditors
29 SA 620 (Revised) Using the Work of an Auditor’s Expert
Audit Conclusions and Reporting
30 SA700 (Revised) Forming an Opinion and Reporting on Financial Statements
31 SA 701 Communicating key Audit Matters in the independent Auditor’s Report
32 SA 705 (Revised) Modifications to the opinion in the independent Auditor’s Report
33 SA 706 (Revised) Emphasis of Matter Paragraphs and other Matter Paragraphs in the
Independent Auditor’s Report
34 SA 710 (Revised) Comparative Information -Corresponding Figures and Comparative

Financial Statements
35 SA 720 (Revised) The Auditor’s responsibilities relating to Other Information

Standards on Quality Control
36 SQC 1 “Quality Control for Firms that Perform Audit and Reviews of Historical
Financial Information, and other Assurance and Related Services
Engagements”
Difference Between SAs, SREs, SAEs SRSs and SQC.
It is to be understood that Standards on Auditing (SAs) apply in “audit of historical financial information” whereas Standards
on Review Engagements (SREs) apply in “review of historical financial information”. Remember that Standards on auditing
apply in “audit” of historical financial information which is a reasonable assurance engagement whereas Standards on
Review Engagements apply in “review” of historical financial information which is a limited assurance engagement only.
Audit Review
In our opinion, the financial statements give a true and fair Nothing has come to our attention that causes us to believe
view of the financial position of ___________ Company as at that the financial statements of ___________ Company as of
_____________, and of its financial performance and its cash __________ are not prepared, in all material respects, in
flows for the year then ended in accordance with CRITERIA accordance with an applicable financial reporting
(Financial Reporting Framework) framework.
Assurance Level High But Not Absolute Assurance level between moderate to low
Positively Worded Assurance Negative Assurance
Concludes that the subject matter is prepared as per the Conclude that the subject matter is plausible in the
criteria in all material respects. circumstances
There is another set of standards which apply in assurance engagements dealing with subject matters other than historical
financial information. Such assurance engagements do not include “audit” or “review” of historical financial information.
These standards are known as Standards on Assurance Engagements.
For example, an assurance engagement relating to examination of Internal Control of The Entity.
Standards on related services

These standards apply in engagements to perform agreed-upon procedures regarding financial information. For example,
an engagement to perform agreed-upon procedures may require the auditor to perform certain procedures concerning
individual items of financial data, say, accounts payable, accounts receivable, purchases from related parties and sales and
profits of a segment of an entity, or a financial statement, say, a balance sheet or even a complete set of financial statements.
Standards on Quality Control

Standards on Quality Control (SQCs) are to be applied for all services covered by Engagement Standards.
ICAI Announcement

Following Engagements and Quality Control Standards on Auditing excluded.
1. 260
2. 265
3. 330
4. 402
5. 450
6. 540
7. 600
8. 620
9. 720

Statements and Guidance Notes
Statements
The Institute has, from time to time, issued ‘Guidance Notes’ and ‘Statements’ on a number of matters. The
‘Statements’ have been issued with a view to securing compliance by members on matters which, in the
opinion of the Council, are critical for the proper discharge of their functions. ‘Statements’ therefore are
mandatory.
Guidance Notes
Primarily designed to provide guidance to members on matters which may arise in the course of their
professional work and on which they may rely in the course of their professional work and on which they may
desire assistance in resolving issues which may pose difficulty.
Guidance Notes are recommendatory in nature.
A member should ordinarily follow recommendations in a guidance note relating to an auditing matter except
where he is satisfied that in the circumstances of the case, it may not be necessary to do so.
Similarly, while discharging his attest function, a member should examine whether the recommendations in a
guidance note relating to an accounting matter have been followed or not. If the same have not been followed,
the member should consider whether keeping in view the circumstances of the case, a disclosure in his report is
necessary.
There are however a few guidance notes in case of which the Council has specifically stated that they should be
considered as mandatory on members while discharging their attest function.


Question - Correct / Incorrect Marks 2 MTP April 2021
It is the function of an audit to establish that payments have been made validly to the persons who are shown to be recipients.
Correct: It is the function of audit to establish that payments have been made validly to persons who are shown to be recipients. For
checking the validity of a transaction, it is usually necessary to refer to documentary evidence.

SA 220 - Quality Control For An Audit Of

Financial Statements
A discussion on SQC-1 - Refer Videos
Standard on Quality Control (SQC) 1
Quality Control for Firms that Perform

● Audits and
● Reviews of Historical Financial Information, and
● Other Assurance and Related Services Engagements.
The firm should establish a system of quality control designed to provide it with reasonable assurance
● that the firm and its personnel comply with
○ professional standards and
○ regulatory and legal requirements, and
● that reports issued by the firm or engagement partner(s) are appropriate in the circumstances.
Elements of a System of Quality Control
1. Leadership responsibilities for quality within the firm.

2. Ethical requirements.
3. Acceptance and continuance of client relationships and specific engagements.
4. Human resources.
5. Engagement performance.
6. Monitoring
Now Let Us Start SA 220
This Standard on Auditing (SA) deals with the specific responsibilities of the auditor regarding quality control
procedures for an audit of financial statements.
It also addresses, where applicable, the responsibilities of the engagement quality control reviewer. This SA is to
be read in conjunction with relevant ethical requirements
System of Quality Control and Role of Engagement Teams
● Quality control systems, policies and procedures are the responsibility of the audit firm.
● Under SQC 1, the firm has an obligation to establish and maintain a system of quality control to provide it
with reasonable assurance that
○ The firm and its personnel comply with professional standards and regulatory and legal
requirements; and

○ The reports issued by the firm or engagement partners are appropriate in the circumstances.
Some definitions
● Engagement partner – the partner or other person in the firm who is a
○ member of the Institute of Chartered Accountants of India and

○ is in full time practice and
○ is responsible for the engagement and its performance, and for the report that is issued on
behalf of the firm, and who, where required,
○ has the appropriate authority from a professional, legal or regulatory body.
● Engagement quality control review –

○ a process designed to provide an objective evaluation,
■ before the report is issued,
○ of the significant judgments the engagement team made and
○ the conclusions they reached in formulating the report.
● Engagement quality control reviewer –

○ a partner, other person in the firm,
○ suitably qualified external person, or
○ a team made up of such individuals,
■ with sufficient and appropriate
● experience and
● authority
■ to objectively evaluate,
■ before the report is issued,
■ the significant judgments the engagement team made and
■ the conclusions they reached in formulating the report.
○ However, in case the review is done by a team of individuals, such a team should be headed by a
member of the Institute.
● Engagement team – all personnel performing an engagement, including any experts contracted by the
firm in connection with that engagement.
● Personnel – partners and staff.

Leadership Responsibilities for Quality on Audits
As per SA 220 “Quality Control for an Audit of Financial Statements”, the engagement partner shall take
responsibility for the overall quality on each audit engagement to which that partner is assigned.
The actions of the engagement partner and his communication with the members of the engagement team
should emphasis on
1. The importance of the following in audit quality

a. Performing work that complies regulatory and legal requirements; with professional standards
and
b. Complying with the firm’s quality control policies and procedures as applicable;
c. Issuing auditor’s reports that are appropriate in the circumstances; and
d. The engagement team’s ability to raise concerns without fear of reprisals; and
2. The fact that quality is essential in performing audit engagements.
Relevant Ethical Requirements (Covered in topics of Independence and Ethical

Requirement)
Acceptance and Continuance of Client Relationships and Audit Engagements
SA 220 requires the firm to obtain information before accepting an engagement. Information such as the
following assists the engagement partner in determining whether the decisions regarding the acceptance
and continuance of audit engagements are appropriate
1. The integrity of the principal owners, key management and those charged with governance of the entity.
2. Whether the engagement team is competent to perform the audit engagement and has the necessary
capabilities, including time and resources;
3. Whether the firm and the engagement team can comply with relevant ethical requirements; and
4. Significant matters that have arisen during the current or previous audit engagement, and their
implications for continuing the relationship.
If the engagement partner obtains information that would have caused the firm to decline the
audit engagement had that information been available earlier, the engagement partner shall
communicate that information promptly to the firm, so that the firm and the engagement partner
can take the necessary action.
Assignment of Engagement Teams

The engagement partner shall be satisfied that the engagement team, and any auditor’s experts who are not
part of the engagement team, collectively have the appropriate competence and capabilities to:
● Perform the audit engagement in accordance with professional standards and regulatory and legal
requirements; and
● Enable an auditor’s report that is appropriate in the circumstances to be issued.
Human Resource (SQC -1 Text)

The firm should establish policies and procedures designed to provide it with reasonable assurance that it has
sufficient personnel with the capabilities, competence, and commitment to ethical principles necessary to
perform its engagements in accordance with professional standards and regulatory and legal requirements, and
to enable the firm or engagement partners to issue reports that are appropriate in the circumstances
Such policies and procedures address the following personnel issues:

(a) Recruitment;
(b) Performance evaluation;
(c) Capabilities;
(d) Competence;
(e) Career development;
(f) Promotion;
(g) Compensation; and
(h) Estimation of personnel needs.
Addressing these issues enables the firm to ascertain the number and characteristics of the individuals
required for the firm’s engagements.
The firm’s recruitment processes include procedures that help the firm select individuals of integrity as well as
the capacity to develop the capabilities and competence necessary to perform the firm’s work.
Engagement Performance
The firm should establish policies and procedures designed to provide it with reasonable assurance that
engagements are performed in accordance with professional standards and regulatory and legal requirements,
and that the firm or the engagement partner issues reports that are appropriate in the circumstances.
Through its policies and procedures, the firm seeks to establish consistency in the quality of engagement
performance. This is often accomplished through written or electronic manuals, software tools or other
forms of standardized documentation, and industry or subject matter- specific guidance materials.
Matters addressed include the following
● How engagement teams are briefed on the engagement to obtain an understanding of the objectives
of their work.
● Processes for complying with applicable engagement standards.
● Processes of engagement supervision, staff training and coaching.

● Methods of reviewing the work performed, the significant judgments made and the form of report
being issued.
● Appropriate documentation of the work performed and of the timing and extent of the review.
● Processes to keep all policies and procedures current.
Through its policies and procedures, the firm seeks to establish consistency in the quality of
engagement performance. This is often accomplished through written or electronic manuals, software
tools or other forms of standardized documentation, and industry or subject matter-specific guidance
materials. Explain the matters to be addressed in this context.
Monitoring
The firm should establish policies and procedures designed to provide it with reasonable assurance that the
policies and procedures relating to the system of quality control are relevant, adequate, operating effectively and
complied with in practice.
The purpose of monitoring compliance with quality control policies and procedures is to provide an evaluation
of:
● Adherence to professional standards and regulatory and legal requirements;
● Whether the quality control system has been appropriately designed and effectively implemented;
● Whether the firm’s quality control policies and procedures have been appropriately applied, so that
reports that are issued by the firm or engagement partners are appropriate in the circumstances.
● Follow-up by appropriate firm personnel so that necessary modifications are promptly made to the
quality control policies and procedures.
Documentation (Homework)
The auditor shall document:
● Issues identified with respect to compliance with relevant ethical requirements and how they were resolved.
● Conclusions on compliance with independence requirements that apply to the audit engagement, and any relevant
discussions with the firm that support these conclusions.
● Conclusions reached regarding the acceptance and continuance of client relationships and audit engagements.
● The nature and scope of, and conclusions resulting from, consultations undertaken during the course of the audit
engagement.
The engagement quality control reviewer shall document, for the audit engagement reviewed, that:
● The procedures required by the firm’s policies on engagement quality control review have been performed;
● The engagement quality control review has been completed on or before the date of the auditor’s report; and
● The reviewer is not aware of any unresolved matters that would cause the reviewer to believe that the significant
judgments the engagement team made and the conclusions they reached were not appropriate.
Question - Write a short note on“Quality control for audit work at firm level”.
Quality Control for Audit Work at Firm Level:

SA 220 on Quality Control for an Audit of Financial Statements deals with the specific responsibilities of the auditor regarding quality
control procedures for an audit of financial statements.
Quality control systems, policies and procedures are the responsibility of the audit firm.
Within the context of the firm’s system of quality control, engagement teams have a responsibility to implement quality control procedures
that are applicable to the audit engagement.
The requirements are
● Leadership Responsibilities for Quality on Audits: The engagement partner shall take responsibility for the overall quality on each
audit engagement to which that partner is assigned.
● Relevant Ethical Requirements: Throughout the audit engagement, the engagement partner shall remain alert, through
observation and making inquiries as necessary, for evidence of non-compliance with relevant ethical requirements by members of
the engagement team. The engagement partner shall form a conclusion on compliance with independence requirements that
apply to the audit engagement.
● Acceptance and Continuance of Client Relationships and Audit Engagements: The engagement partner shall be satisfied that
appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements have been
followed, and shall determine that conclusions reached in this regard are appropriate.
● Assignment of Engagement Teams: The engagement partner shall be satisfied that the engagement team, and any auditor’s
experts who are not part of the engagement team, collectively have the appropriate competence and capabilities to perform the
audit engagement in accordance with professional standards and regulatory and legal requirements and enable an auditor’s
report that is appropriate in the circumstances to be issued.
● Engagement Performance: The engagement partner shall take responsibility for the direction, supervision and performance of the
audit engagement. He shall take responsibility for reviews being performed in accordance with the firm’s review policies and
procedures and shall take responsibility for the engagement team undertaking appropriate consultation on difficult or
contentious matters. For audits of financial statements of listed entities, and those other audit engagements, if any, for which the
firm has determined that an engagement quality control review is required, the engagement partner shall determine that an
engagement quality control reviewer has been appointed. Further, if differences of opinion arise within the engagement team,
with those consulted or, where applicable, between the engagement partner and the engagement quality control reviewer, the
engagement team shall follow the firm’s policies and procedures for dealing with and resolving differences of opinion.
● Monitoring: The engagement partner shall consider the results of the firm’s monitoring process as evidenced in the latest
information circulated by the firm and, if applicable, other network firms and whether deficiencies noted in that information may
affect the audit engagement.
Direction, Supervision and Performance
The engagement partner shall take responsibility for:

● The direction, supervision and performance of the audit engagement in compliance with professional standards
and regulatory and legal requirements; and
● The auditor’s report being appropriate in the circumstances.
Reviews / Engagement Quality Control Review
● The engagement partner shall take responsibility for reviews being performed in accordance with the firm’s
review policies and procedures.
● On or before the date of the auditor’s report, the engagement partner shall, through a review of the audit
documentation and discussion with the engagement team, be satisfied that sufficient appropriate audit evidence
has been obtained to support the conclusions reached and for the auditor’s report to be issued.
● For audits of financial statements of listed entities and those other audit engagements, if any, for which the firm
has determined that an engagement quality control review is required, the engagement partner shall:
○ Determine that an engagement quality control reviewer has been appointed;
○ Discuss significant matters arising during the audit engagement, including those identified during the
engagement quality control review, with the engagement quality control reviewer; and
○ Not date the auditor’s report until the completion of the engagement quality control review.
Matters to be evaluated by EQC Reviewer.

The engagement quality control reviewer shall perform an objective evaluation of the significant judgments made by the
engagement team, and the conclusions reached in formulating the auditor’s report.
This evaluation shall involve:

● Discussion of significant matters with the engagement partner;
● Review of the financial statements and the proposed auditor’s report;
● Review of selected audit documentation relating to the significant judgments the engagement team made and
the conclusions it reached; and
● Evaluation of the conclusions reached in formulating the auditor’s report and consideration of whether the
proposed auditor’s report is appropriate.
Consultation
The engagement partner shall:

a. Take responsibility for the engagement team undertaking appropriate consultation on difficult or contentious
matters;
b. Be satisfied that members of the engagement team have undertaken appropriate consultation during the course
of the engagement, both within the engagement team and between the engagement team and others at the
appropriate level within or outside the firm;
c. AGREED WITH - Be satisfied that the nature and scope of, and conclusions resulting from, such consultations are
agreed with the party consulted; and
d. CONCLUSIONS IMPLEMENTED - Determine that conclusions resulting from such consultations have been
implemented.
Differences of Opinion
If differences of opinion arise within the engagement team, with those consulted or, where applicable, between the
engagement partner and the engagement quality control reviewer, the engagement team shall follow the firm’s policies
and procedures for dealing with and resolving differences of opinion.

Ethical Requirements Relating to an Audit of Financial Statements
The auditor shall comply with relevant ethical requirements, including those pertaining to independence,
relating to financial statement audit engagements. Relevant ethical requirements ordinarily comprise the Code
of Ethics for Professional Accountants (IESBA Code) related to an audit of financial statements.
First, broadly understand what are ethics? ”Ethics” are the principles of conduct governing an individual or
group. Professions like law, medicine have their code of ethics. Auditing profession is no exception. Rather, in
profession of auditing, importance of ethics is manifold.
The IESBA Code establishes the following as the fundamental principles of professional ethics relevant to the
auditor when conducting an audit of financial statements. We shall understand broad meaning and intent of
these fundamental principles as under:-
Integrity
Integrity requires auditor to be straight forward and honest in all professional and business relationships. It
implies fair dealing and truthfulness. It effectively means that he shall not be associated with reports, returns,
communications or other information which he believes contains a materially false or misleading statement;
contains statements or information provided recklessly or omits required information where such omission
could be misleading.
Objectivity
The principle of objectivity requires an auditor not to compromise professional judgment because of bias,
conflict of interest or undue influence of others.
Professional competence and due care
It requires that auditor attains and maintains professional knowledge and skill at the level required to render
competent professional service based on current technical and professional standards and legislation and also
to act diligently and in accordance with technical and professional standards. Diligence includes responsibility to
act carefully, thoroughly and on a timely basis in accordance with requirements of an assignment.
Confidentiality
Confidentiality principle requires an auditor to respect the confidentiality of information acquired as a result of
professional or business relationships
Professional behaviour
It requires an auditor to comply with relevant laws and regulations and avoid any conduct that he knows or
should know might discredit the profession.
Descriptive Question Marks 4 January 2021 Exam Question

Explain the fundamental principles of professional ethics relevant to the auditor when conducting an
audit of financial statements in accordance with Code of Ethics issued by ICAI.
Independence of Auditor
The auditor’s independence safeguards the auditor’s ability to form an audit opinion without being affected by
any influences.
Independence enhances the auditor’s ability to act with integrity, to be objective and to maintain an attitude of
professional skepticism.
Standard on Quality Control (SQC) 1 sets out the responsibilities of the firm for establishing policies and
procedures regarding compliance with relevant ethical requirements.
SA 220 sets out the engagement partner’s responsibilities with respect to relevant ethical requirements. These
include evaluating whether members of the engagement team have complied with relevant ethical
requirements.
SA 220 recognises that the engagement team is entitled to rely on a firm’s systems in meeting its responsibilities
with respect to quality control procedures.
Independence implies that the judgement of a person is not subordinate to the wishes or direction of another
person who might have engaged him.
It is not possible to define “independence” precisely. Rules of professional conduct dealing with independence
are framed primarily with a certain objective. The rules themselves cannot create or ensure the existence of
independence. Independence is a condition of mind as well as personal character. It should not be confused
with the superficial and visible standards of independence which are sometimes imposed by law.
There are two interlinked perspectives of independence of auditors,

1. independence of mind; and two,
2. independence in appearance.
The Code of Ethics for Professional Accountants issued by International Federation of Accountants (IFAC) defines
the term ‘Independence’ as follows:
“Independence is:
(a) Independence of mind – the state of mind that permits the
● provision of an opinion without being affected by influences
● allowing an individual to act with
○ integrity, and
○ exercise objectivity and
○ professional skepticism; and
(b) Independence in appearance

● the avoidance of facts and circumstances

● that are so significant
● that a third party would reasonably conclude
● an auditor’s integrity, objectivity or professional skepticism
○ had been compromised.”
Independence of the auditor has not only to exist in fact, but it should also appear to exist to all reasonable
persons. ( होनी भी चाहिये, दिखनी भी चाहिये )

Threats to Independence
The Code of Ethics for Professional Accountants, prepared by the International Federation of Accountants (IFAC)
identifies five types of threats. These are:
Self-interest threats
Occur when an auditing firm, its partner or associate could benefit from a financial interest in an audit client.
Examples include
● direct financial interest or materially significant indirect financial interest in a client,
● loan or guarantee to or from the concerned client,
● undue dependence on a client’s fees and, hence, concerns about losing the engagement,

● close business relationship with an audit client,

● potential employment with the client, and
● Contingent fees for the audit engagement.
● audit firm unduly relies on fees from a client, it may result in threat to self interest of auditor and he may
not work objectively for the fear of losing client.
Self-review threats,
Where non-audit work is provided to an audit client and is then subject to audit, the auditor will be unlikely to
admit to errors in their own work, or may not identify the errors in their own work.
or when a member of the audit team was previously a director or senior employee of the client.
Instances where such threats come into play are (i) when an auditor having recently been a director or senior
officer of the company, and (ii) when auditors perform services that are themselves subject matters of audit.
Advocacy threats
Promoting the position of a client or representing them in some way would mean the audit firm is seen to be
'taking sides' with the client.
Example - when an auditor deals with shares or securities of the audited company, or becomes the client’s
advocate in litigation and third party disputes.
In such situations, auditor can be perceived as backing and championing causes of auditee clients and it may
lead to belief that the auditor is not acting and working objectively.
Remember that auditor has not only to be independent but also appear to be acting so.
Familiarity threats
Familiarity threats are self-evident, and occur when auditors form relationships with the client where they end
up being too sympathetic to the client’s interests.
This can occur in many ways

● close relative of the audit team working in a senior position in the client company,
● former partner of the audit firm being a director or senior employee of the client,
● long association between specific auditors and their specific client counterparts, and
● acceptance of significant gifts or hospitality from the client company, its directors or employees.
Intimidation threats
Intimidation threats, which occur when auditors are deterred from acting objectively with an adequate degree
of professional skepticism. Basically, these could happen because of threat of replacement over disagreements
with the application of accounting principles, or pressure to disproportionately reduce work in response to
reduced audit fees or being threatened with litigation. Such threats attempt to intimidate auditors to deter
them from acting objectively.

Safeguards to Independence
The Chartered Accountant has a responsibility to remain independent by taking into account the context in
which they practice, the threats to independence and the safeguards available to eliminate the threats.
The following are the guiding principles in this regard: -

1. For the public to have confidence in the quality of audit, it is essential that auditors should always be and
appear to be independent of the entities that they are auditing.
2. In the case of audit, the key fundamental principles are integrity, objectivity and professional skepticism,
which necessarily require the auditor to be independent.
3. Before taking on any work, an auditor must conscientiously consider whether it involves threats to his
independence.
4. When such threats exist, the auditor should either desist from the task or put in place safeguards that
eliminate them.
5. If the auditor is unable to fully implement credible and adequate safeguards, then he must not accept
the work.

Miscellaneous Topics From Basics and Chapter 1

Concept of true and fair view
The concept of true and fair is a fundamental concept in auditing.
The phrase “true and fair” in the auditor’s report signifies that the auditor is required to express his opinion
as to whether the state of affairs and the results of the entity as ascertained by him in the course of his audit are
truly and fairly represented in the accounts under audit. (jo usney paya, accounts mein bhi wo hi dikh raha hai)
This requires that the auditor should examine the accounts with a view to
● verify that all assets, liabilities, income and expenses are stated at amounts
○ which are in accordance with accounting principles and policies which are relevant.
● and no material amount, item or transaction has been omitted.
What constitutes a ‘true and fair’ view is a matter of an auditor’s judgment in the particular circumstances of a
case. In more specific terms, to ensure true and fair view, an auditor has to see:
1. That the assets are neither undervalued or overvalued, according to the applicable accounting principles,
2. No material asset is omitted;
3. The charge, if any, on assets are disclosed;
4. Material liabilities should not be omitted;
5. The profit and loss account and balance sheet discloses all the matters required to be disclosed;
6. Accounting policies have been followed consistently; and
7. All unusual, exceptional or non-recurring items have been disclosed separately.
Types of audit
Auditis not legally obligatory for all types of business organisations or institutions. On this basis audits may be of
two broad categories i.e., audit required under law and voluntary audits.
Audit required under law
Organisations which require audit under law are the following -

● companies governed by the Companies Act;
● banking companies;
● other statutory bodies required by their regulators or by specific Act.
Voluntary Audit
In the voluntary category are the audits of the accounts of
● proprietary entities,

● partnership firms,
● Hindu undivided families, etc.
● In respect of such accounts, there is no basic legal requirement of audit.

● Many of such enterprises as a matter of internal rules require audit.
● Some may be required to get their accounts audited on the directives of Government for various
purposes like sanction of grants, loans, etc.
● But the important motive for getting accounts audited lies in the advantages that follow from an
independent professional audit.
● This is perhaps the reason why large numbers of proprietary and partnership business get their accounts
audited.
Auditing is legally obligatory for all types of business organisation (True or False)
Statement is false - Not obligatory for all, for example proprietorship entities, partnership firm etc.

How can an auditor ensure that FS would not mislead anybody?
The person conducting this task should take care to ensure that financial statements would not mislead
anybody. This he can do honestly by satisfying himself that
1. the accounts have been drawn up with reference to entries in the books of account;
2. the entries in the books of account are adequately supported by sufficient and appropriate evidence;
3. none of the entries in the books of account has been omitted in the process of compilation and nothing
which is not in the books of account has found place in the statements;
4. the information conveyed by the statements is clear and unambiguous;
5. the financial statement amounts are properly classified, described and disclosed in conformity with
accounting standards; and
6. the statement of accounts presents a true and fair picture of the operational results and of the assets and
liabilities.

Scope of Audit
The following points merit consideration in regard to scope of audit:

1. The audit should be organized to cover adequately all aspects of the enterprise relevant to the financial
statements being audited.
2. To form an opinion on the financial statements, the auditor should be reasonably satisfied as to whether
the information contained in the underlying accounting records and other source data is reliable and
sufficient as the basis for the preparation of the financial statements.
3. In forming his opinion, the auditor should also decide whether the relevant information is properly
disclosed in the financial statements subject to statutory requirements, where applicable.
4. The auditor assesses the reliability and sufficiency of the information contained in the underlying
accounting records and other source data by
a. making a study and evaluation of accounting systems and internal controls and
b. carrying out such other tests, enquiries and other verification procedures of accounting
transactions and account balances as he considers appropriate in the particular circumstances.
5. The auditor determines whether the relevant information is properly disclosed in the financial
statements by:
a. comparing the financial statements with the underlying accounting records and other source
data to see whether they properly summarize the transactions and events recorded therein; and
b. Considering the judgments that management has made in preparing the financial statements
accordingly, the auditor assesses the selection and consistent application of accounting policies,
the manner in which the information has been classified, and the adequacy of disclosure.
6. The auditor is not expected to perform duties which fall outside the scope of his competence. For
example, the professional skill required of an auditor does not include that of a technical expert for
determining the physical condition of certain assets.
7. Constraints on the scope of the audit of financial statements that impair the auditor’s ability to express
an unqualified opinion on such financial statement should be set out in his report, and a qualified
opinion or disclaimer of opinion should be expressed as appropriate.

The terms of audit engagement can restrict the scope of an audit.
Aspects to be covered in Audit.

The principal aspects to be covered in an audit of the financial statements are the following:
1. An examination of the system of accounting and internal control to ascertain whether it is appropriate for
the business and helps in properly recording all transactions.
2. Reviewing the system and procedures to find out whether they are adequate and comprehensive and
incidentally whether material inadequacies and weaknesses exist to allow frauds and errors going
unnoticed
3. Checking of the arithmetical accuracy of the books of account by the verification of postings, balances,
etc..

4. Verification of the authenticity and validity of transactions entered into by making an examination of the
entries in the books of accounts with the relevant supporting documents.
5. Ascertaining that a proper distinction has been made between items of capital and of revenue nature
and that the amounts of various items of income and expenditure adjusted in the accounts
corresponding to the accounting period.
6. Comparison of the balance sheet and profit and loss account or other statements with the underlying
record in order to see that they are in accordance therewith.
7. Verification of the title, existence and value of the assets appearing in the balance sheet.
8. Verification of the liabilities stated in the balance sheet.
9. Checking the result shown by the profit and loss and to see whether the results shown are true and fair.
10. Where audit is of a corporate body, confirming that the statutory requirements have been complied with.
11. Reporting to the appropriate person/body whether the statements of account examined do reveal a true
and fair view of the state of affairs and of the profit and loss of the organisation.

What are the advantages of an independent audit?
Advantages of an Independent Audit

The chief utility of audit lies in reliable financial statements on the basis of which the state of affairs may be easy
to understand. Apart from this obvious utility, there are other advantages of audit. Some or all of these are of
considerable value even to those enterprises and organisations where audit is not compulsory, these advantages
are given below
1. It safeguards the financial interest of persons who are not associated with the management of the entity,
whether they are partners or shareholders ,bankers, Financial Institutions, public at large etc.
2. It acts as a moral check on the employees from committing defalcations or embezzlement.
3. Audited statements of account are helpful in settling liability for taxes, negotiating loans and for
determining the purchase consideration for a business.
4. These are also useful for settling trade disputes for higher wages or bonus as well as claims in respect of
damage suffered by property, by fire or some other calamity.
5. An audit can also help in the detection of wastages and losses to show the different ways by which these
might be checked, especially those that occur due to the absence or inadequacy of internal checks or
internal control measures.
6. Audit ascertains whether the necessary books of account and allied records have been properly kept and
helps the client in making good deficiencies or inadequacies in this respect.
7. As an appraisal function, audit reviews the existence and operations of various controls in the
organisations and reports weaknesses, inadequacies, etc., in them.
8. Audited accounts are of great help in the settlement of accounts at the time of admission or death of
partner.
9. Government may require audited and certified statements before it gives assistance or issues a license
for a particular trade.

Relationship of Auditing with other disciplines
Auditing and Accounting
It has been pointed out earlier that both accounting and auditing are closely related with each other as auditing
reviews the financial statements which are nothing but a result of the overall accounting process. It naturally
calls on the part of the auditor to have a thorough and sound knowledge of generally accepted principles of
accounting before he can review the financial statements. In fact, auditing as a discipline is also closely related
with various other disciplines as there is lot of linkages in the work which is done by an auditor in his day-to-day
activities. To begin with, it may be noted that the discipline of auditing itself is a logical construct and everything
done in auditing must be bound by the rules of logic. Ethical precepts are the foundations on which the
foundation of the entire accounting profession rests. The knowledge of language is also considered essential in
the field of auditing as the auditor shall be required to communicate, both in writing as well as orally, in
day-to-day work.
Auditing and Law
The relationship between auditing and law is very close one. Auditing involves examination of various
transactions from the view point of whether or not these have been properly entered into. It necessitates that an
auditor should have a good knowledge of business laws affecting the entity. He should be familiar with the law
of contracts, negotiable instruments, etc. The knowledge of taxation laws is also inevitable as entity is required to
prepare their financial statements taking into account various provisions affected by various tax laws. In
analysing the impact of various transactions particularly from the accounting aspect, an auditor ought to have a
good knowledge about the direct as well as indirect Tax Laws.

Auditing and Data Processing
Today, organisations are witnessing revolution in the field of data processing of accounts. Many organisations are
carrying out their financial accounting activities with the help of computers which can document, record,
collate, allocate and value accounting data and information in very large quantities at very high speed. The
dependence on the accuracy of the programmed instructions given today, the computer is able to carry out
each of these activities with complete accuracy. With such a phenomenal growth in the field of computer
sciences, the auditor should have good knowledge of the components, general capability of the system and the
related terms. In fact, Computerised Information System auditing is developing as a discipline in itself.
Audit is not Investigation

We have to clearly understand that audit is distinct from investigation. Investigation is a critical examination of
the accounts with a special purpose. For example, if fraud is suspected and it is specifically called upon to check
the accounts whether fraud really exists, it takes on the character of investigation.
The objective of audit, on the other hand as we have already discussed, is to obtain reasonable assurance about
whether the financial statements as a whole are free from material misstatement, whether due to fraud or error,
thereby enabling the auditor to express an opinion.
Therefore, audit is never started with a preconceived notion about state of affairs; about wrong-doing; about
some wrong having been committed. The auditor seeks to report what he finds in the normal course of
examination of accounts. However, it is quite possible that sometimes investigation results from the prima facie
findings of the auditor. It may happen that the auditor has given some findings of serious concern. Such findings
may prompt an investigation.

Qualities of An Auditor - https://youtu.be/2wu_UWlAfwk
It is not enough to realise what an auditor should be. He is concerned with the reporting on financial matters of
business and other institutions. Financial matters inherently are to be set with the problems of human fallibility;
errors and frauds are frequent. The qualities required, according to Dicksee, are tact, caution, firmness, good
temper, integrity, discretion, industry, judgement, patience, clear headedness and reliability. In short, all those
personal qualities that go to make a good businessman contribute to the making of a good auditor. In addition,
he must have the shine of culture for attaining a great height. He must have the highest degree of integrity
backed by adequate independence. In fact, Code of ethics mentions integrity, objectivity and independence as
one of the fundamental principles of professional ethics.
He must have a thorough knowledge of the general principles of law which govern matters with which he is
likely to be in intimate contact. The Companies Act need special mention but mercantile law, specially the law
relating to contracts, is no less important. Needless to say, where undertakings are governed by a special statute,
its knowledge will be imperative; in addition, a sound knowledge of the law and practice of taxation is
unavoidable.
He must pursue an intensive programme of theoretical education in subjects like financial and management
accounting, general management, business and corporate laws, computers and information systems, taxation,
economics, etc. Both practical training and theoretical education are equally necessary for the development of
professional competence of an auditor for undertaking any kind of audit assignment.
The auditor should be equipped not only with a sufficient knowledge of the way in which business generally is
conducted but also with an understanding of the special features peculiar to a particular business whose
accounts are under audit. The auditor, who holds a position of trust, must have the basic human qualities apart
from the technical requirement of professional training and education.
He is called upon constantly to critically review financial statements and it is obviously useless for him to
attempt that task unless his own knowledge is that of an expert. An exhaustive knowledge of accounting in all
its branches is the sine qua non of the practice of auditing. He must know thoroughly all accounting principles
and techniques.
Lord Justice Lindley in the course of the judgment in the famous London & General Bank case had succinctly
summed up the overall view of what an auditor should be as regards the personal qualities. He said, “an auditor
must be honest, that is, he must not certify what he does not believe to be true and must take reasonable care
and skill before he believes that what he certifies is true”.

These notes are incomplete without our videos. Study from these notes at your own risk. We keep on updating our books, notes and videos. You should
always study from updated notes with our videos. Amendments and updates will be taught in classes and videos. Extra notes and charts will also be given.
Chapter 2
Audit Strategy, Audit Planning & Audit programme
SA 300 “Planning an Audit of Financial Statements”
Scope
This Standard on Auditing (SA) deals with the auditor’s responsibility to plan an audit of financial statements.
Objective
The objective of the auditor is to plan the audit so that it will be performed in an effective manner.
Involvement of Key Engagement Team Members

The engagement partner and other key members of the engagement team shall be involved in planning the
audit, including planning and participating in the discussion among engagement team members.
The involvement of the engagement partner and other key members of the engagement team in planning
the audit draws on their experience and insight, thereby enhancing the effectiveness and efficiency of the
planning process.
Audit Plan to Conduct an Effective Audit

Plans should be made to cover, among other things:
(a) acquiring knowledge of the client’s accounting systems, policies and internal control procedures;
(b) establishing the expected degree of reliance to be placed on internal control;
(c) determining and programming the nature, timing, and extent of the audit procedures to be
performed; and
(d) coordinating the work to be performed.
Plans should be further developed and revised as necessary during the course of the audit.
Discussion of elements of planning with management

The auditor may decide to discuss elements of planning with the entity’s management to facilitate the
conduct and management of the audit engagement.
Although these discussions often occur, the overall audit strategy and the audit plan remain the auditor’s
responsibility. When discussing matters included in the overall audit strategy or audit plan, care is required in
order not to compromise the effectiveness of the audit.
Question
“The auditor should plan his work to enable him to conduct an effective audit in an effcient and
timely manner.” Explain stating the matters to be covered in plans. (4 Marks)

MTP March 2020.
Benefits of Planning in the Audit of Financial Statements
Planning an audit involves

● establishing the overall audit strategy for the engagement and
● developing an audit plan.
Adequate planning benefits the audit of financial statements in several ways, including the following:
1. Helping the auditor to devote appropriate attention to important areas of the audit
2. Helping the auditor identify and resolve potential problems on a timely basis.
3. Helping the auditor properly organize and manage the audit engagement so that it is performed in
an effective and efficient manner.
4. Assisting in the selection of engagement team members with appropriate levels of capabilities and
competence to respond to anticipated risks, and the proper assignment of work to them.
5. Facilitating the direction and supervision of engagement team members and the review of their
work.
6. Assisting, where applicable, in coordination of work done by auditors of components and experts.
Preliminary Activities
The auditor shall undertake the following activities at the beginning of the current audit engagement
a. Performing procedures required by SA 220 , “Quality Control for an Audit of Financial Statements”
regarding the continuance of the client relationship and the specific audit engagement;
b. Evaluating compliance with ethical requirements, including independence, as required by SA 220 ;
and
c. Establishing an understanding of the terms of the engagement, as required by SA 210.
Performing the preliminary engagement activities at the beginning of the current audit engagement assists
the auditor in identifying and evaluating events or circumstances that may adversely affect the auditor’s
ability to plan and perform the audit engagement.
Performing these preliminary engagement activities enables the auditor to plan an audit engagement for
which, for example:
● The auditor maintains the necessary independence and ability to perform the engagement.
● There are no issues with management integrity that may affect the auditor’s willingness to continue
the engagement.
● There is no misunderstanding with the client as to the terms of the engagement.
Planning Activities
Audit Strategy
What is Audit Strategy

Overall audit strategy sets the scope, timing and direction of the audit, and guides the development of the more
detailed audit plan.
How would the audit strategy be helpful to the auditor?
The process of establishing the overall audit strategy assists the auditor to determine, subject to the
completion of the auditor’s risk assessment procedures, such matters as:
● The resources to deploy for specific audit areas, such as the use of appropriately experienced team
members for high risk areas or the involvement of experts on complex matters
● The amount of resources to allocate to specific audit areas, such as the number of team members
assigned to observe the inventory count at material locations, the extent of review of other auditors’
work in the case of group audits, or the audit budget in hours to allocate to high risk areas
● When these resources are to be deployed, such as whether at an interim audit stage or at key cut-off
dates; and
● How such resources are managed, directed and supervised, such as when team briefing and
debriefing meetings are expected to be held, how engagement partner and manager reviews are
expected to take place (for example, on-site or off-site), and whether to complete engagement quality
control reviews.
Establishment of Overall Audit Strategy
In establishing the overall audit strategy, the auditor shall ( POINTS TO BE KEPT IN MIND WHILE
DEVELOPING OVERALL AUDIT STRATEGY)
a. Identify the characteristics of the engagement that define its scope;

b. Ascertain the reporting objectives of the engagement to plan the timing of the audit and the nature
of the communications required.
c. Consider the factors that, in the auditor’s professional judgment, are significant in directing the
engagement team’s efforts;
d. Consider the results of preliminary engagement activities and, where applicable, whether knowledge
gained on other engagements performed by the engagement partner for the entity is relevant; and
e. Ascertain the nature, timing and extent of resources necessary to perform the engagement.
Audit Plan
Description of Audit Plan
As per SA 300 “Planning an Audit of Financial Statement” the audit plan shall be include a description of
❖ The nature, timing and extent of planned risk assessment procedures, as determined under SA 315.
❖ The nature , timing and extent of planned further audit procedures at the assertion level, as
determined under SA 330.
❖ Other planned audit procedures that are required to be carried out so that the engagement complies
with SAs. (Obtaining written representations from management)
● Planning of the auditor’s risk assessment procedures occurs early in the audit process.

● However, planning the nature, timing and extent of specific further audit procedures depends on the
outcome of those risk assessment procedures.
Knowledge of the Client’s Business
It is one of the important principles in developing an overall audit plan. In fact without adequate knowledge
of the client's business, a proper audit is not possible.
As per SA-315, “Identifying and Assessing the Risk of Material Misstatement through Understanding the
Entity and Its Environment”, the auditor shall obtain an understanding of the following:
1. Relevant industry, regulatory and other external factors including applicable financial reporting
framework.
2. The nature of the entity, including:
a. Its operations;
b. Its ownership and governance structures;
c. The types of investments that the entity is making and plan to make: &
d. The way that the entity is structured and how it is financed.
3. The entity’s selection and application of accounting policies, including the reasons for changes
thereto.
4. The entity’s objectives and strategies, and those related Business risks that may result in risks of
material Misstatement.
5. The measurement and review of the entity’s financial performance.
In addition to the importance of knowledge of the client’s business in establishing the overall audit plan,
such knowledge helps the auditor to identify areas of special audit consideration, to evaluate the
reasonableness of both accounting estimates and management representations and to make judgements
regarding the appropriateness of accounting policies and disclosures.
Without adequate knowledge of the client's business, a proper audit is not possible. It is one of the
important principles in developing an overall audit plan. Explain in context with relevant SA, knowledge
to be obtained by the auditor in establishing the overall plan.
Also explain how such an understanding would be helpful to the auditor.
RTP May 2021
Relationship between the overall audit strategy and the audit plan
● Change in audit strategy will lead to change in audit plan and vice versa
● Audit plan is prepared after the audit strategy and is more detailed. Audit strategy gives less detail but
it forms the basis of the planning
● The auditor shall establish an overall audit strategy that sets the scope, timing and direction of the
audit, and that guides the development of the audit plan
● Detailed audit plans would include the nature, timing and extent of the audit procedures so as to
obtain sufficient appropriate audit evidence.

For Understanding Purpose Only
● SCOPE - Coverage (Consolidate financial statement or otherwise, branches are included or not, etc)
(regulatory or statutory reporting requirements)
● TIMING - Setting milestones for completion of audit work. (Deadlines) (Time Budgets)
● DIRECTION - How we are going to use the information / knowledge gained from other engagements,
Effect of preliminary evaluations of materiality, audit risk and internal control.
The audit strategy relates to the overall approach you will take to the audit, it decides the scope of the audit.
The audit plan is the detailed procedures you will use in your audit depending on what the strategy is.
For example- if you decide the organisation is new and doesn't have proper controls in place, you will decide
not to rely on any controls and perform only substantive testing- This is Audit Strategy
Audit plan is then deciding the substantive audit tests you will perform (AEIOU. Reperformance.
External Confirmation). This includes the nature, timing and extent of audit tests you will undertake to gain
comfort over the financial statement balances.
An audit plan is more detailed.
The audit plan is more detailed than the overall audit strategy. (Correct / Incorrect - November 2020 - 2
Marks)

Planning is a Continuous Process
Planning is not a discrete phase of an audit, but rather a continual and iterative process
Planning is not a discrete phase of an audit, but rather a continual and iterative process that often begins
shortly after (or in connection with) the completion of the previous audit and continues until the completion
of the current audit engagement.
Planning However includes consideration of the timing of certain activities and audit procedures that need
to be completed prior to the performance of further audit procedures. For example, planning includes the
need to consider, prior to the auditor’s identification and assessment of the risks of material misstatement,
such matters as
1. The analytical procedures to be applied as risk assessment procedures.

2. Obtaining a general understanding of the legal and regulatory framework applicable to the entity and
how the entity is complying with that framework.
3. The determination of materiality.
4. The Involvement of experts.
5. The performance of other risk assessment procedures.
Direction, Supervision and Review
The auditor shall

● plan the nature, timing and extent of
● direction and supervision of engagement team members and
● the review of their work.
The nature, timing and extent of the direction and supervision of engagement team members and review of
their work vary depending on many factors, including:
● The size and complexity of the entity.
● The area of the audit.
● The assessed risks of material misstatement
● The capabilities and competence of the individual team members performing the audit work.
Changes to planning decisions During the Audit
● The auditor shall update and change the overall audit strategy and the audit plan as necessary during
the course of the audit.
○ As a result of unexpected events,
○ changes in conditions, or
○ the audit evidence obtained from the results of audit procedures,
● the auditor may need to modify the audit plan & planned nature, timing and extent of further audit
procedures, based on the revised consideration of assessed risks.
● This may be the case when information comes to the auditor’s attention that differs significantly from
the information available when the auditor planned the audit procedures.
● For example, audit evidence obtained through the performance of substantive procedures may
contradict the audit evidence obtained through tests of controls.

Documentation of Audit plan

a. the overall audit strategy;
b. the audit plan; and
c. any significant changes made during the audit engagement to the overall audit strategy or the audit
plan, and the reasons for such changes.
Record of the key decisions

The documentation of the overall audit strategy is a record of the key decisions considered necessary to
properly plan the audit and to communicate significant matters to the engagement team.
Record of the proper planning

It also serves as a record of the proper planning of the audit procedures that can be reviewed and approved
prior to their performance.
Record of change in strategy and procedures explains reasons for change and response to changes
A record of the significant changes to the overall audit strategy and the audit plan, and resulting changes to
the planned nature, timing and extent of audit procedures, explains why the significant changes were made,
and the overall strategy and audit plan finally adopted for the audit. It also reflects the appropriate response
to the significant changes occurring during the audit.
Examples of Documentation (From ICAI Study Material)
Nature and extent of planning activities

The nature and extent of planning activities will vary according to the
● size and complexity of the entity,
● the key engagement team members’ previous experience with the entity, and
● changes in circumstances that occur during the audit engagement.

Additional Considerations in Initial Audit Engagements
Purpose and Objective remains same

The purpose and objective of planning the audit are the same whether the audit is an initial or recurring
engagement.
Planning activities will be expanded

However, for an initial audit, the auditor may need to expand the planning activities because the auditor
does not ordinarily have the previous experience with the entity that is considered when planning recurring
engagements.
For initial audits, additional matters the auditor may consider in establishing the overall audit strategy and
audit plan include the following:
● Performing procedures required by SA 220 regarding the acceptance of the client relationship and
specific audit engagement.
● Unless prohibited by law or regulation, arrangements to be made with the predecessor auditor, for
example, to review the predecessor auditor’s working papers.
● Other procedures required by the firm’s system of quality control for initial audit engagements (for
example, review of the overall strategy by senior partner before starting the audit)

Audit Programme
Meaning
An audit programme consists of

- a series of verification procedures
- to be applied to the financial statements and accounts of a given company
- for the purpose of obtaining sufficient evidence
- to enable the auditor to express an informed opinion on such statements.
One Audit Programme – Not Practicable For All Businesses
● All businesses are not same

● They vary in nature, size, capital raised and on other parameters also
● Some might have a formal and working internal control, while some may not have internal control at
all.
● Applicability of different laws and regulation also differentiate the scope of services to be given by
auditor
● Because of the reasons for variations mentioned above it is not possible to develop one audit program
applicable to all businesses under all circumstances.
● Every audit programme must have details of the nature of work to be done as per the nature, size
and other parameters of the business. .This will help in saving time and special matters and situations
will not be overlooked.
Periodic Review of The Audit Programme
Audit programme must be periodically reviewed, to check its effectiveness in the light of changing
circumstances.
Objective of review - Cover new aspects and remove not required one, keep AP up-to-date.
● The ultimate objective of periodic review is to cover the new aspects of the client’s business and
remove the not required or non-value adding part so as to keep the audit programme up-to-date.
If not reviewed- Obsolete | Negligence on the part of the auditor | May face legal consequences
● If it is not reviewed, it may be become obsolete and as a result entire audit may become ineffective
also this will be considered as negligence on the part of the auditor and they may have to face legal
and regulatory consequences for the same
Constructing an Audit Programme
While developing an audit programme, the auditor may conclude that relying on certain internal controls is an effective
and efficient way to conduct his audit.
However, the auditor may decide not to rely on internal controls when there are other more efficient ways of obtaining
sufficient appropriate audit evidence.

The auditor should also consider

● the timing of the procedures,
● the coordination of any assistance expected from the client,
● the availability of assistants, and the involvement of other auditors or experts.
Further, the auditor normally has flexibility in deciding when to perform audit procedures.
However, in some cases, the auditor may have no discretion as to timing,

- for example, when observing the taking of inventories by client personnel or verifying the securities and cash
balances at the year-end.
For the purpose of programme construction, the following points should be kept in mind:
1. Stay within the scope and limitation of the assignment.

2. Prepare a written audit programme setting forth the procedures that are needed to implement the audit plan.
3. Determine the evidence reasonably available and identify the best evidence for deriving the necessary
satisfaction.
4. Apply only those steps and procedures which are useful in accomplishing the verification purpose in the
specific situation.
5. Include the audit objectives for each area and sufficient details which serve as a set of instructions for the
assistants involved in audit and help in controlling the proper execution of the work.
6. Consider all possibilities of error.
7. Co-ordinate the procedures to be applied to related items.
Audit Programme To provide Audit Evidence
Audit programme is designed to provide for Audit evidence by prescribing procedures and technique.
The best evidence for testing accuracy of an assertion is a matter of professional judgement of the auditor.
Auditor through his training, knowledge and experience Will design the audit program in such a manner
that it will provide the best possible audit evidence for the given assertions.
For example the best evidence for cash in hand can be obtained through counting the cash.
For something which is pledged with the bank the banker’s certificate will be the best audit evidence.
Variety of fields for Audit Evidence
An auditor picks up evidence from a variety of fields and it is generally of the following broad types:
a. Documentary examination,
b. Physical examination,
c. Statements and explanation of management, officials and employees,
d. Statements and explanations of third parties,
e. Arithmetical calculations by the auditor,
f. State of internal controls and internal checks,
g. Inter-relationship of the various accounting data,
h. Subsidiary and memorandum records,
i. Minutes,

j. Subsequent action by the client and by others.
Advantages of Audit Programme

The advantages of an audit programme are:
a. It provides the assistant carrying out the audit with a total and clear set of instructions of the work
generally to be done.
b. It is essential, particularly for major audits, to provide a total perspective of the work to be
performed.
c. Selection of assistants for the jobs on the basis of capability becomes easier when the work is
rationally planned, defined and segregated.
d. Without a written and predetermined programme, work is necessarily to be carried out on the basis
of some ‘mental’ plan. In such a situation there is always a danger of ignoring or overlooking certain
books and records. Under a properly framed programme, such danger is significantly less and the
audit can proceed systematically.
e. The assistants, by putting their signature on programme, accept the responsibility for the work
carried out by them individually and, if necessary, the work done may be traced back to the assistant.
f. The principal can control the progress of the various audits in hand by examination of audit
programmes initiated by the assistants deputed to the jobs for completed work.
g. It serves as a guide for audits to be carried out in the succeeding year.
h. A properly drawn up audit programme serves as evidence in the event of any charge of negligence
being brought against the auditor. It may be of considerable value in establishing that he exercised
reasonable skill and care that was expected of a professional auditor.
Disadvantage
a. The work may become mechanical and particular parts of the programme may be carried out
without any understanding of the object of such parts in the whole audit scheme.
b. The programme often tends to become rigid and inflexible following set grooves; the business may
change in its operation of conduct, but the old programme may still be carried on. Changes in staff or
internal control may render precaution necessary at points different from those originally decided
upon.
c. Inefficient assistants may take shelter behind the programme i.e. defend deficiencies in their work
on the ground that no instruction in the matter is contained therein.
d. A hard and fast audit programme may kill the initiative of efficient and enterprising assistants.
Minimum Essential Work and Alteration
● Initially the audit programme must specify the minimum essential work to be carried out based on
the auditor’s understanding of nature, size, composition of business, his understanding of IC, and
considering the scope of audit.
● With the progress of audit, alteration should be made in the audit program as and when the situation
requires, there may be circumstances which were initially not thought of and now needs to be taken
care of.
● Even some areas which were earlier included can be dropped or the extent of checking can be
reduced
● The users of the audit program, that is the assistants working on them, must be motivated to keep an
open mind and not to stick only to the points mentioned in the audit program, they must be

encouraged to report any significant matters to the seniors with appropriate authority on a timely
basis.
Quality Control For Audit Work Delegation And Supervision Of Audit

Work
An audit is a complex task involving number of people at different levels.

Auditor will have to depend on
● Assistants
● Technical Experts
● Other auditors
In the case of assistants, the auditor has to direct, supervise and review the work delegated to them.
In the case of other auditors and expert auditor has to obtain reasonable assurance that the work performed
by them is adequate for the purpose of the auditor.
The objective of the auditor is to implement quality control procedures at the engagement level that
provides the auditor with reasonable assurance that
● The audit complies with the professional standards and the regulatory and legal requirements
● The Auditor’s report is issued as appropriate in the circumstance.
The responsibility to express an opinion on financial statements and it’s accountability will always be of the
auditor.
Question
Your firm has been appointed as an auditor to audit the accounts of an auto parts manufacturer, ABC
LTD. Elucidate the matters to be considered by an auditor in developing his overall plan for the
expected scope and conduct of audit. (MTP May 2021 ICAI)
Answer As per MTP of ICAI - Please refer ICAI’s website - www.icai.org
Development of an Overall Plan

The auditor should consider the following matters in developing his overall plan for the expected scope
and conduct of the audit
● The terms of his engagement and any statutory responsibilities.
● The nature and timing of reports or other communication.
● The applicable legal or statutory requirements.
● The accounting policies adopted by the client and changes in those policies.
● The effect of new accounting or auditing pronouncements on the audit.
● The identification of significant audit areas.
● The setting of materiality levels for audit purposes.
● Conditions requiring special attention, such as the possibility of material error or fraud or the
involvement of parties in whom directors or persons who are substantial owners of the entity are

interested and with whom transactions are likely.

● The degree of reliance he expects to be able to place on the accounting system and internal
control.
● Possible rotation of emphasis on specific audit areas.
● The nature and extent of audit evidence to be obtained.
● The work of internal auditors and the extent of their involvement, if any, in the audit.
● The involvement of other auditors in the audit of subsidiaries or branches of the client.
● The involvement of experts.
● The allocation of work to be undertaken between joint auditors and the procedures for its control
and review.
● Establishing and coordinating staffing requirements
It is not necessary for the auditor to periodically review the audit programme. ( Correct / Incorrect -
November 2020 2 Marks)

Audit notes can serve as a guide in framing an Audit programme.
Materiality
The general meaning of Material Items
● The items, the knowledge which might influence the decisions of the user of the financial
statements.
● An item may be material because of its size or because of its nature.
● Thus we can say that materiality can be quantitative or qualitative.
● It is not practicable to design audit procedures to detect misstatements that could be material solely
because of their nature.
● Materiality forms the basis for determination of audit scope and the levels of testing the transactions.
● Sometimes materiality in terms of quantity is also defined in law and regulations. For example
○ A company should disclose by way of notes additional information regarding any item of
income or expenditure which exceeds 1% of the revenue from operations or ` 1,00,000
whichever is higher (Refer general Instructions for preparation of Statement of Profit and Loss
in Schedule III to the Companies Act, 2013).
○ A company should disclose in Notes to Accounts, shares in the company held by each
shareholder holding more than 5 per cent shares specifying the number of shares held.
Materiality from auditing point of view
● Auditor is concerned with material misstatements in the financial statements.

● Auditor will apply the concept of materiality while planning and performing the audit, he will also use
it in evaluating the effect of identified misstatements on the audit and of the uncorrected
misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report.

● If materiality is defined or discussed in the financial reporting framework, the auditor will take it as a
point of reference to determine materiality level for the audit.
● Different Financial reporting frameworks may discuss materiality in different terms, the common
points which are generally emphasized are as follows.
1. Misstatements are material if expected to influence the economic decisions of users taken on
the basis of the financial statements
Misstatements, including omissions, are considered to be material if they, individually or in the
aggregate, could reasonably be expected to influence the economic decisions of users taken on the
basis of the financial statements;
2. Judgments about materiality are affected by the size or nature of a misstatement

Judgments about materiality are made in the light of surrounding circumstances, and are affected by
the size or nature of a misstatement, or a combination of both; and
3. Judgments about matters that are material are based on a consideration of the common
financial information needs of users as a group
Judgments about matters that are material to users of the financial statements are based on a
consideration of the common financial information needs of users as a group. The possible effect of
misstatements on specific individual users, whose needs may vary widely, is not considered.
The auditor’s determination of materiality is a matter of professional

judgment.
The auditor’s determination of materiality is a matter of professional judgment, and is affected by the auditor’s
perception of the financial information needs of users of the financial statements. In this context, it is reasonable for the
auditor to assume that users:
a. Have a reasonable knowledge of business and economic activities and accounting and a willingness to study the
information in the financial statements with reasonable diligence;
b. Understand that financial statements are prepared, presented and audited to levels of materiality;
c. Recognize the uncertainties inherent in the measurement of amounts based on the use of estimates, judgment
and the consideration of future events; and
d. Make reasonable economic decisions on the basis of the information in the financial statements.
Not for exams.

In planning the audit, the auditor makes judgments about the size of misstatements that will be considered material.
These judgments provide a basis for: (In short, materiality helps in the following)
● Determining the nature, timing and extent of risk assessment procedures;
● Identifying and assessing the risks of material misstatement; and
● Determining the nature, timing and extent of further audit procedures.

Performance Materiality
● For purposes of the SAs,
● Performance materiality means
● the amount or amounts set by the auditor
● at less than materiality
● for the financial statements as a whole
● to reduce to an appropriately low level
● the probability
● that the aggregate of uncorrected and undetected misstatements exceed materiality for the financial
statements as a whole.
● If, there is one or more particular item
● for which misstatements of lesser amounts than the materiality for the financial statements as a
whole could reasonably be expected
● to influence the economic decisions of users taken on the basis of the financial statements,
● the auditor shall also determine the materiality level or levels to be applied to those particular item.
Performance materiality is also known as Tolerable misstatements

A percentage based on risk at the financial statement level is multiplied by planning materiality to
determine tolerable misstatement, or performance materiality,

Benchmarking
Meaning: Benchmarking is one recognized method through which an Auditor determines the materiality
level. Under this method, a percentage is often applied to a chosen benchmark, as a starting point in
determining materiality for the Financial Statements as a whole.
The auditor has to apply his professional judgement in determining materiality, choosing appropriate
benchmark and determining level of benchmark.
Factors: Factors that may affect the identification of an appropriate benchmark include –
a. Elements of the Financial Statement (e.g., Assets, Liabilities, Equity, Revenue, Expenses)
b. Whether there are items on which the attention of the users of the particulars Entity’s Financial
Statement tends to be focused (e.g., profit, revenue or net assets)
c. Nature of the Entity, where the Entity is at in its life cycle, and the industry and economic
environment in which the Entity operates
d. Ownership Structure and Financial Pattern (e.g., if an entity is financed more by Debt rather than
Equity, users may put more emphasis on Assets, and claims on them, than on the Entity’s Earning)
and
e. The relative volatility of the benchmark.
Some examples of suitable benchmark depending upon various circumstances
Examples of benchmarks that may be appropriate, include categories of reported income such as PBT, Total
Revenue, Gross Profit and Total Expenses, Total Equity or Net Asset Value.
a. Profit Before Tax from continuing operations is often used for profit-oriented entities. In this regard if
Profit Before Tax from continuing operations is volatile, other benchmark may be more appropriate.
b. In an audit of the entities doing public utility programs/projects, Total Cost or Net Cost (Expenses less
Revenues) may be appropriate benchmarks for that particular program/project activity.
c. Where an entity has custody of the assets, assets may be an appropriate benchmark.
Percentage applied to profit before tax from continuing operations will normally be higher than a
percentage applied to total revenue.
With Ref. to SA 320 "Materiality in planning and performing an audit" Indicate the factors which may effect
the identification of an appropriate benchmark while determining materiality for the financial statements
as a whole. (November 2020 - 4 Marks

Financial Data w.r.t Chosen Benchmark

In relation to the chosen benchmark, relevant financial data ordinarily includes –
● prior periods’ financial results and other financial information

● the period to-date financial results.
● budgets or forecasts for the current period,

adjusted for significant changes in the circumstances of the entity (for example, a significant business
acquisition) and relevant changes of conditions in the industry or economic environment in which the entity
operates.
Factors that may indicate lesser amounts than materiality for the
financial statements as a whole could reasonably be expected to
influence the economic decisions of users
● Whether law, regulations or the applicable financial reporting framework affect users’ expectations
regarding the measurement or disclosure of certain items.
● The key disclosures in relation to the industry in which the entity operates.
● Whether attention is focused on a particular aspect of the entity’s business that is separately
disclosed in the financial statements.
Revision as the Audit Progresses

Materiality for the financial statements as a whole (and, if applicable, the materiality level or levels for
particular classes of transactions, account balances or disclosures) may need to be revised as a result of a
● change in circumstances that occurred during the audit (for example, a decision to dispose of a major
part of the entity’s business),
● new information, or
● a change in the auditor’s understanding of the entity and its operations as a result of performing
further audit procedures.
For example, if during the audit it appears that actual financial results are likely to be substantially different
from the anticipated period end financial results that were used initially to determine materiality for the
financial statements as a whole, the auditor revises that materiality.
Documenting the materiality

The audit documentation shall include the following amounts and the factors considered in their
determination:
● Materiality for the financial statements as a whole;
● If applicable, the materiality level or levels for particular classes of transactions, account balances or
disclosures ;
● Performance materiality ; and
● Any revision in above as the audit progressed.
Materiality and Audit Risk

In conducting an audit of financial statements, the overall objectives of the auditor are
● to obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error,
● thereby enabling the auditor to express an opinion on whether the financial statements are prepared,
in all material respects, in accordance with an applicable financial reporting framework;
● and to report on the financial statements, and communicate as required by the SAs, in accordance
with the auditor’s findings.

The auditor obtains reasonable assurance by obtaining sufficient appropriate audit evidence to reduce audit
risk to an acceptably low level .
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements
are materially misstated.
Audit risk is a function of the risks of material misstatement and detection risk .
Materiality and audit risk are considered throughout the audit, in particular, when
● Identifying and assessing the risks of material misstatement.
● Determining the nature, timing and extent of further audit procedures; and
● Evaluating the effect of uncorrected misstatements, if any, on the financial statements and in forming
the opinion in the auditor’s report.
Relationship between materiality and audit risk
● There is an inverse relationship between Materiality and the degree of audit risk.
● Accordingly, if we have high risk in an organisation we should keep our materiality level low.
● Audit Risk has three components – Inherent risk (IR), Control Risk (CR) & Detection Risk.
● If a company is having low IR & CR then the chances are material misstatement are also low.
● Auditor will keep his materiality level high.
● If Risk is high the auditor will keep his materiality level low so that he can detect a greater number
of misstatements.
Correct / Incorrect Marks 2 January 2021 Exam Question

Determining materiality involves the exercise of professional judgement.

Case Studies
You are an audit manager with PKCA & Associates, and you have just been approached by Mishti, the
Managing Director of Mishti YT Ltd., who has asked PKCA & Associates to become Statutory auditors to
Mishti YT Ltd.
Mishti YT Ltd. is in the service sector (was being operated as a proprietorship) which has existed for a
number of years. Mishti explains that the company has recently become legally required to have an
audit. It has not had an audit in the past. PKCA & Associates was recommended by Mishti’s friend.
Mishti is not very familiar with the audit process. She has asked for further information about audit
planning and audit documents.
Which of the following considerations/actions should the auditor take before the audit of Mishti YT Ltd. is accepted?
1. Consider if the audit firm is independent from Mishti YT Ltd..

2. Communicate with the previous auditors.
3. Obtain the agreement of Mishti YT Ltd. management that it acknowledges its responsibility to prepare financial statements.
4. Sign an agreement to give a Clean Opinion.
● 1 and 2
● 1 and 3
● 2 and 4
● 3 and 4
Which TWO of the following must be included in the engagement letter between PKCA & Associates and Mishti YT Ltd.?
● Management’s acknowledgement of its responsibilities with regard to accounts preparation, internal control and provision of
information to the auditors.
● Mishti YT Ltd’s Business Plan.
● Details about Internal Control.
● Auditor’s responsibilities with regard to the audit
● Audit risk evaluation
● The Audit Fees to be charged.
SA 320 on “Materiality in Planning and Performing an Audit” requires that an auditor
a. should not consider materiality and its relationship with audit risk while conducting an audit.
b. should consider materiality and its relationship with audit risk while conducting an audit.
c. should not consider materiality but should consider its relationship with audit risk while conducting an audit.
d. should consider materiality but need not consider its relationship with audit risk while conducting an audit
When planning the audit,

a. the auditor considers what would make the financial information materially misstated.
b. the auditor need not consider what would make the financial information materially misstated
c. the auditor need not consider what would make the financial information materially misstated at planning stage
d. the auditor needs to consider what would make the financial information materially misstated while conducting audit only

SA 315 Identifying and Assessing the Risk of Material Misstatement Through Understanding the Entity and Its Environment requires
auditors to obtain an understanding of the audited entity.
Which of the following methods should PKCA & Associates use to obtain information about Mishti YT Ltd.?
1. Ask management to tell them about the business.

2. Understand Relevant industry, regulatory and other external factors including applicable financial reporting framework
3. Perform analytical review on current and historical financial information
4. Visit Mishti YT Ltd. and watch its activities
5. Ask the previous auditors to tell them about the client.
● 1, 2, 3 and 5
● 2 and 3 only
● 1 and 4 only
● 1, 3 and 4
● 1, 2, 3, 4
Which of the following statements concerning audit documents is TRUE?

● Mishti is entitled to access and review of the firm’s working papers relating to Mishti YT Ltd..
● Audit working papers are the property of the auditor and Mishti is unlikely to be granted access to them.
● The auditors may not show Mishti any working papers for ethical reasons.
● The auditors may not use documents generated by Mishti YT Ltd. staff as working papers.

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Chapter 3 - Audit Documentation and Audit

Evidence
SA 230 - Audit Documentation
Definition of Audit Documentation
SA 230 on "Audit Documentation", deals with the auditor's responsibility to prepare audit documentation for an
audit of financial statements. The standard does not in any way limit the specific documentation requirements of
other SA’s. In other words, if other SAs prescribe more documentation requirements, those documentations are
also to be maintained.
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Nature and Purposes of Audit Documentation
Auditor’s responsibility for failure to detect fraud and errors

As per SA 240 the responsibility for the prevention and detection of fraud and error rests with the management
through the implementation of an adequate system of internal control. Such a system reduces but does not
eliminate the possibility of fraud and error.
In other words, the auditor is not responsible for prevention, detection and correction of misstatements. Moreover
because of Inherent limitations of auditing it is impossible for an auditor to detect all misstatements whether due
to fraud or error.
However, if there are doubtful situation that some material misstatement exist, auditor should extend his
procedure to confirm/dispel the doubt.
The subsequent discovery of a material misstatement of the financial statements resulting from fraud or error does
not by itself indicate a failure to conduct an audit in accordance with SAs.
“ If there remains a deep laid fraud in the accounts, which in the normal course of examination of accounts may
not come to light,
● It will not be construed as failure of audit,
Auditor WILL NOT BE considered as negligent
● If he has carried his work in accordance

○ with SA’s and
Whether the auditor has performed an audit in accordance with SAs and law and regulations is determined by the
Form, Content and Extent of Audit Documentation

The form, content and extent of audit documentation depend on factors such as:

Basis of conclusion - If the basis of conclusion is not readily determinable, from the documentation of the work
performed, then other supporting documents must also be attached.
(for example auditor’s assessment of risk of material misstatement is a matter of professional judgement and the
basis of this assessment of it is not readily determinable)

Form ,Content and Extent of Audit Documentation
The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor to understand.
a) The nature, timing and extent of the audit procedures:
b) The results of the audit procedures performed, and the audit evidence obtained; and
c) Significant matters arising during the audit and the conclusions reached thereon,significant
professional judgements made in reaching those conclusions
In documenting the nature, timing and extent of audit procedures performed, the auditor of shall record:
● The identifying characteristics of the specific items or matters tested. (Assertions tested)
● Who performed the audit work and the date such work was completed; and
● Who reviewed the audit work performed and the date and extent of such review.
The auditor shall document discussions of significant matters with management, those charged with governance,
and others, including the nature of the significant matters discussed and when and with whom the discussions
took place.
If the auditor identified information that is inconsistent with the auditor's final conclusion regarding a significant
matter, the auditor shall document how the auditor addressed the inconsistency
Experience Auditor
● An individual (whether internal or external to the firm) who has practical audit experience, and a
reasonable understanding of:
○ Audit processes;
○ SAs and applicable legal and regulatory requirements;
○ The business environment in which the entity operates; and
○ Auditing and financial reporting issues relevant to the entity’s industry.
While documenting the nature, timing and extent of audit procedures performed in case of audit of PQR Ltd,
explain the important matters it's auditor should record.
RTP May 2021
Examples of Audit Documentation
● Audit Documentation include:

○ Audit programmes.
○ Analyses.
○ Issues memoranda.
○ Summaries of significant matters.
○ Letters of confirmation and representation.
○ Checklists.
○ Correspondence (including e-mail) concerning significant matters.

Audit documentation is not a substitute for the entity’s accounting records.
The auditor may include copies of the entity’s records (for example, significant and specific contracts and
agreements) as part of audit documentation.
The auditor need not include in audit documentation

● superseded drafts of working papers and financial statements,
● notes that reflect incomplete or preliminary thinking,
● previous copies of documents corrected for typographical or other errors, and duplicates of documents.
Ownership of Audit Documentation
Standard on Quality Control (SQC) 1 provides that,

● unless otherwise specified by law or regulation,
● Audit documentation is the property of the auditor.
The auditor should adopt reasonable procedures for custody and confidentiality of his working papers.
He may at his discretion,

● make portions of, or extracts from, audit documentation available to clients,
● provided such disclosure does not undermine the validity of the work performed, or,
● in the case of assurance engagements, the independence of the auditor or of his personnel.
In the case of a company, the main auditor has to consider the report of the branch auditor and has a right to seek
clarification and to visit the branch but cannot ask for the copy of working paper and therefore, the branch auditor
is under no compulsion to give photocopies of his working paper to the principal auditor.
Audit File
Preparation of Audit Documentation
● Preparing sufficient and appropriate audit documentation on a timely basis helps to

○ enhance the quality of the audit and

○ facilitates the effective review and evaluation of the audit evidence obtained and conclusions
reached before the auditor’s report is finalised.
● Documentation prepared after the audit work has been performed is likely to be less accurate than
documentation prepared at the time such work is performed.
Assembly of final audit file

● The auditor’s shall assemble the audit documentation in an audit file and complete the administrative
process of assembling the final audit file on a timely basis after the date of the auditor’s report.
● SQC 1 “Quality Control for Firms that perform Audits and Review of Historical Financial Information, and
other Assurance and related services”, An appropriate time limit within which to complete the assembly of
the final audit file is ordinarily not more than 60 days after the date of the auditor’s report.
● The completion of the assembly of the final audit file after the date of the auditor’s report is an
administrative process that does not involve the performance of new audit procedures or the
drawing of new conclusions.
● Changes may , however be made to the audit documentation during the final assembly process if they are
administrative in nature. Examples of such changes include.
○ Deleting or discarding superseded documentation.
○ Sorting, collating and cross referencing working papers.
○ Signing off on completion checklists relating to the file assembly process.
○ Documenting audit evidence that the auditor has obtained, discussed and agreed with the
relevant members of the engagement team before the date of the auditor’s report.
● After the assembly of the final audit file has been completed, the auditor shall not delete or discard audit
documentation of any nature before the end of its retention period.
Retention
SQC 1 requires firms to establish policies and procedures for the retention of engagement documentation. The
retention period for audit engagements ordinarily is no shorter than seven years from the date of the auditor’s
report, or, if later, the date of the group auditor’s report.
Completion Memorandum or Audit Documentation Summary

The auditor may consider it helpful to prepare and retain as part of the audit documentation a summary
(sometimes known as a completion memorandum) that describes-
● the significant matters identified during the audit and

● how they were addressed.
● Such a summary may facilitate effective and efficient review and inspection of the audit documentation,
particularly for large and complex audits.
● It may also help the auditor to consider whether he is able to achieve the objectives of the relevant
individual SAs and the overall objective of the audit
Documentation of Significant Matters and Related Significant

Professional Judgements
Judging the significance of a matter requires an objective analysis of the facts and circumstances.
An important factor in determining the form, content and extent of audit documentation of significant matters
is the extent of professional judgement exercised in performing the work and evaluating the results. Higher the
professional judgement , High the extent of documentation involved.
Documentation of the professional judgements

● helps in explaining the auditor’s conclusions and
● Helps to reinforce the quality of the judgement.
● Reviewing audit documentation.
● Carrying out subsequent audits.
Example of Significant matters
1. Results of audit procedures indicating financial statements could be materially misstated

2. Results of audit procedures indicating a need to revise the assessment of risk of material misstatement and
the responses to the same.
3. Situation causing significant difficulty in applying audit procedures.
4. Evidence that could result in modification in the auditor’ opinion
5. Evidence that could lead to inclusion of Emphasis of matter paragraph in auditor’s report.
Matters Arising after the Date of the Auditor’s Report

As per SA 230 - Audit Documentation If, in exceptional circumstances, the auditor performs new or additional audit
procedures or draws new conclusions after the date of the auditor’s report, the auditor shall document
a. The circumstances encountered;

b. The new or additional audit procedures performed, audit evidence obtained, and conclusions reached, and
their effect on the auditor's report;
c. When and by whom the resulting changes to audit documentation were made and reviewed.
(The topic was initially not covered in ICAI Study Material, Question was asked in RTP Nov 22. The topic is from bare
text of SA 230)

SA 500 Audit Evidence

Meaning of Audit Evidence
Information contained in the accounting records
Accounting records include
● the records of initial accounting entries and supporting records, such as checks and records of electronic
fund transfers;
● Invoices;
● Contracts
● the ledgers, journal entries and other adjustments to the financial statements.
● records such as worksheets and spreadsheets supporting cost allocations, computations, reconciliations
and disclosures.
Other information
Other information that authenticates the accounting records and also supports the auditor’s rationale behind the
true and fair presentation of the financial statements:
Other information which the auditor may use as audit evidence includes, for example
● minutes of the meetings,

● written confirmations from trade receivables and trade payables,
● manuals containing details of internal control etc.

A combination of tests of accounting records and other information is generally used by the auditor to
support his opinion on the financial statements.
Other Points related to Audit Evidence and Its Nature.
It is cumulative in nature
Primarily obtained from audit procedures performed during the course of the audit.
It may, however, also include information obtained from other sources such as previous audits.
Audit evidence comprises both

● information that supports and corroborates management’s assertions, and
● any information that contradicts such assertions.
The absence of information (for example, management’s refusal to provide a requested representation) also
constitutes audit evidence.
Relation of Audit Evidence and Opinion of the Auditor
There exists a very important relationship between Audit Evidence and the opinion of the Auditor.
While conducting an audit of a company,

● the auditor obtains audit evidence and
● With the help of that audit evidence obtained, the auditor forms an audit opinion on the financial
statements of that company.
Audit evidence is necessary to support the auditor’s opinion and report.
As explained in SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance
with Standards on Auditing”, reasonable assurance is obtained when the auditor has obtained sufficient
appropriate audit evidence to reduce audit risk to an acceptably low level.

Sufficiency of Audit Evidence

● Sufficiency is the measure of the quantity of audit evidence.
● The quantity of audit evidence needed is affected by the auditor’s assessment of the risks of misstatement
(the higher the assessed risks, the more audit evidence is likely to be required) and
● also by the quality of such audit evidence (the higher the quality, the less may be required).
● Obtaining more audit evidence, however, may not compensate for its poor quality.
Factors to determine Sufficiency
Materiality
It may be defined as the significance of classes of transactions, account balances and presentation and disclosures
to the users of the financial statements.
Less evidence would be required in case assertions are less material to users of the financial statements.
But on the other hand if assertions are more material to the users of the financial statements, more evidence
would be required.
Risk of material misstatement

It may be defined as the risk that the financial statements are materially misstated prior to audit.
Less evidence would be required in case assertions that have a lower risk of material misstatement.
But on the other hand, if assertions have a higher risk of material misstatement, more evidence would be required.
Size of a population
It refers to the number of items included in the population.

Less evidence would be required in case of smaller, more homogeneous population but on the other hand in case
of larger, more heterogeneous populations, more evidence would be required.
Appropriateness of Audit Evidence

Appropriateness is the measure of the quality of audit evidence; that is, its relevance and its reliability in providing
support for the conclusions on which the auditor’s opinion is based.
Relevance
Relevance means the relationship of the evidence with audit procedure and the assertion being checked.
A given set of audit procedures may provide audit evidence that is relevant to certain assertions, but not others.
For example, confirmation of balance from a customer is a relevant evidence as regards existence of receivable, but
it may not be relevant as regards collectability of the balance due from customer.
Also, physical observation of inventories is relevant evidence relating to existence, but is not appropriate evidence
to ensure that the entity owns the inventories.
On the other hand, audit evidence from different sources or of a different nature may often be relevant to the same
assertion. For example Checking the terms of the agreement and confirming the same from the third party.
The term competence is also used in place of relevance.
One more example of relevance: To Check if a purchase is complete you don't look at the Purchase contract. For
checking the completeness of purchase we will check that goods or services were received. For this we will check
various documents and records related to receiving goods like stock registers .
Reliability of Audit Evidence

You measure reliability by deciding whether the evidence is credible.
As an auditor, you should adopt an attitude of professional skepticism.
In order to obtain reliable audit evidence, information produced by the entity that is used for performing audit
procedures needs to be sufficiently complete and accurate.
As per SA 500 "Audit Evidence", the reliability of information to be used as audit evidence, and therefore of the
audit evidence itself, is influenced by its
● source and
● its nature, (Direct, indirect, oral, written or original, photocopies) and
● the circumstances under which it is obtained,
● including the controls over its preparation and maintenance where relevant.
Generalisations about the reliability of various kinds of audit evidence are subject to important exceptions.
Even when information to be used as audit evidence is obtained from sources external to the entity, circumstances
may exist that could affect its reliability.

For example, information obtained from an independent external source may not be reliable if the source is not
knowledgeable, or a management's expert may lack objectivity.
While recognising that exceptions may exist, the following generalisations about the reliability of audit evidence
may be useful
1. The reliability of audit evidence is increased when it is obtained from independent sources outside the
entity.
2. The reliability of audit evidence that is generated internally is increased when the related controls,
including those over its preparation and maintenance, imposed by the entity are effective.
3. Audit evidence obtained directly by the auditor (for example, observation of the application of a control) is
more reliable than audit evidence obtained indirectly or by inference (for example, inquiry about the
application of a control).
4. Audit evidence in documentary form, whether paper, electronic, or other medium, is more reliable than
evidence obtained orally (for example, a contemporaneously written record of a meeting is more reliable
than a subsequent oral representation of the matters discussed).
5. Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies or facsimiles, or documents that have been filmed, digitised or otherwise transformed into
electronic form, the reliability of which may depend on the controls over their preparation and
maintenance.
6. Circumstances prevailing in the organisation can have a severe impact on the reliability of the audit
evidence.

Sufficiency is the measure of the quantity of audit evidence.
Sources of Audit Evidence
Some audit evidence is obtained by performing audit procedures to test the accounting records.
Through the performance of such audit procedures, the auditor may determine that the accounting records are
internally consistent and agree to the financial statements.
More assurance is ordinarily obtained from consistent audit evidence obtained from different sources or of a
different nature than from items of audit evidence considered individually.
Information from sources independent of the entity that the auditor may use as audit evidence may include
confirmations from third parties, analysts’ reports, and comparable data about competitors.
Audit Procedures to Obtain Audit Evidence
Audit evidence to draw reasonable conclusions on which to base the auditor’s opinion is obtained by performing
➔ Risk assessment procedures; and
➔ Further audit procedures, which comprise:
◆ Tests of controls, when required by the SAs or when the auditor has chosen to do so; and
◆ Substantive procedures, including tests of details and substantive analytical procedures.
➔ The audit procedures described below may be used as

◆ risk assessment procedures,

◆ tests of controls or
◆ substantive procedures,
● Depending on the context in which they are applied by the auditor.
Audit procedures to obtain audit evidence can include
1. Inspection
2. Observation
4. Recalculation
5. Reperformance
7. Enquiry
Inspection
● examining records or documents,
○ whether internal or external,
○ in paper form, electronic form, or other media, or
● a physical examination of an asset.
● Inspection of records and documents provides audit evidence
○ of varying degrees of reliability,
○ depending on their nature and source and,
● Example - Documentation related to authorisation
Observation
● Observation consists of witnessing a process or procedure being performed by others.
● For example, the auditor may observe the counting of inventories being performed by client's personnel.
External Confirmation
An external confirmation represents audit evidence obtained by the auditor as a direct written response to the
auditor from a third party ( the confirming party), in paper form, or by electronic or other medium.
External confirmation procedures frequently are relevant when addressing assertions associated with certain
account balances and their elements. However, external confirmations need not be restricted to account balances
only.
External confirmation procedures also are used to obtain audit evidence about the absence of certain conditions.
Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may be
performed manually or electronically.
Re-performance
Re-performance involves the auditor’s independent execution of procedures or controls that were originally
performed as part of the entity’s internal control.
Analytical Procedures
● Analytical procedures consist of evaluations of financial information by a study of relationships among both
financial and non- financial data.

● Analytical Procedures refers to studying significant ratios and trends and investigating unusual
fluctuations.
Inquiry

Types of Audit Evidence

Management’s expert
An individual or organisation possessing expertise in a field other than accounting or auditing, whose work in that
field is used by the entity to assist the entity in preparing the financial statements.
When information to be used as audit evidence has been prepared using the work of a management’s expert, the
auditor shall, to the extent necessary, having regard to the significance of that expert’s work for the auditor’s
purposes,:
● Evaluate the competence, capabilities and objectivity of that expert;

● Obtain an understanding of the work of that expert; and
● Evaluate the appropriateness of that expert’s work as audit evidence for the relevant assertion.
Inconsistency in or Doubts over Reliability of Audit Evidence

If:
a. audit evidence obtained from one source is inconsistent with that obtained from another; or
b. the auditor has doubts over the reliability of information to be used as audit evidence,
the auditor shall determine what modifications or additions to audit procedures are necessary to resolve the
matter, and shall consider the effect of the matter, if any, on other aspects of the audit.

SA 505 - External Confirmation

Question - Explain the process of external confirmation. Give some examples where external confirmation can be
used as audit evidence. (M. Imp)
According to SA 505 on
External confirmation may be defined as an audit evidence obtained as a direct written response to the auditor
from a third party (the confirming party), in paper form, or by electronic or other medium.
When using external confirmation procedures, the auditor shall maintain control over external control requests,
including:
1. Selecting the items for which confirmations are needed. (कौन से आइटमस के लिए )
2. Determining the information to be confirmed or requested; (क्या)
3. Selecting the appropriate confirming party; (किस से )
4. Designing the confirmation requests, including determining that requests are properly addressed and
contain return information for responses to be sent directly to the auditor; and (Properly Designed,
Addressed, return information)
5. Sending the requests, including follow-up requests when applicable, to the confirming party. (भ़जो और फोलो
उप रखो)
Examples of situations where external confirmations may be used include the following
● Bank balances and other information from bankers.
● Accounts receivable balances.
● Stocks held by third parties.
● Property title deeds held by third parties.
● Investments purchased but delivery not taken.
● Loans from lenders.
● Accounts payable balances.
● Long outstanding share application money.
● Terms of Agreement or transaction with the third parties
External confirmation procedures are restricted to the items of addressing assertions associated with account
balances & their elements only. - (Correct / Incorrect - November 2020 2 Marks)
Question
While conducting the audit of Amrit Ltd. the auditor A of ABC and Associates, Chartered Accountants
observed that there are a large number of trade receivables standing in the books of account as on 31 st
March. The auditor wanted to send confirmation requests to a few large trade receivables but the
management refused the auditor to send confirmation requests. How would the auditor proceed? -
November 2020 4 Marks
Answer - (Answer is as per the suggested answer issued by ICAI, you can download the same from www.icai.org)
In the given case of Amrit Ltd, the auditor wanted to send confirmation requests to a few large trade receivables
but the management did not want the auditor to send confirmation requests.

If the management refuses to allow the auditor to send a confirmation request , the auditor shall-
1. Inquire as to management’s reasons for the refusal and seek audit evidence as to their validity and
reasonableness.
2. Evaluate the implications of management’s refusal on the auditor’s assessment of the relevant risks of
material misstatement, including the risk of fraud, and on the nature, timing and extent of other audit
procedures; and
3. Perform alternative audit procedures designed to obtain relevant and reliable evidence.
If the auditor concludes that management’s refusal to allow the auditor to send a confirmation request is
unreasonable, or the auditor is unable to obtain relevant and reliable audit evidence from alternative audit
procedures, the auditor shall communicate with those charged with governance in accordance with SA 260.
The auditor shall also determine the implication for the audit and the auditor’s opinion in accordance with SA
705.
What are the factors that are to be considered while designing a confirmation request? (8 Marks)
As per SA -505 "External Confirmations", the design of a confirmation request may directly affect the confirmation
response rate, and the reliability and the nature of the audit evidence obtained from responses.
The following factors should be considered while designing a confirmation request: -

a. The assertions being addressed.
b. Specific identified risks of material misstatement, including fraud risks.
c. The layout and presentation of the confirmation request.
d. Prior experience on the audit or similar engagements.
e. The method of communication (कैसे बताए )
f. Management's authorisation to the confirming parties to respond to the auditor. Confirming parties may
only be willing to respond to a confirmation request containing management's authorisation. (क्यों तझ
ु को
चाहें )
g. The ability of the confirming party to provide the requested information (यारा बता ना पाए – ability)

Negative confirmations provide less persuasive audit evidence than positive confirmations. Accordingly, the
auditor shall not use negative confirmation requests as the sole substantive audit procedure to address an
assessed risk of material misstatement at the assertion level unless all of the following are present:
● The auditor has assessed the risk of material misstatement as low and has obtained sufficient appropriate
audit evidence regarding the operating effectiveness of controls relevant to the assertion;
● The population of items subject to negative confirmation procedures comprises a large number of small,
homogeneous, account balances, transactions or conditions;
● A very low exception rate is expected; and
● The auditor is not aware of circumstances or conditions that would cause recipients of negative
confirmation requests to disregard such requests.
Question

When attending an inventory count, the auditor selects a sample of items from physical inventory and traces
them to inventory records. Which of the following assertion is mainly being checked
● Existence
● Completeness
● Valuation
● Presentation and disclosure
What will be your answer if auditor select sample from inventory records and trace them to physical inventories
Results of the External Confirmation Procedures
Reliability of Responses to Confirmation Requests
● If the auditor identifies factors that give rise to doubts about the reliability of the response to a confirmation
request, the auditor shall obtain further audit evidence to resolve those doubts.
● If the auditor determines that a response to a confirmation request is not reliable, the auditor shall evaluate
the implications on the assessment of the relevant risks of material misstatement, including the risk of
fraud, and on the related nature, timing and extent of other audit procedures.
Evaluating the Evidence Obtained
The auditor shall evaluate whether the results of the external confirmation procedures provide relevant and
reliable audit evidence, or whether performing further audit procedures is necessary.
External Confirmation as a Substantive Procedure
Factors that may assist the auditor in determining whether external confirmation procedures are to be performed
as substantive audit procedures include:
1. The confirming party’s knowledge of the subject matter – responses may be more reliable if provided by a
person at the confirming party who has the requisite knowledge about the information being confirmed.
2. The ability or willingness of the intended confirming party to respond For example, the confirming party (In
the given situations, confirming parties may not respond, may respond in a casual manner or may attempt
to restrict the reliance placed on the response.)
○ may not accept responsibility for responding to a confirmation request;
○ may consider responding too costly or time consuming;
○ may have concerns about the potential legal liability resulting from responding;
○ may account for transactions in different currencies; or
○ may operate in an environment where responding to confirmation requests is not a significant
aspect of day-to-day operations.
3. The objectivity of the intended confirming party – if the confirming party is a related party of the entity,
responses to confirmation requests may be less reliable.

SA 501 - Audit Evidence – Additional Considerations for

Specific Items
Inventory
SAAE Regarding Existence and condition of inventory
When inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit
evidence regarding the existence and condition of inventory by
a. Attendance at physical inventory counting, unless impracticable, to:
i. Evaluate management's instructions and procedures for recording and controlling the results of
the entity's physical inventory counting;
ii. Observe the performance of management's count procedures;
iii. Inspect the inventory; and
iv. Perform test counts; and
b. Performing audit procedures over the entity's final inventory records to determine whether they accurately
reflect actual inventory count results. (Count results is reflected in the records)
Attendance at Physical Inventory Counting
Attendance at Physical Inventory Counting Involves:
a. Inspecting the inventory to ascertain its existence and evaluate its condition, and performing test counts;
b. Observing compliance with management’s instructions and the performance of procedures for recording
and controlling the results of the physical inventory count; and
c. Obtaining audit evidence as to the reliability of management’s count procedures.

Matters Relevant in Planning Attendance at Physical Inventory Counting
Matters relevant in planning attendance at physical inventory counting include,

● Nature of inventory.
● Stages of completion of work in progress.
● The risks of material misstatement related to inventory.
● The nature of the internal control related to inventory.
● Whether adequate procedures are expected to be established and proper instructions issued for physical
inventory counting.
● The timing of physical inventory counting.
● Whether the entity maintains a perpetual inventory system.
● The locations at which inventory is held, including the materiality of the inventory and the risks of
material misstatement at different locations, in deciding at which locations attendance is appropriate
● Whether the assistance of an auditor’s expert is needed.
Physical Inventory Counting Conducted Other than at the Date of the Financial
Statements
If physical inventory counting is conducted at a date other than the date of the financial statements, the auditor
shall, in addition to the procedures required above, perform audit procedures to obtain audit evidence about
whether changes in inventory between the count date and the date of the financial statements are properly
recorded.
If the Auditor is unable to Attend Physical Inventory Counting due to Unforeseen

Circumstances
If the auditor is unable to attend physical inventory counting due to unforeseen circumstances, the auditor shall
make or observe some physical counts on an alternative date, and perform audit procedures on intervening
transactions.

In some cases where attendance is impracticable, alternative audit procedures, for example inspection of
documentation of the subsequent sale of specific inventory items acquired or purchased prior to the physical
inventory counting, may provide sufficient appropriate audit evidence about the existence and condition of
inventory.
In other cases, however, it may not be possible to obtain sufficient appropriate audit evidence regarding the
existence and condition of inventory by performing alternative audit procedures. In such cases, SA 705 requires the
auditor to modify the opinion in the auditor’s report as a result of the scope limitation.
Inventory under the custody and control of a third party



Modification in the opinion
If-
a. management refuses to give the auditor permission to communicate or meet with the entity’s external
legal counsel, or the entity’s external legal counsel refuses to respond appropriately to the letter of
inquiry, or is prohibited from responding; and
b. the auditor is unable to obtain sufficient appropriate audit evidence by performing alternative audit
procedures,
the auditor shall modify the opinion in the auditor’s report in accordance with SA 705.
Written Representations
The auditor shall request management and, where appropriate, those charged with governance to provide written
representations that
● all known actual or possible litigation and claims
● whose effects should be considered when preparing the financial statements
● have been

○ disclosed to the auditor and

○ appropriately accounted for and disclosed in accordance with the applicable financial reporting
framework.
Segment Information
Obtain sufficient appropriate audit evidence regarding the presentation and disclosure of
segment information.
The auditor shall obtain sufficient appropriate audit evidence regarding the presentation and disclosure of
segment information in accordance with the applicable financial reporting framework by
● Obtaining an understanding of the methods used by management in determining segment information,

and (Auditor un methods ki understanding obtain karega jinhe use karke management segment information determine karti hai)
○ Evaluating whether such methods are likely to result in disclosure in accordance with the
applicable financial reporting framework
○ Where appropriate, testing the application of such methods; and
● Performing analytical procedures or other audit procedures appropriate in the circumstances.
Understanding of the Methods Used by Management
Example of matters
● that may be relevant
● when obtaining an understanding of the methods
● used by management in determining segment information and
● whether such methods are likely to result in disclosure in accordance with the applicable financial
reporting framework include:
Sales, transfers and charges between segments, and elimination of inter segment amounts.
Comparisons with budgets and other expected results, for example, operating profits as a
percentage of sales.
The allocation of assets and costs among segments.
Consistency with prior periods, and the adequacy of the disclosures with respect to inconsistencies

SA 580 - WRITTEN REPRESENTATIONS

Meaning

NPV is a firm of Chartered Accountants conducting audit of Trivedi Industries Ltd. The auditor requests
management to provide Banker’s certificate in support of Fixed deposits whereas management provides
only written representation on the matter. Discuss how you would deal as an auditor.
Although written representations provide necessary audit evidence, they do not provide sufficient appropriate
audit evidence on their own about any of the matters with which they deal.
Furthermore, the fact that management has provided reliable written representations does not affect the nature or
extent of other audit evidence that the auditor obtains about the fulfillment of management’s responsibilities, or
about specific assertions.
Applying the above to the given problem, the auditor , NPV a firm of Chartered Accountants, would further request
the management to provide him with the Banker’s certificate in support of fixed deposits held by the company.
Objective of Auditor

Explain the objectives of the auditor regarding written representations.

From Whom
Auditors shall request written representations from management
● with appropriate responsibilities for the financial statements and
● knowledge of the matters concerned.
People from whom written representation is to be requested may vary depending on the governance structure
of the entity, and relevant law or regulations; however, management (rather than TCWG) is often the responsible
party.
Written representations may therefore be requested from the entity’s CEO and CFO, or other equivalent persons in
entities that do not use such titles. In some circumstances , however, other parties, such as TCWG , are also
responsible for the preparation and presentation of the financial statements.
In some cases, however,

- management may decide to make inquiries of others
- who participate in preparing and presenting the financial statements and assertions therein,
- including individuals who have specialized knowledge relating to the matters about which written
representations are requested.
- Such individuals may include:
● An actuary responsible for actuarially determined accounting measurements.
● Staff engineers who may have responsibility for and specialized knowledge about environmental
liability measurements.
● Internal counsel who may provide information essential to provisions for legal claims.
Qualifying language used in Written Representation

In some cases, management may include in the written representations qualifying language to the effect that
representations are made to the best of its knowledge and belief.
It is reasonable for the auditor to accept such wording if the auditor is satisfied that the representations are being
made by those with appropriate responsibilities and knowledge of the matters included in the representations.
Can an auditor accept written representation with qualifying language / words?

Yes, if the auditor is
_________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________
_________________________________________________________________________________________________________________
Written Representations about Management's Responsibilities

The auditor shall request management to provide a written representation that
● It has fulfilled its responsibility for the preparation of the financial statements in accordance with the
applicable financial reporting framework.
● All transactions have been recorded and are reflected in the financial statements.
● It has provided the auditor with all relevant information and access as agreed in the terms of the audit
engagement, and
Audit evidence obtained during the audit that management has fulfilled the responsibilities is not sufficient
without obtaining confirmation from management about the same.

Other Written Representations

Other SAs require the auditor to request written representations. If, in addition to such required representations,
the auditor determines that it is necessary to obtain one or more written representations to support other audit
evidence relevant to the financial statements or one or more specific assertions in the financial statements, the
auditor shall request such other written representations.
(In short, auditor can take any written representation that is necessary to support audit evidence or assertion w.r.t
financial statements)
Reconfirmation of responsibilities
The auditor may also ask management to reconfirm its acknowledgement and understanding of those
representations. This is particularly appropriate when:
● Those who signed the terms of the audit engagement on behalf of the entity no longer have the relevant
responsibilities.
● The terms of the audit engagement were prepared in a previous year.
● There is any indication that management misunderstands those responsibilities; or
● Changes in circumstances make it appropriate to do so.
Date of and Period(s) Covered by Written Representations
● The date of the written representations shall be as near as practicable to, but not after, the date of the
auditor’s report on the financial statements.
● The written representations shall be for all financial statements and period(s) referred to in the auditor’s
report.
● The auditor’s report cannot be dated, before the date of the written representations, Because written
representations are necessary audit evidence, the auditor’s opinion cannot be expressed.
Form of Written Representations
The written representations shall be in the form of a representation letter addressed to the auditor.
Management to make written public statements about its

responsibilities
If law or regulation requires management to make written public statements about its responsibilities, and the
auditor determines that such statements provide some or all of the representations required, the relevant matters
covered by such statements need not be included in the representation letter.
Doubt as to the Reliability of Written Representations.
If the auditor has concerns about the

● competence, integrity, ethical values or diligence of management, or
● about its commitment to or enforcement of these,
the auditor shall determine the effect that such concerns may have on
● the reliability of representations (oral or written) and
● audit evidence in general.

In particular, if written representations are inconsistent with other audit evidence,

- the auditor shall perform audit procedures to attempt to resolve the matter.
The auditor may consider

- whether the risk assessment remains appropriate and, if not,
- revise the risk assessment and
- determine the nature, timing and extent of further audit procedures to respond to the assessed
risks.
If the matter remains unresolved, the auditor shall reconsider the assessment of the
● competence, integrity, ethical values or diligence of management, or
● about its commitment to or enforcement of these,
and shall determine the effect that this may have on
● the reliability of representations (oral or written) and
● audit evidence in general.
If the auditor concludes that the written representations are not reliable,
- the auditor shall take appropriate actions,
- including determining the possible effect on the opinion in the auditor’s report in accordance with SA 705
Requested Written Representations Not Provided
What do you mean by "Written Representations"? As an auditor, how will you deal if management does not
provide requested written representations?
Answer
Written Representations: As per SA 580, "Written Representation", is a written statement by management provided
to the auditor to confirm certain matters or to support other audit evidence.
These representations are an important source of audit evidence.
If management modifies or does not provide the requested written representations, it may alert the auditor to
the possibility that one or more significant issues may exist.
If management does not provide one or more of the requested written representations,
● the auditor shall discuss the matter with management;

● re-evaluate the integrity of management and evaluate the effect that this may have on the reliability of
representations (oral or written) and audit evidence in general; and
● take appropriate actions, including determining the possible effect on the opinion in the auditor's report.
The auditor shall disclaim an opinion on the financial statements if management does not provide the written
representations.
If management does not provide one or more of the requested written representations,
● the auditor shall _______________ the matter with management;

● ________________ the integrity of management and evaluate the effect that this may have on the reliability of representations (oral or
written) and audit evidence in general; and

● _______________ appropriate actions, including determining the possible effect on the opinion in the auditor's report.
The auditor shall __________________________ on the financial statements if management does not provide the written representations.
SA 510 - Initial Audit engagement - Opening balances

Auditor’s Responsibilities
SA 510"Initial Audit EngagementsOpening Balances",
● deals with the auditor's responsibilities
○ relating to opening balances when conducting an initial audit engagement.
Opening Balance
Those account balances that exist at the beginning of the period. Opening balances also include matters requiring
disclosure that existed at the beginning of the period, such as contingencies and commitments.
Initial audit engagement

An engagement in which either:
○ The financial statements for the prior period were not audited; or
○ The financial statements for the prior period were audited by a predecessor auditor.
Predecessor auditor
The auditor from a different audit firm, who audited the financial statements of an entity in the prior period and
who has been replaced by the current auditor.
Objective of Auditor with respect to Opening Balances in conducting

an Initial Audit Engagement.
In conducting an initial audit engagement, the objective of the auditor with respect to opening balances is to
obtain sufficient appropriate audit evidence about whether:
a. Opening balances contain misstatements that materially affect the current period's financial statements;
and
b. Appropriate accounting policies reflected in the opening balances have been consistently applied in the
current period's financial statements, or changes thereto are properly accounted for and adequately
presented and disclosed in accordance with the applicable financial reporting framework.
Audit Procedures regarding Opening Balances
Read Recent Financial Statement and Audit Report

The auditor shall read the most recent financial statements, if any, and the predecessor auditor's report thereon, if
any, for information relevant to opening balances, including disclosures.
Obtain SAAE Whether OB Contains MS Having Material Affect on FS

The auditor shall obtain sufficient appropriate audit evidence about whether the opening balances contain
misstatements that materially affect the current period's financial statements by

a. Correct Brought Forward and Disclosure of adjustment

Determining whether the prior period's closing balances have been correctly brought forward to the
current period or, when appropriate, any adjustments have been disclosed as prior period items in the
current year's Statement of Profit and Loss.
b. Appropriate Accounting Policies

Determining whether the opening balances reflect the application of appropriate accounting policies; and
c. Performing one or more of the following
i. Careful reading of Audited FS and other Docs

Where the prior year financial statements were audited, perusing the copies of the audited financial
statements including the other relevant documents relating to the prior period financial
statements;
ii. Evaluate Audit Procedures
Evaluating whether audit procedures performed in the current period provide evidence relevant to
the opening balances; or
iii. Specific Audit Procedures
Performing specific audit procedures to obtain evidence regarding the opening balances.
Misstatement in Opening Balance

If the auditor obtains audit evidence that the opening balances contain misstatements that could materially
affect the current period's financial statements, the auditor shall perform such additional audit procedures as
are appropriate in the circumstances to determine the effect on the current period's financial statements.
Misstatement in Current period’s Financial Statement

If the auditor concludes that such misstatements exist in the current period's financial statements, the auditor
shall communicate the misstatements with the appropriate level of management and those charged with
governance in accordance with SA 450.
Consistency of Accounting Policies relating to opening balances

The auditor shall obtain sufficient appropriate audit evidence about whether the accounting policies reflected in
the opening balances have been consistently applied in the current period's financial statements, and whether
changes in the accounting policies have been properly accounted for and adequately presented and disclosed in
accordance with the applicable financial reporting framework.
Modification in the Predecessor Auditor's Report - Effect on ROMM

If the prior period's financial statements were audited by a predecessor auditor and there was a modification to the
opinion, the auditor shall evaluate the effect of the matter giving rise to the modification in assessing the risks of
material misstatement in the current period's financial statements in accordance with SA 315
Audit Conclusions and Reporting in relation to Opening Balances

If the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances, the
auditor shall express a qualified opinion or a disclaimer of opinion, as appropriate, in accordance with SA 705.
If the auditor concludes that

● the opening balances contain a misstatement that materially affects the current period's financial
statements, and the

● effect of the misstatement is not properly accounted for or not adequately presented or disclosed, the
auditor shall express a
● qualified opinion or an adverse opinion, as appropriate, in accordance with SA 705.
Consistency of Accounting Policies

If the auditor concludes that:
a. the current period’s accounting policies are not consistently applied in relation to opening balances in
accordance with the applicable financial reporting framework; or
b. a change in accounting policies is not properly accounted for or not adequately presented or disclosed in
accordance with the applicable financial reporting framework,
the auditor shall express a qualified opinion or an adverse opinion as appropriate in accordance with SA 705.
Modification to the Opinion in the Predecessor Auditor’s Report

If
● the predecessor auditor’s opinion regarding the prior period’s financial statements
● included a modification to the auditor’s opinion
● that remains relevant and material to the current period’s financial statements,
● the auditor shall modify the auditor’s opinion on the current period’s financial statements in accordance
with SA 705 and SA 710.

SA 550 - Related Parties

Requirement of SA
The requirements in this SA are designed to assist the auditor in

● identifying and assessing the risks of material misstatement associated with related party relationships
and transactions, and
● in designing audit procedures to respond to the assessed risks.
Connection with Inherent Limitations of an Audit
In the context of related parties, the potential effects of inherent limitations on the auditor’s ability to detect
material misstatements are greater for such reasons as the following:
● Management may be unaware of the existence of all related party relationships

● Related party relationships may present a greater opportunity for collusion, concealment or manipulation
by management.
Professional skepticism as required by SA 200 is therefore particularly important in this context, given the potential
for undisclosed related party relationships and transactions
Higher Risk of Material Misstatement

Many related party transactions are in the normal course of business. In such circumstances, they may carry no
higher risk of material misstatement of the financial statements than similar transactions with unrelated parties.
However, the nature of related party relationships and transactions may, in some circumstances, give rise to higher
risks of material misstatement of the financial statements than transactions with unrelated parties.
Objectives of the auditor

The objectives of the auditor is to obtain an understanding of related party relationships and transactions (RPRT)
sufficient to be able:
a. To recognise fraud risk factors, if any, arising from related party relationships and transactions
b. To conclude whether the financial statements, insofar as they are affected by those relationships and
transactions: (Whether FS Affected by RPRT)
i. Achieve a true and fair presentation; or
ii. Are not misleading; and
Related Party
A related party as defined in the applicable financial reporting framework; or
Where the applicable financial reporting framework establishes minimal or no related party requirements
a. A person or other entity that has control or significant influence,
■ directly or indirectly
■ through one or more intermediaries,
■ over the reporting entity;

b. Another entity over which the reporting entity has control or significant influence, directly or
indirectly through one or more intermediaries; or
c. Another entity that is under common control with the reporting entity through having: —
■ Common controlling ownership;
■ Owners who are close family members; or
■ Common key management.
However, entities that are under common control by a state (i.e., a national, regional or local government) are not
considered related unless they engage in significant transactions or share resources to a significant extent with
one another.
Identification of Related Parties

Framework establish related party requirements
Information regarding the identity of the entity’s related parties is likely to be readily available to management.
Management is likely to have a comprehensive list of related parties and changes from the prior period.
This is because the entity’s information systems will need to record, process and summarise related party
relationships and transactions to enable the entity to meet the accounting and disclosure requirements of the
framework.
For recurring engagements, making the inquiries provides a basis for comparing the information supplied by
management with the auditor’s record of related parties noted in previous audits.
Framework does not establish related party requirements

Where the framework does not establish related party requirements, the entity may not have such information
systems in place.
Auditor will inquire the from management the information with respect to related parties as a part of risk
assessment procedures and it will also give auditor an insight regarding
1. The entity’s ownership and governance structures;
2. The types of investments that the entity is making and plans to make; and
3. The way the entity is structured and how it is financed.
Records or documents that may provide information about related

party relationships and transactions
During the audit, the auditor should maintain alertness for related party information while reviewing records and
documents. He may inspect the following records or documents that may provide information about related party
relationships and transactions, for example:
1. Entity income tax returns.

2. Information supplied by the entity to regulatory authorities.
3. Documents associated with the entity’s filings with a securities regulator e.g, prospectuses)
4. Statements of conflicts of interest from management and those charged with governance.
5. Contracts and agreements with key management or those charged with governance.
6. Significant contracts and agreements not in the entity’s ordinary course of business.

7. Significant contracts re-negotiated by the entity during the period.
8. Specific invoices and correspondence from the entity’s professional advisors.

9. Internal auditors’ reports.
10. Shareholder registers to identify the entity’s principal shareholders.

11. Life insurance policies acquired by the entity.
12. Records of the entity’s investments and those of its pension plans.

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Chapter 4 - Risk assessment and Internal

Control
Audit Risk
Meaning
Risk of material misstatement is defined as ‘the risk that the financial statements are materially misstated
prior to audit
Risk of material misstatement-"what can go wrong?"-is the flip side of the assertion. For example, the "what can go wrong?" related to
The completeness assertion is that one or more valid transactions are not recorded in the system. Identifying what can go wrong allows
the auditor to understand control objectives, for example, "to ensure that all valid transactions are recorded."
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Components
Example - Issuing Unmodified Opinion when FS are materially misstated.
AR = ROMM DR
Should be low IR X CR Depends on ROMM
Assessed by Auditor Controlled by Auditor
How Accurate is the client's system? How Effective is the How much work do we
IC of a client ? have to do?
Exist independent of FS Audit
8 2 2 2

8 2 16 1/4
● Weak System is not equal to wrong financials.

● Weak system = more work
● How to Assess ROMM
○ RAP
● Greater risk requires
○ more persuasive evidence , (NATURE from control/compliance to Substantive)
○ a large sample size, and (Extent)
○ shift from interim to year end testing (Timing)
● There is a direct relationship between risk of material misstatement and the Assurance required from
substantive procedures. More the risk of material misstatement, the more the assurance required from
substantive procedures.
● The assessment of risks is a matter of professional judgment, rather than a matter capable of precise
measurement.
(एक Assertion में misstatement होने के chances because of its nature)
An auditor assesses inherent risk as high if assertion is more likely to contain a material misstatement.
Assertions involving the following factors generally have a high inherent risk.
● high volume transactions
● Complex calculations
● amounts derived from estimates
● Cash
Control risk arises when Client IC does not catch (prevent, detect or correct) it (Risk). It is the function of effectiveness
of the design and operation or internal control.
Some amount of CR will always be there because of Inherent limitations of IC.
Detection risk is the function of effectiveness of audit procedures and of the manner in which they are applied.
Some amount of detection risk will always exist because the auditor does not examine 100% of an account balance
for transactions . Another reason for some amount of detection risk is the mistake in applying audit procedures or
interpreting the results.
Detection risk can be subdivided into tests of details risk and substantive analytical procedures risk.
Analytical procedures are used for assessment of risk of material misstatement (RAP) as well as substantive
procedures.
Other points.
● Proper risk assessment leads to better quality control review.
● Obviously, proper documentation must be maintained for risk assessment.
● Risk assessment tells you what to and what not to do.
● It helps you in getting maximum output out of minimum effort




Factors to be considered while making control risk assessment

Auditors consider control risk as rely or not to rely on controls.
When making control risk assessments, consider:
● Control environment’s influence over internal control
○ The control environment’s influence over internal control.
○ A control environment that supports the prevention, and detection and correction, of material
misstatements allows greater confidence in the reliability of internal control and audit evidence
generated within the entity.
○ However it does not guarantee the effectiveness of specific controls.
○ We therefore, test the operating effectiveness of controls over significant class of transactions (SCOTs) when we plan to take a
controls reliance strategy.
○ Conversely, the control environment may undermine the effectiveness of specific controls and is a key factor in our control risk
assessments.
● IT PROCESSES
○ Evaluations of the related IT processes that support application and IT dependent manual controls.
● SCOTs
○ Our testing approach over SCOTs and disclosure processes (i.e., controls reliance or substantive only
strategy).
● Expectation
○ The expectation of the operating effectiveness of controls based on the understanding of the
entity's processes.
IT-Dependent Manual Controls Definition: IT Dependent Manual Controls are similar to manual controls as they rely on a manual process from
personnel but differ as a portion of the control requires some level of system involvement. IT-Dependent Manual Controls
Example - A system-generated report lists users that have not accessed (e.g., logged into a system) a particular system within the past 90 days.
The internal control may require an administrator to review such reports and disable certain users whose accounts have not been accessed
within the defined 90 days, as a result.
The IT-dependent portion of this control is the system-generated report.
The manual portion of this control is the administrator review of the report and disabling certain users as a result.
What factors are to be considered by an auditor while making control risk assessments?
3 Marks - November 2020
Question - General MCQs Marks 1 MTP April 2021
"Audit risk is a function of the
(a) risks of material misstatement and detection risk.

(b) audit risk and detection risk.
(c) control risk and detection risk.
(d) inherent risk and detection risk."
Question - General MCQs Marks 1 MTP April 2021
"Risk of material misstatement may be defined as the risk
(a) that the financial statements are materially misstated after audit.
(b) that the financial statements are materially misstated during audit.
(c) that the financial statements are materially misstated prior to audit.
(d) All of the above"

Control risk assessment when control deficiencies are identified
When auditor identifies deficiencies and reports on internal controls,

● he determines the significant financial statement assertions that are affected by the ineffective controls
● in order to evaluate the effect on control risk assessments and strategy for the audit of the financial
statements.
When control deficiencies are identified and auditor identifies and tests more than one control for each relevant
assertion, he evaluates control risk considering all of the controls he has tested.
If the auditor determines that they support a ‘rely on controls’ risk assessment, or if compensating controls are
identified, tested and evaluated to be effective, he may conclude that the ‘rely on controls’ is still appropriate.
Otherwise we change our control risk assessment to ‘not rely on controls.’
When a deficiency relates to an ineffective control that is the only control identified for an assertion, he revises risk
assessment to ‘not rely on controls’ for associated assertions, as no other controls have been identified that
mitigate the risk related to the assertion.
If the deficiency relates to one WCGW (what can go wrong) out of several WCGW, he can ‘rely on controls’ but
performs additional substantive procedures to adequately address the risks related to the deficiency.
My NOTE - There can be many risk of material misstatement in purchases, but internal control in deficient in only one part of it and it is also
compensated by other ICs, then we can assess CR as “Rely on control”

Internal Control
Meaning
❖ The process designed, implemented and maintained

❖ By TCWG, management and other personnel
❖ To provide reasonable assurance
❖ with regard to
-reliability of financial reporting,
-effectiveness and efficiency of operations,
-safeguarding of assets, and
- compliance with applicable laws and regulations
Objectives of Internal Control
● Transactions are executed in accordance with management general or specific authorizations;

● All transactions are promptly recorded in the correct amount in the appropriate accounts and in the
accounting period in which executed so as to permit preparation of financial information within a
framework of recognized accounting policies and practices, and relevant statutory requirements, if any, and
to maintain accountability for assets;
● Assets are safeguard from unauthorised access, use or disposition; and
● The recorded assets are compared with the existing assets as at reasonable intervals and appropriate
action is taken with regard to any differences.
Benefits of Understanding of Internal Control
An understanding of internal control assists the auditor in :

● identifying types of potential misstatements ;
● identifying factors that affect the risks of material misstatement, and
● designing the nature, timing, and extent of further audit procedures.
Auditor PK and Associates have been appointed to conduct an audit of Food91 Ltd, a manufacturing company
engaged in manufacturing of various food items. While planning an audit, the auditors do not think that it
would be necessary to understand internal controls. Advise the auditor in this regard explaining clearly the
benefits of understanding the internal control. RTP May 21
Components of IC
The division of internal control into the following five components provides a useful framework for auditors to
consider how different aspects of an entity’s internal control may affect the audit:
1. The control environment;
2. The entity’s risk assessment process
3. The information system, including the related business processes, relevant to financial reporting, and
communication
4. Control activities
5. Monitoring of controls.

Question
The division of internal control into five components provides a useful framework for auditors to consider how
different aspects of an entity's internal control may affect the audit. Mention those components of internal
control. MTP October 2020
Controls Relevant to the Audit

There is a direct relationship between an entity’s objectives and the controls implemented to provide reasonable
assurance about their achievement. In other words, controls help in achievement of objectives of the entity.
The auditor shall obtain an understanding of internal control relevant to the audit.
Although most controls relevant to the audit are likely to relate to financial reporting, not all controls that relate to
financial reporting are relevant to the audit.
It is a matter of the auditor’s professional judgment whether a control, individually or in combination with others,
is relevant to the audit.
For example - Internal control over safeguarding of assets against unauthorised acquisition, use, or disposition
may include controls relating to both financial reporting and operations objectives.
The auditor's consideration of such controls is generally limited to those relevant to the reliability of financial
reporting. For example, use of access controls, such as passwords, that limit access to the data and programs that
process cash disbursements may be relevant to a financial statement audit.
Conversely, safeguarding controls relating to operations objectives, such as controls to prevent the excessive use
of materials in production, generally are not relevant to a financial statement audit.
Relevance of control for audit depends on following factors
Factors relevant to the auditor’s judgement about whether a control, individually or in combination with others, is
relevant to the audit may include such matters as the following:
● Materiality.
● The significance of the related risk.
● The size of the entity.
● The nature of the entity’s business, including , its organisation and ownership characteristics .
● The diversity and complexity of the entity’s operations.
● Applicable legal and regulatory requirements.
● The circumstances and the applicable component of internal control.
● The nature and complexity of the systems that are part of the entity’s internal control, including the use of
service organisations.
● Whether, and how, a specific control, individually or in combination with others, prevents, or detects and
corrects, material misstatements.
Question
Factors relevant to the auditor’s judgment about whether a control, individually or in combination with others, is
relevant to the audit may include such matters as materiality, the significance of the related risk etc. Explain in
detail. RTP May 2021

Evaluating Design and Implementation of Relevant Controls.

Evaluating the design of a control involves considering
● whether the control, individually or in combination with other controls,
● is capable of effectively preventing, or detecting and correcting, material misstatements.
Implementation of a control means that the control exists and that the entity is using it.
An improperly designed control may represent a significant deficiency in internal control.
Risk assessment procedures to obtain audit evidence about the design and implementation of relevant controls
may include-
● Inquiring entity personnel.
● Observing the application of specific controls.
● Inspecting documents and reports.
● Tracing transactions through the information system relevant to financial reporting.
Inquiry alone, however, is not sufficient for such purposes.
Obtaining an understanding of an entity’s controls is not sufficient to test their operating effectiveness, unless there
is some automation that provides for the consistent operation of the controls.
Inherent Limitations of I.C.
Limitations which are inseparable from the system of l.C.
Effect
● Due to Limitations of l.C. System,
● it can provide only reasonable,
● not absolute assurance,
● that its objectives are achieved.
Question (Internal Control ) ( ★★★★★)

Briefly discuss the limitations of Internal Control.
Answer
Limitations of Internal Control:
(i) Internal control can provide only reasonable assurance: Internal control, no matter how effective, can
provide an entity with only reasonable assurance about achieving the entity’s financial reporting objectives. The
likelihood of their achievement is affected by inherent limitations of internal control.
(ii) Human judgment in decision-making: Realities that human judgment in decision- making can be faulty
and that breakdowns in internal control can occur because of human error.
(iii) Lack of understanding the purpose: Equally, the operation of a control may not be effective, such as where
information produced for the purposes of internal control (for example, an exception report) is not effectively
used because the individual responsible for reviewing the information does not understand its purpose or fails to
take appropriate action.
(iv) Collusion among People: Additionally, controls can be circumvented by the collusion of two or more
people or inappropriate management override of internal control. For example, management may enter into

side agreements with customers that alter the terms and conditions of the entity’s standard sales contracts,
which may result in improper revenue recognition. Also, edit checks in a software program that are designed to
identify and report transactions that exceed specified credit limits may be overridden or disabled.
(v) Judgements by Management: Further, in designing and implementing controls, management may make
judgments on the nature and extent of the controls it chooses to implement, and the nature and extent of the
risks it chooses to assume.
(vi) Limitations in case of Small Entities: Smaller entities often have fewer employees due to which
segregation of duties is not practicable. However, in a small owner-managed entity, the owner-manager may be
able to exercise more effective oversight than in a larger entity. This oversight may compensate for the generally
more limited opportunities for segregation of duties.
On the other hand, the owner-manager may be more able to override controls because the system of internal
control is less structured. This is taken into account by the auditor when identifying the risks of material
misstatement due to fraud.
Evaluation of Internal Control By Auditor

The examination and evaluation of the internal control system is an indispensable part of the overall audit
programme. The auditor needs reasonable assurance that the accounting system is adequate and that all the
accounting information which should be recorded has in fact been recorded. Internal control normally contributes
to such assurance.
Role/Advantages of Review
It enables the auditor to ascertain whether
1. Internal control system is adequate & operating effectively.
2. I.C. is able to prevent, detect & correct material misstatement.
3. l.C. Properly safeguards the assets.
4. l.C. ensures correct recording of transactions.
5. Reports & Certificates provided by management are reliable.
6. l.C. are weak / excessive in a-particular area.
7. Effective internal audit department is in operation.
8. Suggestions can be given to management to improve the l.C. system.
9. Extensive Substantive procedures are required.
10. Audit procedures or techniques need to be changed from planned ones.

Keyword Story
Tools / Methods to Evaluate Internal Audit
The first step involves determination of the control and procedures laid down by the management.
By reading company manuals, studying organisation charts and flow charts and by making suitable enquiries from
the officers and employees, the auditor may ascertain the character, scope and efficacy of the control system.
To acquaint himself with how all the accounting information is collected and processed and to learn the nature of
controls that makes the information reliable and protects the company’s assets, calls for considerable skill and
knowledge.
In many cases, very little of this information is available in writing; the auditor must ask the right people the right
questions if he is to get the information he wants. It would be better if he makes written notes of the relevant
information and procedures contained in the manual or ascertained on enquiry.
There are four major tools to review IC
1. Narrative Records
2. Check List
3. Questionnaire
4. Flow Chart
Narrative records
This is a complete and exhaustive description of the system as found in operation by the auditor. Actual testing
and observation are necessary before such a record can be developed. It may be recommended in cases where no
formal control system is in operation and would be more suited to small business.

The basic disadvantages of narrative records are:
● To comprehend the system in operation is quite difficult.

● To identify weaknesses or gaps in the system.
● To incorporate changes arising on account of reshuffling of manpower, etc.
Check List
This is a series of instructions and/or questions which a member of the auditing staff must follow and/or answer.
When he completes instruction, he marks his initials in the space against the instruction. Answers to the checklist
instructions are usually Yes,No or Not Applicable. This is again an on the job requirement and instructions are
framed having regard to the desirable elements of control.
Example A few examples of checklist instructions are given hereunder:
1. Are tenders called before placing orders?

2. Are the purchases made on the basis of a written order?
3. Is the purchase order form standardised?
4. Are purchase order forms pre-numbered?
5. Are the inventory control accounts maintained by persons who have nothing to do with custody of work,
receipt of inventory, inspection of inventory and purchase of inventory?
The complete checklist is studied by the Principal/Manager/Senior to ascertain existence of internal control and
evaluate its implementation and efficiency.

Internal Control Questionnaire (HOMEWORK)

Prepare your notes of ICQ on this page

Miscellaneous topics related to IC
Controls over the completeness and accuracy of information

Controls over the completeness and accuracy of information produced by the entity may be relevant to the audit if the auditor
intends to make use of the information in designing and performing further procedures.
For example, in auditing revenue by applying standard prices to records of sales volume, the auditor considers the accuracy of
the price information and the completeness and accuracy of the sales volume data.
Controls relating to operations and compliance objectives may also be relevant to an audit if they relate to data the auditor
evaluates or uses in applying audit procedures.
Controls relating to objectives that are not relevant to an audit -

An entity generally has controls relating to objectives that are not relevant to an audit and therefore need not be considered.
For example, an entity may rely on a sophisticated system of automated controls to provide efficient and effective operations
(such as an airline’s system of automated controls to maintain flight schedules), but these controls ordinarily would not be
relevant to the audit.
Further, although internal control applies to the entire entity or to any of its operating units or business processes, an
understanding of internal control relating to each of the entity’s operating units and business processes may not be relevant to
the audit.
The statute may require the auditor to report on compliance with certain internal controls
In certain circumstances, the statute or the regulation governing the entity may require the auditor to report on compliance
with certain specific aspects of internal controls as a result, the auditor’s review of internal control may be broader and more
detailed.

Identifying and assessing the risk of material misstatement

through understanding the entity and its environment
Basics
The auditor should
● identify and assess
● the risks of material misstatement,
● whether due to fraud or error,
○ at the financial statement
○ and assertion levels
He should understand
● the entity and
● its environment, including the entity's internal control.
He should do the above mentioned steps so that he can design and implement responses to the assessed risks of
material misstatement.
This will help the auditor to reduce the risk of material misstatement to an acceptably low level.
For the purpose of Identifying and assessing the risk of material misstatement, the auditor shall:
a. Identify risks throughout the process of obtaining an understanding of the entity and its environment,
including relevant controls that relate to the risks, and by considering the classes of transactions, account
balances, and disclosures in the financial statements;
b. Assess the identified risks, and evaluate whether they relate more pervasively to the financial
statements as a whole and potentially affect many assertions;
c. Relate the identified risks to what can go wrong at the assertion level, taking account of relevant
controls that the auditor intends to test; and

d. Consider the likelihood of misstatement, including the possibility of multiple misstatements, and whether
the potential misstatement is of a magnitude that could result in a material misstatement.
Why is there a need to understand the entity and its environment?
We cannot audit all the transactions because of ILA. Therefore, we need to decide the nature, time and
extent of the audit procedures and we also need to know the sample size.
To determine NTE of Audit Procedures we need to understand 2 things

1. RMM (SA 315) (Assessment of RMM will help in deciding the NTE of AP)
2. Materiality (SA 320)
RMM can be further divided into

1. Inherent Risk (Risk which is inseparable, risk that belongs to entity and is there because of nature of entity)
2. Control Risk (Risk that IC will fail to PDC Misstatements)
To Assess Inherent risk we need to understand entity and it’s environment and to assess control risk we need to understand the IC of the entity
Always keep in mind 315 is about assessment and not action and we will formulate our response to the
assessed risk in SA 330
Some Definitions
Business risk
A risk resulting from significant conditions, events, circumstances, actions or inactions that could adversely affect
an entity's ability to achieve its objectives.
Risk assessment procedures

The audit procedures are performed to obtain an understanding of the entity and its environment, including the
entity's internal control, to identify and assess the risks of material misstatement at the financial statement and
assertion levels.
Significant risk
An identified and assessed risk of material misstatement that requires special audit consideration.
Material Weakness
● Weakness in internal control that could have a material effect on the financial statements.
● The auditor shall check that whether any material weakness is there in the DIM of the IC.
● The auditor shall communicate material weakness in internal control (if any) on a timely basis to
management.
Risk Assessment Procedures
1. Inquiries of management, and of others within the entity.

2. Analytical procedures
3. Observation and inspection.
Inquiries of management, and of others within the entity

● Information obtained through inquiry from
○ management and

○ from those who are responsible for financial reporting and

○ from others within the entity and
○ other employees with different levels of authority
■ help in identifying risks of material misstatement.
Analytical procedures
● Analytical procedures may help identify the existence of
○ unusual transactions or
○ events and amounts ,
○ ratio and trends
■ that might indicate matters that have audit implications.
● Unusual or unexpected relationships that are identified may assist the auditor in identifying risks of
material misstatement, especially risks of material misstatements due to fraud.
Observation and inspection.

● Observation and inspection may support inquiries of management and others, and may also provide
information about the entity and its environment.
Risk assessment procedures by themselves, however, do not provide sufficient appropriate audit evidence on which
to base the audit opinion.
The auditor also may choose to perform substantive procedures or tests of controls concurrently with risk
assessment procedures because it is efficient to do so.
The risks to be assessed include both those due to error and those due to fraud,
Understanding the entity
Purpose of Understanding
Obtaining an understanding of the entity and its environment, including the entity’s internal control (referred to
hereafter as an “understanding of the entity”), is a continuous, dynamic process of gathering, updating and
analysing information throughout the audit.

The understanding establishes a frame of reference within which the auditor plans the audit and exercises
professional judgment throughout the audit, for example, when:
● Assessing risks of material misstatement of the financial statements;

● Determining materiality in accordance with SA 320;
● Considering the appropriateness of the selection and application accounting policies;
● Identifying areas where special audit consideration may be necessary, for example, related party
transactions, the appropriateness of management’s use of the going concern assumption, or considering
the business purpose of transactions;
● Developing expectations for use when performing analytical procedures;
● Evaluating the sufficiency and appropriateness of audit evidence obtained, such as the appropriateness of
assumptions and of management’s oral and written representations.
How to Understand the entity - Knowledge of the Client’s Business
It is one of the important principles in developing an overall audit plan. In fact without adequate knowledge of the
client's business, a proper audit is not possible.
As per SA-315, “Identifying and Assessing the Risk of Material Misstatement through Understanding the Entity and
Its Environment”, the auditor shall obtain an understanding of the following:

1. Relevant industry, regulatory and other external factors including applicable financial reporting
framework.
2. The nature of the entity, including:
a. Its operations;
b. Its ownership and governance structures;
c. The types of investments that the entity is making and plan to make: &
d. The way that the entity is structured and how it is financed.
3. The entity’s selection and application of accounting policies, including the reasons for changes
thereto.
4. The entity’s objectives and strategies, and those related Business risks that may result in risks of
material Misstatement.
5. The measurement and review of the entity’s financial performance.
Risks that Require Special Audit Consideration
In exercising judgment as to which risks are significant risks, the auditor shall consider the following:
1. Whether the risk is a risk of fraud;
2. Whether the risk is related to recent significant economic, accounting, or other developments;
3. The complexity of transactions;
4. Whether the risk involves significant transactions with related parties;
5. The degree of subjectivity in the measurement of financial information; and
6. Whether the risk involves significant unusual transactions.
Identifying Significant Risks: Significant risks often relate to significant nonroutine transactions or judgmental
matters. Non-routine transactions are transactions that are unusual, due to either size or nature, and that
therefore occur infrequently.
Judgmental matters may include the development of accounting estimates for which there is significant
measurement uncertainty.
Significant risks are inherent risks with both a higher likelihood of occurrence and a higher magnitude of potential
misstatement.
The auditor assesses assertions affected by a significant risk as higher inherent risk. The following are always
significant risks:
● Risks of material misstatement due to fraud

● Significant transactions with related parties that are outside the normal course of business for the entity
Risks of Material Misstatement– Greater for Significant Non-Routine Transactions
Risks of material misstatement may be greater for significant non-routine transactions arising from matters such
as the following:
● Greater management intervention to specify the accounting treatment.
● Greater manual intervention for data collection and processing.
● Complex calculations or accounting principles.
● The nature of non-routine transactions, which may make it difficult for the entity to implement effective
controls over the risks.

Risks of material misstatement– Greater for Significant Judgmental Matters
Risks of material misstatement may be greater for significant judgmental matters that require the development of
accounting estimates, arising from matters such as the following:
● Accounting principles for accounting estimates or revenue recognition may be subject to differing
interpretation.
● Required judgment may be subjective or complex, or require assumptions about the effects of future
events, for example, judgment about fair value.
Risks of material misstatement may be greater for significant judgmental matters that require the development
of accounting estimates. - Correct / Incorrect November 2020 2 marks
IT Related Risk
What are the specific risks related to internal control in an IT environment?
Risks related to internal control in IT environment: The specific risks related to internal control in an IT environment
includes the following
1. Reliance on systems or programs that are inaccurately processing data, processing inaccurate data, or
both. (either data is wrong or data processing is wrong)
2. Unauthorized access to data that may result in destruction of data or improper changes to data, including
the recording of unauthorized or non-existent transactions, or inaccurate recording of transactions.
Particular risks may arise where multiple users access a common database.
3. The possibility of IT personnel gaining access privileges beyond those necessary to perform their assigned
duties thereby breaking down segregation of duties. (Lack of segregation of duties)
4. Unauthorized changes to data in master files.
5. Unauthorized changes to systems or programs.
6. Failure to make necessary changes to systems or programs.
7. Inappropriate manual intervention.


Benefits of IT to an entity’s Internal Control

As per SA 315, IT benefits an entity’s internal control by enabling an entity to:
● Consistently apply predefined business rules and perform complex calculations in processing large
volumes of transactions or data;
● Enhance the timeliness, availability, and accuracy of information ;
● Facilitate the additional analysis of information;
● Enhance the ability to monitor the performance of the entity’s activities and its policies and procedures;
● Reduce the risk that controls will be circumvented;and
● Enhance the ability to achieve effective segregation of duties by implementation security control in
applications, databases, and operating systems.
DOCUMENTING THE RISK

a. The discussion among the engagement team and the significant decisions reached;
b. Key elements of the understanding obtained regarding each of the aspects of the entity and its
environment and of each of the internal control components, the sources of information from which the
understanding was obtained; and the risk assessment procedures performed;
c. The identified and assessed risks of material misstatement at the financial statement level and at the
assertion level ; and
d. The risks identified, and related controls about which the auditor has obtained an understanding.

Test of Control
What
Audit procedures designed to
● evaluate the operating effectiveness of controls
● in preventing, or detecting and correcting, material misstatements at the assertion level.
When (In what situation)

The auditor shall design and perform tests of controls to obtain sufficient appropriate audit evidence as to the
operating effectiveness of relevant controls when:
a) He expects that the controls are operating effectively, or

b) Substantive procedures alone cannot provide sufficient appropriate audit evidence at the assertion level.
How
● Perform other audit procedures in combination with inquiry to obtain audit evidence about the operating
effectiveness of the controls, including
a. How were the controls applied at relevant times during the audit ?
b. The consistency with which they are applied.
c. By whom or by what means they were applied ?
● Determine whether the controls to be tested depend upon other controls (indirect controls), and if so,
whether it is necessary to obtain audit evidence supporting the effective operation of those indirect
controls
In designing and performing tests of controls, the auditor shall obtain more persuasive audit evidence the greater
the reliance the auditor places on the effectiveness of a control.
Or - Greater the reliance we want to place on Effectiveness of a control, We need to increase the extent of testing of
control and obtain more persuasive audit evidence.
When more persuasive audit evidence is needed regarding the effectiveness of a control
a. it may be appropriate to increase the extent of testing of the control and reduce the extent of the degree of reliance
on controls.
b. it may be appropriate to decrease the extent of testing of the control as well as the degree of reliance on controls.
c. it may be appropriate to decrease the extent of testing of the control and increase the extent of the degree of
reliance on controls.
d. it may be appropriate to increase the extent of testing of the control as well as the degree of reliance on controls
Matters to be considered in determining the extent of tests of controls.

1. The frequency of the performance of the control by the entity during the period.
2. The length of time during the audit period that the auditor is relying on the operating effectiveness of the
control. (Hum kitney period ki checking kar rahey hai agar period kam hai toh TOC ka extent _____________)
3. The expected rate of deviation from a control.
4. The relevance and reliability of the audit evidence to be obtained regarding the operating effectiveness of
the control at the assertion level. (How much effect the operating effectiveness of control will have on assertion, if the
operating effectiveness of the control is going to have an high level impact on assertions, then the extent of testing for that particular
controls needs to be increased)

5. The extent to which audit evidence is obtained from tests of other control related to the assertion. (For a
particular assertion there might be multiple controls, if audit evidence is obtained from other internal controls for a particular assertion
is sufficient, then extent of testing can be reduced for other controls for the same assertion)
Using audit evidence obtained in previous audits

In determining whether it is appropriate to use audit evidence about the operating effectiveness of controls
obtained in previous audits, the auditor shall consider the following
If the auditor plans to use audit evidence from a previous audit about the operating effectiveness of specific
controls
● the auditor shall establish that evidence obtained earlier is relevant
● by obtaining audit evidence about whether significant changes in those controls have occurred
subsequent to the previous audit.
For this he will use inquiry, observation and inspection etc.
If there have been changes that affect the continuing relevance of the audit evidence from the previous audit, the
auditor shall test the controls in the current audit
If there have not been such changes, the auditor shall test the controls at least once in every third audit.
The auditor shall test some controls each audit to avoid no testing of controls in the subsequent two audit periods.
This period of testing also depends on factors such as degree of control risk or reliance on internal control. Higher
the risk or higher the reliance lower will be the period.
When the auditor plans to rely on controls over a risk the auditor has determined to be a significant risk, the
auditor shall test those controls in the current period.

Auditor ensures that the tests of control appropriately cover a period of change or fluctuation.
Evaluating the Operating Effectiveness of Controls

Based on the results of the tests of control, the auditor should evaluate whether the internal controls are designed
and operating as contemplated in the preliminary assessment of control risk.
In case of deviations, the auditor will evaluate the deviations.
The evaluation of deviations may result in the auditor concluding that the assessed level of control risk needs to be
revised. In such cases, the auditor would modify the nature, timing and extent of planned substantive procedures.
When evaluating the operating effectiveness of relevant controls, the auditor shall evaluate whether
misstatements that have been detected by substantive procedures indicate that controls are not operating
effectively.
The absence of misstatements detected by substantive procedures, however, does not provide audit evidence that
controls related to the assertion being tested are effective.
A material misstatement detected by the auditor’s procedures is a strong indicator of the existence of a significant
deficiency in internal control.
Specific inquiries by the auditor when deviations from controls are detected.
When deviations from controls upon which the auditor intends to rely are detected, the auditor shall make specific
inquiries to understand these matters and their potential consequences, and shall determine whether
● The tests of controls that have been performed provide an appropriate basis for reliance on the controls
● Additional tests of controls are necessary
● The potential risks of misstatement need to be addressed using substantive procedures.
Timing of Test of Controls
The auditor shall test controls for

● the particular time, or
● throughout the period,
in order to provide an appropriate basis for the auditor’s intended reliance.
Audit evidence pertaining only to a point in time may be sufficient for the auditor’s purpose, for example, when
testing controls over the entity’s physical inventory counting at the period end.
If, on the other hand, the auditor intends to rely on a control over a period, tests that are capable of providing audit
evidence that the control operated effectively at relevant times during that period are appropriate.
Such tests may include tests of the entity’s monitoring of controls.

Substantive Procedures
What?
Substantive procedure may be defined as an audit procedure designed to detect material misstatements at the
assertion level.
Substantive procedures comprise:

1. Tests of details (of classes of transactions, account balances, and disclosures), and
2. Substantive analytical procedures.
Designing and Performing Substantive Procedures

Irrespective of the assessed risks of material misstatement, the auditor shall design and perform substantive
procedures for each material class of transactions, account balance, and disclosure.
1. This requirement reflects the facts that:

a. the auditor’s assessment of risk is judgemental and so may not identify all risks of material
misstatement; and (Can auditor identify all risks of material misstatement? _______________)
b. there are inherent limitations to internal control, including management override.
2. Depending on the circumstances, the auditor may determine that

a. Performing only substantive analytical procedures will be sufficient to reduce audit risk to an
acceptably low level. For example, where the auditor’s assessment of risk is supported by audit
evidence from tests of controls.
b. Only tests of details are appropriate.
c. A combination of substantive analytical procedures and tests of details are most responsive to the
assessed risks.
3. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend
to be predictable over time. SA 520, “Analytical Procedures” establishes requirements and provides guidance on the
application of analytical procedures during an audit.
4. The nature of the risk and assertion is relevant to the design of tests of details.
a. For example, tests of details related to the existence or occurrence assertion may involve selecting
from items contained in a financial statement amount and obtaining the relevant audit
evidence.
b. On the other hand, tests of details related to the completeness assertion may involve selecting
from items that are expected to be included in the relevant financial statement amount and
investigating whether they are included.
5. Because the assessment of the risk of material misstatement takes account of internal control, the extent
of substantive procedures may need to be increased when the results from test of controls are
unsatisfactory.
6. In designing tests of details, the extent of testing is ordinarily thought of in terms of the sample size.
However, other matters are also relevant, including whether it is more effective to use other selective
means of testing.
Substantive Procedures Related to the Financial Statement Closing Process

The auditor’s substantive procedures shall include the following audit procedures related to the financial
statement closing process:
a. Agreeing or reconciling the financial statements with the underlying accounting records; and
b. Examining material journal entries and other adjustments made during the course of preparing the
financial statements.
The nature, and also the extent, of the auditor’s examination of journal entries and other adjustments depends on
the nature and complexity of the entity’s financial reporting process and the related risks of material
misstatement.
Substantive Procedures Responsive to Significant Risks:

When the auditor has determined that an assessed risk of material misstatement at the assertion level is a
significant risk, the auditor shall perform substantive procedures that are specifically responsive to that risk.
When the approach to a significant risk consists only of substantive procedures, those procedures shall include
tests of details.

Internal Audit
Definition
As defined in the scope of the Standards on Internal Audit, Internal Audit means
● “An independent management function,
● which involves a continuous and critical appraisal
● of the functioning of an entity
● with a view to suggest improvements thereto and
● add value to and strengthen the overall governance mechanism of the entity,
● including the entity’s strategic risk management and internal control system.
Applicability of Provisions of Internal Audit - Section 138

(1) Such class or classes of companies as may be prescribed shall be required to appoint an internal auditor, who
shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by
the Board to conduct internal audit of the functions and activities of the company.
(2) The Central Government may, by rule, prescribe the manner and the intervals in which the internal audit shall
be conducted and reported to the Board.
Rule 13 - Companies required to appoint Internal auditor

13. (1) The following class of companies shall be required to appoint an internal auditor which may be either an
individual or a partnership firm or a body corporate, namely:—
a. every listed company;
b. every unlisted public company having-
i. paid up share capital of fifty crore rupees or more during the preceding financial year; or (ठीक ठीक )
ii. turnover of two hundred crore rupees or more during the preceding financial year, or (बहुत ज़्यादा )
iii. outstanding loans or borrowings from banks or public financial institutions exceeding one
hundred crore rupees or more at any point of time during the preceding financial year; or (ज़्यादा) )
iv. outstanding deposits of twenty five crore rupees or more at any point of time during the
preceding financial year: and (कम )
c. every private company having-
i. turnover of two hundred crore rupees or more during the preceding financial year, or
ii. outstanding loans or borrowings from banks or public financial institutions exceeding one hundred
crore rupees or more at any point of time during the preceding financial year:
Provided that an existing company covered under any of the above criteria shall comply with the requirements of
section 138 and this rule within six months of commencement of such section.
Explanation. - For the purposes of this rule -

i. the internal auditor may or may not be an employee of the company;
ii. The term "Chartered Accountant" or "Cost Accountant" shall mean a "Chartered Accountant" or a "Cost
Accountant", as the case may be, whether engaged in practice or not.
(2) The Audit Committee of the company or the Board shall, in consultation with the Internal Auditor, formulate the
scope, functioning, periodicity and methodology for conducting the internal audit.
Few members of the Board of Directors oppose the appointment of Mr. N, an employee of the company, as an Internal Auditor, stating

that Mr. N is not a chartered accountant and further he is an employee of the company.
Objective and Scope of Internal Audit Function




Discuss the objectives and scope of internal audit functions with respect to activities relating to internal control.
Correct / Incorrect Marks 2 January 2021 Exam Question The objectives and scope of internal audit
functions are restricted to activities relating to evaluation of internal control only.

Basics of Internal Financial Controls and Reporting Requirements
● Sec 134(5)(e) of companies Act,2013 defines the term Internal Financial Control as
○ the policies and procedures adopted by the company for ensuring
■ the orderly and efficient conduct of its business, including Adherence to company’s
policies,
■ The safeguarding of its assets,
■ The prevention and detection of frauds and errors,
■ The accuracy and completeness of the accounting records, and
■ The timely preparation of reliable financial information.
● Rule 8(5)(viii) of the companies (Accounts) Rules,2014 requires that the director’s report should contain
details in respect of adequacy of internal financial controls with reference to the financial reporting.
Auditor’s responsibility for reporting on IFC
Clause (i) of Sec.143 (3) of the companies Act,2013 requires the company auditor to report whether the company
has adequate internal financial controls with reference to financial statements in place and the operating
effectiveness of such controls.

“Our responsibility is to express an opinion on the Company’s internal financial controls over financial reporting
based on our audit”
Objectives of an auditor in an audit of internal financial controls over financial reporting: The auditor’s objective in
an audit of internal financial controls over financial reporting is, “ to express an opinion on the effectiveness of the
company’s internal financial controls over financial reporting.” It is carried out along with an audit of the financial
statements.
Auditor’s reporting on internal financial controls is a requirement specified in the Act and, therefore, will apply only
in case of reporting on financial statements prepared under the Act and reported under Section 143.
Accordingly, reporting on internal financial controls will not be applicable with respect to interim financial
statements, such as quarterly or half-yearly financial statements, unless such reporting is required under any other
law or regulation.
Explain how Internal Financial Control and Internal controls over financial reporting differ?
Answer as per ICAI Suggested Answer - For Details and Source Please refer www.icai.org
Difference between internal financial control and internal control over financial reporting
● Sec 134(5)(e) of companies Act,2013 defines the term Internal Financial Control as
○ the policies and procedures adopted by the company for ensuring
■ the orderly and efficient conduct of its business, including Adherence to company’s
policies,
■ The safeguarding of its assets,
■ The prevention and detection of frauds and errors,
■ The accuracy and completeness of the accounting records, and
■ The timely preparation of reliable financial information.
On the other hand, Internal controls over financial reporting-is required where auditors are required to express
an opinion on the effectiveness of an entity’s internal controls over financial reporting, such opinion is in addition
to and distinct from the opinion expressed by the auditor on the financial statements.
SA 265
COMMUNICATING DEFICIENCIES IN INTERNAL
CONTROL TO THOSE CHARGED WITH
GOVERNANCE AND MANAGEMENT
1. This Standard on Auditing (SA) deals with the auditor's responsibility to communicate appropriately to
those charged with governance and management deficiencies in internal control that the auditor has
identified in an audit of financial statements.
2. Deficiency in internal control - This exists when

a. A control is designed, implemented or operated in such a way that it is unable to prevent, or

detect and correct, misstatements in the financial statements on a timely basis; or
b. A control necessary to prevent, or detect and correct, misstatements in the financial statements on
a timely basis is missing.
c. Significant deficiency in internal control - A deficiency or combination of deficiencies in internal
control that, in the auditor's professional judgment, is of sufficient importance to merit the
attention of those charged with governance. जिस पर TCWG का ध्यान लाना ज़रूरी है
3. Requirements
a. The auditor shall determine whether, on the basis of the audit work performed, the auditor has
identified one or more deficiencies in internal control. कुछ मिली क्या
b. If the auditor has identified one or more deficiencies in internal control, the auditor shall determine,
they constitute significant deficiencies or not. - मिली तो SIGNIFICANT है क्या ?
c. The auditor shall communicate in writing significant deficiencies in internal control identified
during the audit to those charged with governance on a timely basis. The auditor shall also
communicate to management at an appropriate level of responsibility on a timely basis:
(Significant है तो TCWG और Apt. level of Mgt. को Communicate करदो in writing)
d. The auditor shall include in the written communication of significant deficiencies in internal control
i. A description of the deficiencies and an explanation of their potential effects; क्या थी और इस से
क्या हो सकता है
ii. Sufficient information to enable those charged with governance and management to
understand the context of the communication. In particular, the auditor shall explain that:
➢ The purpose of the audit was for the auditor to express an opinion on the financial
statements;
➢ The audit included consideration of internal control relevant to the preparation of
the financial statements in order to design audit procedures that are appropriate
in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of internal control; and
➢ The matters being reported are limited to those deficiencies that the auditor has
identified during the audit and that the auditor has concluded are of sufficient
importance
Letter of Weakness
1. The auditor does compliance procedure to ascertain that the internal control system exist in the entity, it
works effectively; it work continuously in the entity during review period.
2. When he comes across any weakness in the control points, he issues letter of weakness.
3. Letter of weakness is a report issued by auditor stating the weakness in internal control mechanism. It also
suggests measures by which the weakness in the system be corrected and the control system be made
better protected.
4. Lapses in operation of internal control too are reported in the communication of weakness.
5. The communication of weakness is reporting to management of such weakness in design and operation of
internal control as have come to notice of auditor during his auditing and it should not be taken to be a
review and comment on adequacy of the control mechanism for management purpose.

Components of Internal Control
The Control Environment
Question (Internal Control | Components of Control Internal Control)

The auditor of XYZ Ltd, engaged in FMCG (Fast Moving Consumable Goods) obtains an understanding of
the control environment. As part of obtaining this understanding, the auditor evaluates whether:
● Management has created and maintained a culture of honesty and ethical behavior; and
● The strengths in the control environment elements collectively provide an appropriate foundation
for the other components of internal control.
Advise what is included in the control environment. Also explain the elements of control environment.
Answer
Control Environment – Component of Internal Control: The auditor shall obtain an understanding of the
control environment. As part of obtaining this understanding, the auditor shall evaluate whether:
● Management has created and maintained a culture of honesty and ethical behavior; and
● The strengths in the control environment elements collectively provide an appropriate foundation for the
other components of internal control.
What is included in Control Environment?

The control environment includes:
● The governance and management functions and
● The attitudes, awareness, and actions of those charged with governance and management.
The control environment sets the tone of an organization, influencing the control consciousness of its people.
Elements of the Control Environment: Elements of the control environment that may be relevant when
obtaining an understanding of the control environment include the following:
a. Communication and enforcement of integrity and ethical values – These are essential elements that
influence the effectiveness of the design, administration and monitoring of controls.
b. Commitment to competence – Matters such as management’s consideration of the competence levels
for particular jobs and how those levels translate into requisite skills and knowledge.
c. Participation by those charged with governance – Attributes of those charged with governance such
as:
i. Their independence from management.
ii. Their experience and stature.
iii. The extent of their involvement and the information they receive, and the scrutiny of activities.
iv. The appropriateness of their actions, including the degree to which difficult questions are raised
and pursued with management, and their interaction with internal and external auditors.
d. Management’s philosophy and operating style – Characteristics such as management’s:
i. Approach to taking and managing business risks.
ii. Attitudes and actions toward financial reporting.
iii. Attitudes toward information processing and accounting functions and personnel.
e. Organisational structure – The framework within which an entity’s activities for achieving its objectives
are planned, executed, controlled, and reviewed.
f. Assignment of authority and responsibility - Matters such as how authority and responsibility for
operating activities are assigned and how reporting relationships and authorisation hierarchies are
established.
g. Human resource policies and practices – Policies and practices that relate to, for example, recruitment,
orientation, training, evaluation, counseling, promotion, compensation, and remedial actions.

Satisfactory Control Environment – not an absolute deterrent to fraud
The existence of a satisfactory control environment can be a positive factor when the auditor assesses the risks of
material misstatement. However, although it may help reduce the risk of fraud, a satisfactory control environment
is not an absolute deterrent to fraud. Conversely, deficiencies in the control environment may undermine the
effectiveness of controls, in particular in relation to fraud. For example, management’s failure to commit sufficient
resources to address IT security risks may adversely affect internal control by allowing improper changes to be
made to computer programs or to data, or unauthorized transactions to be processed. As explained in SA 330, the
control environment also influences the nature, timing, and extent of the auditor’s further procedures.
The control environment in itself does not prevent, or detect and correct, a material misstatement. It may, however,
influence the auditor’s evaluation of the effectiveness of other controls (for example, the monitoring of controls and
the operation of specific control activities) and thereby, the auditor’s assessment of the risks of material
misstatement.
The Entity’s Risk Assessment Process– Component of IC
The auditor shall obtain an understanding of whether the entity has a process for:
a. Identifying business risks relevant to financial reporting objectives;
b. Estimating the significance of the risks;
c. Assessing the likelihood of their occurrence; and
d. Deciding about actions to address those risks.
NOTES
● The entity’s risk assessment process forms the basis for the risks to be managed.
● If that process is appropriate, it would assist the auditor in identifying risks of material misstatement.
● Whether the entity’s risk assessment process is appropriate to the circumstances is a matter of judgment.
Information System - Component of IC
The auditor shall obtain an understanding of the information system, including the related business processes,
relevant to financial reporting, including the following are as:
a. The classes of transactions in the entity’s operations that are significant to the financial statements
b. The procedures by which those transactions are initiated, recorded, processed, corrected as necessary,
transferred to the general ledger and reported in the financial statements;
c. The related accounting records, supporting information and specific accounts in the financial statements
that are used to initiate, record, process and report transactions;
d. How the information system captures events and conditions that are significant to the financial
statements;
e. The financial reporting process used to prepare the entity’s financial statements;
f. Controls surrounding journal entries.
Question
The auditor shall obtain an understanding of the information system, including the related business
processes, relevant to financial reporting, including the classes of transactions in the entity’s operations

that are significant to the financial statements, controls surrounding journal entries etc. Explain the other
considerations in this regard
RTP May 2021 - https://youtu.be/o2jR94vjHio
Control Activities - Component of IC
The auditor of PQR Ltd, a company engaged in the manufacturing of Auto parts obtains an understanding of
control activities relevant to the audit, which the auditor considers necessary to assess the risks of material
misstatement.
Auditor is of the view that he requires an understanding of only those control activities related to significant
class of transactions, account balance, and disclosure in the financial statements and the assertions which
the auditor finds relevant in his risk assessment process.
Advise explaining the meaning of control activities. Also identify and explain the control activities which are
relevant to the audit.
Answer
Control Activities - Component of Internal Control
The auditor shall obtain an understanding of control activities relevant to the audit, which the auditor considers
necessary to assess the risks of material misstatement. An audit requires an understanding of only those control
activities related to significant class of transactions, account balance, and disclosure in the financial statements
and the assertions which the auditor finds relevant in his risk assessment process.
Control activities are the policies and procedures that help ensure that management directives are carried
out.
Control activities, whether within IT or manual systems, have various objectives and are applied at various
organisational and functional levels.
Control activities that are relevant to the audit are:

● Control activities that relate to significant risks and those that relate to risks for which substantive
procedures alone do not provide sufficient appropriate audit evidence.; or
● Those that are considered to be relevant in the judgment of the auditor.
● As part of the risk assessment, the auditor shall determine whether any of the risks identified are, in
the auditor’s judgment, a significant risk.
The auditor shall obtain an understanding of control activities relevant to the audit, which the auditor
considers necessary to assess the risks of material misstatement. Explain in detail stating clearly the
meaning of control activities and also discuss control activities that are relevant to the audit.
RTP May 2021 - https://youtu.be/p-6KV-uIMrk
Monitoring of Control - Component of IC

Knowledge
● This is the client's process of assessing the effectiveness of controls over time and taking necessary
remedial action.
● Monitoring can be either ongoing or performed on a separate evaluation basis (or a combination of
both).
● Monitoring of internal controls is often the key role of internal auditors.
Monitoring of Controls – Component of Internal Control

The auditor shall obtain an understanding of the major activities that the entity uses to monitor internal control
over financial reporting.
Monitoring of controls Defined: Monitoring of controls is a process to assess the effectiveness of internal control
performance over time.
1. Helps in assessing the effectiveness of controls on a timely basis: It involves assessing the effectiveness of
controls on a timely basis and taking necessary remedial actions.
2. Management accomplishes through ongoing activities, separate evaluations etc.: Management

accomplishes monitoring of controls through ongoing activities, separate evaluations, or a combination of
the two. Ongoing monitoring activities are often built into the normal recurring activities of an entity and
include regular management and supervisory activities.
3. Management’s monitoring activities include: Management’s monitoring activities may include using
information from communications from external parties such as customer complaints and regulator
comments that may indicate problems or highlight areas in need of improvement.
4. In case of Small Entities: Management’s monitoring of control is often accomplished by management’s or

the owner-manager’s close involvement in operations. This involvement often will identify significant
variances from expectations and inaccuracies in financial data leading to remedial action to the control.
The auditor shall obtain an understanding of major activities that the entity uses to monitor internal
control over financial reporting. Discuss "Monitoring of control'' as a component of Internal control.
November 2020 4 marks
Examples of Components of Internal Control (Read them for knowledge purpose, not for exams)
1. Control environment - communication of ethical values to personnel through policy statements and codes
of conduct.
2. Risk assessment process – management monitors changes in the operating environment to plan for the
future.
3. Information system - quarterly management accounts are presented to the board of directors for their
consideration.
4. Control activities - an annual inventory count is held to confirm the quantities of inventories physically held.
5. Monitoring of controls – Internal audit conducts a regular review of sales personnel's compliance with the
company's terms of sales contracts

Chapter 5 - FRAUD AND RESPONSIBILITIES OF

THE AUDITOR IN THIS REGARD
Meaning of Fraud
SA
240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”
Characteristics of Fraud
Intentional
● Misstatements in the financial statements can arise from either fraud or error.
● The distinguishing factor between fraud and error is whether misstatement of the financial statements is
intentional or unintentional.
Fraud is a broad legal concept.

Although fraud is a broad legal concept, for the purposes of the SAs, the auditor is concerned with fraud that
causes a material misstatement in the financial statements.
Two types of intentional misstatements are relevant to the auditor

● Misstatement resulting from fraudulent financial reporting.
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● Misstatements resulting from misappropriation of assets.
Although the auditor may suspect or, in rare cases, identify the occurrence of fraud, the auditor does not make
legal determinations of whether fraud has actually occurred.
Fraud Involves
Fraud, whether fraudulent financial reporting or misappropriation of assets, involves incentive or pressure to
commit fraud, a perceived opportunity to do so and some rationalisation of the act.
● Incentive or pressure to commit fraud: it may exist when management is under pressure, from sources
outside or inside the entity, to achieve an expected (and perhaps unrealistic )earnings target or financial
outcome.
● A perceived opportunity to do so: It may exist when an individual believes internal control can be
overridden, for example, because the individual is in a position of trust or has knowledge of specific
weaknesses in internal control.
● Rationalisation of the act: Individuals may be able to rationalise committing fraudulent act. Some
individuals possess an attitude, character or set of ethical values that allow them knowingly and
intentionally to commit a dishonest act. However, even otherwise honest individuals can commit fraud in
an environment that imposes sufficient pressure on them.
Fraudulent Financial Reporting

Involves intentional misstatements including omissions of amounts or disclosures in financial statements to
deceive financial statement users.
May be Accomplished By
● Manipulation, falsification (including forgery), or alteration of accounting records
● Misrepresentation / Intentional omission
● Intentional Misapplication of accounting principle

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● Management Override of Control
Manipulation of Accounts
Detection of manipulation of accounts with a view to presenting a false state of affairs is a task requiring great
tact and intelligence because
● generally management personnel in higher management cadre are associated with this type of fraud and
● This is perpetrated in a methodical way.
This type of fraud is generally committed:
a. to avoid incidence of income-tax or other taxes;

b. for declaring a dividend when there are insufficient profits;
c. to withhold declaration of dividend even when there is adequate profit (this is often done to manipulate
the value of shares in stock market to make it possible for selected persons to acquire shares at a lower
cost); and
d. for receiving higher remuneration where managerial remuneration is payable by reference to profits.
Ways in Which Manipulation of Accounts can take place

There are numerous ways of committing this type of fraud. Some of the methods are given below
● inflating or suppressing purchases and expenses.

● inflating or suppressing sales and other items of income.
● inflating or deflating the value of closing inventory;
● failing to adjust outstanding liabilities or prepaid expenses.
● charging items of capital expenditure to revenue or by capitalising revenue expenses.
Misrepresentation in or intentional omission from, the financial statements of events, transactions or other
significant information.
Intentional misapplication of accounting principles relating to amounts, classification, manner of presentation, or

disclosure.
Management Override of Control
Fraudulent financial reporting often involves management override of controls that otherwise may appear to be
operating effectively. Fraud can be committed by management overriding controls using such techniques as:
● Recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate
operating results or achieve other objectives.
● Inappropriately Adjusting assumptions and changing judgments used to estimate account balances.
● Concealing, or not disclosing, Facts that could affect the amounts recorded in the financial statements.

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● Engaging in complex Transactions that are structured to misrepresent the financial position or financial
performance of the entity.
● Altering records and terms related to significant and unusual transactions.

● Omitting, advancing or delaying Recognition in the financial statements of events and transactions that
have occurred during the reporting period.

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Why do Management/ Employees commit fraud? What induces Management/ Employees to

commit fraud?
Following are certain instances which will help to understand these questions.
● Financial obligations/ Pressure.

● Management’s unrealistic goals.
● Dissatisfied Employees or Lack of motivation among employees.
● Opportunity to commit fraud.
● Name game (eg. management using power of authority by asking employees to do something illegal).

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Misappropriation of Assets
● Misappropriation of assets
○ means the theft of an entity’s assets and

○ is often perpetrated by employees
■ in relatively small and immaterial amounts.
○ However, it can also involve management who are usually more capable of disguising or
concealing misappropriations in ways that are difficult to detect.
● Misappropriation of assets can be accomplished in a variety of ways including
○ Embezzling receipts (for example, misappropriating collections on accounts receivable or diverting

receipts in respect of written-off accounts to personal bank accounts).
○ Stealing physical assets or intellectual property (for example, stealing inventory for personal use
or for sale, stealing scrap for resale, colluding with a competitor by disclosing technological data in
return for payment).
○ Causing an entity to pay for goods and services not received (for example, payments to fictitious
vendors, kickbacks paid by vendors to the entity’s purchasing agents in return for inflating prices,
payments to fictitious employees).
○ Using an entity’s assets for personal use (for example, using the entity’s assets as collateral for a
personal loan or a loan to a related party).
Misappropriation of Goods

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Fraud in the form of misappropriation of goods is difficult to detect;
For this, management has to rely on various measures. Such as

● Proper record-keeping
● Periodic checks
● Rules related to access of warehouse or other areas where goods are kept
● Authorisation procedures for using or taking the goods out of the relevant premises
Goods can be anything in the premises; it may be machinery. It may even be the daily necessities of the office like
stationery.
The goods may be removed by subordinate employees or even by persons quite higher up in the management.
Auditors can detect this by undertaking a thorough and strenuous checking of records followed by a physical
verification process.
Also, by resorting to the intelligent ratio analysis, auditors may be able to form an idea of whether such fraud exists.
Ways of Defalcating Cash
1. Inflating Cash Payments

a. Making payments against fictitious vouchers.
b. Making payments against vouchers, the amounts whereof have been inflated.
c. Manipulations totals of wage by including names of dummy workers in wage rolls.
d. Overcasting for petty cash expenditure.
2. Suppressing cash receipts

a. Teeming and lading
b. Adjusting unauthorised rebates, allowances, discounts etc. to customers’ accounts and
misappropriating amount paid by them.
c. Writing off is as debts in respect of balances against which cash has already been received but has
been misappropriated.
d. Not accounting for cash sales fully.
e. Not accounting for miscellaneous receipts e.g sale of scrap etc.
f. Writing down asset values in entirely, selling them subsequently and misappropriating the
proceeds.
3. By casting wrong totals in the cash book.

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Teeming and Lading

Amount received from a customer being misappropriated; also to prevent its detection the money received from
another customer subsequently being credited to the account of the customer who has paid earlier.
Similarly, money received from the customer who has paid thereafter is credited to the account of the second
customer and such a practice is continued so that no one account is outstanding for payment for any noticeable
length of time, which may lead the management to either send out a statement of account to him or
communicate with him.

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Detection of fraud and error duty of an auditor
Primary responsibility
As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”,
● The primary responsibility for the prevention and detection of fraud rests with both those charged with
governance of the entity and management.
● It is important that management, with the oversight of those charged with governance, place a strong
emphasis on fraud prevention, detection of Fraud/Error.
● This involves a commitment to creating a culture of honesty and ethical behaviour which can be reinforced
by an active oversight by those charged with governance.
Broadly, the general principles laid down in the SA may be noted as under:
Auditor’s Objective
● An auditor conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance
that the financial statements taken as a whole are free from material misstatement, whether caused by
fraud or error.
Owning to ILA
● As described in SA 200, “Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Standards on Auditing,”
○ owing to the inherent limitations of an audit, there is an unavoidable risk that some material
misstatements of the financial statements will not be detected,
○ even though the audit is properly planned and performed in accordance with the SAs.
Risk of not detecting

● The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not
detecting one resulting from error.
● This is because fraud may involve
○ sophisticated and carefully organized schemes designed to conceal it, such as
■ forgery,
■ deliberate failure to record transactions, or
■ intentional misrepresentations being made to the auditor.
Management Fraud
● Furthermore, the risk of the auditor not detecting a material misstatement resulting from management
fraud is greater than for employee fraud,
○ because management is frequently in a position to
■ directly or indirectly manipulate accounting records,
■ present fraudulent financial information or

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■ override control procedures designed to prevent similar frauds by other employees.
Professional Skepticism
● When obtaining reasonable assurance, the auditor is responsible for maintaining an attitude of
professional skepticism throughout the audit, considering the potential for management override of
controls and recognizing the fact that audit procedures that are effective for detecting error may not be
effective in detecting fraud.
Auditor’s failure and Negligence

The subsequent discovery of a material misstatement of the financial statements resulting from fraud or error does
not by itself indicate a failure to conduct an audit in accordance with SAs.
“ If there remains a deep-laid fraud in the accounts, which in the normal course of examination of accounts may
not come to light,
● It will not be construed as a failure of audit,
Auditor WILL NOT BE considered negligent

● If he has carried out his work in accordance
○ with SA’s and
Whether the auditor has performed an audit in accordance with SAs and law and regulations is determined by the

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AUDITOR UNABLE TO CONTINUE THE ENGAGEMENT

If, as a result of a misstatement resulting from fraud or suspected fraud, the auditor encounters exceptional
circumstances that bring into question the auditor’s ability to continue performing the audit, the auditor shall:
Responsibilities Applicable, Including reporting requirement

● Determine the professional and legal responsibilities applicable in the circumstances,
○ including whether there is a requirement
○ for the auditor to report to the person or persons who made the audit appointment or, in some
cases, to regulatory authorities;
Withdrawal
Withdrawal if possible
● Consider whether
○ it is appropriate to withdraw from the engagement,
○ where withdrawal is possible under applicable law or regulation; and
Discuss withdrawal and reasons, Determine requirement to report withdrawal and reasons
● If the auditor withdraws:
○ Discuss with the appropriate level of management and those charged with governance the
auditor’s withdrawal from the engagement and the reasons for the withdrawal; and
○ Determine whether there is a professional or legal requirement to report to the person or persons
who made the audit appointment or, in some cases, to regulatory authorities,
■ the auditor’s withdrawal from the engagement and the reasons for the withdrawal.

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FRAUD RISK FACTORS AND the POSSIBILITY OF FRAUD
Fraud Risk Factors - Defined

Fraud Risk Factors may be defined as events or conditions that indicate an incentive or pressure to commit fraud
or provide an opportunity to commit fraud.
Fraud Risk Factors Examples For Fraudulent Financial Reporting

Risk Factors Relating to Misstatements Arising from Fraudulent Financial Reporting: The following are examples of
risk factors relating to misstatements arising from fraudulent financial reporting
Incentive / Pressure
Financial stability or profitability is threatened by economic, industry or entity operating conditions such as
a) High degree of competition or market saturation, accompanied by declining margins.

b) High vulnerability to rapid changes, such as changes in technology, product obsolescence, or interest
rates.
c) Significant declines in customer demand and increasing business failures in either the industry or the
overall economy.
d) Operating losses making the threat of bankruptcy, foreclosure, or hostile takeover imminent.
e) Recurring negative cash flows from operations or an inability to generate cash flows from operations while
reporting earnings and earnings growth.
f) New accounting, statutory, or regulatory requirements.
Opportunities
The nature of the industry or the entity’s operations provides opportunities to engage in fraudulent financial
reporting that can arise from the following:
a) Significant related-party transactions not in the ordinary course of business.
b) A strong financial presence or ability to dominate a certain industry sector that allows the entity to
dictate terms or conditions to suppliers or customers that may result in inappropriate or non-arm’s length

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transactions.
c) Assets, liabilities, revenues, or expenses based on significant estimates that involve subjective judgements
or uncertainties that are difficult to corroborate.
d) Significant, unusual, or highly complex transactions, especially those close to the period end that pose
difficult “substance over form” questions.
e) Significant bank accounts or subsidiary or branch operations in tax haven jurisdictions for which there
appears to be no clear business justification.
Attitudes /Rationalizations
Communication, implementation, support, or enforcement of the entity’s values or ethical standards by
management, or the communication of inappropriate values or ethical standards, that are not effective.
a) Known history of violations of securities laws or other laws and regulations, or claims against the entity, its
senior management or TCWG alleging fraud or violations of laws and regulations.
b) Excessive interest by management in maintaining or increasing the entity’s stock price or earning
trend.
c) Management failing to correct known material weaknesses in internal control or in a timely basis.
d) An interest by management in employing inappropriate means to minimize reported earnings for
tax-motivated reasons.
e) The owner-manager makes no distinction between personal and business transactions.
f) The relationship between management and the current or predecessor auditor is strained, as exhibited by
the following:
● Frequent disputes with the current or, predecessor auditor on accounting, auditing, or reporting
matters.
● Unreasonable demands on the auditor, such as unrealistic time constraints regarding the
completion of the audit or the issuance of the auditor’s report.
● Restrictions on the auditor that inappropriately limit access to people or information or the ability
to communicate effectively with those charged with governance.
● Domineering management behaviour in dealing with the auditor, especially involving attempts to
influence the scope of the auditor’s work or the selection or continuance of personnel assigned to
or consulted on the audit engagement.
Fraud Risk factors Examples relating to misstatements arising from Misappropriation of

Assets.
Incentives / pressures
Personal financial obligations may create pressure on management or employees with access to cash or other
assets susceptible to theft to misappropriate those assets.
Adverse relationships between the entity and employees with access to cash or other assets susceptible to theft
may motivate those employees to misappropriate those assets. For example, adverse relationships may be created
by the following:
a) Known or anticipated future employee layoffs.
b) Recent or anticipated changes to employee compensation or benefits plans.

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c) Promotions, compensation, or other rewards inconsistent with expectations.
Opportunities
Certain characteristics or circumstances may increase the susceptibility of assets to misappropriation. For example,
opportunities to misappropriate assets increase when there are the following:
a) Large amounts of cash on hand or processed.
b) Inventory items that are small in size, of high value, or in high demand.
c) Easily convertible assets, such as bearer bonds, diamonds, or computer chips.
d) Fixed assets that are small in size, marketable, or lacking observable identification of ownership.
Inadequate internal control over assets may increase the susceptibility of misappropriation of those assets. For
example, misappropriation of assets may occur because there is the following:
1. Inadequate segregation of duties or independent checks.

2. Inadequate oversight of senior management expenditures, such as travel and other reimbursements.
3. Inadequate management oversight of employees responsible for assets, for example, inadequate
supervision or monitoring of remote locations.
4. Inadequate job applications screening of employees with access to assets.
5. Inadequate record-keeping with respect to assets.
6. Lack of mandatory vacations for employees performing key control functions.
7. Inadequate system of authorization and approval of transactions (for example, in purchasing)
8. Inadequate physical safeguards over cash, investments, inventory, or fixed assets.
9. Inadequate access controls over automated records, including controls over and review of computer
systems event logs.
10. Lack of timely and appropriate documentation of transactions, for example, credits for merchandise
returns.
11. Lack of complete and timely reconciliations of assets.
12. Inadequate management understanding of information technology, which enables information
technology employees to perpetrate a misappropriation.
Attitudes /Rationalizations
a) Disregard for the need for monitoring or reducing risks related to misappropriations of assets.
b) Disregard for internal control over misappropriation of assets by overriding existing controls or by failing to
correct known internal control deficiencies.
c) Behaviour indicating displeasure or dissatisfaction with the entity or its treatment of the employee.
d) Changes in behaviour or lifestyle that may indicates assets have been misappropriated.
e) Tolerance of petty theft.

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Circumstances Relating to Possibility of Fraud

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Chapter 6 - Audit in Automated Environment

Automated Environment and Audit - Basics
Introduction
Transactions are executed and recorded electronically through computer systems and use of Information
technology.
Internal controls are also based on Information technology.
Computers are used for preparation of financial information and maintenance of records.
It is critical to understand the IT specific risks that could potentially impact the integrity and reliability of
financial transactions and data flowing through a company’s systems.
What is an automated environment?
An automated environment basically refers to a business environment where the

- Processes,
- Operations,
- Accounting and
- Even Decisions are carried out by using computer systems – also known as Information Systems (IS) or
Information Technology (IT) systems.
The fundamental principle of an automated environment is the ability to carry out business with less
manual intervention and more system driven.
The complexity of a business environment depends on the level of automation i.e., if a business environment
is more automated, it is likely to be more complex.
Entity uses different softwares to initiate, execute, process and record the transaction, these systems can be
in the form of Enterprise Resource Planning Packages (ERPs) or simple accounting softwares.
ERPs are comparatively more automated and hence more complex.
Key features of an Automated Environment

The key features of an automated environment are as follows.
- Enables faster business operation.

- Accuracy in data processing and computation
- Ability to process large volumes of transactions
- Integration between business operations
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- Better security and controls

- Less prone to human errors
- Provides latest information
- Connectivity and Networking capability
Relevance of IT in auditing
Business functions and activities happening within the systems
When a business operates in a more automated environment it is likely that we will see several business
functions and activities happening within the systems.
For Example
● Computation and Calculations are automatically carried out (for example, bank interest
computation and inventory valuation)
● Accounting entries are posted automatically (Posting from Journal Entries to ledger and then to trial
balance, Profit & Loss, Balance Sheet and Cash Flow)
● Business policies and procedures, including internal controls, are applied automatically (for example,
customer credit limit checks are performed automatically)
● Reports used in business are produced from systems. Management and other stakeholders rely on
these reports and information produced (for example, debtors ageing report)

● User access and security are controlled by assigning system roles to users (for example, segregation
of duties can be enforced effectively)
Situations in which IT will be relevant to an audit.
Given below are some situations in which IT will be relevant to an audit.
● Increased use of systems and Applications software in Business ( for example , use of ERPs)
● Complexity of business transactions (multiple systems, network of systems)
● Hi-tech nature of business ( Telecom , e-Commerce).
● High volume of transactions ( Insurance, Banking , etc.)
● Company Policy (Compliance).
● Regulatory requirements- IT Act, 2008.
● Requirement of standards of Auditing -SA 315.
● Requirement of other national and international standards and practice related to IT
● Using Computer Programs/ Softwares for audit which Increases efficiency and effectiveness of audit.
Due importance is given to the internal financial control in the companies Act, 2013. Auditors are also
required to report on those Internal Financial Controls over Financial Reporting. This also requires
understanding the IT environment of the company and relevant risks & controls.
What are the three main reasons because of which IT should be considered relevant to an audit of
financial statements?
The auditor should consider relevance of IT in an audit of financial statements for the following reasons:
1. Reliance on Reports and Information - The auditors rely on the reports and information generated
by IT systems, there could be risk in the IT systems that could have an impact on audit in terms of
generation of wrong information and reports.
2. Requirement of Standards on Auditing - Standards on auditing SA 315 and SA 330 require auditors
to understand, assess and respond to risks that arise from the use of IT systems.
3. Relying on Automated Controls and Using Data Analytics - By relying on automated controls and
using data analytics in an audit, it is possible to increase the effectiveness and efficiency of the audit
process.

Risks and Controls in An Automated Environment
Understanding of IT Systems
For conducting an Audit, an auditor is required to identify and assess the risk of material misstatements. For
this auditor conducts risk assessment procedures.
The auditor assesses the risk of material misstatement through understanding the entity, it’s environment
and it’s internal control.
When an entity's business environment is automated, the auditor also needs to understand the IT used in
such an automated environment and the risks related to the same, in order to properly identify and assess
the risk of material misstatement.
Given below are some of the points that an auditor should consider to obtain an understanding of the
company’s automated environment
● Information systems being used (one or more application systems and what they are)
● Their purpose (financial and non-financial)
● Location of IT systems - local vs global
● Architecture (desktop based, client-server, web application, cloud based)
● Version (functions and risks could vary in different versions of same application)
● Interfaces within systems (in case multiple systems exist)
● In-house vs Packaged
● Outsourced activities (IT maintenance and support)
● Key persons (CIO, CISO, Administrators)
The understanding of a company’s IT environment that is obtained should be documented.
Understanding the Risks that arise from the use of IT and IT Systems
Having obtained an understanding of the IT systems and the automated environment of a company, the
auditor should now understand the risks that arise from the use of IT systems.
Given below are some such risks that should be considered:

● Inaccurate processing of data, processing inaccurate data, or both.
● Unauthorized access to data.
● Direct data changes (backend changes).
● Excessive access / Privileged access (super users).
● Lack of adequate segregation of duties.
● Unauthorized changes to systems or programs.
● Failure to make necessary changes to systems or programs.
● Loss of data.

Impact of IT related risks
Discuss the impact of IT related risks on Substantive Audit, Controls and Reporting. (RTP May 2018)
The auditor should apply professional judgement in determining and assessing IT related risks and plan the
audit response appropriately.
IT related risks will have the following impact on Substantive Audit, Controls and Reporting.
SUBSTANTIVE AUDIT - Thorough Testing of Data ETC
1. First, we may not be able

○ to rely on the data obtained from systems where such risks exist.
■ This means,
● all forms of data, information or reports
● that we obtain from systems for the purpose of audit
● has to be thoroughly tested and corroborated for completeness and accuracy.
CONTROLS - Non-Reliance on Controls
2. Second, we will not be able

○ to rely on automated
■ controls,
■ calculations,
■ accounting procedures
● that are built into the applications.
➢ Additional audit work may be required in this case.
REPORT - Modification in Report
3. Third, due to the regulatory requirement of auditors to report on internal financial controls of a
company, the audit report also may have to be modified in some instances.
In all the above scenarios, it is likely that the auditor will be required to obtain more audit evidence and
perform additional audit work.
The auditor should also be able to demonstrate

● how the risks were identified and
● what audit evidence was obtained and
● how IT risks were addressed.
As the complexity, automation and dependence of business operations on IT systems increases, the severity
and impact of IT risks too increases accordingly.

Testing methods in an automated environment.
Testing General Note
There are basically four types of audit tests that should be used.
They are inquiry, observation, inspection and reperformance.
Inquiry is the most efficient audit test but it also gives the least audit evidence.
Hence, inquiry should always be used in combination with any one of the other audit testing methods.
Inquiry alone is not sufficient.
Reperformance is most effective as an audit test and gives the best audit evidence. However, testing by
reperformance could be very time consuming and least efficient most of the time.
Generally, applying inquiry in combination with inspection gives the most effective and efficient audit
evidence.
Which audit test to use, when and in what combination is a matter of professional judgement and will vary
depending on several factors including
● Risk assessment,
● Control environment,
● Desired level of evidence required,
● History of errors/misstatements,
● Complexity of business, assertions being addressed, etc.
The auditor should document the nature of the test (or combination of tests) applied along with the
judgements in the audit file as required by SA 230.
Discuss the different testing methods used when auditing in an automated environment. Which is
the most effective and efficient method of testing?

Common methods applied by the auditor when testing in an automated environment
When testing in an automated environment, some of the more common methods are as follows
1. Obtain an understanding of how an automated transaction is processed by doing a walkthrough

of one end-to-end transaction using a combination of inquiry, observation and inspection.
2. Observe how a user processes transactions under different scenarios.
3. Inspect the configuration defined in an application.
4. Inspect the system logs to determine any changes made since last audit testing.
5. Inspect technical manual / user manual of systems and applications.
6. Carry out a test check (negative testing- entering wrong data) and observe the error message
displayed by the application.
7. Conduct reperformance using raw source data and independently applying formulae, business rules
or validations on the source data using ( Computer Assisted Auditing Techniques) CAATs.
Discuss the common methods applied by the auditor when testing in an automated environment is
done by him.
Starting Para
There are basically four types of audit tests that should be used. They are inquiry, observation, inspection
and reperformance. Inquiry is the most efficient audit test but it also gives the least audit evidence. Hence,
inquiry should always be used in combination with any one of the other audit testing methods. Inquiry
alone is not sufficient.
After this write 7 points mentioned above.

Data Analytics and its use For Audit

In today’s digital age when companies rely more and more on IT systems and networks to operate business,
the amount of data and information that exists in these systems is enormous.
A famous businessman recently said, “Data is the new Oil”.
The combination of
● processes,
● tools and techniques
○ that are used to
■ tap vast amounts of electronic data
■ To obtain meaningful information is called data analytics.
While it is true that companies can benefit immensely from the use of data analytics in terms of increased
profitability, better customer service, gaining competitive advantage, more efficient operations, etc., even
auditors can make use of similar tools and techniques in the audit process and obtain good results.
The tools and techniques that auditors use in applying the principles of data analytics are known as
Computer Assisted Auditing Techniques or CAATs in short.
Data analytics can be used in

● testing of electronic records and data residing in IT systems
○ using spreadsheets and
○ specialised audit tools viz., IDEA and ACL to perform the following,
★ Check completeness of data and population that is used in either test of controls or substantive audit
tests
★ Selection of audit samples – random sampling, systematic sampling
★ Re-computation of balances – reconstruction of trial balance from transaction data
★ Reperformance of mathematical calculations – depreciation, bank interest calculation
★ Analysis of journal entries as required by SA 240
★ Fraud investigation
★ Evaluating impact of control deficiencies.
Steps that should be followed to achieve success with CAATs
There are several steps that should be followed to achieve success with CAATs and any of the supporting
tools. A suggested approach to benefit from the use of CAATs is given below
1. Understand business environment including IT

2. Define the Objectives and Criteria
3. Identify Source and format of data
4. Extract Data
5. Verify the completeness and accuracy of extracted data.
6. Apply criteria on data obtained
7. Validate and confirm results
8. Report and Document results and conclusions.

Assess and Report Audit Findings
The auditor needs to assess each finding or exception to determine impact on the audit and evaluate if the
exception results in a deficiency in internal control.
The assessment requires use of professional judgement.
Deficiency in internal control – This exists when:
● A control is designed, implemented or operated in such a way that it is unable to prevent, or detect
and correct, misstatements in the financial statements on a timely basis; or
● A control necessary to prevent, or detect and correct, misstatements in the financial statements on a
timely basis is missing.
Some points to consider while assessing the findings are as follows:
● Are there any weaknesses in IT controls?

● What is the impact of these weaknesses on overall audit?
● Report deficiencies To Management.
● Communicate in writing any significant deficiencies to Those Charged With Governance as per SA
260 and SA 265
● Consider Presence of compensating controls.
Deficiency in internal control – This exists when:
● A control is designed, implemented or operated in such a way that it is unable to prevent, or detect
and correct, misstatements in the financial statements on a timely basis; or
● A control necessary to prevent, or detect and correct, misstatements in the financial statements on a
timely basis is missing.
Auditor generally report control deficiency in the following format

- Observation
- Exposure
- Recommendation
- Management Response.


Types of Controls in an Automated Environment
- General IT Controls
- Application Controls
- IT-Dependant Controls.
General IT Controls
General Controls are

● pervasive controls and
● apply to all systems components, processes, and data for a given enterprise or systems environment.
● For example- Information security policy.
General IT controls are policies and procedures that relate to

● many applications and
● support the effective functioning of application controls.
They apply to mainframe, miniframe, and end-user environments.
General IT-controls that maintain the integrity of information and security of data commonly include controls
over the following:
● Data centre and network operations
● Program change
● Access security
● Application system acquisition, development, and maintenance
Application Controls
Application controls include both automated or manual controls that operate at a business process level.
Automated Application controls are embedded into IT applications like ERPs and help in ensuring the
completeness, accuracy and integrity of data in those systems.
Examples of automated applications include

● edit checks and validation of input data,
● sequence number checks,
● user limit checks,
● reasonableness checks,
● mandatory data fields.
IT dependent Controls
IT dependent controls are basically manual controls that make use of some form of data or information or
report produced from IT systems and applications.
In this case, even though the control is performed manually, the design and effectiveness of such controls
depends on the reliability of source data.

Example - A system-generated report lists users that have not accessed a particular system within the past
60 days. The internal control may require an administrator to review such reports and disable certain users
out of it.
Due to the inherent dependency on IT, the effectiveness and reliability of Automated application controls and
IT dependent controls require the General IT Controls to be effective.
Definition of Important Terms Used in the Audit of Automated

Environment.
Applications These are computer software programs that provide a medium for recording, storage
and retrieval of business operations or transactions in electronic format.
Automated A task or activity that is routinely performed by computer system and does not require
manual effort.
CAATs Computer Assisted Audit Techniques, are a collection of computer based tools and
techniques that are used in an audit for analysing data in electronic form to obtain audit
evidence.
Data Refers to the digital content that is stored in electronic form within computer systems.
Data Refers to the systematic recording, storage, retrieval, modification and transformation of
Processing electronic data using information systems.
Database A logical subsystem within a larger information system where electronic data is stored in
a predefined form and retrieved for use.
Direct Data A backend modification that is made directly to data that is stored in a database by
Change passing business rules built-in to a business application software.
ERP Enterprise A type of business application software that provides an integrated platform to
Resource automate multiple interrelated business processes and operations.
Planning
Financial Refers to the process of preparation, presentation and disclosure of financial statements
Reporting in accordance with a specified reporting framework
General (IT) Are a type of internal controls that help in mitigating risks that arise due to use of
Controls information technology and information systems in a business.
Information Electronic data residing in computer systems that is organised in a logical and
meaningful manner that is easy to read, understand and analyse.
Information Refers to a collection of electronic hardware, software, networks and processes that are
system used in a business to carry out operations and transactions.
Information The branch of science and engineering that involves designing, building, implementing
Technology and maintaining computer systems and networks that can be used in a variety of ways
including operating businesses and setting up information systems.

Mainframe A term that is used to describe a very large computer with high computing power,
memory and storage that are required for running large business operations. In addition
to business operations, Mainframes are also used in fields of Research & Development,
Space, Healthcare, Weather, etc.
Operating Refers to a system software that is installed in a computer to convert high level user
System instructions or commands into low level machine understandable format and enable
interaction with a computer.
Privileged A type of super user access to information systems that enforces less or no limits on
access using that system.
Risk A possibility of something that can go wrong in a business process, transaction or

operation and could result in a loss.
Segregation of A type of internal control that is implemented in a company to prevent two or more
duties conflicting functions from being assigned to or being carried out by the same person.
Significant A control deficiency or a combination of deficiencies in internal controls that is

Deficiency important enough to merit the attention of those charged with governance since there
is a reasonable possibility that a misstatement will not be prevented or detected in a
timely manner by management.
Software A computer program or a collection of computer programs that provides an interface to

a user for performing a specific activity, task, operation or transaction in electronic form
through a computer or information system.
System Refers to a collection of electronic hardware, software, networks and processes that are
used in a business to carry out operations and transactions.

Chapter 7 and SA 530 “Audit sampling”

Meaning of Sampling
According to SA 530 - Audit sampling (sampling)

- The application of audit procedures
- to less than 100% of items within a population of audit relevance
- such that all sampling units have a chance of selection in order
- to provide the auditor with a
- reasonable basis
- on which to draw conclusions about the entire population.
This Standard on Auditing (SA) applies when the auditor has

- decided to use audit sampling in performing audit procedures.
It deals with the auditor’s

- use of statistical and non-statistical sampling when
- designing and selecting the audit sample,
- performing tests of controls and tests of details, and
- evaluating the results from the sample.
We can also say that sampling is one of the means to select samples for testing.
Sampling is also known as test check
Precautions to be taken while applying test check techniques.
● Thorough study of accounting system should be done before adopting sampling

● Proper study of internal control systems.
● Areas which are not suitable for sampling should be carefully considered. Eg: compliance with
statutory provisions, transactions of unusual nature etc.
● Proper planning for Sampling methods to be used and explaining the staff,
● Transactions and balances have to be properly classified (stratified)
● Sample size should be appropriately determined.
● Sample should be chosen in unbiased way,
● Errors located in the sample should be analysed properly.
Population
Meaning
Population refers to the entire set of data from which a sample is selected and about which the auditor
wishes to draw conclusions.

Characteristics
Appropriateness
Appropriate means the population from which the samples are drawn shall be relevant for the specific
objective. Auditor will choose the sample and test it and then will project the results on the entire population.
Appropriateness will include consideration of the direction of testing.
For example, if the auditor’s objective is to test for overstatement of accounts payable, the population could
be defined as the accounts payable listing.
On the other hand, when testing for understatement of accounts payable, the population is not the accounts
payable listing but rather subsequent disbursements, unpaid invoices, suppliers’ statements, unmatched
receiving reports or other populations that provide audit evidence of understatement of accounts payable;
Completeness.
- Conclusion about the entire population can be drawn only when the population is complete
- For example, if the auditor intends to select payment vouchers from a file, conclusions cannot be
drawn about all vouchers for the period unless the auditor is satisfied that all vouchers have in fact
been filed.
Reliable
Auditors should obtain evidence about the reliability of the population. If the population is not reliable with
respect to accuracy and source, the sample drawn will definitely not be relevant for the specific audit
objective.
Sampling Unit
- The individual items constitute a population.
- For example checks listed on deposit slips, credit entries on bank statements, sales invoices or
debtors’ balances, or a monetary unit.
- The conclusion on the population is based on the audit procedures applied on the sampling unit.

SAMPLE DESIGN, SIZE AND SELECTION OF ITEMS FOR TESTING
Sample Design
While designing an audit sample auditor should consider the

● purpose of audit procedure and
● characteristic of population from which the sample will be drawn
The auditor first considers

● the specific objectives to be achieved and
● the combination of audit procedures which is likely to best achieve those objectives.
Auditor has to clearly define what will be considered as a misstatement. It will help the auditor in projecting
the misstatement in the population.
For example - In a test of details relating to the existence of accounts receivable, such as confirmation,
payments made by the customer before the confirmation date but received shortly after that date by the
client, are not considered a misstatement.
When performing tests of controls,

- The auditor generally makes an assessment of the rate of error the auditor expects to find in the
population to be tested.
- This assessment is based on the auditor’s understanding of the design of the relevant controls and
whether they have been implemented or the examination of a small number of items from the
population.
Similarly, for tests of details, the auditor generally makes an assessment of the expected amount of error in
the population.
These assessments are useful for designing an audit sample and in determining sample size.
For example, if the expected rate of error is unacceptably high, tests of controls will normally not be
performed.
However, when performing tests of details, if the expected amount of error is high, 100% examination or the
use of a large sample size may be appropriate.
Sample Size
● The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level.
● The level of sampling risk that the auditor is willing to accept affects the sample size required.
● The lower the risk the auditor is willing to accept, the greater the sample size will need to be
● The sample size can be determined by the application of a statistically-based formula or through the
exercise of professional judgement. There are various factors typically on the determination of sample
size. When circumstances are similar, the effect on sample size of factors will be similar regardless of
whether a statistical or non- statistical approach is chosen.

Examples of Factors Influencing Sample Size for Tests of Controls

The following are factors that the auditor may consider when determining the sample size for tests of
controls.
FACTOR EFFECT ON SAMPLE SIZE
An increase in the extent to which the auditor’s risk assessment takes into Increase
account relevant controls
An increase in the tolerable rate of deviation Decrease
An increase in the expected rate of deviation of the population to be Increase

tested
An increase in the auditor’s desired level of assurance Increase
Examples of Factors Influencing Sample Size for Tests of Details

The following are factors that the auditor may consider when determining the sample size for tests of details.
FACTOR EFFECT ON SAMPLE SIZE
An increase in the auditor’s assessment of the risk of material misstatement Increase
An increase in the use of other substantive procedures directed at the same Decrease
assertion.
An increase in the auditor’s desired level of assurance. Increase
An increase In Tolerable misstatement. Decrease
An increase in the amount of misstatement the auditor expects to find in Increase

the population
Stratification of the population when appropriate Decrease
Selection of Items for Testing (Selecting the sample)

● The auditor should select items for the sample with the expectation that all sampling units in the
population have a chance of selection.
● Statistical sampling requires that sample items are selected at random so that each sampling unit
has a known chance of being selected.
● The sampling units might be physical items (such as invoices) or monetary units.
● With non-statistical sampling, an auditor uses professional judgement to select the items for a
sample.
● Because the purpose of sampling is to draw conclusions about the entire population, the auditor
endeavours to select a representative sample by choosing sample items which have characteristics
typical of the population, and the sample needs to be selected so that bias is avoided.

Whatever may be the approach of non-statistical or statistical sampling, the sample must be representative.
This means that it must be closely similar to the whole population although not necessarily exactly the same.
The sample must be large enough to provide statistically meaningful results
Sampling Risk

Sampling Risk in Test of Details
The recorded value of population is
OK Not OK
OK ● Correct Decision ● Incorrect Decision

● Risk of Incorrect
Acceptance
● Not effective
The sample indicates
that the population is
Not OK ● Incorrect Decision ● Correct Decision
● Risk of Incorrect
Rejection
● Not Efficient
Sampling Risk in Test of Control
The actual operation of control is
OK Not OK
OK ● Correct Decision ● Incorrect Decision

● Risk of Over reliance
The sample indicates ● Risk of assessing the CR

that the control in too low
operation in ● Not effective
Not OK ● Incorrect Decision ● Correct Decision

● Risk of under reliance
● Risk of Assessing the
CR too high
● Not Efficient
Non-Sampling Risk
“Non-sampling risk” arises from factors that cause the auditor to reach an erroneous conclusion for any
reason not related to the size of the sample.
For example,
- ordinarily the auditor finds it necessary to rely on audit evidence that is persuasive rather than
conclusive,
- the auditor might use inappropriate audit procedures, or
- the auditor might misinterpret audit evidence and fail to recognize an error.
- Human Mistakes

Tolerable Misstatement and Deviation
Tolerable misstatement
A monetary amount set by the auditor in respect of which the auditor seeks to obtain an appropriate level of
assurance that the monetary amount set by the auditor is not exceeded by the actual misstatement in the
population.
Tolerable rate of deviation

A rate of deviation from prescribed internal control procedures set by the auditor in respect of which the
auditor seeks to obtain an appropriate level of assurance that the rate of deviation set by the auditor is not
exceeded by the actual rate of deviation in the population.
Performing Audit Procedures
- The auditor shall perform audit procedures, appropriate to the purpose, on each item selected.
- If a selected item is not appropriate for the application of the audit procedure, the audit procedure is
ordinarily performed on a replacement item.
- For example, a cancelled cheque may be selected when testing for evidence of payment
authorization. If the auditor is satisfied that the check had been properly cancelled such that it
does not constitute an error, an appropriately chosen replacement is examined.
- If the auditor is unable to apply the designed audit procedures, or suitable alternative procedures, to a
selected item, the auditor shall treat that item as a deviation from the prescribed control, in the case
of tests of controls, or a misstatement, in the case of tests of details.
- An example of a suitable alternative audit procedure might be the examination of subsequent
receipts when no reply has been received in response to a positive confirmation request.
Nature And Cause Of Deviations And Misstatements
The auditor shall

● investigate the nature and cause of any deviations or misstatements identified, and
● evaluate their possible effect on the purpose of the audit procedure and on other areas of the audit.
In analysing the deviations and misstatements identified,

● the auditor may observe that many have a common feature, for example, type of transaction, location,
product line or period of time.
In such circumstances, the auditor may decide to identify all items in the population that possess the
common feature, and extend audit procedures to those items. In addition, such deviations or misstatements
may be intentional, and may indicate the possibility of fraud.
In the extremely rare circumstances when the auditor considers a misstatement or deviation discovered in a
sample to be an anomaly, the auditor shall obtain a high degree of certainty that such misstatement or
deviation is not representative of the population.
The auditor shall obtain a high degree of certainty by performing additional audit procedures to obtain
sufficient appropriate audit evidence that the misstatement or deviation does not affect the remainder of
the population.

Anomaly may be defined as a misstatement or deviation that is demonstrably not representative of

misstatements or deviations in a population. (one-off event)
Projecting Misstatements
The auditor is required to project misstatements for the population to obtain a broad view of the scale of
misstatement but this projection may not be sufficient to determine an amount to be recorded.
When a misstatement has been established as an anomaly, it may be excluded when projecting
misstatements to the population.
However, the effect of any such misstatement, if uncorrected, still needs to be considered in addition to the
projection of the non-anomalous misstatements.
For tests of details, the auditor shall project misstatements found in the sample to the population whereas
for tests of controls, no explicit projection of deviations is necessary since the sample deviation rate is also the
projected deviation rate for the population as a whole. (if there are 8% deviation in the sample, this will also become the rate of deviation in
the population)
Evaluating Results Of Audit Sampling
The auditor shall evaluate-
- The results of the sample; and

- Whether the use of audit sampling has provided a reasonable basis for conclusions about the
population that has been tested.
For tests of controls,

- an unexpectedly high sample deviation rate may lead
- to an increase in the assessed risk of material misstatement, unless further audit evidence substantiating the
initial assessment is obtained.
For tests of details, an unexpectedly high misstatement amount in a sample may cause the auditor to
believe that a class of transactions or account balance is materially misstated, in the absence of further audit evidence that
no material misstatement exists
In the case of tests of details, the projected misstatement plus anomalous misstatement, if any, is the
auditor’s best estimate of misstatement in the population.
When the projected misstatement plus anomalous misstatement, if any, exceeds tolerable misstatement,
the sample does not provide a reasonable basis for conclusions about the population that has been tested.
The closer the projected misstatement plus anomalous misstatement is to tolerable misstatement, the more
likely that actual misstatement in the population may exceed tolerable misstatement.

Also if the projected misstatement is greater than the auditor’s expectations of misstatement used to
determine the sample size, the auditor may conclude that there is an unacceptable sampling risk that the
actual misstatement in the population exceeds the tolerable misstatement.
Considering the results of other audit procedures helps the auditor to assess the risk that actual
misstatement in the population exceeds tolerable misstatement, and the risk may be reduced if additional
audit evidence is obtained.
In case the auditor concludes that audit sampling has not provided a reasonable basis for conclusions about
the population that has been tested, the auditor may request management.
- to investigate misstatements that have been identified and the potential for further misstatements
and
- to make any necessary adjustments; or tailor the nature, timing and extent of those further audit
procedures to best achieve the required assurance.
For example, in the case of tests of controls, the auditor might

- extend the sample size,
- test an alternative control or
- modify related substantive procedures.
Sample Selection Methods
Some of the important methods of selecting the sample are discussed below -
Random Sampling
- Random selection ensures that all items in the population have a equal chance of selection.
- It may involve use of random number tables.
- Random sampling includes two very popular methods which are discussed below
Simple Random Sampling
- Under this method each unit of the whole population e.g. purchase or sales invoice has an equal
chance of being selected.
- Samples are selected through a random number table.
- Random number tables are simple and easy to use and also provide assurance that the auditors’ bias
does not affect the selection.
- Each item in a population is selected by use of a random number table either with the help of a
computer or picking up a number in a random way.
This method is considered appropriate provided the population to be sampled consists of reasonably similar
units and fall within a reasonable range i.e it is suitable for a homogeneous population having a similar range.
Example
The population can be considered homogeneous, if say, trade receivables balances fall within the range of ₹
50,000 to ₹ 2,00,000 and not in the range between ₹500 to ₹ 11,50,000.

Stratified Sampling
This method involves dividing the whole population to be tested in a few separate groups called strata and
taking a sample from each of them.
- Each stratum is treated as if it was a separate population and

- items are selected from each of these stratum.
- The number of groups into which the whole population has to be divided is determined on the basis
of auditor judgement.
Example
The population in the range between ₹500 to ₹ 11,50,000 say for trade receivables balances may be divided
into groups as follows:-
1. balances in excess of ₹ 10,00,000;

2. balances in the range of ₹ 7,75,001 to ₹ 10,00,000;
3. balances in the range of ₹ 5,50,001 to ₹ 7,75,000
4. balances in the range of ₹ 2,25,001 to ₹ 5,50,000; and
5. balances ₹ 2,25,000 and below.
From these above groups the auditor may pick up different percentages of items from each of the group.
- From the top group i.e. balances in excess of ₹ 10,00,000, the auditor may examine all the items;
- from the second group 25 per cent of the items;
- from the third group 10 percent of the items; and
- from the lowest group 2 percent of the items may be selected.
Random sample is chosen from each stratum using random number tables.
The reasoning behind the stratified sampling is that for a highly diversified population, weights should be
allocated to reflect these differences.
It can be seen that the stratified sampling is simply an extension of simple random sampling.
Stratification means
- dividing a heterogeneous (Diversified) population
- into a Homogeneous (having similar characteristics) sub population,
- where samples are drawn from each subpopulation.
Interval Sampling or Systematic Sampling
- Systematic selection is a selection method in which the number of sampling units in the population is
divided by the sample size to give a sampling interval, for example 50,
- and having determined a starting point within the first 50,
- each 50th sampling unit thereafter is selected.
The starting point may be determined haphazardly, the sample is more likely to be truly random if it is
determined by use of a computerised random number generator or random number tables.

When using systematic selection, the auditor would need to determine that sampling units within the
population are not structured in such a way that the sampling interval corresponds with a particular pattern
in the population.
Example
If in a population of branch sales, particular branch sales occur only as every 50th item and the sampling interval selected is also 50. The
result would be that either the auditor would have selected all or none of the sales of that particular branch.
Therefore, systematic sampling when chosen as a method should be carefully applied to bring together
every type of transaction within its purview. More than one starting point can be considered to minimise
such risk.
Monetary Unit Sampling
It is a type of
- value-weighted selection in which
- sample size,
- selection and
- evaluation results in a conclusion in monetary amounts.
In this individual monetary units are identified as sampling units.
Value-Weighted Selection
Values are given weight.
This selection is done in such a way that high value items for example invoice have high chance of selection.
Having selected specific monetary units from within the population, for example, the accounts receivable
balance, the auditor may then examine the particular items, for example, individual balances, that contain
those monetary units.
One benefit of this approach is that audit effort is directed to the larger value items because they have a
greater chance of selection, and can result in smaller sample sizes.
This approach may be used in conjunction with the systematic method of sample selection and is most
efficient when selecting items using random selection.
Haphazard sampling
Haphazard selection, in which the

- auditor selects the sample
- without following a structured technique.

The auditor should try to avoid any conscious bias or predictability (for example, avoiding difficult to locate
items, or always choosing or avoiding the first or last entries on a page) and thus attempt to ensure that all
items in the population have a chance of selection.
Haphazard selection is not appropriate when using statistical sampling.
Haphazard sampling has

- no structured approach,
- does not involve judgement and
- does not even use the random number tables.
Block Sampling
- This method involves
- selection of a block(s) of
- Contiguous (in sequence) items from within the population.
Block selection cannot ordinarily be used in audit sampling because most populations are structured such
that items in a sequence can be expected to have similar characteristics to each other, but different
characteristics from items elsewhere in the population.
Although in some circumstances it may be an appropriate audit procedure to examine a block of items, it
would rarely be an appropriate sample selection technique when the auditor intends to draw conclusion
about the entire population based on the sample.
If the client has the idea of the block selection pattern of the auditor, then material misstatements and
deviations can be easily manipulated by management’s practice of recording them.
Example
Take the first 100 sales invoices from the sales day book in the month of September; alternatively take any
four blocks of 25 sales invoices.
Therefore, once the first item in the block is selected, the rest of the block follows items to the completion.
There is a close similarity between this method and non-statistical sampling. Consequently it has similar characteristics, namely,
simplicity and economy. On the other hand there is a risk of bias and of establishing a pattern of selection which may be noted by the
auditees.

APPROACHES TO SAMPLING
1. Non-statistical or
2. Statistical sampling approaches.
Statistical Sampling
Probability Theory
Statistical sampling is an approach to sampling that has the
- random selection of the sample units;
- and the use of probability theory
- in determining the appropriate sample size
- In Sample selection
- to evaluate sample results,
- including measurement of sampling risk characteristics.
Mathematical and statistical methods

Sample is chosen by applying certain mathematical and statistical methods.
More Scientific
Statistical Sampling- More Scientific
Probability theory, a branch of mathematics concerned with the analysis of random phenomena. The outcome of a random event cannot be determined before it occurs, but
it may be any one of several possible outcomes. The actual outcome is considered to be determined by chance. (https://www.britannica.com/science/probability-theory)
Large number of similar items

Widely used where a population to be tested consists of a large number of similar items and more in the
case of transactions involving compliance testing, trade receivables’ confirmation, payroll checking, vouching
of invoices and petty cash vouchers.
No personal bias
There Is no personal bias of the auditor in the case of statistical sampling.
Projection more reliable

Since it is scientific, the results of the sample can be evaluated and projected on the whole population in a
more reliable manner.
For Example: An auditor while verifying the Purchases during the year realised that the purchase
transactions in that year are more than 95000 in number, then in such case, statistical sampling will be
highly recommended in the audit program.
Advantages of Statistical Sampling
1. The amount of testing (sample size) does not increase in proportion to the increase in the size of the area
(universe) tested. (Smaller sample size gives a better representation of the population, in judgemental or non
statistical sampling sample size is large still it does not give a fair representation of the population )
2. The sample selection is more objective and thereby more defensible.

3. The method provides a means of estimating the

● minimum sample size associated with a specified risk. (Basically helps in determining the sample size
depending upon audit risk)
4. It provides a means for deriving a “calculated risk” (sampling error) i.e. the probable difference in result due to the
use of a sample in lieu of examining all the records in the group (universe), using the same audit procedures.
5. It may provide a better description of a large mass of data when compared to a non-statistical approach of
sampling.
6. Results of sampling can be evaluated and projected in a better way
Non-Statistical Sampling
The sample size and its composition are determined on the basis of the
- personal experience and
- knowledge of the auditor.
Does not have any of the characteristics of random selection and use of probability theory.
This approach is simple. The sample may not be a true representative of the total population because of
personal bias and no scientific method of selection.
For example,
- April, August and March may be selected in year one and different months would be selected in the
next year,
- On the basis of the value of items, The top 10 highest values. Etc.
● An attempt would be made to avoid establishing a pattern of selection year after year.
● An element of surprise is maintained.
● It is a common practice to check large numbers of items towards the close of the year so that the
adequacy of cut-off procedures can also be determined.
● Also, because year end transactions are prone to high risk of misappropriation.
The non-statistical sampling is criticised on the grounds that it is neither objective nor scientific.
- Expected degree of objectivity cannot be assured in nonstatistical sampling

- because the risk of personal bias in selection of sample items cannot be eliminated.
Projection may not be as accurate as it was in statistical sampling because the sample has not been selected
in accordance with the mathematically based statistical techniques.
The auditor with his experience and knowledge of the client’s business can evaluate the sample findings to
make audit decisions without the mathematical proof of accuracy.
Misc Topic
Factors that should be considered for deciding upon the extent of checking on a
sampling plan
The factors that should be considered for deciding upon the extent of checking on a sampling plan are following:

1. Size of the organisation under audit.

2. State of the internal control.
3. Adequacy and reliability of books and records.
4. Tolerable error range.
5. Degree of the desired confidence.
Sampling Vs Traditional method of Auditing (Homework Do it from ICAI Study Mat)

Chapter 8 Analytical Procedure SA 520

What is the meaning of Analytical Procedures?
As per the Standard on Auditing (SA) 520 “Analytical Procedures”, the term “analytical procedures” means
● evaluations of financial information
● through analysis of plausible relationships
● among both financial and non-financial data.
It includes
● Comparable information for prior periods.
● Anticipated results of the entity, such as
○ budgets or forecasts, or
○ expectations of the auditor,
■ such as an estimation of depreciation.
● Similar industry information,
○ such as a comparison of the entity’s ratio of sales to accounts receivable with industry averages
or with other entities of comparable size in the same industry.
If analytical procedures performed in accordance with SA 520

● they identify fluctuations or relationships
● that are inconsistent with other relevant information or
● that differ from expected values by a significant amount, the auditor shall investigate such differences
SA 520 - Basic Overview

SA 520 deals with the auditor’s use of analytical procedures as
● substantive procedures (“substantive analytical procedures”), and
● as procedures near the end of the audit that assist the auditor when forming an overall conclusion on
the financial statements.
The use of analytical procedures as risk assessment procedures is dealt with in SA 315.
SA 330 includes requirements and guidance regarding the nature, timing and extent of audit procedures in
response to assessed risks; these audit procedures may include substantive analytical procedures.

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Objectives
The objectives of the auditor are:

a. To obtain relevant and reliable audit evidence when using substantive analytical procedures; and
b. To design and perform analytical procedures near the end of the audit
○ that assist the auditor when forming an overall conclusion
○ as to whether the financial statements
○ are consistent with the auditor’s understanding of the entity.
Timing of Analytical Procedures

Analytical Procedures can also be used for testing correctness of

individual items
For instance, the cost of importing goods which are subjected to an ad-valorem duty at uniform rate can be
verified from the amount of duty paid.
Similarly, a quantity of goods sold by a manufacturer can be verified independently from the amount of GST
paid.
Similarly, the amount of any income or expenses which has a direct relationship with the amount of profits or
that of sales can be verified independently, e.g., commission paid to a manager calculated on the basis of net
profits, commission paid to a selling agent as percentage of sales, etc.
Such calculation of ratios, trends and comparisons is also termed as analytical review.
Using SUBSTANTIVE ANALYTICAL PROCEDURES at the assertion level

The auditor’s substantive procedures at the assertion level may be
● Tests of details,
● Substantive analytical procedures,
● or a Combination of both.
This is based on the auditor’s judgment about the expected effectiveness and efficiency of the available audit
procedures to reduce audit risk at the assertion level to an acceptably low level.
The auditor may inquire of management as to the availability and reliability of information needed to apply
substantive analytical procedures, and the results of any such analytical procedures performed by the entity.
It may be effective to use analytical data prepared by management, provided the auditor is satisfied that
such data is properly prepared.
Factors to be considered for Substantive Audit Procedures

The auditor should consider the following factors for Substantive Audit Procedures:
Availability of Data
The availability of reliable and relevant data will facilitate effective analytical procedures.
Disaggregation
The degree of disaggregation in available data can directly affect the degree of its usefulness in detecting
misstatements.
Account Type
Substantive analytical procedures are more useful for certain types of accounts than for others.
● Income statement accounts tend to be more predictable because they reflect accumulated
transactions over a period,
● whereas balance sheet accounts represent the net effect of transactions at a point in time or are
subject to greater management judgement.

Source - Type of class of transactions

Some classes of transactions tend to be more predictable because they consist of numerous, similar
transactions.
Whereas the transactions recorded by

● non-routine and
● estimation SCOTs (Significant Classes of Transactions) are often subject to management judgement
and therefore more difficult to predict.
Predictability
Substantive analytical procedures are more appropriate when an account balance or relationships between
items of data are predictable (e.g., between sales and cost of sales or between trade receivables and cash
receipts).
A predictable relationship is one that may reasonably be expected to exist and continue over time.
Nature of Assertion
Substantive analytical procedures may be more effective in providing evidence for some assertions (e.g.,
completeness or valuation) than for others (e.g.rights and obligations). Predictive analytical procedures using
data analytics can be used to address completeness, valuation/measurement and occurrence.
Completeness - Through analytical procedures we can get an idea of whether all sales are recorded or not.
Valuation - analytical procedures will also give an idea about unusual fluctuations in valuations of assets and liabilities having an effect on other
items.
Inherent Risk or “What Can Go Wrong”

When we are designing audit procedures to address an inherent risk or “what can go wrong”, we consider
the nature of the risk of material misstatement in order to determine if a substantive analytical procedure
can be used to obtain audit evidence. When inherent risk is higher, we may design tests of details to address
the higher inherent risk. When significant risks have been identified, audit evidence obtained solely from
substantive analytical procedures is unlikely to be sufficient.
INVESTIGATING RESULTS OF ANALYTICAL PROCEDURES

If analytical procedures performed in accordance with SA 520 identified
● fluctuations or relationships that are inconsistent with other relevant information or
● that differ from expected values by a significant amount, the auditor shall investigate such differences
by:
Inquiring of management and obtaining appropriate audit evidence relevant to

management’s responses:
Audit evidence relevant to management’s responses may be obtained by evaluating those responses taking
into account
● the auditor’s understanding of the entity and its environment, and
● with other audit evidence obtained during the course of the audit.

Prforming other audit procedures as necessary in the circumstances
The need to perform other audit procedures may arise when, for example, management is unable to provide
an explanation, or the explanation, together with the audit evidence obtained relevant to management's
response, is not considered adequate.
Techniques Available as Substantive Analytical Procedures
Substantive analytical procedures generally take one of the following forms
Trend analysis
● commonly used technique.
● The auditor evaluates
○ whether the current balance of an account moves in line with the trend
established with previous balances for that account, after adjusting for
relevant factors responsible for changes
● comparison of
○ current data with the prior period balance or
○ with a trend in two or more prior period balances.
In other words, trend analysis implies

● analysing account fluctuations
● by comparing current year to prior year information and,
● also, to information derived over several years.
Ratio analysis
● Ratio analysis is useful for analysing
○ asset and liability accounts as well as revenue and expense accounts.
● An individual balance sheet account is difficult to predict on its own, but its relationship to another
account is often more predictable (e.g., the trade receivables balance related to sales).
● Ratios can also be compared

○ over time or
○ to the ratios of separate entities within the group, or
○ with the ratios of other companies in the same industry.
Reasonableness tests
Does not Rely on

Does not rely on data and events of prior periods.
Uses non-financial data of current period

● Uses non-financial data for the audit period under consideration
○ Example
■ occupancy rates to estimate rental income or
■ interest rates to estimate interest income or expense
More applicable to income statement, accrual and prepayment accounts

● These tests are generally more applicable to income statement accounts and certain accrual or
prepayment accounts.
Review Relationship for Reasonableness

● In other words these tests are made by
○ reviewing the relationship of certain account balances (FDs) to other balances (Interest)
○ for reasonableness of amounts.
Structural modelling
A modelling tool constructs a statistical model
- from financial and/or non-financial data of prior accounting periods
- to predict current account balances
(Simple words - We use a statistical model to predict current account balance on the basis of prior accounting periods.)
The most commonly used procedure is regression analysis, which is used for income statements using
monthly data for the past three years.
The 36 or 48 monthly observations are used to establish a relationship that is used to predict current period
balances.
Analytical Procedures used as Substantive Tests

When designing and performing substantive analytical procedures, either alone or in combination with
tests of details, as substantive procedures in accordance with SA 330, the auditor shall
1. Suitability for Assertion

○ Determine the suitability of particular substantive analytical procedures for given assertions,
Taking account of the
■ assessed risks of material misstatement and
■ Tests of details, if any, for these assertions;
■ Predictability of the amount
2. Reliability of Data

○ Evaluate the reliability of data

■ from which the auditor’s expectation of recorded amounts or ratios is developed,
■ taking account of
● Source of Information
● Comparability of the information
● Nature & Relevance of Information
● Controls over the preparation of the information
3. Develop an expectation
○ Develop an expectation of recorded amounts or ratios and
○ evaluate whether the expectation is sufficiently precise to identify a misstatement that,
individually or when aggregated with other misstatements, may cause the financial
statements to be materially misstated; and
4. Acceptable Difference
○ Determine the amount of any difference of recorded amounts from expected values that is
acceptable without further investigation.
SUITABILITY OF PARTICULAR ANALYTICAL PROCEDURES FOR GIVEN

ASSERTIONS
● Substantive analytical procedures are generally more applicable to large volumes of transactions that
tend to be predictable over time.
● Suitability of a particular analytical procedure will depend upon the auditor’s assessment of how
effective it will be in detecting a misstatement that may cause the financial statements to be
materially misstated, whether individually or in aggregate.
● The determination of the suitability of particular substantive analytical procedure is influenced by the
nature of the assertion and the auditor’s assessment of the risk of material misstatement. If risk is
high due to lack of controls we will use more tests of details and less (or even no) substantive
analytical procedure.
● Substantive analytical procedure may also be considered suitable to support the test of details.
THE RELIABILITY OF DATA

The reliability of data is influenced by its source and nature and is dependent on the circumstances under
which it is obtained. Accordingly, the following are relevant when determining whether data is reliable for
purposes of designing substantive analytical procedures:
1. Source of the information available. For example, information may be more reliable when it is
obtained from independent sources outside the entity;
2. Nature and relevance of the information available. For example, whether budgets have been
established as results to be expected rather than as goals to be achieved; and
3. Comparability of the information available. For example, broad industry data may need to be
supplemented to be comparable to that of an entity that produces and sells specialised products;
4. Controls over the preparation of the information that are designed to ensure its completeness,
accuracy and validity. For example, controls over the preparation, review and maintenance of budgets.
EVALUATION OF WHETHER THE EXPECTATION IS SUFFICIENTLY PRECISE

Matters relevant to the auditor’s evaluation of whether the expectation can be developed sufficiently
precisely to identify a misstatement that may cause the financial statements to be materially misstated,
include:

1. The accuracy with which the expected results of substantive analytical procedures can be predicted.
Higher the accuracy, the more precise the expectations can be.
For example, the auditor may expect greater consistency in comparing salaries and wages from one period to another than in
comparing discretionary expenses, such as research etc.
2. The degree to which information can be disaggregated.

For example, substantive analytical procedures may be more effective when applied to financial statements of components of
a diversified entity, than when applied to the financial statements of the entity as a whole.
3. The availability of the information, both financial and non-financial

For example, the auditor may consider whether financial information, such as budgets or forecasts, and non-financial
information, such as the number of employees (curent, who left, new joinees) etc, is available to design substantive analytical
procedures. If the information is available, the auditor may also consider the reliability of the information
AMOUNT OF DIFFERENCE OF RECORDED AMOUNTS FROM EXPECTED

VALUES THAT IS ACCEPTABLE
The auditor’s determination of the amount of difference from the expectation that can be accepted without
further investigation is influenced by
● materiality and
● the consistency with the desired level of assurance,
● taking account of the possibility that a misstatement may cause the financial statements to be
materially misstated. As the assessed risk increases, the amount of difference considered acceptable
without investigation decreases in order to achieve the desired level of persuasive evidence.
CONSIDERATIONS SPECIFIC TO PUBLIC SECTOR ENTITIES

The relationships between individual financial statements items traditionally considered in the audit of
business entities may not always be relevant in the audit of governments or other non-business public sector
entities
For example, in many public sector entities there may be little direct relationship between revenue and expenditure.
In addition, because expenditure on the acquisition of assets may not be capitalised, there may be no
relationship between expenditures on, for example, inventories and fixed assets and the amount of those
assets reported in the financial statements.
Also, industry data or statistics for comparative purposes may not be available in the public sector.
However, other relationships may be relevant, for example, variations in the cost per kilometre of road
construction or the number of vehicles acquired compared with vehicles retired.

Chapter 9 - Audit of Items of Financial Statements
Assertions
In preparing financial statements, Company’s management makes implicit or explicit claims (i.e. assertions). These
assertions are categorised for Account balance, Transaction and related disclosures
The auditor then needs to draw an audit programme to verify the assertions made by the management by obtaining
sufficient and appropriate audit evidence for each of the claims made on Account Balances, Class of Transactions and
Related Disclosures.
Assertions about classes of transactions and events for the period under audit
1. Occurrence – transactions and events that have been recorded have occurred and pertain to the entity.
2. Completeness – all transactions and events that should have been recorded have been recorded.
3. Accuracy – amounts and other data relating to recorded transactions and events have been recorded
appropriately.
4. Cut-off– transactions and events have been recorded in the correct accounting period.
5. Classification – transactions and events have been recorded in the proper accounts.
Assertions about account balances at the period end
1. Existence – assets, liabilities, and equity interests exist.

2. Rights and obligations – the entity holds or controls the rights to assets, and liabilities are the obligations of the
entity.
3. Completeness – all assets, liabilities and equity interests that should have been recorded have been recorded.
4. Valuation and allocation – assets, liabilities, and equity interests are included in the financial statements at
appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.
If Company PK Girpade PVT LTD. balance sheet shows Building with carrying amount of ₹ 150 lakh, the auditor shall assume that
the management has claimed/ asserted that:
- The building recognized in the balance sheet exists as at the period- end (existence assertion);
- Company PK Girpade PVT LTD. owns and controls such building (Rights and obligations assertion);
- The building has been valued accurately in accordance with the measurement principles (Valuation assertion);
- All buildings owned and controlled by Company X are included within the carrying amount of ₹ 150 lakh (Completeness
assertion).
- Inventory recognized in the balance sheet actually existed as at the period end.
- The entity owns or controls the inventory recorded in the financial statements i.e. the purchase invoices have been made
in the name of client Any inventory held by the entity on behalf of another entity has not been recognized as part of
inventory of the entity.
- All inventory units held by the entity that should have been recorded, have been recognized appropriately in the financial
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statements. Any inventory held by a third party on behalf of the entity has been included as part of the inventory balance
Inventory held by the entity as a Consignee (on behalf of third party i.e. Consignor)) shall be excluded.
- Inventory has been recognized at the lower of
- cost and
- net realisable value in accordance with AS 2 - Inventories.
- Any costs that could not be reasonably allocated to the cost of production (e.g. general and administrative costs)
and any abnormal wastage have been excluded from the cost of inventory. An acceptable valuation basis (eg.
FIFO, Weighted average etc.) has been used to value inventory as at the period-end.
Assertions about presentation and disclosure

1. Occurrence and rights and obligations – disclosed events, transactions, and other matters have occurred and
pertain to the entity.
2. Completeness – all disclosures that should have been included in the financial statements have been included.
3. Classification and understandability – financial information is appropriately presented and described, and
disclosures are clearly expressed.
4. Accuracy and valuation – financial and other information are disclosed fairly and at appropriate amounts.
Companies prepare their financial statements in accordance with the framework of generally accepted accounting principles (Indian
GAAP), also commonly referred to as accounting standards (AS). In preparing financial statements, Company’s management makes
implicit or explicit claims (i.e. assertions) regarding assets, liabilities, equity, income, expenses and disclosures in accordance with the
applicable accounting standards. Explain with example stating the relevant assertions involved in this regard. Also explain financial
statement audit.
(RTP, May 2020, NA)
What does the Valuation assertion mean in respect of Assets, liabilities and equity balances? Explain with the help of example in respect
of Inventory.
(RTP, May 2020, NA)
Audit Procedures
2. Enquiry
3. Inspection
4. Observation
5. U- Recalculation
6. Reperformance
Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may be
performed manually or electronically.
Re-performance
Re-performance involves the auditor’s independent execution of procedures or controls that were originally
performed as part of the entity’s internal control.
Few topics are as it is taken from ICAI Study material and other publications. Source ICAI Publications as uploaded on
www.icai.org

Audit of Share Capital -
General Audit procedures
1. Tally the period-end share capital balance authorised, issued and paid up to the previous year audited
2. In case there is no change during the year, obtain a written confirmation/ representation from the Company
Secretary that there were no changes to the entity's capital structure during the year.
3. In case there is any change, verify whether the paid up capital as at the period-end is within the limits of
authorised capital. Authorised capital should be verified by examining MOA.
4. Obtain the certified copies of relevant resolutions passed at the meetings of board of directors, shareholders
authorising the increase/ decrease in authorised share capital, if required, or paid up share capital.
5. In case of Fresh issue made in the current year, check with compliance of Companies Act 2013 with regard to
○ Return of Allotment,
○ Minimum Subscription,
○ Minimum application money to be collected,
○ Maintenance of separate Bank account,
○ Payment of underwriting commission as per Sec 40 etc.
○ No shares have been issued at Discount (Sec. 53 of Companies Act)
○ Check if Shares are issued for cash or for Consideration other than cash . (Eg: To promoters for their
services, underwriters for commission payable to them etc.)
○ Compliance with SEBI regulations and Guidelines.
○ Also, obtain and verify copies of forms filed with Ministry of Corporate Affairs (MCA)
■ Form SH 7 for increase in authorised share capital,
■ Form PAS 3 for increase in paid up capital) and with Reserve Bank of India
■ Form FC-GPR in case of Foreign Direct Investment (FDI) by a Non-resident shareholder and
verify the number of securities issued along with the issue price.
6. In case there was an increase in share capital, verify whether the Company has accurately calculated the
required fee and stamp duty payable to MCA.

Shares Issued at Premium
Section 52 of the Companies Act, 2013 provides that a Company shall transfer the amount received as premium to
securities premium account and state the purpose for which the amount in the account can be applied.
There is no restriction or conditions prescribed in the Act for issue of shares at premium.
Application of securities premium account: The securities premium account may be applied by the Company for the
following purposes:
a. towards the issue of unissued shares of the company to the members of the company as fully paid bonus
shares;
b. in writing off the preliminary expenses of the Company;
c. in writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or
debentures of the company;
d. in providing for the premium payable on the redemption of any redeemable preference shares or of any
debentures of the company; or
e. for the purchase of its own shares or other securities under Section 68. (Buyback)
The auditor needs to verify

1. whether the premium received on shares, if any, has been transferred to a “securities premium account” and
2. whether the application of any amount out of the said “securities premium account” is only for the purposes
mentioned above.
The securities premium account may only be applied by the company towards the issue of unissued shares of the company to the
members of the company as fully paid bonus shares. Comment.
(SA, May 2019, 3 Marks)
"Sec. 52 of the Companies Act states that Security Premium Account can be applied by the Company for one of the purpose mentioned
below. Which of the following is a CORRECT option?
(a) To adjust loss on revaluation of Assets
(b) To pay dividend to equity shareholders
(c) Providing for the premium payable on redemption of Preference shares
(d) To use it as working capital for its business."
(MTP1, Nov 2021, 2 marks)

Shares issued at a discount
According to Section 53 of the Companies Act, 2013,

- A company shall not issue shares at a discount, except in the case of an issue of sweat equity shares given
under Section 54 of the Companies Act, 2013.
- Any shares issued by a company at a discounted price shall be void.
- Notwithstanding anything mentioned in above two points, a company may issue shares at a discount to its
creditors when its debt is converted into shares in pursuance of any statutory resolution plan or debt
restructuring scheme in accordance with any guidelines or directions or regulations specified by the Reserve
Bank of India under the Reserve Bank of India Act, 1934 or the Banking (Regulation) Act, 1949.
- Where any company fails to comply with the provisions of this section, such company and every officer who is
in default shall be liable to a penalty which may extend to an amount equal to the amount raised through
the issue of shares at a discount or five lakh rupees, whichever is less, and the company shall also be liable
to refund all monies received with interest at the rate of twelve per cent per annum from the date of issue
of such shares to the persons to whom such shares have been issued.
The auditor needs to check
1. The movement in share capital during the year and wherever there is any issue,
2. The should verify that the Company has not issued any of its shares at a discount by reading the minutes of
meeting of its directors and shareholders authorising issue of share capital and the issue price.
3. Further, auditor should also verify that whether the company has issued shares at a discount to its creditors
when its debt is converted into shares in pursuance of any statutory resolution plan or debt restructuring
scheme in accordance with any guidelines or directions or regulations specified by the Reserve Bank of India
under the Reserve Bank of India Act, 1934 or the Banking (Regulation) Act, 1949.
Any share issued by a company at a discounted price shall be void. Explain also the audit procedure in this regard.
(MTP1, May 2019, 3 Marks)
OR
Validity and consequence of issue of shares at discount, check with respect to the provisions of the Companies Act, 2013.
(SA, Nov 2019, 4 Marks)
OR
While conducting audit of Air Space Ltd, the auditor observes that it has issued shares at discount to its creditors when its debt is
converted into shares in pursuance of debt restructuring scheme in accordance with any guidelines specified by the Reserve Bank of
India. Discuss clearly the provisions relating to discount on issue of shares and its verification by the auditor.
(RTP, May 2022, NA)
According to Section 53 of the Companies Act, 2013, a company can issue shares at a discount.
(RTP, Nov 2019, NA)
Issue of Sweat Equity Shares
According to Section 54 of the Companies Act, 2013, the employees may be compensated in the form of ‘Sweat Equity
Shares”.
“Sweat Equity Shares” mean equity shares issued by the company to employees or directors at a
- discount or

- for consideration other than cash

for providing know-how or making available rights in the nature of intellectual property rights or value additions, by
whatever name called.
The auditor needs to verify that the Sweat Equity Shares issued by the company are of a class of shares already issued
and following conditions have been complied with (as per Section 54):
a. The issue is authorised by a special resolution passed by the company;

b. the resolution specifies the number of shares, the current market price, consideration, if any, and the class or
classes of directors or employees to whom such equity shares are to be issued;
c. where the equity shares of the company are listed on a recognised stock exchange, the sweat equity shares
are issued in accordance with the regulations made by the Securities and Exchange Board in this behalf and
if they are not so listed, the sweat equity shares are issued in accordance with such rules as may be
prescribed.The rights, limitations, restrictions and provisions as applicable to equity shares shall be applicable
to the sweat equity shares issued under this section and the holders of such shares shall rank pari passu with
other equity shareholders.
The auditor also needs to verify:

- whether the fresh issue of shares was a rights issue or a preferential issue
- and whether the relevant requirements for issue of share capital as per provisions of Companies Act, 2013 have
been complied with.
What audit points are to be borne in mind in case of issue of “Sweat Equity Shares” by a limited company?

Reduction of Capital
Reduction of Capital For verifying reduction of capital, the auditor needs to examine whether the company has
followed the specific requirements as required by Sec 66 of the Companies Act, 2013. The auditor shall undertake the
following audit procedures
1. Verify that the meeting of the shareholders held to pass the special resolution was properly convened and
that the proposal was circularised in advance to all the shareholders;
2. Verify that the Articles of Association authorises reduction of capital;
3. Examine that there has been no default w.r.t repayment of deposits accepted by company or payment of
interest on such deposits. Reduction of capital shall not be affected if such default exists.
4. Examine the order of the Tribunal confirming the reduction and verify that a copy of the order and the
minutes have been registered and filed with the Registrar of Companies;
5. Check the Registrar’s Certificate as regards to reduction of capital;
6. Vouch the accounting entries recorded to reduce the capital and to write down the assets by reference to the
resolution of shareholders and other documentary evidence; also check whether the requirements of
Schedule III, Part I, have been complied with in relation to presentation;
7. Confirm whether the revaluation of assets has been properly disclosed in the Balance Sheet;
8. The company may reduce the capital by reduction in unpaid capital or cancellation of lost capital or paying off
excess paid up capital. Verify the adjustment made in the members’ accounts in the Register of Members and
confirm that either the paid-up amount shown on the old share certificates has been altered or new
certificates have been issued in lieu of the old, and the old ones have been cancelled;
9. Confirm that the words “and reduced”, if required by the order of the Tribunal, have been added to the name
of the company in the Balance Sheet.
10. Check if the company has complied with all the terms and conditions imposed by the tribunal while
confirming reduction of share capital.
11. Verify that the Memorandum of Association of the company has been suitably amended.
If the Company has made any buyback of securities, ensure compliance of specific requirements as given under sec
68 of Companies Act 2013.
BNP Ltd has reduced its Share Capital to a greater extent in the year for which you are conducting the audit. State how will you proceed
for verifying the reduction of Capital.

Disclosure requirements of Schedule IlI
For each class of share capital (different classes of preference shares to be treated separately):
a. the number and amount of shares authorised;
b. the number of shares issued, subscribed and fully paid, and subscribed but not fully paid;
c. par value per share;
d. a reconciliation of the number of shares outstanding at the beginning and at the end of the reporting
period;
e. the rights, preferences and restrictions attaching to each class of shares including restrictions on the
distribution of dividends and the repayment of capital;
f. shares in respect of each class in the company held by its holding company or its ultimate holding company
including shares held by or by subsidiaries or associates of the holding company or the ultimate holding
company in aggregate;
g. shares in the company held by each shareholder holding more than 5 per cent shares specifying the number
of shares held;
h. shares reserved for issue under options and contracts/commitments for the sale of shares/disinvestment,
including the terms and amounts;
i. for the period of five years immediately preceding the date as at which the Balance Sheet is prepared:
i. Aggregate number and class of shares allotted as fully paid up pursuant to contract(s) without
payment being received in cash.
ii. Aggregate number and class of shares allotted as fully paid up by way of bonus shares.
iii. Aggregate number and class of shares bought back.
j. terms of any securities convertible into equity/preference shares issued along with the earliest date of
conversion in descending order starting from the farthest such date.
k. calls unpaid (showing aggregate value of calls unpaid by directors and officers)
l. forfeited shares (amount originally paid up)
m. A company shall disclose Shareholding of Promoters as below
i. S.no
ii. Promoter Name
iii. No. of Shares
iv. % of Total Shares
v. Change during the year
Explain the disclosure requirements of IND AS compliant Schedule III to Companies Act, 2013 for each component of "Other Equity."
Amount Loaned or Received For Indirect Investment etc.
Where company has

- advanced or loaned or invested funds (either borrowed funds or share premium or any other sources or kind of
funds)
- to any other person(s) or entity(ies), including foreign entities (Intermediaries)
- with the understanding (whether recorded in writing or otherwise)

- that the Intermediary shall

directly or indirectly lend or invest in other persons or entities identified in any manner whatsoever by
or on behalf of the company (Ultimate Beneficiaries) or
provide any guarantee, security or the like to or on behalf of the Ultimate Beneficiaries;
The company shall disclose the following:-

a. date and amount of fund advanced or loaned or invested in Intermediaries with complete details of each
Intermediary.
b. date and amount of fund further advanced or loaned or invested by such Intermediaries to other
intermediaries or Ultimate Beneficiaries along with complete details of the ultimate beneficiaries.
c. date and amount of guarantee, security or the like provided to or on behalf of the Ultimate Beneficiaries
d. declaration that relevant provisions of the Foreign Exchange Management Act, 1999 (42 of 1999) and
Companies Act has been complied with for such transactions and the transactions are not violative of the
Prevention of Money-Laundering act, 2002 (15 of 2003).;
Where a company has

- received any fund
- from any person(s) or entity(ies), including foreign entities (Funding Party)
- that the company shall
or on behalf of the Funding Party (Ultimate Beneficiaries) or
provide any guarantee, security or the like on behalf of the Ultimate Beneficiaries,
The company shall disclose the following

a. date and amount of fund received from Funding parties with complete details of each Funding party.
b. date and amount of fund further advanced or loaned or invested by other intermediaries or Ultimate
Beneficiaries along with complete details of the other intermediaries or ultimate beneficiaries.
Prevention of Money-Laundering act, 2002 (15 of 2003).

Reserves and Surplus
Types
The reserves can be segregated as revenue or capital reserves.
Revenue reserves
Revenue reserves represent profits that are available for distribution to shareholders or below purposes such as:
- To supplement divisible profits in lean years,
- to finance an extension of business,
- to augment the working capital of the business or
- to generally strengthen the company’s financial position.
Capital Reserve
- Capital Reserve represents a reserve which does not include any amount regarded as free for distribution.
They can be utilised only for certain limited purposes.
- Capital Reserve is created from capital profits earned through sale of capital assets such as sale of fixed assets,
profit on sale of shares.
- A capital reserve, generally, can be utilised for writing down fictitious assets or losses or (subject to provisions
in the Articles) for issuing bonus shares if it is realised.
- But the amount of securities premium or capital redemption reserve account can be utilised only for the
purposes specified in Sections 52 and 55 of the Companies Act, 2013, respectively.
Assertions to be Examined
1. Existence To establish the existence of reserves and surplus as at the year end.
2. Completeness - Reserves and Surplus balances that were supposed to be recorded have been recognized in
the financial statements.
3. Valuation - Reserves and Surplus balances have been valued appropriately as per relevant law and regulation
and applicable financial reporting framework.
4. Presentation and disclosure - Required disclosures for reserves and surplus have been appropriately made.
Audit Procedures
1. Trace and tally the opening balance of reserves and surplus to the previous year audited financial statements.
2. For addition/utilisation in current year, in case of:
a. Profit and Loss balance –
➢ Trace the movement to surplus/ deficit as per the Statement of profit and loss for the year
under audit.
➢ The movement should be traced in the Statement of Changes in Equity.
➢ Verify the resolution passed by the board of directors regarding the recommendation of
dividend, resolution passed by shareholders declaring the dividend.
b. Securities Premium - It needs to be confirmed that the company has issued shares in excess of the
nominal value of the shares and for the same, the auditor should obtain and verify the resolution
passed by the board of directors. Auditor needs to ensure the usage of securities premium amount is
as per Section 52 of Companies Act 2013)

Reserves are amounts appropriated out of profits whereas on the contrary, provisions are amounts charged against revenue. Discuss
explaining the difference between the two and also explain clearly revenue reserve and capital reserve.
(RTP, May 2019, NA)
Disclosure requirements of Schedule III

Ensure whether the following disclosure requirements of Schedule III (Part 1) to Companies Act, 2013 have been
complied with:
1. Reserves and Surplus shall be classified as:

a. Capital Reserves;
b. Capital Redemption Reserve;
c. Securities Premium.;
d. Debenture Redemption Reserve;
e. Revaluation Reserve;
f. Share Options Outstanding Account;
g. Other Reserves– (specify the nature and purpose of each reserve and the amount in respect thereof);
h. Surplus i.e., balance in Statement of Profit and Loss disclosing allocations and appropriations such as
dividend, bonus shares and transfer to/ from reserves, etc.; (Additions and deductions since last balance
sheet to be shown under each of the specified heads);
2. A reserve specifically represented by earmarked investments shall be termed as a “fund”.
3. Debit balance of statement of profit and loss shall be shown as a negative figure under the head “Surplus”.
Similarly, the balance of “Reserves and Surplus”, after adjusting the negative balance of surplus, if any, shall be
shown under the head “Reserves and Surplus” even if the resulting figure is in the negative.
For each component of reserves and surplus, whether the company has disclosed the following (to the extent applicable):
1. Balance at the beginning of the reporting period
2. Changes, if any, due to changes in accounting policy or prior period error
3. Total profit/ loss for the year
4. Dividends
5. Transfer to retained earnings
6. Any other change (to be specified)
7. Balance at the end of reporting period.

Borrowings
On going through the financial statements of PQR Ltd, its auditors Kamal Gagan and Associates observed that the
company has taken Loans from banks and financial institutions. Further, the audit team discusses the following about
Liabilities:
“Liabilities are the financial obligations of an enterprise other than owners’ funds. Liabilities include loans/ borrowings,
trade payables and other current liabilities, deferred payment credits and provisions.
Verification of liabilities is as important as that of assets, for, if any liability is omitted (or understated) or over stated, the
Balance Sheet would not show a true and fair view of the state of affairs of the company.”
Advise stating clearly the audit procedures generally required to be undertaken for verification of existence of Borrowings.
(MTP1, May 2018, 5 Marks) (MTP2, Nov 2018, 5 Marks)
Borrowings are the amount borrowed using external sources like bank loans, debentures, public fixed deposits etc.
Audit procedures
● Review board minutes for approval of new lending agreements. During review, make sure that any new
loan agreements or bond issuances are authorized.
● Ensure that significant debt commitments should be approved by the board of directors
● Agree details of loans recorded such as interest rate, nature and repayment terms to the loan
agreement. (NOTE - Checking completeness)
● Verify that the loans obtained are within the borrowing limits of the entity.
● Roll out and obtain independent balance confirmations (SA 505) in respect of all the borrowings from
the lender (banks/ financial institutions etc.).
● Agree details of leases and hire purchase creditors recorded to underlying contracts/agreements.
● In case of Debentures, examine trust deeds for terms and dates of redemption borrowing restrictions
and compliance with covenants.
● When debt is retired, ensure that a discharge is received on assets securing the debt.
● Obtain Written Representation that all the liabilities which have been recorded represent a valid claim
by the lenders.
Direct confirmation procedures
Roll out and obtain independent balance confirmations in respect of all the borrowings from the lender (banks/
financial institutions etc.) and perform the following:
a. Ascertain that the confirmation asks for all information likely to be relevant to the tests of debt and related
interest balances (e.g., applicable interest rates, due dates, collateral and security interests).
b. Send reminders for non-replies.

c. Compare the balances are per the conformations obtained to the books of the accounts. Ask for
reconciliations, if there are any differences and test the supporting documents for the reconciling items on a
test check basis.
Disclosure as per Schedule III
Ensure borrowings have been presented, classified and DISCLOSED in the financial statements in accordance with the
requirements of applicable financial reporting framework i.e. Companies Act, 2013 and applicable Indian GAAP.
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 are made for
each amount disclosed under each of the following headings: Long- Term Borrowings
Long-term borrowing
1. Long-term borrowings shall be classified as:

a. Bonds/debentures;
b. Term loans:
A. from banks.
B. from other parties.
c. Deferred payment liabilities;
d. Deposits;
e. Loans and advances from related parties;
f. Long term maturities of finance lease obligations;
g. Other loans and advances (specify nature).
2. Borrowings shall further be sub-classified as secured and unsecured. Nature of security shall be specified
separately in each case.
3. Where loans have been guaranteed by directors or others, the aggregate amount of such loans under each
head shall be disclosed.
4. Bonds/debentures (along with the rate of interest and particulars of redemption or conversion, as the case may
be) shall be stated in descending order of maturity or conversion, starting from farthest redemption or
conversion date, as the case may be. Where bonds/debentures are redeemable by instalments, the date of
maturity for this purpose must be reckoned as the date on which the first instalment becomes due.
5. Particulars of any redeemed bonds/debentures which the company has power to reissue shall be disclosed.
6. Terms of repayment of term loans and other loans shall be stated.
7. Period and amount of continuing default as on the balance sheet date in repayment of loans and interest, shall
be specified separately in each case.
8. Other Long term Liabilities Other Long term Liabilities shall be classified as:
a. Trade Payables;
b. Others
Short Term Borrowings

a. Short-term borrowings shall be classified as:
A. Loans repayable on demand;
B. from banks.
C. from other parties.
D. Loans and advances from related parties;

E. Deposits;
F. Other loans and advances (specify nature).
b. Borrowings shall further be sub-classified as secured and unsecured. Nature of security shall be
specified separately in each case.
c. Where loans have been guaranteed by directors or others, the aggregate amount of such loans under
each head shall be disclosed.
d. Period and amount of default as on the balance sheet date in repayment of loans and interest, shall be
specified separately in each case.
e. Current maturities of Long term borrowings shall be disclosed separately.

Disclosures related to borrowings in special cases
Borrowings on the basis of security
Where the Company has borrowings from banks or financial institutions on the basis of security of current assets, it
shall disclose the following:-
1. whether quarterly returns or statements of current assets filed by the Company with banks or financial
institutions are in agreement with the books of accounts.
2. if not, summary of reconciliation and reasons of material discrepancies, if any to be adequately disclosed.
Wilful Defaulter
Where a company is a declared wilful defaulter by any bank or financial institution or other lender, following details
shall be given:
a. Date of declaration as wilful defaulter,
b. Details of defaults (amount and nature of defaults),
A person or a company is termed as a “wilful defaulter” When the borrower (individual or company) defaults on their payment obligation, even when
it has the capacity to honour the said obligations. There is a deliberate intention of not repaying the loan. (other reasons are also there, but we will
stick to this only for our limited understanding)
Wilful defaulter" here means a person or an issuer who or which is categorized wilful defaulter by any bank or financial institution or consortium
thereof, in accordance with the guidelines on wilful defaulters issued by the Reserve Bank of India.
Registration of charges or satisfaction with Registrar of Companies
Where any charges or satisfaction yet to be registered with Registrar of Companies beyond the statutory period, details and reasons
thereof shall be disclosed.
Amount Loaned or Received For Indirect Investment etc.
Where company has

- advanced or loaned or invested funds (either borrowed funds or share premium or any other sources or kind of
funds)
- to any other person(s) or entity(ies), including foreign entities (Intermediaries)
- that the Intermediary shall
or on behalf of the company (Ultimate Beneficiaries) or
provide any guarantee, security or the like to or on behalf of the Ultimate Beneficiaries;
The company shall disclose the following:-

a. date and amount of fund advanced or loaned or invested in Intermediaries with complete details of each
Intermediary.
b. date and amount of fund further advanced or loaned or invested by such Intermediaries to other
intermediaries or Ultimate Beneficiaries along with complete details of the ultimate beneficiaries.

Prevention of Money-Laundering act, 2002 (15 of 2003).;
Where a company has

- received any fund
- from any person(s) or entity(ies), including foreign entities (Funding Party)
- that the company shall
or on behalf of the Funding Party (Ultimate Beneficiaries) or
provide any guarantee, security or the like on behalf of the Ultimate Beneficiaries,
The company shall disclose the following

a. date and amount of fund received from Funding parties with complete details of each Funding party.
b. date and amount of fund further advanced or loaned or invested by other intermediaries or Ultimate
Beneficiaries along with complete details of the other intermediaries or ultimate beneficiaries.
Prevention of Money-Laundering act, 2002 (15 of 2003).
Audit Procedures with respect to valuation of borrowings (Homework)
That liability is recorded at the correct amount. (VALUATION)
1. Determine that the accounting policies and methods of recording debt are appropriate and
applied consistently.
2. Agree loan balance and loan payables to the loan agreement.
3. Recompute the interest and discount or premium on redemption, if any.
4. Check computation of the amortisation of premium or discount, if any.
5. For foreign currency loans, check the closing exchange rate(s) used and verify the computations of
the restatements of foreign currency balances outstanding at year end. (As per AS 11)
6. Read the provisions in loan and debt agreements and perform the following:
a. Test that the entity is in compliance with loan covenants and other significant provisions of the
agreements.
b. If there are any provisions with which the entity is not in compliance, determine whether the
debt should be classified as current. If enforcement of the provisions has been waived by
the lender in case of breach of any covenant by the entity, obtain confirmation of the waiver from
the lender.
7. Examine the due dates on loans for proper classification between long-term and short-term.
8. Where instalments of long-term loans falling due within the next twelve months have been disclosed in the
financial statements (e.g. in parentheses or by way of a footnote), verify the correctness of the amount of such
instalments.

9. Examine the debt agreements for any restrictive covenants. Review restrictive covenant and provisions relating
to default and ensure disclosure thereof in the financial statements.
10. Examine the important terms in the loan agreements and the documents, if any, evidencing charge in respect
of such loans and advances. Examine whether the requirements of the applicable statute regarding creation
and registration of charges have been complied with including disclosure of the same to the extent mandated
by statute and considered necessary for proper understanding of the user of financial statements.
11. In case the value of the security falls below the amount of the loan outstanding, examine whether the loan is
classified as secured only to the extent of the market value of the security.
12. Examine the hire purchase agreements for the purchase of assets by the entity and ensure the correctness of
the amounts shown as outstanding in the accounts, and also examine the security aspect.
13. He should carefully review the borrowings from related parties and ensure compliance with AS 18 or IND AS 24.
Verify whether liabilities towards bank in respect of bills discounted, bills negotiated, cheques discounted, etc.
are correctly reflected and disclosed in the financial statements.
14. The auditor should also verify that the amount borrowed is within the borrowing powers of the
company as laid down by the Articles of Association and Memorandum of Association.
15. Verify that the company has not contravened the restrictions laid down by Section 180 of the
Companies Act, in respect of the borrowings of the company. Also, check compliance of Sections 185 and
186 of the Companies Act, 2013. Examine the purpose for which the amount is borrowed and ensure that
the amount is not used against the interest of the company.
16. Where the entity has accepted deposits, examine whether the directives issued by the Reserve Bank of
India or other appropriate authority have been complied with.

Trade Receivables
“Until the invoice is paid, the invoice amount is recorded on the organisation’s balance sheet as accounts receivable. If balances are not
recoverable, then these amounts will need to be written off as an expense in the income statement/ profit and loss account.”
It is important to carry out compliance procedures in the sales audit as part of the debtors’ audit procedure.
Verify to ensure that the system for receivables has the necessary features.
OR
“Trade receivables are an essential part of any organisation's balance sheet. Often referred to as debtors, these are monies which are owed
to an organisation by a customer. The most common form of an account receivable is a sale made on credit, via an invoice, to a customer.”
It is important to carry out compliance procedures in the sales audit as part of the debtors’ audit procedure.
Verify to ensure that the system for receivables has the necessary features.
Trade receivables are an essential part of any organisation's balance sheet.

- Often referred to as debtors, these are monies which are owed to an organisation by a customer.
- The most common form of an account receivable is a sale made on credit, via an invoice, to a customer.
- Typically, an invoice is raised and issued to the customer with the invoice amount being recorded as a debtor
balance. Until the invoice is paid, the invoice amount is recorded on the organization’s balance sheet as accounts
receivable.
- If balances are not recoverable, then these amounts will need to be written off as an expense in the income
statement/ profit and loss account.
It is important to carry out compliance procedures in the sales audit as part of the debtors’ audit procedure. In summary,
check to ensure that the system for receivables has the following features
● Only bona fide sales lead to receivables

● Sales are made to approved customers.
● All such sales are duly recorded in the books
● Once recorded, the debts can only be eliminated by receipt of cash or on the authority of a responsible official
● Debts are collected promptly
● Balances are regularly reviewed and aged, a proper system of follow up exists and if necessary adequate provision
for bad debt exists
● Clear segregation of duties relating to identification of debt, receipt of income, reconciliations and write off of debts
Correct/Incorrect
No entry is passed for cheques received by the auditee on the last day of the year and not yet
deposited with the Bank.
(MTP1, May 2021, 2 marks) (RTP, May 2022, NA)
The statement is Incorrect.

The person who is controlling the trade receivables should ensure that proper accounting entries have been passed by
crediting the respective trade receivables account. The balance of cheque in hand should be disclosed along with the cash
and bank balances in the financial statements.

Write the audit Procedure for verification of existence of Trade Receivables.

For Verification of Existence of Trade Receivables, the auditor should check the following :
i) Check whether there are controls in place to ensure that

○ invoices cannot be recorded more than once and
○ receivable balances are automatically recorded in the general ledger from the original invoice.
○ Ask for a period-end accounts receivable ageing report and trace the balance as per the report to the
general ledger.
ii) Check whether realization is recorded invoice-wise or not.
○ If not, check that money received from debtors is adjusted chronologically invoice-wise and on FIFO basis i.e.
previous bill is adjusted first.
iii) If any large balance is due for a long time, auditor should ask for reasons and justification for the same.
iv) A list of trade receivables selected for confirmation should be given to the entity for preparing request letters for
confirmation which should be properly addressed.
v) The auditor should maintain strict control to ensure the correctness and proper despatch of request letters. It should
be ensured that confirmations as well as any undelivered letters are returned to the auditor and not to the client.
vi) Any discrepancies revealed by the confirmations received or by the additional tests carried out by the auditor may
have a bearing on other accounts not included in the original sample.
vii) Where no reply is received, the auditor should perform alternative procedures regarding the balances. This could
include:
○ Agreeing the balance to cash received subsequently;

○ Preparing a detailed analysis of the balance, ensuring it consists of identifiable transaction and confirming
that these revenue transactions actually occurred. (examination in depth for those balances)
viii) If there are any related party receivables, review them for collectability as well as whether they were properly
authorized and the value of such transactions were reasonable and at arm’s length.
ix) Check that receivables for other than sales or services are not included in the list.
x) Review a trend line of sales and accounts receivable, or a comparison of the two over time, to check if there are
any unusual trends i.e. perform Analytical procedures. Make inquiries about reasons for changes in trends with the
management and document the same in audit work papers.
All Trade receivable balances that were supposed to be recorded have been recognized in
the financial statements. (COMPLETENESS)
1. The auditor needs to satisfy himself of the cut-offs. Without a cut-off, sales could be understated or
overstated, hence there is a need to perform the following cut off procedure:
a. Ensure that all goods invoiced prior to the cut off have been invoiced and included in debtors on a test
check basis;
b. Ensure that no goods invoiced after the year- end have been included in debtors for the period under
audit.

2. Test invoices listed in the receivable report. Select a few invoices from the accounts receivable ageing report
and compare them to supporting documentation to see if they were billed with the correct amounts, to the
correct customers, and on the correct dates.
3. Match invoices to shipping/ dispatch log. Match invoice dates to the shipment dates for those items in the
shipping/ dispatch log, to see if sales are being recorded in the correct accounting period. This can include an
examination of invoices issued subsequent to the period being audited, to see if they should have been
included in the period under audit.
4. Assess bills and hold sales. If there is a situation where the Company is billing customers for sales despite still
retaining the goods on-site (known as “bill and hold”), examine supporting documentation to determine
whether a sale has actually taken place or not.
5. Check if the Company has recorded an inordinately large amount of customer returns after the audit period,
which would suggest that the Company may have shipped more goods near the end of the audit period than
what the customers had authorized to inflate the profits of the company;
6. Review the process of giving discounts/ incentives and check whether the same were given as per the
Company’s policy/ general industry trends.
7. Review credit memos, on a sample basis, issued during the audit period to see if they were properly
authorized.

Trade receivable balances have been VALUED appropriately
1. Review the process followed by the Company to derive an allowance for doubtful accounts.
2. Check if provisions are made at appropriate rates considering the recoverability of amounts due.
3. Obtain the ageing report of accounts receivable , split between not currently due, 30 days old, 30-60 days old,
60- 180 days old, 180- 365 days old and more than 365 days old.
4. Obtain the list of debtors under litigation and compare with previous year.
5. Identify those debtors which appear doubtful;
○ discuss with management about reasons as to why these debtors are not included in the provision for
bad debts.
○ Perform further testing where any disputes exist.
6. Check that write-offs of the receivable balances have been approved by an appropriate authority i.e. the
Board of Directors in case of a company.
Required DISCLOSURE for trade receivables have been appropriately made
1. Check that the restatement of foreign currency trade receivables has been done properly in accordance with AS 11.
2. Proper disclosure of Related Party Transactions. regarding receivables have been made as per AS 18 or IND AS 24.
3. Ensure that the transactions with parties covered under Section 189 of the Companies Act, 2013 are reported properly in
Companies Auditors’ Report Order (CARO),2020.
4. Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 are made for each
amount disclosed under the heading “Trade Receivables”
i. Trade Receivables ageing schedule*.
ii. Trade receivables shall be sub-classified as:
(a) Secured, considered good
(b) Unsecured, considered good;
(c) Doubtful.
iii. Allowance for bad and doubtful debts shall be disclosed under the relevant heads separately.
iv. Debts due by
(a) directors or other officers of the company or any of them either severally or jointly with any other person or
(b) firms or private companies respectively in which any director is a partner or a director or a member should
be separately stated.
Trade Receivables ageing schedule*
Particulars Outstanding for following periods from due date of payment#
Less than 6 6 Months to 1 year 1-2 years More than 3 years Total
Months
(i) Undisputed
Trade receivables
considered good
(ii)Undisputed
Trade Receivables
considered
doubtful
(iii) Disputed
Trade

Receivables
considered good
(iv) Disputed Trade

Receivables
considered
doubtful
Where no due date of payment is specified, in that case disclosure shall be from the date of the transaction. Unbilled dues shall be
disclosed separately.

Cash and cash equivalents
To establish the Existence of cash and cash equivalent balances as at the period- end.
1. Check by Surprise
○ Special care is necessary in regard to verification of cash balances.
○ The cash should be checked not only on the last day of the year, but also checked again sometime after
the close of the year without giving notice of the auditor’s visit either to the entity or to his staff.
(Surprise check)
2. More than one cash balance
○ If there are more than one cash balances, e.g., when there is a cashier, a petty cashier, a branch cashier
and, in addition, there are imprest balances with employees, all of them should be checked
simultaneously.
3. Presence of cashier and sign
○ It is desirable for the cashier to be present while cash is being counted and he should be made to sign
the statement prepared containing details of the cash balance counted along with denomination of
cash.
Cash and cash equivalent balances that were supposed to be recorded have been recorded
in the financial statements. (COMPLETENESS)
1. If there is any rough Cash Book or details of daily balance are separately kept, the auditor should test entries
from the rough Cash Book with those in the Cash Book to prove that entries in the Cash Book are correct.
2. If the auditor finds any slip, chit or I.O.U.s in respect of temporary advances paid to the employees included
as part of the cash balance, he should check whether those are approved by an authorized official and
recorded in the appropriate accounts.
3. The auditor should also perform a cash sensitivity analysis
○ by compiling a summary of total cash receipts and payments each month and
○ analyzing the trends to see if there have been variations in any specific month and
○ request brief descriptions from the management.
4. BRS
○ The auditor needs to obtain bank reconciliation statements (BRS) for all bank accounts maintained by
the entity as at the reporting period and additionally need to understand the client’s process and
periodicity of making the BRS.
5. Verification of BRS
○ The auditor should ensure that BRS is signed by the authorized personnel so that he is able to assign
responsibility in case of any errors. Verification of BRS shall entail the following:
i. Tallying the balance as per bank book to the bank confirmation/ statement.
ii.
➢ Checking of all material reconciling items included under cheques issued but
presented for payment to the underlying bank book forming part of books of account.
➢ In addition, the auditor should request for bank statements of subsequent period and
should verify if the cheques issued have subsequently been cleared by the bank.
➢ For all cases where cheques have become stale i.e. 3 months or more have lapsed since
the issue date, the same should not appear in the BRS.
iii.
➢ Checking of all material reconciling items included under cheques deposited but not

credited by bank by requesting for bank deposit slips, duly acknowledged by bank and
verifying if the balances were credited by bank subsequently by tallying to the bank
statement of subsequent period.
➢ For any instances related to cheques not cleared beyond reasonable time, the auditor
should seek brief descriptions from the management and in case such explanations are
found to be unsatisfactory, the auditor should verify the revenue recognition related to
such parties was in order and as per the Company’s revenue recognition policy.
○ Checking of all material reconciling items included under amounts or charges debited/ credited by
bank but not accounted for by requesting for bank statements for the period under audit and tallying
the same. If the amounts are found to be material, the auditor should ensure that the management
records the adjustments for the same in its books of account. If management does not adjust, the
auditor shall consider to qualify his report.
Direct confirmation procedure
1. A significant and important audit activity is to contact banks/ financial institutions directly and ask them to
confirm the amounts held in current accounts, deposit accounts, etc as of the end of the reporting period
under audit.
2. The Company should be asked to investigate and reconcile the discrepancies, if any, including seeking written
explanations/ clarifications from the banks/ financial institutions on any unresolved queries.
3. The auditor should emphasize for confirmation of 100% of bank account balances. In remote situations, where
no reply is received, the auditor should perform additional testing regarding the balances. This testing could
include
a. Agreeing the balance to bank statement received by the Company or internet/ online login to account
in auditor’s personal presence;
b. Sending the audit team member to the bank branch along with the entity’s personal to obtain balance
confirmation from the bank directly.
Cash and cash equivalent balances have been VALUED appropriately
In addition to the procedures performed above, the auditor should ensure that all bank accounts holding foreign
currency have been restated at the closing exchange rates as per applicable Financial Reporting Framework.
A significant and important audit activity is to contact banks/ financial institutions directly and ask them to confirm the amounts held in
current accounts, deposit accounts, EEFC account, cash credit accounts, etc. as at the end of the reporting period under audit. Explain the
audit procedure in this context.
(RTP, Nov 2020, NA)
Required DISCLOSURES for cash and cash equivalents have been appropriately made.
How is "Cash and cash equivalents" disclosed in the Financial Statements as required under Schedule IlI (part 1) to Companies Act, 2013 ?
(SA, Dec 2021, 3 Marks)
Cash and cash equivalents

1. Cash and cash equivalents shall be classified as:
a. Balances with banks;
b. Cheques, drafts on hand;

c. Cash on hand;
d. Others (specify nature)
2. Earmarked balances with banks (for example, for unpaid dividend) shall be separately stated.
3. Balances with banks to the extent held as margin money or security against the borrowings, guarantees,
other commitments shall be disclosed separately.
4. Repatriation restrictions, if any, in respect of cash and bank balances shall be separately stated.
5. Bank deposits with more than 12 months’ maturity shall be disclosed separately.

Inventories
To establish the EXISTENCE of Inventories as at the period- end.
● Review entity’s plan for performing inventory count.

● Ensure that consigned goods have been segregated.
● Auditor should participate in the inventory count with the management.
● Test counts of inventory by auditor should include:
○ observing employees are adhering to the agreed plan.
○ assuring that all items are properly tagged.
○ Assuring that there is appropriate supervision on the count procedure.
○ Observing that proper amounts are shown on tags.
○ Staying alert at all times and specifically being cautious about empty boxes, etc. and obsolete items.
○ Performing cut-off testing by documenting the last 5-10 receiving reports and shipping documents as
of the period end.
○ Ensuring exclusion of third party stock and damaged or obsolete stock.
○ Investigating any significant differences between the physical stock take and the stock records as per
books.
The auditor should ask the entity’s personnel to sign all stock count sheets and also agree the variances
observed, if any, to avoid any conflicts.
● When the entity uses a periodic system for inventory count, it should be undertaken at the end of the period. If
the entity uses a perpetual system with proper and adequate records, inventory may be counted at interim
dates.
● Confirm or investigate any inventory of the entity lying with a third party (specifically relevant for cases where
the entity gets job work done in its process of production).
Only the inventories held by the entity have been recorded in the financial statements and
do not include any inventories that belong to third parties but does include inventories
owned by the entity and lying with a third party.
● Perform analytical procedures (comparison tests with industry averages, budgets, prior years, trend analysis,
etc.).
● Perform purchase and sales cut-offtests..
● With respect to tagged inventory, perform tests for omitted transactions and tests for invalid transactions.
● Verify the clerical and arithmetical accuracy of inventory listings.
● Reconcile physical inventory amounts with perpetual records.
● Reconcile physical counts with general ledger control totals.
● Reconcile inventories which belong to client but are held with third parties like transporters, warehouses, port
authorities etc.
● Goods received on consignment basis have been properly segregated from other items of inventory.
Valid legal ownership rights
The entity has valid legal ownership rights over the inventories claimed to be held by the entity and recorded in the
● Vouch recorded purchases to underlying documentation (purchase requisition, purchase order, receiving
report, vendor invoice and cancelled cheque or payment file).
● Evaluate the consigned goods.
● Examine client correspondence, sales and receivables records, purchase documents.

● Review material purchase commitment agreements.

● Examine invoices for evidence of ownership i.e. the invoices shall be in the name of the client.
● Auditors shall obtain confirmation for significant items of inventory as per SA 501.
● For instances of inventory held by third party, the auditor should insist on obtaining declaration from the third
party on its business letterhead and signed by an authorized personnel of that third party confirming that the
items of inventory belong to the entity and are being held by such third party on behalf of and for the benefit
of the entity under audit.
Inventories have been VALUED appropriately and as per generally accepted accounting
policies and practices
● Depending on how the business operates, the management may value inventory using First-in-first-out (FIFO)
or weighted average basis. Consider the reasonableness of the method adopted.
● For Raw materials and consumables
○ Ascertain what elements of cost are included e.g. carriage inward, non-refundable duties etc.
○ If standard costs are used, enquire into the basis of standards; how these are compared with actual
costs and how variances are analyzed and accounted for/ treated in accounting records.
○ Test check cost prices used with purchase invoices received in the month(s) prior to counting.
○ Follow up valuation of all damaged or obsolete inventories with a view to establishing a realistic net
realizable value.
● For Work in progress
○ Ascertain how the various stages of production/ value additions are measured and in case estimates
are made, understand the basis for such estimates.
○ Ascertain what elements of cost are included. If overheads are included, ascertain the basis on which
they are included.
● For Finished goods and goods for resale

○ Enquire as to what costs are included, how these have been established and ensure that the overheads
included have been determined based on normal costs and appear reasonable in relation to the
information disclosed in the financial statements.
○ Ensure that inventories are valued at net realizable value if they are likely to fetch a value lower than
their cost.
○ Follow up for items that are obsolete, damaged, slow moving and ascertain the possible realizable
value of such items. For the purpose, request the client to provide inventory ageing split between less than 30 days, 30-60
days old, 60- 90 days old, 90- 180 days old, 180- 365 days old and more than 365 days old.
○ Follow up any inventories which at time of observance of physical counting were noted as being
damaged or obsolete.
○ Examine vendor price lists to determine if recorded cost is less than current prices.
○ Calculate inventory turnover ratio. Obsolete inventory may be revealed if ratio is significantly lower.
○ In manufacturing environments, test overhead allocation rates and ensure that only direct labor, direct
material and overhead have been included.
Goods Lying with Third Party: The auditor should check that the materiality of the item under this caption is included
in inventories.
i) He should obtain confirmation of the amount of goods lying with them.
ii) He should inquire into the necessity of sub contractor retaining the inventory.
iii) The goods lying with them for a very long period would merit auditors’ special attention for making
provision.

iv) The records, voucher/slips for the regulating the movement of inventory into and out of entity for
sub-contracting work be reviewed by vouching for few transactions for ensuring existence and working of
internal control system for them.
v) The valuation of inventories should be correctly made for including material cost on appropriate inventory
valuation formulae and also for inclusion of proportionate processing charges for the work in process with the
contractors.
vi) Evaluate the condition of goods and see whether adequate provision has been made.
vii) Check whether subsequently the goods lying with third party were sold or received back after the expiry of
the stipulated time period.
viii) Ensure that the goods have been included in the closing inventory though lying with a third party.
Management of Z Ltd. wants to include all the cost incurred by the Company in valuing the cost of its inventories. The Accountant
is, however, of the view that certain costs should be excluded from the cost of inventories and should be recognised as expenses
for the period in which they are incurred. What are such costs that should be excluded while determining the cost of inventories?
While conducting an audit of Vee Ltd, CA Aman, auditor of the company, found that some goods were lying with third parties for a long
period. Advise Aman how he will verify them.
"ABC Limited has a closing balance of work in progress of inventories aggregating Rs 850 lakhs in their balance sheet as at March 31, 2020.
As Statutory Auditor of ABC Limited, explain various audit procedures which need to be performed to confirm Work-in-progress of
inventories have been valued appropriately and as per generally accepted accounting policies and practices."
(SA, Jan 2021, 3 marks)
Examples of costs to be excluded in determining cost of Inventory:

In determining the cost of inventories, it is appropriate to exclude certain costs and recognise them as expenses in
the period in which they are incurred. Examples of such costs are:
i) abnormal amounts of wasted materials, labour, or other production costs;
ii) storage costs, unless those costs are necessary in the production process prior to a further production stage;
iii) administrative overheads that do not contribute to bringing the inventories to their present location and
condition; and
iv) selling and distribution costs.
In the given situation, contention of Z Ltd. is not correct to include all the cost of its inventories while determining the
cost of inventory. However, the contention of the accountant is correct that certain cost should be excluded from the
cost of inventories and to be recognised as expenses in the period in which they are incurred.
Required DISCLOSURES for inventories have been appropriately made
● Ensure whether the following disclosures as required under Schedule III (Part 1) to the Companies Act, 2013
have been made
● Whether inventory has been classified as:
○ Raw materials
○ Work-in-progress
○ Finished goods
○ Stock-in-trade (goods acquired for trading)

○ Stores and spares

○ Loose tools Others (specify nature).
○ Whether goods-in-transit have been disclosed separately under each sub-head of inventories. Mode of
valuation shall be stated.

LAND, BUILDING, PLANT & EQUIPMENT, FURNITURE & FIXTURES, VEHICLES,

OFFICE EQUIPMENT, COMPUTERS ETC. REFERRED TO AS “PROPERTY,
PLANT AND EQUIPMENT” (“PPE”)
To establish the EXISTENCE of PPE as at the period-end
1. Review entity’s plan for performing physical verification of PPE

a. By whom
b. Period
2. Evidence of appropriate supervision of those performing physical verification of PPE should be examined.
3. Obtain PPE physical verification report backed by the working sheets from the entity and perform the
following procedures:
- Assess if all items of PPE are properly tagged and carry identification marks/ numbers.
- Reconciliation of items of PPE as physically verified with the fixed asset register.
- Verify the discrepancies noted, based on physical verification undertaken and the manner in which
such discrepancies have been dealt with in the entity’s books and financial statements.
Additions to PPE during the period under audit have been recorded in the financial
statements
● Verify the movement in the PPE schedule compiled by the management i.e. Opening balances + Additions
during the period – Deletions during the period = Closing balances. Tally the closing balance to the entity’s
books of account.
● Check the arithmetical accuracy of the movement in PPE schedule.
● Tally the opening balances to the previous year audited financial statements.
● For additions during the period under audit, obtain a listing of all additions from the management and
perform the following procedures:
● For all material additions, verify if such expenditure meets the criteria of PPE as per AS 10 Revised.
● Ensure that the entity is not recognizing costs of the day-to-day servicing in the carrying amount of an item of
property, plant and equipment.
● Test the purchase invoice, installation certificate or report or other similar documentation maintained by the entity
to verify the date of addition, for all additions samples of PPE during the period under audit.
● Verify whether the PPE additions have been approved by authorized personnel.
● Verify whether proper internal processes and procedures like inviting competitive quotations/ floating tenders
etc. were followed prior to finalising the vendor for procuring items of PPE/ awarding of work contract for
capital projects by checking the supporting documents of the samples selected.
● In relation to deletions to PPE, understand from the management the reason and rationale for deletion
(example could be new purchase of similar asset once the old asset was no longer fit to be used in production
process) and the manner of disposal.
● Verify the process followed for sale of discarded PPE.
● Verify that the management has accurately recorded the deletion, profit or loss on disposal of PPE
PPE have been VALUED appropriately and as per generally accepted accounting policies
and practices

It is a common understanding that the value of fixed assets/ PPE depreciates due to efflux of time, use and
obsolescence. The diminution of the value represents an item of cost to the entity for earning revenue during a given
period. Unless this cost in the form of depreciation is charged to the accounts, the profit or loss would not be correctly
ascertained and the values of PPE would be shown at higher amounts.
The auditor should:

● Verify that the entity has charged depreciation on all items of PPE unless any item of PPE is non-
depreciable like freehold land;
● Assess that the depreciation method used reflects the pattern in which the asset's future economic benefits
are expected to be consumed by the entity. It could be the Straight line method, diminishing value method, unit of production
method, as applicable.
● The auditor should also verify whether the management has done an impairment assessment to determine
whether an item of property, plant and equipment is impaired as per the requirements of AS 28 - Impairment
of Assets.
The entity has valid legal ownership rights over the PPE claimed to be held by the entity and
recorded in the financial statements (RIGHTS AND OBLIGATION) - https://youtu.be/82ztH4bkPWs
● Verify that purchase invoices are in the name of the entity that entitles legal title of ownership to the
respective entity.
● For all additions to land and building in particular, the auditor should check the conveyance deed/ sale deed
to verify whether the entity is the legal and valid owner or not. The auditor should insist and verify the original title deeds
for all immovable properties held as at the balance sheet date.
● In case the entity has given such immovable property as security for any borrowings and the original title
deeds are not available with the entity, the auditor should request the entity's management for obtaining a
confirmation from the respective lenders that they are holding the original title deeds of immovable property
as security.
● In addition, the auditor should also verify the register of charges, available with the entity to assess that any
charge has been created against the PPE.
The auditor A of ABC & Co.- firm of auditors is conducting the audit of XYZ Ltd and while performing testing of additions wanted to verify
that all PPE (Property Plant and Equipment) purchase invoices are in the name of the entity he is auditing. For all additions to land,
building in particular, the auditor desires to have concrete evidence about ownership. The auditor is worried about whether the entity has
valid legal ownership rights over the PPE claimed to be held by the entity and recorded in the financial statements. Advise the auditor.
(RTP, May 2018, NA) (RTP, Nov 2019, NA) (MTP1, Nov 2019, 3 Marks)
Answer Discussion - https://youtu.be/82ztH4bkPWs
CA R is the statutory auditor of QRS Ltd. While performing testing of additions during the year, he wanted to verify that :
(i)All PPE (property, plant and equipment) are in the name of the entity he is auditing.
(ii) For all additions to land and building in particular, the auditor desires to have concrete evidence about the ownership.
(iii) The auditor wants to know whether the entity has valid legal ownership rights over the PPE, where it is kept as security for any
borrowings.
Advise the auditor on the audit procedure to be undertaken by him to establish the Rights and Obligations of the entity over the PPE.
Required DISCLOSURES for PPE have been appropriately made

Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made under the
heading “Property, Plant and Equipment”:
i. Classification shall be given as:

a. Land;
b. Buildings;
c. Plant and Equipment;
d. Furniture and Fixtures;
e. Vehicles;
f. Office equipment;
g. Others (specify nature).
ii. Assets under lease shall be separately specified under each class of asset.
iii. A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting
period showing additions, disposals, acquisitions through business combinations, amount of change due to revaluation (if
change is 10% or more in the aggregate of the net carrying value of each class of Property, Plant and Equipment) and other
adjustments and the related depreciation and impairment losses/reversals shall be disclosed separately.
iv. Where sums have been written-off on a reduction of capital or revaluation of assets or where sums have been added on
revaluation of assets, every balance sheet subsequent to date of such write-off, or addition shall show the reduced or
increased figures as applicable and shall by way of a note also show the amount of the reduction or increase as applicable
together with the date thereof for the first five years subsequent to the date of such reduction or increase.
For each class of Property, Plant and Equipment, whether the entity has disclosed a reconciliation of the gross and net carrying
amounts at the beginning and end of the reporting period showing separately:
● Opening balance of gross carrying amount

● Additions
● Acquisitions through business combinations Disposals Disposals through demergers Other adjustments Borrowing costs
capitalized Closing balance of gross carrying amount
For each class of property, plant and equipment, whether the entity has disclosed:
● Opening accumulated depreciation
● Charge for the year
● Deduction/ other adjustments for depreciation
● Closing accumulated depreciation For each class of property, plant and equipment, whether the entity has disclosed:
● Opening accumulated impairment losses
● Impairment losses
● Impairment reversals
● Closing accumulated impairment losses.
Other Points
Title deeds of Immovable Property not held in name of the Company

The company shall provide the details of all the immovable property (other than properties where the Company is the lessee and
the lease agreements are duly executed in favour of the lessee) whose title deeds are not held in the name of the company in format
given below and where such immovable property is jointly held with others, details are required to be given to the extent of the
company‘s share.
Relevant line Description of Gross carrying Title deeds held Whether title Property held Reason for not
item in the item of property value in the name of deed holder is a since which being held in
Balance sheet promoter, date the name of the
director or company (Also

relative# of indicate the

promoter*/direc dispute if any)
tor or employee
of
promoter/direct
or
PPE Land Building
Where the Company has revalued its Property, Plant and Equipment,
the company shall disclose as to whether the revaluation is based on the valuation by a registered valuer as defined under rule 2 of
the Companies (Registered Valuers and Valuation) Rules, 2017.
Capital-Work-in Progress (CWIP)

a. For Capital-work-in progress, following ageing schedule shall be given:
b. For capital-work-in progress, whose completion is overdue or has exceeded its cost compared to its original plan, following
CWIP completion schedule shall be given.
Details of projects where activity has been suspended shall be given separately
Intangible Assets (comprising Goodwill, Brand/Trademarks, Computer

Software etc.
To establish the EXISTENCE of intangible fixed assets as at the period- end.
1. The auditor should verify whether such intangible asset is in active use in the production or supply of goods or
services, for rental to others or for administrative purposes.
○ Example For verifying the existence of software, the auditor should verify whether such software is in active use by
the entity and for the purpose, the auditor should verify the sale of related services/ goods during the period under
audit, in which such software has been used.
○ ExampleFor verifying the existence of design/ drawings, the auditor should verify the production data to establish if
such products for which the design/ drawings were purchased, are being produced and sold by the entity.
● In case any intangible asset is not in active use, deletion should have been recorded in the books of account
post approvals by the entity’s management and amortization charge should have ceased beyond the date of
deletion.
Additions to Intangible assets during the period under audit have been recorded
appropriately in the financial statements
● Verify the movement in the intangible assets schedule (asset class wise like software, designs/ drawings,
goodwill etc.) compiled by the management i.e. Opening balances + Additions Deletions = Closing balances.
Tally the closing balances to the entity's books of account.
● Check the arithmetical accuracy of the movement in intangible assets schedule.
For additions during the period under audit, obtain a listing of all additions from the management and undertake
the following procedures:
● For all material additions, verify whether such expenditure meets the criterion for recognition of an
intangible asset as per AS 26.
● Ensure that no cost related to research (or from the research phase of an internal project) gets recognized as
an intangible asset.

● Check the certificate or report or other similar documentation maintained by the entity to verify the date of
use of the intangible which could be linked to date of commencement of commercial production/ economic
use to the entity, for all additions to intangible assets during the period under audit.
● Verify whether the additions (acquisitions) have been approved by appropriate entity’s personnel.
● Verify whether proper internal processes and procedures like inviting competitive quotations/ proper tenders
etc. were followed prior to finalizing the vendor for procuring item of intangible assets by testing those
documents on a sample basis.
● In relation to deletions of intangible assets,
○ understand from the management the reason and rationale for deletion and the manner of disposal.
○ Obtain the management approval and disposal note authoring disposal of the asset from its active use.
○ Verify the process followed for sale of discarded asset,
■ example inviting competitive quotes, tenders and the basis of calculation of sales proceeds.
○ Verify that the management has accurately recorded the deletion of intangible asset (original cost and
accumulated amortization up to the date of disposal) and the resultant gain/ loss on disposal in the entity’s books of account.
Intangible assets have been VALUED appropriately and as per generally accepted
accounting policies and practices
The value of intangible assets may diminish due to efflux of time, use and/ or obsolescence. The diminution of the
value represents cost to the entity for earning revenue during a given period. Unless this cost in the form of
amortization is charged to the accounts, the profit or loss would not be correctly ascertained and the values of
intangible asset would be shown at higher amounts. The auditor should:
● Verify that the entity has charged amortization on all intangible assets;
● Verify that the amortization method used reflects the pattern in which the asset’s future economic benefits are
expected to be consumed by the entity.
● The auditor should also verify whether the management has done an impairment assessment to determine
whether an intangible asset is impaired. For this purpose, the auditor needs to verify whether the entity has
applied AS 28 - Impairment of Assets.
The entity has valid legal ownership rights over the Intangible Assets claimed to be held by
the entity and recorded in the financial statements (RIGHTS AND OBLIGATION)
The auditor while performing testing of additions should also verify that all expense invoices/ purchase contracts are in
the name of the entity that entitles legal title of ownership to the entity.
While auditing the books of accounts of QHMP Ltd., CA. Ranker, the statutory auditor of the company, came to know that the
management of the company has recognized internally generated goodwill as a fixed asset. CA. Ranker discussed with the management
that according to accounting standards, internally generated goodwill is not recognized as an asset because it is not an identifiable
resource controlled by the enterprise that can be measured reliably at cost. However, the management is quite rigid to the accounting
treatment followed for internally generated goodwill and not paying attention to the auditor. Thus, through an example, CA. Ranker
explained which type of goodwill may be recognized as a fixed asset for which the management got justified. State which of the following
examples the auditor must have given to the management?
(a) If an item meeting the definition of an intangible asset is acquired in a business combination, it forms part of the goodwill to be
recognized at the date of the amalgamation.
(b) Only those goodwill needs to be recognized as a fixed asset which can be touched like physical assets, for example, land and buildings.
(c) Goodwill is recognised only when there is a contractual or other legal rights for a physical asset which shall not be amortized over the
period.

(d) All of the above.

(Sample MCQs) (RTP, May 2019, NA)
Explain with examples the audit procedure to establish the existence of intangible fixed assets as at the period- end.
(RTP, Nov 2018, NA) (MTP2, May 2019, 3 Marks) (RTP, Nov 2019, NA)
You are an auditor of PQR Ltd. which has spent Rs 10 lakhs on Research activities of the product during period under audit. Board of
Directors want to recognize it as an internally generated intangible assets. Advise and discuss the conditions necessary to be fulfilled to
recognize the intangible assets in the financial statements.
(SA, May 2019, 4 Marks) (MTP1, May 2021, 4 marks)
OR
You are an auditor of PQR Ltd. which has spent Rs 50 lakhs on Research activities of the product during period under audit, Board of
Directors want to recognize it as an internally generated intangible assets. Advise and discuss the conditions necessary to be fulfilled to
recognize the intangible assets in the financial statements.
Answer Discussion - https://youtu.be/SyCkAUgr_8E
An intangible asset is an identifiable monetary asset.

(RTP, Nov 2019, NA)
The value of intangible assets may diminish due to efflux of time, use and/or obsolescence. The domination of the value represents cost to
the entity for earning revenue during a given period. Discuss the audit procedures to be applied by the auditor to ensure that intangible
assets have been valued appropriately and as per generally accepted accounting policies and practices.
(SA, July 2021, 3 Marks)
Correct/Incorrect
Computer software which is the integral part of the related hardware should be treated as fixed asset/tangible asset
(RTP, Nov 2021, NA)
Required DISCLOSURES for Intangible Assets have been appropriately made
Ensure that the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made under the
heading “Intangible Assets”:
i. Classification shall be given as:
a. Goodwill
b. Brands /trademarks;
c. Computer software;
d. Mastheads and publishing titles;
e. Mining rights;
f. Copyrights, and patents and other intellectual property rights, services and operating rights;
g. Recipes, formulae, models, designs and prototypes;
h. Licences and franchise;
i. Others (specify nature).
ii. A reconciliation of the gross and net carrying amounts of each class of assets at the beginning and end of the reporting
period showing additions, disposals, acquisitions through business combinations, amount of change due to revaluation (if

change is 10% or more in the aggregate of the net carrying value of each class of intangible assets) and other adjustments
and the related depreciation and impairment losses or reversals shall be disclosed separately.
iii. Where sums have been written-off on a reduction of capital or revaluation of assets or where sums have been added on
revaluation of assets, every balance sheet subsequent to date of such write-off, or addition shall show the reduced or
increased figures as applicable and shall by way of a note also show the amount of the reduction or increase as applicable
together with the date thereof for the first five years subsequent to the date of such reduction or increase.
For each class of intangible asset, whether the entity has disclosed a reconciliation of the gross and net carrying amounts at the
beginning and end of the reporting period showing separately:
● Opening balance of gross carrying amount
● Additions
● Disposals
● Impairments
● Other adjustments.
For each class of intangible assets, whether the entity has disclosed:
● Opening accumulated amortization
● Charge for the year 0 Deduction/ other adjustments for amortization
● Closing accumulated amortization.
Intangible assets under development:

● Intangible assets under development ageing schedule shall be given
● For Intangible assets under development, whose completion is overdue or has exceeded its cost compared to its original
plan, a different Intangible assets under development completion schedule shall be given

Trade Payables and Other Current Liabilities
To establish the EXISTENCE of trade payables and other current liabilities as at the
period-end
● Check whether there are controls in place to ensure that any purchase/ expense invoice does not get recorded
more than once and payable balances are automatically recorded in the general ledger at the time of
recording of expense.
● Obtain the accounts payable ageing report and trace its balances to the general ledger.
○ If there are any differences, investigate reconciling items.
○ Journal entries specially for large amounts should be carefully examined.
Direct confirmation procedure

An important audit activity is to contact vendors directly/independently and ask them to confirm the amounts of accounts
payable. This should necessarily be done for all significant account payable balances as at the period-end and for parties from
whom material purchases have been made during the period under audit even if period-end balance of such parties is not
significant.
The auditor employs direct confirmation procedure with the consent of the entity under audit.
There may be situations where the management of the entity requests the auditor not to seek confirmation from certain trade
payables. In such cases, the auditor should consider whether there are valid grounds for such a request.
The trade creditors may be requested to confirm the balances either

a. as at the date of the balance sheet, or
b. as at any other selected date which is reasonably close to the date of the balance sheet.
The date should be decided by the auditor in consultation with the Company.
The form of requesting confirmation from the trade creditor may be either
a. the form with balance as at year end wherein the trade creditor is requested to respond whether or not he is in agreement
with the balance shown, or
b. the form with no balance wherein the trade creditor is requested to respond to the balance as per his records. The use of
the form with no balance is preferable.
The method of selection of the trade creditors should not be revealed to the Company.
A list of trade creditors selected for confirmation should be given to the entity for preparing request letters for confirmation which
should be properly addressed.
In the alternative, the auditor may request the client to furnish duly authorised confirmation letters and the auditor may fill in the names, addresses and the amounts
relating to trade creditors selected by him and mail the letters directly.
The auditor should maintain strict control to ensure the correctness and proper dispatch of request letters. It should be ensured that
confirmations as well as any undelivered letters are returned to the auditor and not to the client. Any discrepancies revealed by the
confirmations received or by the additional tests carried out by the auditor, may have a bearing on other accounts not included in
the original sample.
Where no reply is received, the auditor should perform additional testing regarding the balances. This testing could include:
● Testing of subsequent payments in respect of the trade payables to whom confirmations were rolled out but no replies
received.

● Agreeing the details of the respective balance to the underlying vendor invoices;
● Preparing a detailed analysis of the balance, ensuring it consists of identifiable transactions and confirming that these
purchases/ expense transactions actually occurred. (examination in depth).
If there are any related party payables, review whether they were properly authorized and the value of such transactions were
reasonable and at arm’s length. Review a trend line of purchases/ expenses and accounts payable, or a comparison of the two
over time, to see if there are any unusual trends. Make inquiries about reasons for changes in trends from the management.
Trade payables and liability balances that were supposed to be recorded have been
recognized in the financial statements. (COMPLETENESS)
1. The auditor needs to perform the following cut off procedures:

○ For the last 5 invoices received/ recorded at the end of the reporting date (cut off date) and which have
been included in the trade payables; the risk and rewards of ownership in goods should have been
transferred in favour of the entity;
2. Test purchases/ expenses on a sample basis selecting the same from the accounts payable ledgers and
checking their supporting documents to ensure that the purchases were recorded at the correct amounts and
correct dates.
3. Match purchase invoice dates to the gate entry (inward) dates to check whether the purchases are being
recorded in the correct accounting period. This can include an examination of purchase/ expense invoices
received subsequent to the period being audited, to see if they should have been included in the period under
audit.
4. Review subsequent expense vouchers. Review all material expense vouchers recorded post the balance sheet
date to see if they relate to transactions from within the audit period.
Statutory dues liability

5. In relation to statutory dues liability like withholding tax (TDS) payable, GST payable, luxury tax payable,
professional tax payable, PF and ESI payable etc., prepare a reasonability statement with respect to sales/
purchases/ employee benefit expenses. Example- GST liability for last month may be calculated by applying the applicable rate to
the sales made and in case of any variance with the GST liability recorded by the entity, reasons for variance should be requested from client
and in case found satisfactory, the same should be maintained as part of audit documentation.
6. Similarly, Provident Fund liability for last month may be calculated by applying the applicable rate to the
employee benefit expense and in case of any variance with the liability recorded by the entity, reasons for
variance should be requested from client and in case found satisfactory, the same should be maintained as
part of audit documentation.
7. Further, the auditor should obtain and verify the
○ challans for deposits made subsequent to the period-end for all statutory liabilities as at the balance
sheet date and
○ also analyse the reasons, if any, in consultation with the management for any variance between the
amounts deposited subsequently vis-à-vis the liability recorded in books of account.
8. He shall prepare a complete list of all statutory dues and consider his reporting requirements under CARO,
2020.
Trade payables and other liability balances have been VALUED appropriately.
1. Review the process followed by the Company to identify if any old creditor balance/ liability needs to be
written back. This will include a consistency comparison with the method used in the last year, and a determination of
whether the method is appropriate for the underlying business environment.

2. Obtain the ageing of payable balances, split between current, less than 30 days old, 30-60 days old, 60-180
days old, 180- 365 days old and more than 365 days old .
3. Also, obtain the list of vendors with whom the Company has disputes and any claims from customers, under
litigation and compare with previous year.
4. Check that write backs in the liability balances assessed as no longer payable have been approved by an
appropriate and authorised member of senior management, for example – CEO/MD.
5. Check that the restatement of foreign currency trade payables has been done properly In accordance with
AS.
6. Understand management’s process to identify the principal amount and the interest due thereon (if any)
remaining unpaid to any Micro, Small and Medium Sized Enterprises suppliers at the end of accounting
year. Test check the management process to assess if the auditor could rely on the management process.
Verification of liabilities is as important as that of assets, considering if any liability is omitted (or understated) or overstated, the Balance
Sheet would not show a true and fair view of the state of affairs of the entity. Explain stating also criteria for a liability to be classified as
current liability.
(RTP, Nov 2018, NA) (MTP2, May 2019, 3 Marks)
Liabilities include trade payables and other current liabilities, deferred payment credits and provisions. Verification of liabilities is as
important as that of assets, considering if any liability is omitted (or understated) or overstated, the Balance Sheet would not show a true
and fair view of the state of affairs of the entity.
Advise stating clearly the audit procedure to establish the existence of trade payables and other current liabilities as at the period-end.
Required DISCLOSURES for trade payables and other liabilities have been appropriately
made
Ensure whether the following disclosures as required under Schedule III (Part 1) to Companies Act, 2013 have been made:
● Whether the Company has classified a payable as a trade payable if it is in respect of the amount due on account of goods sold or
services rendered in the normal course of business.
● Whether the Company has disclosed the following details relating to micro and small enterprises in the notes
○ the principal amount and the interest due thereon (to be shown separately) remaining unpaid to any supplier at the end
of each accounting year.
○ the amount of interest paid by the buyer in terms of section 16 of the Micro, Small and Medium Enterprises Development
Act, 2006, along with the amount of the payment made to the supplier beyond the appointed day during each accounting
year.
○ the amount of interest due and payable for the period of delay in making payment (which have been paid but beyond the
appointed day during the year) but without adding the interest specified under the Micro, Small and Medium Enterprises
Development Act, 2006.
○ the amount of interest accrued and remaining unpaid at the end of each accounting year.
○ the amount of further interest remaining due and payable even in the succeeding years, until such date when the interest
dues above are actually paid to the small enterprise, for the purpose of disallowance of a deductible expenditure under
section 23 of the Micro, Small and Medium Enterprises Development Act, 2006.
○ Trade payables due for payment
■ The ageing schedule shall be given for Trade payables due for payment.
■ where no due date of payment is specified in that case disclosure shall be from the date of the transaction.
■ Unbilled dues shall be disclosed separately.
● Other Current Liabilities
○ Whether the amount disclosed under other current liabilities are classified as below
■ Current maturities of finance lease obligations

■ Interest accrued but not due on borrowings

■ Interest accrued and due on borrowings
■ Income received in advance
■ Unpaid Dividends
■ Application money received for allotment of securities and due for refund and interest accrued thereon. Share
application money includes advances towards allotment of share capital. The terms and conditions including the
number of shares proposed to be issued, the amount of premium, if any, and the period before which shares shall
be allotted shall be disclosed. It shall also be disclosed whether the company has sufficient authorised capital to
cover the share capital amount resulting from allotment of shares out of such share application money. Further,
the period for which the share application money has been pending beyond the period for allotment as
mentioned in the document inviting application for shares along with the reason for such share application
money being pending shall be disclosed. Share application money not exceeding the issued capital and to the
extent not refundable shall be shown under the head Equity and share application money to the extent
refundable, i.e., the amount in excess of subscription or in case the requirements of minimum subscription are
not met, shall be separately shown under “Other current liabilities”;
■ Unpaid matured deposits/debentures and interest accrued thereon
■ Unpaid matured debentures and interest accrued thereon
■ Others (specify nature).
Loans and Advances and Other Current Assets
To establish the EXISTENCE of loans and advances and other current assets as at the
period-end.
For establishing existence of loans and advances direct confirmation procedures should be performed, the principal
amount, interest receivable, if any, as per the agreed terms between the parties, may also be included as part of the
balance to be confirmed.
Loans and advances and other current asset balances that were supposed to be recorded
have been recognized in the financial statements. (COMPLETENESS)
1. Obtain a list of all advances and other current assets and compare them with balances in the ledger.
2. Verify loan agreements and acknowledgements of parties in respect of outstanding loans.
3. Examine, in case of material loan or advances, authorisation by the Memorandum and Articles of Association in the
case of Company.
4. The auditor should confirm that the loans advanced were within the competence of persons who had
advanced the same, directors in the case of a Company, partners in the case of a firm and trustees in the case
of a trust.
5. Inspect the minutes of meeting of board of directors to confirm if all material loans and advances were
approved by the board of directors.
6. Inspect if any security has been deposited against due repayment of the loan.
7. Ascertain if loans are being recovered regularly as per agreed instalments.
8. If there are any related party loans and advances, review whether they were properly authorized and the value
of such transactions were reasonable and at arm’s length.
Loans and advances and other current asset balances have been VALUED appropriately.
1. Assess the allowance for doubtful accounts.

a. Review the process followed by the Company to derive an allowance for doubtful accounts.

b. This will include

i. a consistency comparison with the method used in the last year, and
ii. a determination of whether the method is appropriate for the underlying business
environment.
2. Obtain the ageing report of loans and advances, split between not currently due, 30 days old, 3060 days old,
60- 180 days old, 180- 365 days old and more than 365 days old.
3. Also, obtain the list of loans and advances under litigation and compare with previous year.
4. Identify those loans and advances that appear doubtful; discuss with management about the reasons as to
why these loans/ advances are not included in the provision for doubtful balances.
5. Assess bad loans/ advances write-offs. Prepare schedule of movements on Bad loans/ advances – Provision
Accounts and loans/ advances written off
6. Check that write-offs or other reductions in the recoverable balances have been approved by the authorsied
and appropriate senior authority.
7. Check that the restatement of foreign currency loans and advances/ other current assets has been done
properly in accordance with AS 11.
Write the audit procedures to be performed as an auditor for valuation (assertion) of following:
(i) Loans and Advances and other current assets.
(ii) Finished goods and goods for resale.
(SA, Nov 2018, 10 Marks) (MTP1, May 2020, 6 Marks)
Required DISCLOSURE for loans and advances and other current assets have been
appropriately made
Long Term loans & Advances

i. Long-term loans and advances shall be classified as:
a. Capital Advances;
b. Loans and advances to related parties (giving details thereof);
c. Other loans and advances (specify nature).
ii. The above shall also be separately subclassified as:
a. Secured, considered good;
b. Unsecured, considered good;
c. Doubtful.
iii. Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately.
iv. Loans and advances due by
a. Directors or other officers of the company or any of them either severally or jointly with any other persons or
b. amounts due by firms or private companies respectively in which any director is a partner or a director or a
member should be separately stated.
Short-term loans and advances

i. Short-term loans and advances shall be classified as:
a. Loans and advances to related parties (giving details thereof);
b. Others (specify nature).
ii. The above shall also be sub-classified as:

a. Secured, considered good;

b. Unsecured, considered good;
c. Doubtful.
iii. Allowance for bad and doubtful loans and advances shall be disclosed under the relevant heads separately.
iv. Loans and advances due by
a. directors or other officers of the company or any of them either severally or jointly with any other person or
b. amounts due by firms or private companies respectively in which any director is a partner or a director or a
member shall be separately stated.
Following disclosures shall be made where Loans or Advances in the nature of loans are granted to promoters, Directors, KMPs and
the related parties (as defined under Companies Act, 2013,) either severally or jointly with any other person, that are:
a. repayable on demand or
b. without specifying any terms or period of repayment
Type of Borrower Amount of loan or advance in the nature Percentage to the total Loans and
of loan outstanding Advances in the nature of loans
Promoters
Directors
KMPs
Related Parties

Provisions and Contingent Liabilities

A provision is a liability which can be measured only by using a substantial degree of estimation.
A provision is recognised when:

- an entity has a present obligation (legal or constructive) as a result of a past event;
- it is probable that an outflow of resources embodying economic benefits will be required to settle the
obligation; and
- a reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognized.
A contingent liability is:

- a possible obligation that arises from past events and whose existence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the
entity; or
- a present obligation that arises from past events but is not recognized because:
- it is not probable that an outflow of resources embodying economic benefits will be required to settle
the obligation; or
- the amount of the obligation cannot be measured with sufficient reliability.
To establish the EXISTENCE of provisions as at the period end Provisions that were supposed
to be recorded have been recognized in the financial statements. (COMPLETENESS)
1. Obtain a list of all provisions and compare them with balances in the ledger.
2. Inspect the underlying agreements like agreement with customers to assess warranty commitments, any
legal and other claims on the entity i.e. litigations.
3. Obtain the underlying working and the basis for each of the provisions made, from the management and
verify whether the same is complete and accurate.
4. Wherever required, obtain expert’s report, calculation and underlying working for the provision amount,
○ example for warranty involving complex calculations, some entities get that valued through an actuary.
In such a case, the auditor may request the management to share the actuarial valuation report.
○ The auditor should then verify the underlying assumptions used by the expert with the data shared by
the management.
Provision balances have been valued appropriately. (VALUATION)
● As per SA 500 – “Audit Evidence”, issued by ICAI, when using the work of a management’s expert, audit
evidence that the auditor should obtain include:
○ Evaluate the competence, capabilities and objectivity of that expert:
■ Whether the expert is employed by the entity or is an outside party.
■ Whether the expert is independent in respect of the entity.
■ Auditor’s previous experience of the work of the expert.
■ Knowledge of the expert, his qualification, membership of a professional body or industry
association, etc.
○ Obtain an understanding of the work of that expert:
■ Whether the auditor has expertise to evaluate the work of the expert.
■ Evaluating the assumptions and methods used by the management.

■ Evaluating the nature of internal or external data used by the expert.

○ Evaluate the appropriateness of his work as audit evidence for the relevant assertion:
■ Relevance and reasonableness of the expert's findings or conclusions
■ Evaluating the relevance, completeness and accuracy of the source data used by the expert.
○ The auditor shall obtain written representation from the management that it has made all the
provisions which were required to be made as per the recognized accounting principles.
The management of BOB Ltd. could not differentiate between any obligation for which either provisions need to be made or the
contingent liability to be shown. The auditor of the company clarifies the management that the provisions are the amounts charged
against revenue to provide for a known liability, the amount whereof cannot be determined with substantial accuracy. On the other hand,
a contingent liability is a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or
non-occurrence of one or more uncertain future events not wholly within the control of the entity; or a present obligation that arises from
past events but is not recognized because it is not probable that an outflow of resources embodying economic benefits will be required to
settle the obligation or the amount of the obligation cannot be measured with sufficient reliability. The auditor further explains the
concept with the help of examples. State which of the following examples the auditor must have provided in respect of contingent
liability?
(a) Depreciation.
(b) Clean-up costs for unlawful environmental damage.
(c) Product warranties.
(d) Lawsuit against the company where it is more likely that no present obligation exists.
(Sample MCQs)
Explain the difference between reserves and provisions.

is a possible obligation that arises from the past events and whose existence will be confirmed only by the occurrence/ non
occurrence of one or more uncertain future events not wholly within the control of the entity:-
(a) Provisions
(b) Reserves
(c) Contingent Liabilities
(d) Liability"
(MTP1, Nov 2020, 2 Marks) (RTP, May 2021, NA)
From the auditing point of view, the auditor should verify that a proper disclosure about contingent liabilities is made in financial
statements as required by AS 29. What type of disclosures should be made for each class of contingent liability as at the balance sheet
date?
(MTP1, May 2021, 3 marks) (MTP2, May 2021, 4 marks)
Answer Discussion - https://youtu.be/M2vu6YL2dGI
Required DISCLOSURE for provisions have been appropriately made

Long-term provisions
The amounts shall be classified as: (a) Provision for employee benefits
a. Provision for employee benefits;

Short-term provisions
The amounts shall be classified as:
a. Provision for employee benefits.
Contingent liabilities and commitments (to the extent not provided for)
i. Contingent liabilities shall be classified as:
a. Claims against the company not acknowledged as debt;
b. Guarantees;
c. Other money for which the company is contingently liable.
ii. Commitments shall be classified as:
a. Estimated amount of contracts remaining to be executed on capital account and not provided for;
b. Uncalled liability on shares and
c. other investments partly paid;
In terms of AS 29, “Provisions, Contingent Liabilities and Contingent Assets”, ensure whether disclosures required have been made

Sale of Products and Services
Sales and collections cycle

The sales and collections cycle in a business refers to the set of processes that begin when a customer purchases
goods or services and ends when the entity receives complete payment against the sales.
Important items / High ROMM

Sales is one of the most important items in the financial statements which will have a considerable effect on the profit
generated, closing stock etc. As per SA 315, the risk of material misstatement in case of revenue items is generally high.
Test Sale Transaction and Controls

As part of the year-end audit of an entity’s financial statements, auditors test sales transactions and the internal
controls over those transactions to ensure that the entity is not materially misstating its revenues or accounts
receivable.
Clear understanding about organisation and revenue centres.

Auditor needs to obtain a clear understanding about the organisation and its revenue centres.
Example
Type of services or products the entity provides, demand for the services or products, major selling product/service,
introduction of new products/service line, discontinuance of products/services, major customers, sales term (Credit or
cash sales).
Understanding of Controls
An auditor needs to obtain an understanding of the management control (internal control) in respect of sales process.
Example
- Whether segregation of duties exist,
- who checks the credit limit (if applicable),
- who authorizes sales orders, who raises sales invoice,
- when and how the goods are delivered/despatched or services are provided,
- who collects and records the amounts received from debtors,
- who ensures that the risks and rewards are transferred to the customer, how the sales have been recognised in
the system.
Test of controls/ Strength and Reliability

An auditor tests the controls the entity has set up for the sales cycle to determine how strong and reliable they are. If
they are strong and operating effectively, the auditor can reduce the extent of substantive testing.
Any deficiencies in the internal control shall be communicated as per SA 265.
Substantive audit procedures

- Performing substantive audit procedures is a must.

- Substantive analytical procedures will consist of sales trend analysis, comparison with previous accounting
period, category-wise sales analysis, any analysis the auditor may find relevant and most important of all,
building a sales expectation and comparing that with the client’s sales records.
Example
For a manufacturing company, if the average sales price of product X is ₹ 10 and 1,500 units were sold in that month,
the auditors expected sales will be ₹ 15,000. The auditor should compare this figure with the client’s data and see what
they have recorded against Product X. The auditor should consider discussing any variances (see if there were
discounts or sales were wrongly booked in the system) between his expectations and client’s records. The auditor will
have to also identify and understand how the entity accounts for their sales discounts and sales return in the system
and how those affect the gross sales.
Audit Procedures - Recorded sales represent goods shipped/ services performed during the
period (OCCURRENCE)
Ensure revenue is not overstated by performing following audit procedures
1. Check whether a single sales invoice is recorded twice or a cancelled sales invoice could also be recorded.
2. Test check a few invoices with their relevant entries in sales journal.
3. Obtain confirmation from few customers to ensure genuineness of sales transaction Whether any fictitious
customers and sales have been recorded.
4. Whether any shipments were done without the consent and agreement of the customer, especially at the
year end to inflate the sales figure Whether unearned revenue recorded as earned. Whether any substantial
uncertainty exists about collectability.
5. Review sequence of sales invoices
6. Review journal entries for unusual transactions
7. Calculate the ratio of sales return to sales and compare it with previous year and enquire for the reasons for
increase/ decrease
8. Check the sales return with a sales invoice, challan, credit note, stock register, etc.
All sales made during the period were recorded and there is no understatement or
overstatement. - (COMPLETENESS)
1. Perform cut-off procedures to ensure that revenues are recognised in the current accounting period.
Cut-off errors will usually arise when companies recognise revenue based on the date on which the sales invoices are
generated rather than the date on which the risks and rewards are transferred to the buyer.
2. Auditors should also verify the credit notes issued after the accounting period.
Sometimes sales team or sales personnel can make fictitious sales before the year-end to meet performance target
and cancel out those sales with a post year end credit note.
3. Trace from the shipping documents to the sales journal.

4. Check whether quantity is appearing in sales register or not.
5. Check reconciliation of total sales/goods dispatched as per stock records and financial records and statutory
records like GST.

6. Review GST tax and GST returns and ensure that the same are reconciled with revenue reported in the profit
and loss account.
7. Verify the reasonableness of GST by applying the applicable rate to the gross sales value and compare the
amount of GST as per statutory returns and analyze the reasons for variance, if any.
All sales are accurately measured as per applicable accounting standards and correctly
journalized, summarized, and posted (MEASUREMENT)
1. Trace a few transactions from inception to completion. (Examination in depth)

○ E.g: Take few sales transaction, and check from the receipt of sales order to the payment of receivable
balance, every underlying document to ensure if it is properly recorded at every stage and measured
accurately taking into consideration all the incentives, discounts, if any. The recognition shall be
according to the revenue recognition policy of the entity.
2. if the client is engaged in export sales, then compliance with AS 11 shall be ensured.
3. Auditors must understand the client's operations and related GAAP issues e.g. point of sale revenue
recognition vs. percentage of completion, wherever applicable.
4. Compare the rate of sales affected with related parties and review them for collectability, as well as whether
they were properly authorized and the value of such transactions were reasonable and at arm's length.
Required DISCLOSURE for sales have been appropriately made
● Whether disclosure of sales in respect of each class of goods has been made.
● Whether revenue from operations is disclosed separately in the notes as revenue arising from:
○ Sale of products (including excise duty)
○ Sale of services
○ Other operating revenues.
● Whether brokerage and discount on sales other than usual trade discount has been disclosed.
● Whether the transactions with related parties are appropriately disclosed in notes to accounts.
Auditor of ABC Ltd while auditing its financial statements wants to ensure whether the disclosures regarding sales has been made as
required under Schedule III (Part 1) to Companies Act, 2013. Explain such disclosure requirements.
(MTP1, May 2021, 3 marks)
Answer Discussion - https://youtu.be/SyCkAUgr_8E
CA "X" while conducting an audit of Joyful Ltd. found a considerable increase in sales as compared to the previous year, he doubts that
few fictitious sales have been recorded by the company to overstate its revenues. Discuss any four audit procedures to be undertaken by
the auditor to ensure revenue from sales of goods and services performed during the period is not overstated?
(SA, July 2021, 4 Marks)
Other Income comprising interest income, dividend income, Gain/ Loss on

sale of investments etc.
Any form of income earned by an entity which is not linked to the entity’s core business operations is generally
classified as other income. Examples – interest on excess funds parked in fixed deposits with banks (the entity not

being a bank or financial institution), interest on loans given to third parties/ within the group, return on mutual fund
investment etc.
● Interest income on fixed deposits is recognized on a time proportion basis taking into account the amount
outstanding and the applicable interest rate.
● Dividends are recognised in the statement of profit and loss only when:
○ the entity’s right to receive payment of the dividend is established;
○ it is probable that the economic benefits associated with the dividend will flow to the entity; and
○ the amount of the dividend can be measured reliably.
● Gain/(loss) on sale of investment in mutual funds is recorded as other income on transfer of title from the
entity and is determined as the difference between the redemption price and carrying value of the
investments.
Audit procedures For

- Recorded other income was earned during the Period (OCCURRENCE)
- Other income earned during the period was appropriately recorded and there in no understatement or
overstatement. (COMPLETENESS)
- Other income has been measured appropriately as per the applicable accounting standards (MEASUREMENT)
1. Obtain a listing of fixed deposits opened during the period under audit along with the applicable interest
rate and the number of days for which the deposit was outstanding during the period.
2. Verify the arithmetical accuracy of the interest calculation made by the entity by recomputing i.e. multiplying
the deposit amount with the applicable rate and number of days during the period under audit.
3. For deposits still outstanding as at the period- end, trace the same to the direct confirmations obtained from
the respective bank/ financial institution.
4. Obtain a confirmation of interest income from the bank and verify that the interest income as per bank
reconciles to the calculation shared by the entity.
5. Also, obtain a copy of Form 26AS (TDS withholding by the bank/ financial institution) and reconcile the
interest reflected therein to the calculation shared by client.
6. For Dividends, verify that the same are recognised in the statement of profit and loss only when the entity’s
right to receive payment of the dividend is established.
7. Verify that Gain/(loss) on sale of investment in mutual funds is recorded as other income only on
○ transfer of title from the entity AND
○ is determined as the difference between the redemption price and carrying value of the
investments.
8. For the purpose, obtain the mutual fund statement and trace the gain / loss as recorded in the books of
account to the gain/ loss as reflected in the statement
Required DISCLOSURE for other income have been appropriately made

- Whether ‘other income’ has been classified as:
- Interest income
- Dividend income
- Not gain/ loss on sale of investments
- Other non-operating income (net of expenses directly attributable to such income).

As statutory auditor of the company, list out audit procedures required to be undertaken for the following:
(i) Interest income from fixed deposits.
(ii) Dividend income.
(iii) Gain/(loss) on sale of investment in Mutual funds.
Also indicate disclosure requirements of above as per Companies Act, 2013.
(SA, May 2018, 10 Marks) (SA, Jan 2021, 3 marks)
Correct/Incorrect
Dividends are recognized in the statement of profit and loss only when the amount of dividend can be measured reliably.
ABC limited appointed XYZ & Company, Chartered Accountants, as a Statutory Auditor of the Company for the year 2019-20. CA X, partner
of XYZ & Company, was looking after the audit of other income of the company which consists of interest income on fixed deposits. As a
Statutory Auditor how would CA X verify interest income on fixed deposits for the year 2019-20?
Answer discussion - https://youtu.be/voW7uzdef5M
Undisclosed income
The Company shall give details of any transaction not recorded in the books of accounts that has been surrendered or disclosed as
income during the year in the tax assessments under the Income Tax Act, 1961 (such as, search or survey or any other relevant
provisions of the Income Tax Act, 1961), unless there is immunity for disclosure under any scheme and also shall state whether the
previously unrecorded income and related assets have been properly recorded in the books of account during the year.
Purchases
Purchases and disbursement cycle

Purchases and disbursement cycle in a business refers to the set of processes that begin when an order for buying
goods or services is placed based on requirements of the production/ user department and ends when the entity
receives the product and makes complete payment to the vendor.
Test Purchases and Controls

As part of the year-end audit of an entity’s financial statements, auditors test purchase transactions and the internal
controls over those transactions to ensure that the entity is not materially misstating its purchases or accounts
payables.
Clear understanding about organisation and production centres.

Auditor needs to obtain a clear understanding about the organisation and its production centres
Example
Type of services or products they procure that are used in the production/ rendering of services, sources of
procurement whether domestic or overseas, general availability and terms and conditions of purchase of the service or
products, major vendors, credit period, quality checks, purchase terms (Credit or cash purchase) etc.

Understanding of Controls
An auditor needs to identify the control points over purchases.
Example
- whether segregation of duties exist, whether competitive quotes are invited,
- whether a purchase committee exists who authorises purchase price, issues and authorizes purchase orders,
- when and how the goods are received and acknowledged,
- who checks the quality, quantity and specifications of the goods received and prepares Goods Receipt Note (GRN),
- who approves the vendor invoice,
- whether a 2 way/ 3 way match process exists (i.e. tally between purchase order, GRN and vendor invoice),
- how the purchases have been recognised in the system.
Test of controls/ Strength and Reliability

An auditor tests the controls the entity has set up for the purchase cycle to determine whether they are effective or
not. If the controls are effective, the auditor can reduce the extent of substantive testing.
The auditor selects a random sample of transactions and examines the related purchase orders, GRN, purchase
invoices, inward gate entry register and vendor reconciliation/ statements.
Performing substantive audit procedures

- Performing substantive audit procedures is a must.
- Substantive analytical procedure will consist of purchase trend analysis, comparison with previous accounting
period, category wise purchases, any analysis auditor may find relevant and most important of all setting a
purchase expectation in relation to the sales made during the period under audit and compare that with the
client’s purchase records.
Example
The auditor would need to know the purchase prices of the products or services over the year, monthly average purchase price per
product or service etc. E.g: If the purchase price is 100 and if 15000 units were received under multiple orders during the year, the
auditor expects the purchases to be 15,00,000. If there is a variance in the amount recorded in the books, he shall check for
additional details like discounts received, change of purchase price for few orders due to excess demand etc.
Audit Procedures for Recorded purchases represent goods actually received/ services
availed during the period (OCCURRENCE)
Ensure purchases are not understated/ overstated by performing following audit procedures:
1. Whether any fictitious vendors have been booked or purchases have been recorded by reviewing the vendor
selection process followed by the entity and also performing procedures to ensure existence of the vendors.
2. Whether the goods were received at the factory gate and whether there exists an entry in the security gate
inward register
3. Whether quality inspection of goods was done.
4. Whether a goods receipt note was prepared and signed by an appropriate client personnel.
5. Whether the purchase invoice was approved as per delegation of authority and whether a 3 or 2-way match
was done.

6. Whether the stock record has been updated by the authorised personnel.
Special considerations during audit of purchases

1. The purchase invoice received should be the “Original” copy (and not photocopy/ carbon copy) against which
the entity has recorded the purchase in its books of account.
2. Purchase invoice should have been booked only once risk and reward incidental to ownership has been
transferred to the entity.
3. Purchase invoice should be in the name of entity. However, in case of different branches, it should be
addressed to the appropriate branch.
4. Input tax component should have been booked in the input tax ledger. The auditor should obtain tax returns
filed with the authorities and tally the input tax as reflected in the books to the amount disclosed in the
returns.
5. In case of purchases made from related parties or allied and associated concerns, the auditor needs to verify if
requisite approval from Board of Directors (appropriate authority) has been obtained and should verify the
selected samples and perform analytical procedures in relation to price of goods to confirm that the price
charged is at arm’s length.
6. The auditor should review whether purchases should be capitalized or expensed off in Statement of Profit
and loss according to his professional judgement.
7. Review journal entries for unusual transactions.
Audit Procedures For

- All purchases made during the period were recorded and there in no understatement or overstatement.
(COMPLETENESS)
- All purchases have been measured appropriately (MEASUREMENT)
In addition to the procedures for establishing occurrence of purchases as discussed above, the auditor should:
1. Perform cut-off test to ensure that purchases are recognised in the correct accounting period. For the
purpose, the auditor should examine material inward records, say, last 5 transactions at the period end to
check that all corresponding invoices have been duly entered in the Purchases book and none have been
omitted.
2. Ensure correct accounting treatment of goods – in – transit as per the agreed terms with the vendor
regarding transfer of risk and reward of ownership in goods.
3. Obtain written representation from the management that all the purchases that took place during the year
have been properly recorded in the books.
4. Perform analytical procedures to obtain audit evidence as to overall reasonableness of purchase quantity
and price which may include:
- Consumption Analysis: Auditor should scrutinize raw material consumed as per manufacturing
account and compare the same with previous years with closing stock and ask for the reasons from
the management, if any significant variations are found.
- Stock Composition Analysis: Auditor to collect the reports from management for composition of stock
i.e. raw materials as a percentage of total stock and compare the same with previous year and ask
for reasons from management in case of significant variations.
5. Ratios: Auditor should compare the creditors turnover ratios and stock turnover ratios of the current year
with previous years. Auditor should review quantitative reconciliation of closing stocks with opening stock,
purchases and consumption.

Discuss the audit procedure to be considered by an auditor while performing analytical procedure to obtain audit evidence as to overall
reasonableness of purchase quantity and price.
(SA, May 2019, 3 Marks)(SA, Nov 2019, 3 Marks)
Required DISCLOSURES for purchases have been appropriately made
● Whether purchases of stock-in-trade have been specifically disclosed.
● Whether changes in inventories of finished goods, stock–in-trade and work- in-progress have been specifically disclosed.
● Whether the transactions with related parties are appropriately disclosed in notes to accounts.

Employee Benefits Expenses
Employee benefits expenses or commonly called as payroll expenses represent the aggregate sum an entity pays as a
consideration to its employees for their labour/ efforts along with associated expenses such as perquisites/ benefits,
postemployment benefits like gratuity, superannuation, leave encashment, provident fund contribution etc. as well as
towards their hiring, their welfare and training.
In many industries, employee benefits expense is the biggest expense category and hence it is critical for businesses
to manage this expenditure properly and for the auditors to verify and ensure that such expenditure is appropriate
and has been accounted as per applicable accounting standards and generally accepted accounting principles.
Auditor needs to obtain a clear understanding about the organisation and its hiring, appraisal and retirement process
in the following manner:
1. An auditor tests the controls the entity has set around the employee benefit payment process to determine
how effective they are.
If they are effective, the auditor can reduce the substantive testing. Common internal controls over the employee benefit
payment cycle includes
● maintaining of attendance records,
● employee master,
● authorisation and approval of monthly payroll processing and disbursement,
● computation of employee deductions like payroll taxes,
● accrual of other benefits like gratuity,
● leave encashment, bonus etc.
2. The auditor selects a random sample of transactions and examines the related appointment letters, appraisal
letters, attendance records, HR policies, employee master etc.
Performing substantive audit procedures is a must.

Substantive analytical procedure will consist of
- monthly expense reasonability,
- comparison with previous accounting period,
- setting an expectation in relation to the expense incurred during the period under audit and comparing that
with the client’s business operations and overall trend in the industry.
Audit Procedures For

- Recorded employee benefit expenses were actually incurred during the period (OCCURRENCE)
- Employee benefit expenses pertaining to the period have been recorded appropriately (COMPLETENESS)
- Employee benefit expenses have been measured appropriately. There in no understatement or overstatement.
(MEASUREMENT)
● Obtain an understanding of the entity's process of capturing employee attendance.
There is always a risk that an entity could record expense for fictitious employees. To address this risk, the auditor may choose to
meet the employees in person, on a sample basis. Further, the auditor may choose to select a sample of employees and ask the
payroll department to share their bank details/ identity proofs of the employees.

● Obtain a list of employees as at the period- end along with a monthly movement split between new hires,
leavers and continuing employees.
● For a sample (selected randomly) of new hires, obtain the appointment letter and verify whether the salary
for first month and subsequent months was processed as per the agreed terms.
● For a sample (selected randomly) of resigned employees, obtain their full and final computation and verify
whether all their dues including post-retirement benefits like gratuity, leave encashment have been paid and
whether the respective employee’s acknowledgement on final computation has been obtained.
● Obtain the monthly salary registers for all 12 months.
Calculate the average salary per employee per month and compare with the previous year and preceding month and analyse the reasons
for variance which could be attributable to annual increments, an employee at senior level joining/ leaving the entity, bonus pay-out etc.
● Verify if accrual/ provision has been made for all employee benefits and obligations like bonus, gratuity, leave
encashment, etc.
● In case provident fund (PF), employee state insurance (ESI) are applicable to the entity, compile a
reasonability by applying the rate to the basic wages and comparing to the amount recorded in books and
analyse reasons for variance, if any. Also, obtain monthly deposit challans to verify if the month on month
liability was subsequently deposited with the authorities and within the defined timelines.
● Perform analytical procedures to obtain audit evidence as to overall reasonableness of employee benefit
expenses which may include production per employee analysis.
Auditor should analyse units produced per employee and compare the same with previous years and present industry trends and ask
for the reasons from the management, if any significant variations are found.
While reviewing Employee benefits expenses of a company, how you as an auditor you will evaluate its hiring, appraisal and retirement
process?
Required DISCLOSURES for employee benefit expenses have been appropriately made
● Whether employee benefit expense has been classified as:

○ Salaries and wages.
○ Contributions to provident and other funds.
○ Staff welfare expenses.

Depreciation and Amortisation
An asset’s cost should proportionally be expensed based on the period over which the asset is expected to be used.
It is done through depreciation and amortization.
Depreciation represents systematic allocation of the depreciable value of an item of PPE over its useful life while.
Amortisation represents systematic allocation of the depreciable amount of an intangible asset over its useful life.
Correct/ incorrect
One of the key principles of accrual basis of accounting requires that an asset’s cost is proportionally expensed based on the period over
which the asset is expected to be used.
(RTP, Nov 2020, NA)
Correct/Incorrect
Tangible assets are depreciated when the asset is actually put to active use.
(MTP1, Nov 2020, 2 Marks
Depreciation and amortisation generally constitute an entity’s significant part of overall expenses and have direct
impact on the profit/ loss of the entity, hence auditors need to verify and ensure that such expenditure is appropriate,
accurately calculated and has been accounted as per applicable provisions of Companies Act or other statutes, to the
extent applicable on the respective industry and as per generally accepted accounting principles.
Auditor needs to consider the following attributes while verifying for depreciation and amortisation expenses:
● Obtain the understanding of entity's accounting policy related to depreciation and amortisation.
● Ensure the Company policy for charging depreciation and amortisation is as per the relevant provisions of
Companies Act/ applicable accounting standards.
● The accounting policy has been applied consistently year on year.
● Any change in the accounting policy has been adequately disclosed.
● Whether the depreciation has been calculated after making adjustment of residual value from the cost of
the assets.
● Whether depreciation and amortisation charges are valid.
● Whether depreciation and amortisation charges are accurately calculated and recorded.
● Whether all depreciation and amortisation charges are recorded in the appropriate period.
● Ensure the parts (components) of each item of property, plant and equipment that are to be depreciated
separately have been properly identified.
● Whether the most appropriate depreciation method for each separately depreciable component has been
used.
Mention any five attributes to be considered by an auditor while verifying for a depreciation and amortisation expenses.
OR
Depreciation and amortisation expense generally constitute an entity's significant part of overall expenses and have direct impact on
the profit/loss of the entity. What are the attributes, the Auditor needs to consider while verifying Depreciation and amortisation
expense.

Audit Procedures To Check
● Depreciation and amortization expenses pertaining to the period have been recorded appropriately and there
is no understatement/overstatement Depreciation and amortisation expenses have been measured
appropriately.
● Recorded depreciation and amortisation expenses were actually incurred during the period
1. Obtain an understanding of entity’s process of charging depreciation and amortization.

2. Obtain the fixed asset register maintained by the entity.
There is always a risk that an entity could capitalize expense of revenue nature to increase its profit or charge capital expenditure
directly in income and expense statement to reduce its profit. To address this risk, the auditor may choose to check the nature of
asset from fixed asset register.
There is always a risk that a fake asset has been capitalized in the books and to mitigate this risk, auditors should physically verify the
fixed assets, at least the ones that are material in value. Obtain a list of all additions/ deletions along with their proper approval from
the authorised person for the same.
3. Select the sample of assets from the Fixed Assets Register, on materiality considerations and verify the rates
of depreciation and depreciation calculations.
4. Ensure Intangible assets like patents, goodwill, copy rights have been properly amortized over the period.
5. Ensure depreciation is charged on the assets from the date when it is ready to use and not from the date of
actual usage Ensure depreciation on revalued amount has been properly accounted from revaluation reserve.
6. Depreciation computation as per Income tax Act, 1961- Ensure that additions are tallying with the additions
as per Companies Act and the opening WDV to the Tax audit schedule for the assessment year preceding the
previous year under audit.
7. Perform analytical procedures to obtain audit evidence as to overall reasonableness of depreciation and
amortisation expense - check the arithmetical accuracy of records and perform independent calculations.
8. Ensure that the depreciation and amortization has been charged as per the useful lives of PPE and
intangible assets.
9. Ensure that residual values have been properly verified as that impacts the computation of depreciation.
10. Ensure that the depreciation and amortization has been computed prospectively whenever there is any
change in useful lives of PPE and intangible assets.
Required disclosures for depreciation and amortisation have been appropriately made
Ensure whether the following disclosures as required have been made:

● Accounting policy for depreciation and amortization.
● Useful lives of assets as per Schedule Il to the Companies Act, 2013.
● Residual value of assets.
● Depreciation method.

Other Expenses like Power and Fuel, Rent, Repair to Building, Plant and
Machinery, Insurance, Travelling, Legal and Professional, Miscellaneous
Expenses
An entity in addition to making purchases and incurring employee benefit expenses, also incurs other expenditures
like rent, power and fuel, repairs and maintenance, insurance, travelling, miscellaneous expenses etc., that are essential
and incidental to running of business operations.
While the auditor may choose to analyse the monthly trends for expenses like rent, power and fuel, an auditor
generally prefers to vouch for other expenses to verify following attributes:
- Whether the expenditure was in relation to the entity’s business and not a personal expenditure. (Occurrence)
- Whether the expenditure had a valid supporting documents like travel tickets, insurance policy, third party
invoice etc.; - (Accuracy & Completeness)
- Whether the expenditure pertained to current period under audit; (Cut-off)
- Whether the expenditure qualified as a revenue and not capital expenditure; - (Classification)
- Whether the expenditure has been classified under the correct expense head;
- Whether the expenditure was authorised as per the delegation of authority matrix; (Internal Control)
An entity in addition to undertaking purchases and incurring employee benefit expenses also spends on other expenditure like rent,
power and fuel, repairs and maintenance, insurance, travelling, miscellaneous expenses etc., that are essential and incidental to running of
business operations.
While the auditor may choose to analyse the monthly trends for expenses like rent, power and fuel, an auditor generally prefers to vouch
for other expenses to verify some important attributes
Advise stating clearly those attributes and the audit procedures generally required to be undertaken while auditing other expenses
"While the auditor may choose to analyse the monthly trends for expenses like rent, power and fuel but for other expenses, an auditor
generally prefers to verify other attributes." Mention those attributes.
(SA, Nov 2018, 5 Marks) (MTP1, Nov 2021, 4 Marks)
OR
Profit and Loss account of an organisation shows various types of expenses like rent, power and fuel, repairs and maintenance, insurance,
travelling, miscellaneous expenses etc., that are essential and incidental to running of business operations. What are the attributes that an
auditor generally prefers for vouching these types of expenses ?
"Explain the audit procedure to vouch/verify :

(i) Rent expenses
(ii) Power and Fuel expenses"
(RTP, May 2019, NA)
Audit procedures for different expenses
Rent expense
● Obtain a month wise expense schedule along with the rent agreements.

● Examine whether expense has been recorded for all 12 months and whether the rent paid is as per the
underlying agreement.
● Examine whether the agreement contains any escalation clause and if yes, verify whether the rent has been
increased or adjusted during the period only as per escalation clause.
● Verify whether the agreement is in the name of the entity and verify whether the expense pertains to
premises used for running business operations of the entity.
Power and fuel expense

● Obtain a month wise expense schedule along with the power bills.
● Verify whether the expenses have been recorded for all 12 months.
● Also, compile a month wise summary of power units consumed and the applicable rate and check the
arithmetical accuracy of the bill raised on a monthly basis.
● Analyse the monthly power units consumed by linking it to units of finished goods produced and
investigate reasons for variance in monthly trends.
Insurance expense
● Obtain a summary of insurance policies taken along with their validity period.
● Verify whether the expense has been correctly classified between prepaid and expense for the period based
on the number of days.
Legal and professional expenses

● Obtain a month-wise and consultant-wise summary.
● In case of monthly retainership agreements, verify whether the expenditure for all 12 months has been
recorded correctly.
● For non- recurring expenses, select a sample and vouch for the attributes discussed above.
● The auditor should be cautious while vouching for legal expenses as the same may highlight a dispute for
which the entity may not have made any provision and the matter may also not have been discussed/
highlighted to the auditor for his specific consideration.
An entity in addition to undertaking purchases and incurring employee benefit expenses also spends on other expenditure that are
essential and incidental to running of business operations. One of such expenses is the legal and professional expenses. These are the fees
paid for professional advices regarding specific deals.
Iconic Ltd. is having a retainership agreement with a lawyer, Mr. Avi, to whom the company is paying a huge sum as legal and professional
expenses on monthly basis. While vouching such expenses, what should be kept in mind by the auditor?
(a) In case of monthly retainership agreements, only verify if the expenditure for all 12 months has been recorded correctly.
(b) The auditor should verify that the payments have been only through bank vouchers.
(c) The auditor should be cautious while vouching for legal expenses as the same may highlight a dispute for which the entity may not
have made any provision and the matter may also not have been discussed/ highlighted to the auditor for his specific consideration.
(d) In case of monthly retainership agreements, only verify that all the payments have been made and there is no outstanding balance to
be shown as liability in the Balance Sheet.
(Sample MCQs)
Travel, repair and maintenance, printing and stationery, miscellaneous expenses –

● The auditor should select a sample and vouch for the attributes discussed above. Wherever possible, the
auditor should try to prepare a summary of expenditure on a monthly basis and then analytically compare
the trends.
● Perform analytical procedures to obtain audit evidence as to overall reasonableness of other expense which
may include expenditure per unit of production analysis.

● Auditor should analyse expenses per unit produced and compare the same with previous years and present
industry trends and ask for the reasons from the management, if any significant variations are noticed.
Required DISCLOSURE for other expenses have been appropriately made
Ensure other expense have been classified under:

● Rent.
● Insurance.
● Power and fuel.
● Repairs and maintenance- Building, Plant and machinery, others.
● Legal and professional.
● Printing and stationary.
● Travel expenses.
● Miscellaneous expenses.
Other Points
Details of Benami Property held

Where any proceedings have been initiated or pending against the company for holding any benami property under the
Benami Transactions (Prohibition) Act, 1988 (45 of 1988) and the rules made thereunder, the company shall disclose the
following:-
a. Details of such property, including year of acquisition,

b. Amount thereof,
c. Details of Beneficiaries,
d. If property is in the books, then reference to the item in the Balance Sheet,
e. If property is not in the books, then the fact shall be stated with reasons,
f. Where there are proceedings against the company under this law as an abetter of the transaction or as the
transferor then the details shall be provided,
g. Nature of proceedings, status of same and company‘s view on same.
Details of Crypto Currency or Virtual Currency

Where the Company has traded or invested in Crypto currency or Virtual Currency during the financial year, the following
shall be disclosed:-
a. profit or loss on transactions involving Crypto currency or Virtual Currency
b. amount of currency held as at the reporting date,
c. deposits or advances from any person for the purpose of trading or investing in Crypto Currency/ virtual currency.
Following Ratios to be disclosed:-

a. Current Ratio,
b. Debt-Equity Ratio,
c. Debt Service Coverage Ratio,
d. Return on Equity Ratio,
e. Inventory turnover ratio,
f. Trade Receivables turnover ratio,
g. Trade payables turnover ratio,
h. Net capital turnover ratio,
i. Net profit ratio,
j. Return on Capital employed,

k. Return on investment.
The company shall explain the items included in numerator and denominator for computing the above ratios. Further
explanation shall be provided for any change in the ratio by more than 25% as compared to the preceding year.
Corporate Social Responsibility (CSR)

Where the company covered under section 135 of the companies act, the following shall be disclosed with regard to CSR
activities:-
a. amount required to be spent by the company during the year,

b. amount of expenditure incurred,
c. shortfall at the end of the year,
d. total of previous years shortfall,
e. reason for shortfall,
f. nature of CSR activities,
g. details of related party transactions, e.g., contribution to a trust controlled by the company in relation to CSR
expenditure as per relevant Accounting Standard,
h. where a provision is made with respect to a liability incurred by entering into a contractual obligation, the
movements in the provision during the year should be shown separately.
Rounding off of income

Depending upon the Total Income of the company, the figures appearing in the Financial Statements shall be rounded off as
given below:-
Total Income Rounding off
less than one hundred crore rupees To the nearest hundreds, thousands, lakhs or millions, or
decimals thereof.
(one hundred crore rupees or more To the nearest lakhs, millions or crores, or decimals thereof.
Once a unit of measurement is used, it should be used uniformly in the Financial Statements.
Relationship with Struck off Companies

Where the company has any transactions with companies struck off under section 248 of the Companies Act, 2013 or section 560 of
Companies Act, 1956, the Company shall disclose the following details:-
Name of struck off Company Nature of transactions with Balance outstanding Relationship with the Struck
struck off Company off company, if any, to be
disclosed
Investments in securities
Receivables
Payables
Shares held by stuck off

company

Other outstanding balances

(to be specified)
Miscellaneous Questions
Expenses which are essentially of a revenue nature if incurred for creating an asset or adding to its value for achieving higher productivity
are regarded as expenses of a capital nature. Describe any five such expenses.
OR
Expenses which are essentially of a revenue nature if incurred for creating an asset or adding to its value for achieving higher productivity
are regarded as expenses of a capital nature. Describe any six such expenses.
Define the different types of lease agreements as per Accounting Standard/Ind-AS.

Newton Ltd. has made loans and advances on the basis of following securities to various borrowers. As an' auditor what type of
documents can be verified to ensure that the company holds a legally enforceable security?
(i) Shares and Debentures
(ii) Life Insurance Policy
(iii) Hypothecation of goods.
(MTP1, May 2020, 3 Marks) (RTP, May 2021, NA) (MTP2, May 2021, 3 Marks)
Answer Insurance - https://youtu.be/nW2lc2CGT_w
How will you vouch/verify the following?

(a) Trademarks and copyrights
(b) Investments income in the case of charitable institutions
(c) Contingent liabilities
(d) Leasehold rights
(RTP, Nov 2020, NA)
Correct/Incorrect
Mr. Z, a team member of auditor of Grateful and Competent Limited was of the opinion that while conducting an audit of a company no
distinction is required to be made between revenue expenditure and capital expenditure.
Discuss the audit procedures generally required to be undertaken by the auditor while auditing Goods sent out on Sale or Return Basis.
Answer - https://youtu.be/S_5UcsEgpj4
Correct/Incorrect

If the purpose of an audit procedure is to test for understatement in the existence or valuation of accounts payable then testing the
recorded accounts payable may be relevant audit procedure.
XYZ Ltd. which is in the business of trading of automobile components is following Cash Basis of Accounting for sale of spare parts. As
Statutory Auditor of XYZ Ltd. explain the reporting requirements, manner of qualification and disclosure, if any, to be made in the auditor's
report in line with AS-1 ‘Disclosure of Accounting Policies’.
List out the steps to be taken by auditor while vouching/ verifying the 'Refund of General Insurance premium paid'.
(RTP, May 2021, NA)
Answer Discussion - https://youtu.be/5wXTzge4SvM
"Which of the following is an example of revenue expenditure-

(a) Wages on installation of Machinery
(b) Regular repairs incurred on PPE
(c) Legal expenses in purchase of land and building
(d) Freight inwards on purchase of PPE"
(MTP1, May 2021, 1 mark)
Correct/Incorrect
As per AS 26, internally generated goodwill is not recognised as an asset.
"Explain how you will verify the items given while conducting an audit of an entity :
(a) Recovery of Bad debts written off - https://youtu.be/NGVLpwiA054
(b) Receipt of Insurance claims - https://youtu.be/DOIlklluvcA
(c) Payment of Taxes - https://youtu.be/ctdUkGIrygA
(d) Sale proceeds of scrap material"- https://youtu.be/UqMgDeNpCPo
(RTP, Nov 2021, NA) (RTP, May 2022, NA)
Answer Discussion -
https://youtu.be/NGVLpwiA054
APQ Ltd. deals in real estate and classifies all of its land holding under current assets as inventory. The same is, therefore valued at cost or
market value whichever is less. How would you verify profit or loss arising on sale of plots of land by such a dealer?
(RTP, Nov 2021, NA)
Answer Discussion - https://youtu.be/tLMQUC0PNc0

"Statement I : A capital reserve cannot be utilised for writing down fictitious assets or losses or (subject to provisions in the Articles) for
issuing bonus shares if it is realized.
Statement II : The amount of securities premium or capital redemption reserve account can be utilised only for the purposes specified in
Sections 52 and 55 of the Companies Act, 2013, respectively.
(a) only Statement I is correct
(b) only Statement II is correct
(c) both the statements are correct
(d) both the statements are incorrect. "

Chapter 10 Company Audit
CHAPTER X
AUDIT AND AUDITORS
Appointment of auditors - 139
Subsequent auditor of a company other than government company
139. (1) Subject to the provisions of this Chapter,

● every company
● shall,
● at the first annual general meeting,
● appoint an individual or a firm as an auditor
● who shall hold office
○ from the conclusion of that meeting till the conclusion of its sixth annual general meeting
○ And the manner and procedure of selection of auditors by the members of the company at
such meetings shall be such as may be prescribed.
First Proviso Deleted
Provided further that

● before such appointment is made,
● the written consent of the auditor to such appointment, and
● a certificate from him or it
○ that the appointment,
○ if made,
○ shall be in accordance with the conditions as may be prescribed, shall be obtained from the
auditor:
Provided also that the certificate shall also indicate whether the auditor satisfies the criteria provided in
section 141
Provided also that the company shall inform the auditor concerned of his or its appointment, and also file a
notice of such appointment with the Registrar within fifteen days of the meeting in which the auditor is
appointed.
Role of Audit Committee in Appointment of Auditor
Join Us on YouTube www.youtube.com/neerajarora Chapter 10 Company Audit | 1

139 (11) Where a company is required to constitute an Audit Committee under section 177, all appointments,
including the filling of a casual vacancy of an auditor under this section shall be made after taking into
account the recommendations of such committee.
Manner and procedure of selection and appointment of auditors - Rule 3 Companies (Audit and
Auditors) Rules, 2014
3. (1) In case of a company that is required to constitute an Audit Committee under section 177, the
committee, and, in cases where such a committee is not required to be constituted, the Board, shall take into
consideration the qualifications and experience of the individual or the firm proposed to be considered for
appointment as auditor and whether such qualifications and experience are commensurate with the size
and requirements of the company:
Provided that while considering the appointment, the Audit Committee or the Board, as the case may be,
shall have regard to any order or pending proceeding relating to professional matters of conduct against the
proposed auditor before the Institute of Chartered Accountants of India or any competent authority or any
Court.
(2) The Audit Committee or the Board, as the case may be, may call for such other information from the
proposed auditor as it may deem fit.
(3) Subject to the provisions of sub-rule (1), where a company is required to constitute the Audit Committee,
the committee shall recommend the name of an individual or a firm as auditor to the Board for consideration
and in other cases, the Board shall consider and recommend an individual or a firm as auditor to the
members in the annual general meeting for appointment.
(4) If the Board agrees with the recommendation of the Audit Committee, it shall further recommend the
appointment of an individual or a firm as auditor to the members in the annual general meeting.
(5) If the Board disagrees with the recommendation of the Audit Committee, it shall refer back the
recommendation to the committee for reconsideration citing reasons for such disagreement.
(6) If the Audit Committee, after considering the reasons given by the Board, decides not to reconsider its
original recommendation, the Board shall record reasons for its disagreement with the committee and send
its own recommendation for consideration of the members in the annual general meeting; and if the Board
agrees with the recommendations of the Audit Committee, it shall place the matter for consideration by
members in the annual general meeting.
(7) The auditor appointed in the annual general meeting shall hold office from the conclusion of that
meeting till the conclusion of the sixth annual general meeting, with the meeting wherein such
appointment has been made being counted as the first meeting.
Conditions for appointment and notice to Registrar - Rule 4
4. (1) The auditor appointed under rule 3 shall submit a certificate that -
a. the individual or the firm, as the case may be, is eligible for appointment and is not disqualified for
appointment under the Act, the Chartered Accountants Act, 1949 and the rules or regulations made
thereunder;
b. the proposed appointment is as per the term provided under the Act;

c. the proposed appointment is within the limits laid down by or under the authority of the Act;
d. the list of proceedings against the auditor or audit firm or any partner of the audit firm pending with
respect to professional matters of conduct, as disclosed in the certificate, is true and correct.
(2) The notice to Registrar about appointment of auditor under fourth proviso to sub-section (1) of section 139
shall be in Form ADT- 1


Rule 3 Charts


Subsequent Auditor of Government Company
(5) Notwithstanding anything contained in sub-section (1), in the case of a Government company or any
other company owned or controlled, directly or indirectly, by the Central Government, or by any State
Government or Governments, or partly by the Central Government and partly by one or more State
Governments, the Comptroller and Auditor-General of India shall, in respect of a financial year, appoint an
auditor duly qualified to be appointed as an auditor of companies under this Act, within a period of one
hundred and eighty days from the commencement of the financial year, who shall hold office till the
conclusion of the annual general meeting.
First Auditor other than government company

(6) Notwithstanding anything contained in sub-section (1), the first auditor of a company, other than a
Government company, shall be appointed by the Board of Directors within thirty days from the date of
registration of the company and in the case of failure of the Board to appoint such auditor, it shall inform the
members of the company, who shall within ninety days at an extraordinary general meeting appoint
such auditor and such auditor shall hold office till the conclusion of the first annual general meeting.
First auditor Government Company
(7) Notwithstanding anything contained in sub-section (1) or sub-section (5), in the case of a Government
company or any other company owned or controlled, directly or indirectly, by the Central Government, or by
any State Government, or Governments, or partly by the Central Government and partly by one or more State
Governments, the first auditor shall be appointed by the Comptroller and Auditor-General of India within
sixty days from the date of registration of the company and in case the Comptroller and Auditor-General
of India does not appoint such auditor within the said period, the Board of Directors of the company shall
appoint such auditor within the next thirty days; and in the case of failure of the Board to appoint such
auditor within the next thirty days, it shall inform the members of the company who shall appoint such
auditor within the sixty days at an extraordinary general meeting, who shall hold office till the
conclusion of the first annual general meeting.


139(2) - Rotation
No listed company or a company belonging to such class or classes of companies as may be prescribed, shall
appoint or re-appoint—
a. an individual as auditor for more than one term of five consecutive years; and
b. an audit firm as auditor for more than two terms of five consecutive years
Cooling period
Provided that—
● an individual auditor who has completed his term under clause (a) shall not be eligible for
re-appointment as auditor in the same company for five years from the completion of his term;
● an audit firm which has completed its term under clause (b), shall not be eligible for re-appointment
as auditor in the same company for five years from the completion of such term:
Firms having a common partner or partners also have to serve the cooling period.
Provided further that as on the date of appointment no audit firm having a common partner or partners to
the other audit firm, whose tenure has expired in a company immediately preceding the financial year, shall
be appointed as auditor of the same company for a period of five years
Provided also that, nothing contained in this sub-section shall prejudice

● the right of the company to remove an auditor or
● the right of the auditor to resign from such office of the company.
139(3)
Subject to the provisions of this Act, members of a company may resolve to provide that—
a. in the audit firm appointed by it, the auditing partner and his team shall be rotated at such intervals
as may be resolved by members; or
b. the audit shall be conducted by more than one auditor
139(4)
The Central Government may, by rules, prescribe the manner in which the companies shall rotate their
auditors in pursuance of sub-section (2).
Section 139(2) - Super Summary For Understanding
For listed and prescribed companies

● Individuals cannot be appointed as auditor for more than one term of 5 consecutive years.
● Firm cannot be appointed as auditor for more than 2 terms of 5 consecutive years.

Individual or firm as the case may be once completed the term (1 term of 5 CY or 2 term of 5CY) as
mentioned above will not be eligible to be reappointed as auditor in the same company for 5 years from
the completion of such term.
Not only individual or the firm the following will also be not eligible to be appointed as the auditor of such
a company
● Partner of the outgoing firm
● Firm having common partner as on the date of appointment.
● the incoming auditor or audit firm shall not be eligible if such auditor or audit firm is associated
with the outgoing auditor or audit firm under the same network of audit firms.
○ For the purposes of these rules the term 'same network" includes the firms operating or
functioning, hitherto or in future, under the same brand name, trade name or common
control.
● Firm joined by partner who certified the financial statements.
Any break in 1 term of 5CY or 2 terms of 5CY will be considered as break only if it is of 5 years or more.
Example - Individual is auditor in a company specified under Section 139(2), the auditor resigned after 4
years. The same auditor was reappointed after 1 year for another 5 years. Discuss
Discussion in classes or videos



Question
Clue Ltd. is a Public unlisted company having paid-up share capital of Rs. 9 crores and public borrowings
from the financial institutions of Rs. 51 crores. They appointed M/s Pray and Co., A Chartered Accountant
firm as the statutory auditor in its annual general meeting for 11 years.
● Is the manner of rotation of the auditor applicable in the case of Clue Ltd.?
● Whether the appointment of M/s Pray and Co. is valid?
November 2020 - 4 Marks
139(8) - Casual Vacancy

Any casual vacancy in the office of an auditor shall—

● in the case of a company other than a company whose accounts are subject to audit by an auditor
appointed by the Comptroller and Auditor-General of India, be filled by the Board of Directors within
thirty days, but if such casual vacancy is as a result of the resignation of an auditor, such appointment
shall also be approved by the company at a general meeting convened within three months of the
recommendation of the Board and he shall hold the office till the conclusion of the next annual
general meeting;
● in the case of a company whose accounts are subject to audit by an auditor appointed by the
Comptroller and Auditor-General of India, be filled by the Comptroller and Auditor-General of India
within thirty days:
Provided that in case the Comptroller and Auditor-General of India does not fill the vacancy within the said
period, the Board of Directors shall fill the vacancy within the next thirty days.
Question - Correct / Incorrect Marks 2 January 2021 Exam Question
As per Section 139(8) of the Companies Act, 2013, any casual vacancy in the office of an auditor shall in case
of a company other than a company whose accounts are subject to audit by an auditor appointed by
Comptroller and Auditor General of India, be filled by the Shareholders at an Annual General Meeting
within 60 days.
139(9) Reappointment of retiring auditor
Subject to the provisions of sub-section (1) and the rules made thereunder, a retiring auditor may be
re-appointed at an annual general meeting, if—
a. he is not disqualified for re-appointment;
b. he has not given the company a notice in writing of his unwillingness to be re-appointed; and
c. a special resolution has not been passed at that meeting appointing some other auditor or providing
expressly that he shall not be re-appointed.
139(10) - No auditor is appointed or reappointed

Where at any annual general meeting, no auditor is appointed or reappointed, the existing auditor shall
continue to be the auditor of the company.

Section 140- Removal, resignation of auditor and giving of special notice
Removal before expiry of term
140. (1) The auditor appointed under section 139 may be removed from his office before the expiry of his term
only by a special resolution of the company, after obtaining the previous approval of the Central Government
in that behalf in the prescribed manner:
Provided that before taking any action under this sub-section, the auditor concerned shall be given a
reasonable opportunity of being heard.
Removal of the auditor before expiry of his term
7. (1) The application to the Central Government for removal of auditor shall be made in Form ADT-2 and
shall be accompanied with fees as provided for this purpose under the Companies (Registration Offices
and Fees) Rules, 2014.
(2) The application shall be made to the Central Government within thirty days of the resolution passed by
the Board.
(3) The company shall hold the general meeting within sixty days of receipt of approval of the Central
Government for passing the special resolution.
Statement of Reasons
(2) The auditor who has resigned from the company shall file within a period of thirty days from the date of
resignation, a statement in the prescribed form with the company and the Registrar, and in case of
companies referred to in sub-section (5) of section 139, the auditor shall also file such statement with the
Comptroller and Auditor-General of India, indicating the reasons and other facts as may be relevant with
regard to his resignation.
(3) If the auditor does not comply with the provisions of sub-section (2), he or it shall be liable to a penalty of
fifty thousand rupees or an amount equal to the remuneration of the auditor, whichever is less, and in case of
continuing failure, with further penalty of five hundred rupees for each day after the first during which such
failure continues, subject to a maximum of two lakh rupees.
(4)
i. Special notice shall be required for a resolution at an annual general meeting appointing as auditor a
person other than a retiring auditor, or providing expressly that a retiring auditor shall not be
re-appointed, except where the retiring auditor has completed a consecutive tenure of five years or, as
the case may be, ten years, as provided under sub-section (2) of section 139.
ii. On receipt of notice of such a resolution, the company shall forthwith send a copy thereof to the
retiring auditor.
iii. Where notice is given of such a resolution and the retiring auditor makes with respect thereto
representation in writing to the company (not exceeding a reasonable length) and requests its
notification to members of the company, the company shall, unless the representation is received by
it too late for it to do so,—

a. in any notice of the resolution given to members of the company, state the fact of the
representation having been made; and
b. send a copy of the representation to every member of the company to whom notice of the
meeting is sent, whether before or after the receipt of the representation by the company, and
if a copy of the representation is not sent as aforesaid because it was received too late or
because of the company's default, the auditor may (without prejudice to his right to be heard
orally) require that the representation shall be read out at the meeting:
Provided that if a copy of representation is not sent as aforesaid, a copy thereof shall be filed with the
Registrar:
Provided further that if the Tribunal is satisfied on an application either of the company or of any other
aggrieved person that the rights conferred by this sub-section are being abused by the auditor, then, the
copy of the representation may not be sent and the representation need not be read out at the meeting.
(5) Without prejudice to any action under the provisions of this Act or any other law for the time being in
force, the Tribunal either suo motu or on an application made to it by the Central Government or by any
person concerned, if it is satisfied that the auditor of a company has, whether directly or indirectly, acted in a
fraudulent manner or abetted or colluded in any fraud by, or in relation to, the company or its directors or
officers, it may, by order, direct the company to change its auditors:
Provided that if the application is made by the Central Government and the Tribunal is satisfied that any
change of the auditor is required, it shall within fifteen days of receipt of such application, make an order that
he shall not function as an auditor and the Central Government may appoint another auditor in his place:
Provided further that an auditor, whether individual or firm, against whom final order has been passed by
the Tribunal under this section shall not be eligible to be appointed as an auditor of any company for a
period of five years from the date of passing of the order and the auditor shall also be liable for action under
section 447.
Explanation I.—It is hereby clarified that in the case of a firm, the liability shall be of the firm and that of every
partner or partners who acted in a fraudulent manner or abetted or colluded in any fraud by, or in relation to,
the company or its directors or officers.
Explanation II.—For the purposes of this Chapter the word "auditor" includes a firm of auditors.






Section 141- eligibility, qualifications and disqualifications of auditors
141. (1) A person shall be eligible for appointment as an auditor of a company

● only if he is a chartered accountant
● Provided that a firm whereof
○ majority of partners practising in India are qualified for appointment as aforesaid
○ may be appointed by its firm name to be auditor of a company.
2(17) "chartered accountant" means a chartered accountant as defined in clause (b) of subsection (1) of
section 2 of the Chartered Accountants Act, 1949 (38 of 1949) who holds a valid certificate of practice under
subsection (1) of section 6 of that Act
2(1)(b) of The Chartered Accountants Act, 1949- chartered accountant” means a person who is a member of
the Institute
(2) Where a firm including a limited liability partnership is appointed as an auditor of a company,
● only the partners who are chartered accountants shall be authorised to act and sign on behalf of the
firm.
(3) The following persons shall not be eligible for appointment as an auditor of a company, namely:—
(a) a body corporate other than a limited liability partnership registered under the Limited Liability
Partnership Act, 2008 (6 of 2009);
(b) an officer or employee of the company;
(c) a person who is a partner, or who is in the employment, of an officer or employee of the company;
(d) a person who, or his relative or partner—
(i) is holding any security of or interest in the company or its subsidiary, or of its holding or
associate company or a subsidiary of such holding company:
Provided that the relative may hold security or interest in the company of face value not exceeding one
thousand rupees or such sum as may be prescribed (Not exceeding Rs. 1 lakh)
In the event of acquiring any security or interest by a relative, above the threshold prescribed (Rs. 1,00,000),
the
corrective action to maintain the limits as specified above shall be taken by the auditor within 60 days of
such acquisition or interest.
(ii) is indebted to the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company, in excess of such amount as may be prescribed (Not
exceeding Rs. 5 lakh) ; or
(iii) has given a guarantee or provided any security in connection with the indebtedness of any
third person to the company, or its subsidiary, or its holding or associate company or a
subsidiary of such holding company, for such amount as may be prescribed; (Not exceeding
Rs. 1 lakh.)
(e) a person or a firm who, whether directly or indirectly, has business relationship with the company, or
its subsidiary, or its holding or associate company or subsidiary of such holding company or associate
company of such nature as may be prescribed;

For the purpose of clause (e) of sub-section (3) of section 141, the term "business relationship" shall be
construed as any transaction entered into for a commercial purpose, except -
i. commercial transactions which are in the nature of professional services permitted to be

rendered by an auditor or audit firm under the Act and the Chartered Accountants Act, 1949
and the rules or the regulations made under those Acts;
ii. commercial transactions which are in the ordinary course of business of the company at
arm's length price -like sale of products or services to the auditor, as customer, in the ordinary
course of business, by companies engaged in the business of telecommunications, airlines,
hospitals, hotels and such other similar businesses.
(f) - a person whose relative

- is a director or
- is in the employment of the company as a
- director or key managerial personnel;
(g) - a person who is in full time employment elsewhere or

- a person or a partner of a firm holding appointment as its auditor, if such persons or partner is at the
date of such appointment or reappointment holding appointment as auditor of more than twenty
companies other than one-person Company, dormant companies , small companies and private
Companies having paid up capital less than 100 Crores which has not committed default in filing it’s
financial statements u/s 137 or annual return u/s 92 of companies act with the registrar.
(h) a person who has been convicted by a court of an offence involving fraud and a period of ten years
has not elapsed from the date of such conviction.
(i) a person who, directly or indirectly, renders any service referred to in section 144 to the company or its
holding company or its subsidiary company.
Explanation.—For the purposes of this clause, the term "directly or indirectly" shall have the meaning
assigned to it in the Explanation to section 144.
(4) Where a person appointed as an auditor of a company incurs any of the disqualifications mentioned in
141(3) after his appointment, he shall vacate his office as such auditor and such vacation shall be deemed to
be a casual vacancy in the office of the auditor.
Meaning of Relative : The term “relative” as defined under the Companies Act, 2013, means anyone who is
related to another as members of a HUF; husband and wife; Father (including step-father), mother (including
stepmother), Son (including step-son), Son’s wife, Daughter, Daughter’s husband, Brother (including
step-brother), sister (including step-sister).
Ceiling on Tax Audit Assignments: The specified number of tax audit assignments that an auditor, as an individual
or as a partner of a firm, can accept is 60 numbers.
A chartered accountant in practice as well as firm of chartered accountants in practice shall maintain a record of
the audit assignments accepted by him or by the firm of chartered accountants, or by any of the partner of the firm
in

his individual name or as a partner of any other firm as far as possible, in the prescribed manner.
In exercise of the powers conferred by the Chartered Accountants Act, 1949, the Council of the Institute of
Chartered Accountants of India specifies that a member of the Institute in practice shall be deemed to be
guilty of professional misconduct, if he holds at any time appointment of more than the “specified number
of audit assignments of the companies under Section 141(3)(g) of the Companies Act, 2013).
Explain the provisions prescribed under Companies Act, 2013 in respect of ceiling on number of audits in a
company to be accepted by an auditor.
ICAI RTP May 2021.
144 - Auditor not to render certain services.
An auditor appointed under this Act shall provide to the company only such other services as are approved
by the Board of Directors or the audit committee, as the case may be, but which shall not include any of the
following services (whether such services are rendered directly or indirectly to the company or its holding
company or subsidiary company), namely
(a) accounting and book keeping services;

(b) internal audit;
(c) design and implementation of any financial information system;
(d) actuarial services;
(e) investment advisory services;
(f) investment banking services;
(g) rendering of outsourced financial services;
(h) management services; and
(i) any other kind of services as may be prescribed :
Explanation.—For the purposes of this subsection, the term "directly or indirectly" shall include rendering of
services by the auditor
i. in case of auditor being an individual,

○ either himself or
○ through his relative or
○ any other person connected or associated with such individual or
○ through any other entity, whatsoever, in which such individual has significant influence or
control,
○ or whose name or trade mark or brand is used by such individual;
ii. in case of auditor being a firm,
○ either itself or
○ through any of its partners or
○ through its parent, subsidiary or associate entity or

○ through any other entity, whatsoever, in which the firm or any partner of the firm has
significant influence or control, or
○ whose name or trademark or brand is used by the firm or any of its partners.
AB & Co. is an audit firm having partners Mr. A and Mr. B. Mr. C, the relative of Mr. B, is holding
securities having face value of ₹ 2,00,000 in XYZ Ltd. AB & Co. is qualified for being appointed as an
auditor of XYZ Ltd.
Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to be appointed as an
auditor of a company if his relative is holding any security of or interest in the company of face value
exceeding ₹1 lakh.
Therefore, AB & Co. shall be disqualified for being appointed as an auditor of XYZ Ltd. as Mr. C, the relative
of Mr. B who is a partner in AB & Co., is holding securities in XYZ Ltd. having face value of ₹2 lakh.
A Chartered Accountant holding securities of S Ltd. having face value of ₹950 is qualified for
appointment as an auditor of S Ltd.
Incorrect: As per the provisions of the Companies Act, 2013, a person is disqualified to be appointed as an
auditor of a company if he is holding any security of or interest in the company.
As the chartered accountant is holding securities of S Ltd. having face value of ₹950, he is not eligible for
appointment as an auditor of S Ltd.
Mr. N, a member of the Institute of Chartered Accountants of England and Wales, is qualified to be
appointed as auditor of Indian Companies.
Incorrect: A person shall be eligible for appointment as an auditor of a company only if he is a chartered
accountant.
It may be noted that a firm whereof majority of partners practicing in India are qualified for appointment
as aforesaid may be appointed by its firm name to be auditor of a company.
Thus, Mr. N is disqualified to be appointed as an auditor of Indian Companies.
M/s R & Co., a firm of Chartered Accountants, was appointed as statutory auditors of Ramesh
Company Ltd. Ramesh Company Ltd. holds 51% shares in Suresh Company Ltd. Mr. R, one of the
partners of M/s R & Co., owed ₹1,500 as on the date of appointment to Suresh Company Ltd. for goods
purchased in normal course of business. Comment.
Indebtedness to the Subsidiary Company: As per Section 141(3)(d)(ii) of the Companies Act, 2013, a person

who, or his relative or partner is indebted to the company, or its subsidiary, or its holding or associate
company, or a subsidiary of its holding company, for an amount exceeding ₹5,00,000, then he is not
qualified for appointment as an auditor of a company.
Where an auditor purchases goods or services from a company audited by him or its subsidiary, or its
holding or associate company, or a subsidiary of its holding company, whether in normal course of
business, he is definitely indebted to the company and if the amount outstanding exceeds ₹5,00,000, he is
disqualified for appointment as an auditor of the company. In such a case, he becomes indebted to the
company and consequently he has deemed to have vacated his office.
In the given case, M/s R & Co., a firm of Chartered Accountants, was appointed as statutory auditors of
Ramesh Company Ltd. where the company holds 51% shares in Suresh Company Ltd. Mr. R, one of the
partners of M/s R & Co. owed ₹ 1,500 as on the date of appointment to Suresh Company Ltd. for goods
purchased.
Accordingly, the partner, Mr. R, is not disqualified to be appointed as auditor of the company as he is
indebted to the company for an amount not exceeding ₹ 5,00,000.
Due to this, M/s R & Co. is not disqualified to be appointed as an auditor of Ramesh Company Ltd.
ABC Ltd. appointed CA Prem as an auditor of the company for the current financial year. Further the
company offered him the services of investment banking, rendering of outsourced financial services and
management services which was also approved by the Board of Directors. State the services which the
auditor is restrained from rendering and then advise accordingly. (For Answer Please refer Section 144)
An auditor purchased goods worth ₹ 510,200 on credit from a company being audited by him. The
company allowed him one month's credit, which it normally allowed to all known customers.
Purchase of Goods on Credit by the Auditor: Section 141(3)(d)(ii) of the Companies Act, 2013 specifies that a
person shall be disqualified to act as an auditor if he is indebted to the company for an amount exceeding
five lakh rupees.
Where an auditor purchases goods or services from a company audited by him on credit, he is definitely
indebted to the company and if the amount outstanding exceeds rupees five lakh, he is disqualified for
appointment as an auditor of the company.
It will not make any difference if the company allows him the same period of credit as it allows to
other customers on the normal terms and conditions of the business.
The auditor cannot argue that he is enjoying only the normal credit period allowed to other customers. In
fact, in such a case he has become indebted to the company and consequently he has deemed to have
vacated his office.

Mr. A, a chartered accountant has been appointed as auditor of Laxman Ltd. in the Annual General
Meeting of the company held in September, 2018. Subsequently in January, 2019 he joined Mr. B, another
chartered accountant, who is the Manager Finance of Laxman Ltd., as partner.
Disqualifications of an Auditor: Section 141 (3)(c) of the Companies Act, 2013 prescribes that any person who
is a partner or in employment of an officer or employee of the company will be disqualified to act as an
auditor of a company. Sub-section (4) of Section 141 provides that an auditor who incurs any of the
disqualifications mentioned in sub-section (3) after his appointment, he shall vacate his office as such
auditor.
In the present case, Mr. A, an auditor of Laxman Ltd., joined as partner with Mr. B, who is Manager Finance
of Laxman Limited, has attracted sub-section (3)(c) of Section 141 and, therefore, he shall be deemed to
have vacated office of the auditor of Laxman Limited.
If an LLP (Limited Liability Partnership Firm) is appointed as an auditor of a company, every partner of
a firm shall be authorized to act as an auditor.
Incorrect: As per section 141(2) of the Companies Act, 2013, where a firm including a limited liability
partnership (LLP) is appointed as an auditor of a company, only the partners who are Chartered
Accountants shall be authorized to act and sign on behalf of the firm.
KBC & Co. a firm of Chartered Accountants has three partners, namely, Mr. K, Mr. B & Mr. C. Mr. K is
also in whole time employment elsewhere. The firm is offered the audit of ABC Ltd. and is already
holding audits of 40 companies.
Ceiling on Number of Company Audits: Section 141 (3)(g) of the Companies Act, 2013 states that the
following persons shall not be eligible for appointment as an auditor of a company i.e. a person who is in
full time employment elsewhere; or a person, or a partner of a firm holding appointment as its auditor, if
such person, or partner is at the date of such appointment, or reappointment holding appointment as
auditor of more than twenty companies.
In the given case, Mr. K, a partner in the firm KBC & Co., is in whole-time employment elsewhere, therefore,
he will be excluded in determining the number of company audits that the firm can hold. If Mr. B and Mr. C
do not hold any audits in their personal capacity or as partners of other firms, the total number of company
audits that can be accepted by KBC & Co., is 40, and in the given case company is already holding 40
audits, therefore, KBC & Co. can't accept the offer for audit of ABC Ltd.
Ram and Hanuman Associates, Chartered Accountants in practice have been appointed as Statutory
Auditor of Krishna Ltd. for the accounting year 2014-2015. Mr. Hanuman holds 100 equity shares of
Shiva Ltd., a subsidiary company of Krishna Ltd.

Auditor Holding Securities of a Company: As per sub-section (3)(d)(i) of Section 141 of the Companies Act,
2013 along with Rule 10 of the Companies (Audit and Auditors) Rule, 2014, a person shall not be eligible for
appointment as an auditor of a company, who, or his relative or partner is holding any security of or
interest in the company or its subsidiary, or of its holding or associate company or a subsidiary of such
holding company. Provided that the relative may hold security or interest in the company of face value not
exceeding ₹ 1 lakh.
Also, as per sub-section 4 of Section 141 of the Companies Act, 2013, where a person appointed as an
auditor of a company incurs any of the disqualifications mentioned in sub-section (3) after his
appointment, he shall vacate his office as such auditor and such vacation shall be deemed to be a casual
vacancy in the office of the auditor.
In the present case, Mr. Hanuman, Chartered Accountant, a partner of M/s Ram and Hanuman Associates,
holds 100 equity shares of Shiva Ltd. which is a subsidiary of Krishna Ltd.
Therefore, the firm, M/s Ram and Hanuman Associates would be disqualified to be appointed as statutory
auditor of Krishna Ltd., which is the holding company of Shiva Ltd., because one of the partners Mr.
Hanuman is holding equity shares of its subsidiary.
Preksha, a member of the ICAI, does not hold a Certificate of practice. Is her appointment as an
auditor valid?
Qualifications of an Auditor: A person shall be qualified for appointment as an auditor of a company, only if
one is a Chartered Accountant within the meaning of the Chartered Accountants Act, 1949. Under the
Chartered Accountants Act, 1949, only a Chartered Accountant holding the certificate of practice can
engage in public practice. Preksha does not hold a certificate of practice and hence cannot be appointed
as an auditor of a company.
'B' owes ₹ 5,01,000 to 'C' Ltd., of which he is an auditor. Is his appointment valid? Will it make any
difference, if the advance is taken for meeting-out travelling expenses?
Indebtedness to the Company: As per Section 141(3)(d)(ii) of the Companies Act, 2013, a person who, or his
relative or partner is indebted to the company, or its subsidiary, or its holding or associate company, or a
subsidiary of its holding company, for an amount exceeding ₹ 5,00,000/- then he is not qualified for
appointment as an auditor of a company. Accordingly, B's appointment is not valid and he is disqualified as
the amount of debt exceeds ₹ 5,00,000.
Even if the advance was taken for meeting out travelling expenses particularly before commencement of
audit work, his appointment is not valid because in such a case also the auditor shall be indebted to the
company. The auditor is entitled to recover fees on a progressive basis only.

Mr. Aditya, a practicing chartered accountant is appointed as a "Tax Consultant" of ABC Ltd., in which
his father Mr. Singhvi is the Managing Director.
Appointment of a Practicing CA as 'Tax Consultant': A chartered accountant appointed as an auditor of a

company, should ensure the independence in respect of his appointment as an auditor, else it would
amount to "misconduct" under the Chartered Accountants Act, 1949 read with Guidance Note on
Independence of Auditors.
In this case, Mr. Aditya is a "Tax Consultant" and not a "Statutory Auditor" or "Tax Auditor" of ABC Ltd., hence
he is not subject to the above requirements.
PBS & Associates, a firm of Chartered Accountants, has three partners P, B and S. The firm is already
having audit of 45 companies. The firm is offered 20 company audits. Decide and advise whether PBS
& Associates will exceed the ceiling prescribed under Section 141(3)(g) of the Companies Act, 2013 by
accepting the above audit assignments?
Ceiling on Number of Audits: Before appointment is given to any auditor, the company must obtain a
certificate from him to the effect that the appointment, if made, will not result in an excess holding of
company audit by the auditor concerned over the limit laid down in section 141 (3)(g) of the Act which
prescribes that a person who is in full time employment elsewhere or a person or a partner of a firm
holding appointment as its auditor, if such person or partner is at the date of such appointment or
reappointment holding appointment as auditor of more than 20 companies.
In the case of a firm of auditors, it has been further provided that 'specified number of companies' shall be
construed as the number of companies specified for every partner of the firm who is not in full time
employment elsewhere.
If Mr. P, B and S do not hold any audits in their personal capacity or as partners of other firms, the total
number of company audits that can be accepted by M/s PBS & Associates is 60. But, the firm is already
having audit of 45 companies. So the firm can accept the audit of 15 companies only, which is well within
the limit, specified by Section 141(3)(g) of the Companies Act, 2013.
Mr. Fat, auditor of Thin Ltd., has his office and residence in the building owned by Thin Ltd. Mr. Fat has
been given 10% concession in rent by the company as compared to other tenants.
Independence of Auditor: As per SA 200, "Overall Objectives of the Independent Auditor and the conduct
of an audit in accordance with standards on auditing", In the case of an audit engagement it is in the
public interest and, therefore, required by the Code of Ethics, that the auditor be independent of the entity
subject to the audit.
The Code describes independence as comprising both independence of mind and independence in
appearance. The auditor's independence from the entity safeguards the auditor's ability to form an audit
opinion without being affected by influences that might compromise that opinion. Independence

enhances the auditor's ability to act with integrity, to be objective and to maintain an attitude of
professional skepticism.
In the instant case, Mr. Fat has his office and residence in the building owned by Thin Ltd. who are subject
to audit by Mr. Fat. Giving 10% concession in rent may be due to some other reasons other than holding
the auditor ship of Thin Ltd. It may be due to being a very old tenant or due to office and residence in the
same building or Mr. Fat might have carried out major renovations and so on.
Thus in the instant case unless and until there is direct proof, giving 10% concession in rent does not affect
independence of the auditor in expressing his opinion on the audit of Thin Ltd.
Under what circumstances the retiring Auditor cannot be reappointed? (झकास)

Answer Circumstances where Retiring Auditor Cannot be Reappointed: In the following circumstances, the
retiring auditor cannot be reappointed-
1. A specific resolution has not been passed to reappoint the retiring auditor.
2. A resolution has been passed in AGM appointing somebody else or providing expressly that the
retiring auditor shall not be reappointed.
3. The proposed auditor suffers from the disqualifications under section 141(3), 141(4) and 144 of the
Companies Act, 2013.
4. He has given the company a notice in writing of his unwillingness to be reappointed.
5. The auditor proposed to be reappointed does not possess the qualification prescribed under
section 141 of the Companies Act, 2013.
6. A written certificate has not been obtained from the proposed auditor to the effect that the
appointment or reappointment, if made, will be in accordance within the limits specified under
section 141 (3)(g) of the Companies Act, 2013.
Mr. Amar, a Chartered Accountant, bought a car financed at ₹ 7,00,000 by Chaudhary Finance Ltd.,
which is a holding company of Charan Ltd. and Das Ltd. He has been the statutory auditor of Das Ltd.
and continues to be to even after taking the loan.
Indebtedness to the Holding Company: According to section 141(3)(d)(ii) of the Companies Act, 2013, a
person is not eligible for appointment as auditor of any company, If he is indebted to the company, or its
subsidiary, or its holding or associate company or a subsidiary of such holding company, in excess of ₹ 5
lakh.
In the given case Mr. Amar is disqualified to act as an auditor under section 141 (3)(d) (ii)) as he is indebted
to M/s Chaudhary Finance Ltd. for more than ₹ 5'00'000. Also according to Section 141(3)(d)(ii), he cannot
act as an auditor of any subsidiary of Chaudhary Finance Ltd. i.e. he is also disqualified to work in Charan
Ltd. & Das Ltd. Therefore, he has to vacate his office in Das Ltd. Even though it is a subsidiary of Chaudhary
Finance Ltd.
Hence audit work performed by Mr. Amar as an auditor is invalid, he should vacate his office immediately
and Das Ltd must have to appoint any other CA as an auditor of the company.

Question (Imp Question) Mr. Y was appointed as an auditor of PQR Ltd. for the year ended 31.3.20 _ _
at the Annual General Meeting held on 16.08.20 _ _ . Mr. Y has been indebted to the company for sum
of Rs. 5,10,000 as on 01.04.20 _ _ , the opening date of accounting year which has been subject to his
audit. However, Mr. Y having come to know that he might be appointed as auditor, he repaid the
amount on 10.8.20 _ _ . One of the shareholders, complains that the appointment of Mr. Y as an
auditor was invalid because he incurred disqualification u/s 141 of the Companies Act, 2013. Comment.
Indebtedness to the Company: According to the section 141(3)(d)(ii) of the Companies Act, 2013, a person
who is indebted to the company for an amount exceeding ₹ 5,00,000 shall be disqualified to act as an
auditor of such company and he should vacate his office of auditor when he incurs this disqualification
subsequent to his appointment.
However, where the person has liquidated his debt before the appointment date, there is no
disqualification to be construed for such appointment.
In the given case, Mr. Y was appointment as an auditor of PQR Ltd. for the year ended 31.03.20 _ _ at the
Annual General Meeting held on 16.08.2014. He repaid the loan amount fully to the company on 10.8.20 _ _
i.e. before the date of his appointment.
Hence, the appointment of Mr. Y as an auditor is valid and the shareholder's complaint is not acceptable.
Section 143 Powers and duties of auditors and auditing standards
143(1) Right To Access, Information and Explanation and Inquiries
143. (1) Every auditor of a company shall have a
● right of access
○ at all times
○ to the books of account and vouchers of the company,
○ whether kept at the registered office of the company or at any other place and
● shall be entitled to require

○ from the officers of the company
○ such information and explanation as he may consider necessary for the performance of his
duties as auditor and
NOTE: - The right of access is not limited to those books and records maintained at the registered or head
office so that in the case of a company with branches, the right also extends to the branch records, if the
auditor considers it necessary to have access thereto as per Section 143(8).
● amongst other matters inquire into the following matters, namely:—

a. whether loans and advances made by the company on the basis of security have been properly
secured and whether the terms on which they have been made are prejudicial to the interests of
the company or its members;
b. whether transactions of the company which are represented merely by book entries are
prejudicial to the interests of the company;
c. where the company not being an investment company or a banking company, whether so
much of the assets of the company as consist of shares, debentures and other securities have
been sold at a price less than that at which they were purchased by the company;
d. whether loans and advances made by the company have been shown as deposits;
e. whether personal expenses have been charged to revenue account;
f. where it is stated in the books and documents of the company that any shares have been
allotted for cash, whether cash has actually been received in respect of such allotment, and if no
cash has actually been so received, whether the position as stated in the account books and the
balance sheet is correct, regular and not misleading:
Provided that the auditor of a company which is a holding company shall also have the right of access to the
records of all its subsidiaries and associate companies insofar as it relates to the consolidation of its financial
statements with that of its subsidiaries and associate companies.
Question
During the audit of PQR Ltd. you as an auditor requested officers of the company to have access to secretarial
records and correspondence which they refused to provide. Comment. - ICAI RTP May 2021
Question
The auditor has to make inquiries on certain matters under section 143(1) of Companies Act, 2013.Discuss those
matters. - MTP 1 May 2021
Question
RJ Limited is in the business of trading cycles having Head Office at Delhi and branch at Mumbai. Statutory audit
of Head Office was to be done by CA D and statutory audit of branch at Mumbai was to be done by CA M. During
the course of audit by CA D at head office, CA D Wanted to visit branch at Mumbai and verify the inventory

records at Mumbai. The management of RJ Limited did not allow CA D to visit Mumbai office and verify the
inventory records as the branch audit of Mumbai was already being undertaken by another CA M.
In the above situation, discuss the rights available with CA D in terms of the Companies Act, 2013. - November
2020 - 4 Marks
Answer - As per ICAI’S SUGGESTED ANSWERS -
Section 143(1) of the Act provides that the auditor of a company, at all times, shall have a
● right of access to the books of account and vouchers of the company, whether kept at the registered office of
the company or at any other place and
● He is entitled to require from the officers of the company such information and explanation as he may
consider necessary for the performance of his duties as auditor.
The right of access is not limited to those books and records maintained at the registered or head office so that in the
case of a company with branches, the right also extends to the branch records, if the auditor considers it necessary to
have access thereto as per Section 143(8).
In the given case where CA D was appointed as Statutory Auditor of Head office of RJ Ltd and CA M was appointed to
conduct Statutory Audit of Branch office of RJ Ltd., CA D wanted to visit Mumbai Branch to verify the inventory records
at Mumbai but management of RJ Ltd did not allow CA D to verify the inventory records at its Mumbai Branch on the
ground that branch audit was already being undertaken by another CA M.
Keeping in view the above provisions of the Companies Act and facts of the case, it can be concluded that CA D has a
right to visit the branch for verifying inventory records at Mumbai even if the branch accounts are audited by another
auditor CA M, if he considers it necessary to do so for the performance of his duties as an auditor.
Right of Access to Minute Book:
Section 143(1) of the Companies Act, 2013 grants powers to the auditor that every auditor has a right of access, at all
times, to the books of account and vouchers of the company for conducting the audit.
Further, he is also entitled to require from the officers of the company such information and explanations which he
considers necessary for the proper performance of his duties as Auditor. Therefore, he has a statutory right to inspect
the directors’ minute book.
In order to verify actions of the company and to vouch and verify some of the transactions of the company, it is
necessary for the auditor to refer to the decisions of the shareholders and/or the directors of the company.
It is, therefore, essential for the auditor to refer to the Minute Book. In the absence of the Minute Book, the auditor may
not be able to vouch/verify certain transactions of the company.
Whether powers of the Statutory Auditors can be restricted by shareholders?

Section 143(1) of the Companies Act, 2013 provides that an auditor of a company shall have right of access at all times to
the books and accounts and vouchers of the company whether kept at the Head Office or other places and shall be
entitled to require from the offices of the company such information and explanations as the auditor may think
necessary for the purpose of his audit.
These specific rights have been conferred by the statute on the auditor to enable him to carry out his duties and
responsibilities prescribed under the Act, which cannot be restricted or abridged in any manner. Hence, any such
resolution even if passed by the entire body of shareholders is ultra vires and therefore void.

Comment on Matters Contained under Section 143(1) of the Companies Act, 2013:
Section 143(1) of the Act deals with duties of an auditors requiring the auditor to make an enquiry in respect of
specified matters. The matters in respect of which the enquiry has to be made by the auditor include relating to
loans and advances, transactions represented merely by book entries, investments sold at less than cost price, loans
and advances shown as deposits, etc.
Since the law requires the auditor to make an enquiry, the Institute opined that the auditor is not required to report on
the matters specified in sub-section (1) unless he has any special comments to make on any of the items referred to
therein.
If the auditor is satisfied as a result of the enquiries, he has no further duty to report that he is so satisfied.
Section 2(13)
Books of account" includes records maintained in respect of—

i. all sums of money received and expended by a company and matters in relation to which the receipts and
expenditure take place;
ii. all sales and purchases of goods and services by the company;
iii. the assets and liabilities of the company; and
iv. the items of cost as may be prescribed under section 148 in the case of a company which belongs to any class
of companies specified under that section;
The phrase ‘books, accounts and vouchers’ includes all books which have any bearing, or are likely to have any bearing
on the accounts, whether these be the usual financial books or the statutory or statistical books; memoranda books,
e.g., inventory books, costing records and the like may also be inspected by the auditor.
Similarly the term ‘voucher’ includes all or any of the correspondence which may in any way serve to vouch for the
accuracy of the accounts.
The auditor of a holding company shall also have the right of access to the records of all its subsidiaries and associate
companies so far as it relates to the consolidation of its financial statements with that of its subsidiaries and associate
companies.
2(59) - Officer
"officer" includes any director, manager or key managerial personnel or any person in accordance with whose
directions or instructions the Board of Directors or any one or more of the directors is or are accustomed to act;


143(2) Report To Members
The auditor shall

● make a report
● to the members of the company (किस को )
● on the accounts examined by him and on every financial statements which are required by or under
this Act to be laid before the company in general meeting and (किस पर )
● the report shall be made after taking into account

○ the provisions of this Act,

○ the accounting and auditing standards and
○ matters which are required to be included in the audit report under the provisions of this Act
or any rules made thereunder or
○ under any order made under sub-section (11)
○ to the best of his information and knowledge
The report shall state whether the said accounts, financial statements give a true and fair view of the state of
the company's affairs as at the end of its financial year and profit or loss and cash flow for the year and such
other matters as may be prescribed.

143(8) Branch Audit
(8) Where a company has a branch office, the accounts of that office shall be audited either by the auditor
appointed for the company (herein referred to as the company's auditor) under this Act or by any other
person qualified for appointment as an auditor of the company under this Act and appointed as such under
section 139, or where the branch office is situated in a country outside India, the accounts of the branch office
shall be audited either by the company's auditor or by an accountant or by any other person duly qualified to
act as an auditor of the accounts of the branch office in accordance with the laws of that country and the
duties and powers of the company's auditor with reference to the audit of the branch and the branch
auditor, if any, shall be such as may be prescribed

Provided that the branch auditor shall prepare a report on the accounts of the branch examined by him and
send it to the auditor of the company who shall deal with it in his report in such manner as he considers
necessary.
Duties and powers of the company's auditor with reference to the audit of the branch and the branch
auditor. - Rule 12
1. For the purposes of sub section (8) of section 143, the duties and powers of the company's auditor
with reference to the audit of the branch and the branch auditor, if any, shall be as contained in sub
sections (1) to (4) of section 143.
2. The branch auditor shall submit his report to the company's auditor.
3. The provisions of sub section (12) of section 143 read with rule 12 hereunder regarding reporting of
fraud by the auditor shall also extend to such branch auditor to the extent it relates to the
concerned branch.

143(9) & 143(10)
(9) Every auditor shall comply with the auditing standards.
(10) The Central Government may prescribe the standards of auditing or any addendum thereto, as
recommended by the Institute of Chartered Accountants of India, constituted under section 3 of the
Chartered Accountants Act, 1949 (38 of 1949), in consultation with and after examination of the
recommendations made by the National Financial Reporting Authority:
Provided that until any auditing standards are notified, any standard or standards of auditing specified by
the Institute of Chartered Accountants of India shall be deemed to be the auditing standards.

143 (11) LATER With CARO
(11) The Central Government may, in consultation with the National Financial Reporting Authority, by general
or special order, direct, in respect of such class or description of companies, as may be specified in the order,
that the auditor's report shall also include a statement on such matters as may be specified therein.

143(3) - Report on Other Elements
The auditor's report shall also state—

a. whether he has sought and obtained all the information and explanations which to the best of his
knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and
the effect of such information on the financial statements;
b. whether, in his opinion, proper books of account as required by law have been kept by the company
so far as appears from his examination of those books and proper returns adequate for the purposes
of his audit have been received from branches not visited by him;
c. whether the report on the accounts of any branch office of the company audited under sub-section
(8) by a person other than the company's auditor has been sent to him under the proviso to that
sub-section and the manner in which he has dealt with it in preparing his report;
d. whether the company's balance sheet and profit and loss account dealt with in the report are in
agreement with the books of account and returns;
e. whether, in his opinion, the financial statements comply with the accounting standards;
f. the observations or comments of the auditors on financial transactions or matters which have any
adverse effect on the functioning of the company;
g. whether any director is disqualified from being appointed as a director under sub-section (2) of
section 164;
h. any qualification, reservation or adverse remark relating to the maintenance of accounts and other
matters connected therewith;
i. whether the company has adequate internal financial controls with reference to financial
statements in place and the operating effectiveness of such controls.
j. such other matters as may be prescribed
Reporting under clause(i) of Sec. 143(3) shall not apply to a private company:
● Which is a one-person company or a small company ; or
● Which has turnover less than Rs 50 crores as per latest audited financial statement And Which has
aggregate borrowings from banks or financial institutions or any body corporate at any point of
time during the financial year less than Rs 25 Cr.

Other Matters Prescribed-Rule 11 of Companies (Audit & Auditors) Rules , 2014
The auditor’s report shall also include their views and comments on the following matters, namely:
1. Whether the company has disclosed the impact, if any, of pending litigations on its financial position
in its financial statement;
2. Whether the company has made provisions, as required under any law or accounting standards, for
material foreseeable losses, if any, on long term contracts including derivative contracts;
3. Whether there has been any delay in transferring amounts, required to be transferred, to the
Investor Education and Protection Fund by the company.
4.
a. Whether the management has represented that, to the best of it’s knowledge and belief, other
than as disclosed in the notes to the accounts, no funds have been advanced or loaned or
invested (either from borrowed funds or share premium or any other sources or kind of funds)
by the company to or in any other person(s) or entity(ies), including foreign entities
(“Intermediaries”), with the understanding, whether recorded in writing or otherwise, that the
Intermediary shall, whether, directly or indirectly lend or invest in other persons or entities
identified in any manner whatsoever by or on behalf of the company ( “ Ultimate Beneficiaries”
) or provide any guarantee, security or the like on behalf of the Ultimate Beneficiaries;
b. Whether the management has represented, that, to the best of it’s knowledge and belief,
other than as disclosed in the notes to the accounts, no funds have been received by the
company from any person(s) or entity(ies), including foreign entities (“ Funding Parties”), with
the understanding, whether recorded in writing or otherwise, that the company shall,
whether, directly or indirectly, lend or invest in other persons or entities identified in any
manner whatsoever by or on behalf of the Funding Party (“Ultimate Beneficiaries”) or provide
any guarantee, security or the like on behalf of the Ultimate Beneficiaries; and
c. Based on such audit procedures that the auditor has considered reasonable and appropriate in the
circumstances, nothing has come to their notice that has caused them to believe that the
representations under sub-clause (i) and (ii) contain any material misstatement.
d. Whether the dividend declared or paid during the year by the company is in compliance with section
123 of the Companies Act, 2013


143(4) - Reasons
Where
● any of the matters required to be included in the audit report
● under this section
● is answered in the negative
● or with a qualification,
● The report shall state the reasons therefor.
(5) In the case of a Government company or any other company owned or controlled, directly or indirectly, by
the Central Government, or by any State Government or Governments, or partly by the Central Government
and partly by one or more State Governments, the Comptroller and AuditorGeneral of India shall appoint the
auditor under subsection (5) or subsection (7) of section 139 and direct such auditor the manner in which the
accounts of the company are required to be audited and]thereupon the auditor so appointed shall submit a
copy of the audit report to the Comptroller and Auditor General of India which, among other things, include
the directions, if any, issued by the Comptroller and Auditor General of India, the action taken thereon and its
impact on the accounts and financial statement of the company.
(6) The Comptroller and Auditor General of India shall within sixty days from the date of receipt of the audit
report under subsection (5) have a right to,—
(a) conduct a supplementary audit of the financial statement of the company by such person or persons as
he may authorise in this behalf; and for the purposes of such audit, require information or additional
information to be furnished to any person or persons, so authorised, on such matters, by such person or
persons, and in such form, as the Comptroller and AuditorGeneral of India may direct; and
(b) comment upon or supplement such audit report:
In simple words,
- a supplementary audit can be conducted or
- CAG can add comment on existing points in audit report or supplement the audit report with his new points
Provided that any comments given by the Comptroller and AuditorGeneral of India upon, or supplement to,
the audit report shall be sent by the company to every person entitled to copies of audited financial
statements under subsection (1) of section 136 and also be placed before the annual general meeting of the
company at the same time and in the same manner as the audit report.
(7) Without prejudice to the provisions of this Chapter, the Comptroller and Auditor General of India may, in
case of any company covered under subsection (5) or subsection (7) of section 139, if he considers necessary,
by an order, cause test audit to be conducted of the accounts of such company and the provisions of section
19A of the Comptroller and AuditorGeneral's (Duties, Powers and Conditions of Service) Act, 1971 (56 of 1971),
shall apply to the report of such test audit.
(CAG can cause test audit to be conducted in case of government companies and the report of such audit
shall be laid before the prescribed authority)

Section 19A - Laying of reports in relation to accounts of Government companies and corporation

Reporting of Fraud
143(12)
Notwithstanding anything contained in this section,

- if an auditor of a company in the course of the performance of his duties as auditor,
- has reason to believe
- that an offence of fraud involving such amount or amounts as may be prescribed,
- is being or has been committed in the company by its officers or employees,
- the auditor shall
- report the matter to the Central Government
- within such time and
- in such manner as may be
- prescribed:
Fraud of less than specified amount.

Provided that in case of a fraud involving lesser than the specified amount,
- the auditor shall report the matter to the audit committee constituted under section 177 or to the
Board in other cases
- within such time and in such manner as may be prescribed:
Responsibilities of the companies in case of fraud of less than specified amount.

Provided further that the companies,
- whose auditors have reported frauds under this subsection to the audit committee or the Board
- but not reported to the Central Government,
- shall disclose the details about such frauds in the Board's report in such manner as may be
prescribed.
No Duty will be regarded as being Contravened
(13) No duty to which an auditor of a company may be subject to shall be regarded as having been
contravened by reason of his reporting the matter referred to in sub section (12) if it is done in good faith.
Cost Accountant and CS
(14) The provisions of this section shall mutatis mutandis apply to—
a. the cost accountant conducting cost audit under section 148; or
b. the company secretary in practice conducting secretarial audit under section 204.
Penalty for non-compliance
If any auditor, cost accountant, or company secretary in practice does not comply with the provisions of
sub-section (12), he shall,—
a. in case of a listed company, be liable to a penalty of five lakh rupees; and
b. in case of any other company, be liable to a penalty of one lakh rupees.]

Rule 13 - Reporting of frauds by auditor and other matters.
13. (1) If an auditor of a company, in the course of the performance of his duties as statutory auditor, has
reason to believe that an offence of fraud, which involves or is expected to involve individually an amount
of rupees one crore or above, is being or has been committed against the company by its officers or
employees, the auditor shall report the matter to the Central Government.
(2) The auditor shall report the matter to the Central Government as under:—
a. the auditor shall report the matter to the Board or the Audit Committee, as the case may be,
immediately but not later than two days of his knowledge of the fraud, seeking their reply or
observations within fortyfive days;
b. on receipt of such reply or observations, the auditor shall forward his report and the reply or
observations of the Board or the Audit Committee along with his comments (on such reply or
observations of the Board or the Audit Committee) to the Central Government within fifteen days
from the date of receipt of such reply or observations;
c. in case the auditor fails to get any reply or observations from the Board or the Audit Committee
within the stipulated period of forty five days, he shall forward his report to the Central Government
along with a note containing the details of his report that was earlier forwarded to the Board or the
Audit Committee for which he has not received any reply or observations;
d. the report shall be sent to the Secretary, Ministry of Corporate Affairs in a sealed cover by Registered
Post with Acknowledgement Due or by Speed Post followed by an email in confirmation of the
same;
e. the report shall be on the letterhead of the auditor containing postal address, email address and
contact telephone number or mobile number and be signed by the auditor with his seal and shall
indicate his Membership Number; and
f. the report shall be in the form of a statement as specified in Form ADT4.
(3) In case of a fraud involving lesser than the amount specified in subrule (1), the auditor shall report the
matter to Audit Committee constituted under section 177 or to the Board immediately but not later than
two days of his knowledge of the fraud and he shall report the matter specifying the following:—
a. Nature of Fraud with description;
b. Approximate amount involved; and
c. Parties involved
(4) The following details of each of the fraud reported to the Audit Committee or the Board under subrule
(3) during the year shall be disclosed in the Board's Report:—
a. Nature of Fraud with description;
b. Approximate Amount involved;
c. Parties involved, if remedial action not taken; and
d. Remedial actions taken.
(5) The provision of this rule shall also apply, mutatis mutandis, to a Cost Auditor and a Secretarial Auditor
during the performance of his duties under section 148 and section 204 respectively.]

Reporting of Fraud Etc.



Central Government to specify audit of items of cost in respect of certain

companies - Section 148
Cost Records
148. (1) Notwithstanding anything contained in this Chapter,

● the Central Government may, by order,
● in respect of such class of companies
● engaged in the production of such goods or providing such services as may be prescribed,
● direct that
○ particulars relating to the utilisation of
■ material or
■ labour or to
■ other items of cost as may be prescribed
○ shall also be included in the books of account kept by that class of companies:

Provided that the Central Government shall, before issuing such order in respect of any class of companies
regulated under a special Act, consult the regulatory body constituted or established under such special Act.
In simple words CG can order maintenance of cost records in case of prescribed companies. Such cost
records will be included in the books of accounts.

Cost Audit
(2) If
● the Central Government is of the opinion,
○ that it is necessary to do so,
○ it may,
○ by order,
● direct that the audit of cost records of class of companies,
○ which are covered under sub-section (1) and
■ which have a net worth of such amount as may be prescribed or
■ a turnover of such amount as may be prescribed,
● shall be conducted in the manner specified in the order.
In simple words, CG can order the conduct of audit of cost records of certain prescribed companies,
based on net worth or turnover, which were required to maintain cost records.

(3) The audit under sub-section (2) shall be conducted by a cost accountant who shall be appointed by the
Board on such remuneration as may be determined by the members in such manner as may be
prescribed:[Read Rule 6(1) & (1A), 2 of Cost Records And Audit) Rules 2014.]
Provided that no person appointed under section 139 as an auditor of the company shall be appointed for
conducting the audit of cost records:
Provided further that the auditor conducting the cost audit shall comply with the cost auditing standards.
Explanation.—For the purposes of this sub-section, the expression "cost auditing standards" mean such
standards as are issued by the 5a[Institute of Cost Accountants of India, constituted under the Cost and
Works Accountants Act, 1959 (23 of 1959), with the approval of the Central Government.

Procedure for appointment and fixation of remuneration of the Cost Auditor - Rule 14 of Companies (Audit
and Auditors) Rules, 2014.
Case I: The Company is required to constitute an audit committee

● The Board shall appoint the cost auditor on the recommendations of the Audit Committee.
● The Audit Committee shall recommend the remuneration of the cost auditor.
● The remuneration of the cost auditor shall be considered and approved by the Board and ratified
subsequently by the members.
Case II: The Company is not required to constitute an audit committee

● The Board shall appoint the cost auditor.
● The remuneration of the cost auditor shall be fixed by the Board and ratified subsequently by the
members.
Only a cost accountant in practice or a firm of cost accountants in practice can be appointed as a cost
auditor.
(4) An audit conducted under this section shall be in addition to the audit conducted under section 143.
(5) The qualifications, disqualifications, rights, duties and obligations applicable to auditors under this
Chapter shall, so far as may be applicable, apply to a cost auditor appointed under this section and it shall be
the duty of the company to give all assistance and facilities to the cost auditor appointed under this section
for auditing the cost records of the company:
Provided that the report on the audit of cost records shall be submitted by the cost accountant to the Board
of Directors of the company. [Read Rule 6(5) of Cost Records And Audit) Rules 2014.]

(6) A company shall within thirty days from the date of receipt of a copy of the cost audit report prepared in
pursuance of a direction under sub-section (2) furnish the Central Government with such report along with
full information and explanation on every reservation or qualification contained therein. [Read Rule 6(6) of
Cost Records And Audit) Rules 2014.]
(7) If, after considering the cost audit report referred to under this section and the information and
explanation furnished by the company under sub-section (6), the Central Government is of the opinion that
any further information or explanation is necessary, it may call for such further information and explanation
and the company shall furnish the same within such time as may be specified by that Government.

(8) If any default is made in complying with the provisions of this section,—

a. The company and every officer of the company who is in default shall be punishable in the manner as
provided in sub-section (1) of section 147;
b. The cost auditor of the company who is in default shall be punishable in the manner as provided in
sub-sections (2) to (4) of section 147.
Cost Audit Rule 6 of Companies (Cost Records And Audit) Rules 2014.
(1) The category of companies specified in rule 3 and the thresholds limits laid down in rule 4, shall within one
hundred and eighty days of the commencement of every financial year, appoint a cost auditor:
Provided that before such appointment is made, the written consent of the cost auditor to such
appointment, and a certificate from him or it, as provided in sub-rule (1A), shall be obtained.
(1A) The cost auditor appointed under sub-rule (1) shall submit a certificate that—
● the individual or the firm, as the case may be, is eligible for appointment and is not disqualified for
appointment under the Act, the Cost and Works Accountants Act, 1959 (23 of 1959) and the rules or
regulations made thereunder;
● the individual or the firm, as the case may be, satisfies the criteria provided in section 141 of the Act, so
far as may be applicable;
● the proposed appointment is within the limits laid down by or under the authority of the Act; and
● the list of proceedings against the cost auditor or audit firm or any partner of the audit firm pending
with respect to professional matters of conduct, as disclosed in the certificate, is true and correct.

(2) Every company referred to in sub-rule (1) shall inform the cost auditor concerned of his or its appointment
as such and file a notice of such appointment with the Central Government within a period of thirty days of
the Board meeting in which such appointment is made or within a period of one hundred and eighty days of
the commencement of the financial year, whichever is earlier, through electronic mode, in form CRA-2,
alongwith the fee as specified in Companies (Registration Offices and Fees) Rules, 2014.
(3) Every cost auditor appointed as such shall continue in such capacity till the expiry of one hundred and
eighty days from the closure of the financial year or till he submits the cost audit report, for the financial year
for which he has been appointed:

Provided that the cost auditor appointed under these rules may be removed from his office before the expiry
of his term, through a board resolution after giving a reasonable opportunity of being heard to the Cost
Auditor and recording the reasons for such removal in writing
Provided further that the Form CRA-2 to be filed with the Central Government for intimating appointment of
another cost auditor shall enclose the relevant Board Resolution to the effect:
Provided also that nothing contained in this sub-rule shall prejudice the right of the cost auditor to resign
from such office of the company.
(3A) Any casual vacancy in the office of a cost auditor, whether due to resignation, death or removal, shall be
filled by the Board of Director, within thirty days of occurrence of such vacancy and the company shall inform
the Central Government in Form CRA-2 within thirty days of such appointment of cost auditor.

(3B) The cost statements, including other statements to be annexed to the cost audit report, shall be
approved by the Board of Directors before they are signed on behalf of the Board by any of the directors
authorised by the Board, for submission to the cost auditor to report thereon.
(4) Every cost auditor, who conducts an audit of the cost records of a company, shall submit the cost audit
report along with his or its reservations or qualifications or observations or suggestions, if any, in form CRA-3.
(5) Every cost auditor shall forward his duly signed report to the Board of Directors of the company within a
period of one hundred and eighty days from the closure of the financial year to which the report relates and
the Board of Directors shall consider and examine such report, particularly any reservation or qualification
contained therein.

(6) Every company covered under these rules shall, within a period of thirty days from the date of receipt of a
copy of the cost audit report, furnish the Central Government with such report along with full information
and explanation on every reservation or qualification contained therein, in Form CRA-4 in Extensible
Business Reporting Language format in the manner as specified in the Companies (Filing of Documents and
Forms in Extensible Business Reporting Language) Rules, 2015 along with fees specified in the Companies
(Registration Offices and Fees) Rules, 2014.
Provided that the Companies which have got extension of time of holding Annual General Meeting under
section 96 (1) of the Companies Act, 2013, may file form CRA-4 within resultant extended period of filing
financial statements under section 137 of the Companies Act, 2013
(7) The provisions of sub-section (12) of section 143 of the Act and the relevant rules made thereunder shall
apply mutatis mutandis to a cost auditor during performance of his functions under section 148 of the Act
and these rules.

Remuneration of auditors. 142
142. (1)
The remuneration of the auditor of a company shall be fixed in its general meeting or in such manner as may
be determined therein
Provided that the Board may fix remuneration of the first auditor appointed by it.
142(2)
The remuneration under sub-section (1) shall, in addition to the fee payable to an auditor, include the
expenses, if any, incurred by the auditor in connection with the audit of the company and any facility
extended to him but does not include any remuneration paid to him for any other service rendered by him at
the request of the company.
Auditor to sign audit reports, etc. - 145.

The person appointed as an auditor of the company shall sign the auditor's report or sign or certify any other
document of the company in accordance with the provisions of sub-section (2) of section 141, and the
qualifications, observations or comments on financial transactions or matters, which have any adverse effect
on the functioning of the company mentioned in the auditor's report shall be read before the company in
general meeting and shall be open to inspection by any member of the company.
Auditors to attend a general meeting - 146

All notices of, and other communications relating to, any general meeting shall be forwarded to the auditor
of the company, and the auditor shall, unless otherwise exempted by the company, attend either by himself
or through his authorised representative, who shall also be qualified to be an auditor, any general meeting
and shall have right to be heard at such meeting on any part of the business which concerns him as the
auditor.

Punishment for contravention.
147. (1) If any of the provisions of sections 139 to 146 (both inclusive) is contravened, the company shall be
punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five
lakh rupees and every officer of the company who is in default shall be punishable with fine which shall not
be less than ten thousand rupees but which may extend to one lakh rupees
147 (2) If an auditor of a company contravenes any of the provisions of section, section 144 or section 145, the
auditor shall be punishable with fine which shall not be less than twenty-five thousand rupees but which
may extend to five lakh rupees or four times the remuneration of the auditor, whichever is less
Provided that if an auditor has contravened such provisions knowingly or wilfully with the intention to
deceive the company or its shareholders or creditors or tax authorities, he shall be punishable with
imprisonment for a term which may extend to one year and with fine which shall not be less than fifty
thousand rupees but which may extend to twenty-five lakh rupees or eight times the remuneration of the
auditor, whichever is less
147 (3) Where an auditor has been convicted under sub-section (2), he shall be liable to—
i. refund the remuneration received by him to the company; and
ii. pay for damages to the company, statutory bodies or authorities or to members or creditors of
the company for loss arising out of incorrect or misleading statements of particulars made in
his audit report.
147 (4) The Central Government shall, by notification, specify any statutory body or authority or an officer for
ensuring prompt payment of damages to the company or the persons under clause (ii) of sub-section (3) and
such body, authority or officer shall after payment of damages to such company or persons file a report with
the Central Government in respect of making such damages in such manner as may be specified in the said
notification.
147 (5) Where, in case of audit of a company being conducted by an audit firm, it is proved that the partner or
partners of the audit firm has or have acted in a fraudulent manner or abetted or colluded in any fraud by, or
in relation to or by, the company or its directors or officers, the liability, whether civil or criminal as provided in
this Act or in any other law for the time being in force, for such act shall be of the partner or partners
concerned of the audit firm and of the firm jointly and severally:
Provided that in case of criminal liability of an audit firm, in respect of liability other than fine, the concerned
partner or partners, who acted in a fraudulent manner or abetted or, as the case may be, colluded in any
fraud shall only be liable.

Audit Committee
What is a Committee?
A group of people appointed for a specific function by a larger group and typically consisting of members of that
group.
What is the Audit Committee?

● Group of People
● Specific Function
● Larger group
● Members
Section 177 Read with Relevant Rules.
The Board of Directors of every listed public company and such other class or classes of companies, as may be
prescribed , shall constitute an Audit Committee.
Prescribed companies as per rules

● the Public Companies having paid-up share capital of ten crore rupees or more.
● the Public Companies having turnover of one hundred crore rupees or more
● the Public Companies which have, in aggregate, outstanding loans, debentures and deposits, exceeding fifty
crore rupees
Members
The Audit Committee shall consist of a minimum of three directors with independent directors forming a majority.
Provided that the majority of members of the Audit Committee including its Chairperson shall be persons with
ability to read and understand the financial statement.
Functions
Every Audit Committee shall act in accordance with the terms of reference specified in writing by the Board which
shall inter alia, include
i. the recommendation for appointment, remuneration and terms of appointment of auditors of the company.
ii. review and monitor the auditor's independence and performance, and effectiveness of the audit process
iii. examination of the financial statement and the auditors' report thereon.
iv. approval or any subsequent modification of transactions of the company with related parties.
v. scrutiny of inter-corporate loans and investments.
vi. valuation of undertakings or assets of the company, wherever it is necessary
vii. evaluation of internal financial controls and risk management systems
viii. monitoring the end use of funds raised through public offers and related matters.

Provided that the Audit Committee may make omnibus approval for related party transactions proposed to be
entered into by the company subject to such conditions as may be prescribed. -
Provided further that in case of transaction, other than transactions referred to in section 188, and where
Audit Committee does not approve the transaction, it shall make its recommendations to the Board
Provided also that in case any transaction involving any amount not exceeding one crore rupees is entered into
by a director or officer of the company without obtaining the approval of the Audit Committee and it is not
ratified by the Audit Committee within three months from the date of the transaction, such transaction shall be
voidable at the option of the Audit Committee and if the transaction is with the related party to any director or
is authorised by any other director, the director concerned shall indemnify the company against any loss
incurred by it
Provided also that the provisions of this clause shall not apply to a transaction, other than a transaction
referred to in section 188, between a holding company and its wholly owned subsidiary company
Powers
● Call for comments

○ The Audit Committee may call for the comments of the auditors about
■ internal control systems,
■ the scope of audit, including the observations of the auditors and review of financial
statement before their submission to the Board and
■ may also discuss any related issues with the internal and statutory auditors and the
management of the company.
● Authority to investigate & Obtain professional advice

○ The Audit Committee shall have authority to investigate any matter in relation to the items specified
in sub-section (4) (Functions of Audit Committee) or referred to it by the Board and for this purpose
■ shall have power to obtain professional advice from external sources and
■ have full access to information contained in the records of the company.
Other Points
The auditors of a company and the key managerial personnel shall have a right to be heard in the meetings of the
Audit Committee when it considers the auditor's report but shall not have the right to vote.
The Board's report under sub-section (3) of section 134 shall disclose the composition of an Audit Committee and
where the Board had not accepted any recommendation of the Audit Committee, the same shall be disclosed in such
report along with the reasons therefor.

Misc. Points
Every listed company or such class or classes of companies, as may be prescribed, shall establish a vigil mechanism
for directors and employees to report genuine concerns in such manner as may be prescribed.
The vigil mechanism under sub-section (9) shall provide for adequate safeguards against victimisation of persons
who use such mechanism and make provision for direct access to the chairperson of the Audit Committee in
appropriate or exceptional cases:
Provided that the details of the establishment of such mechanism shall be disclosed by the company on its website, if
any, and in the Board's report.

CARO - COMPANIES (AUDITOR'S REPORT)

ORDER, 2020
Section 143(11)
The Central Government may,
● in consultation with the National Financial Reporting Authority,
● by general or special order,
● direct, in respect of
○ such class or description of companies,
○ as may be specified in the order,
○ that the
■ auditor's report shall also include a statement on
■ such matters as may be specified therein
Applicability
It shall apply to every company including a foreign company as defined in clause (42) of section 2 of the
Companies Act. 2013 except
● A banking company;
● An insurance company;
● A company licensed to operate u/s 8 of the Companies Act;
● A One person company as defined in sec. 2(62) of the Companies Act and a small Company as defined
in Sec. 2(85) of the Companies Act; and
● A private limited company, not being a subsidiary or holding of a public company,
○ Having a paid up capital & Reserves & surplus not more than Rs 1 Cr. as on the balance sheet
date, and
○ Which does not have total borrowings exceeding Rs 1 Cr. from any bank or financial institution
at any point of time during the financial year; and
○ Which does not have a total revenue as disclosed in Schedule III to the Companies Act, 2013
(Including revenue from discontinuing operations) exceeding Rs. 10 Crore during the financial
year as per the financial statements.
This Order shall NOT apply to the auditor's report on Consolidated FS except clause (xxi) of paragraph 3.
Paid up Share capital
● Paid up capital includes equity as well as preference.

● Amount originally paid up on forfeited shares should be added to the figure of paid up capital.
● Share Application money pending allotment - NO.
● Securities Premium - YES
● General Reserve - YES
● Reserves include Capital reserves, revenue reserves as well as Revaluation Reserves.
● Credit Balance of Profit and Loss Account will form part of the reserve.
● In case of debit balance of profit or loss, the same shall be netted for computing reserves & surplus.

Borrowings
● Loans from banks and financial institutions are to be considered in aggregate.
● Financial Institutions include NBFC.
● Loans may be in any form like term loan, demand loans, cash credit overdraft, export credit, bill
purchased/discounted.
● Long term loans as well as short term loans, secured as well as unsecured will be considered .
● Outstanding dues, in respect of credit cards will also be considered.
● Interest accrued and also due will form part of loans and borrowings. If interest is only accrued it will
not form part of loan
● Fund based facilities are counted in borrowings whereas non fund based facilities are not counted.
● Security amount is not to be adjusted
● Loans from other than banking and financial institutions shall not be considered
● Limit or actual Amount? -
Total Revenue
● Revenue from operations and other Income.
● Here revenue will also include revenue from discontinuing operations as specified in the Order.
● Other income shall consist of the following;
❖ Interest Income (other than a finance company);
❖ Dividend Income;
❖ Net gain/loss on sale of investments;
❖ Other non-operating income (net of expenses directly attributable to such income).
● GST, Excise etc will not form part of revenue
Other Notes
Discussion on Small Company
A company is covered under the definition of small company; it will remain exempted from the applicability
of the Order even if it falls under any of the criteria specified for private company.
Definition of Small Company
Sec 2(85) of the Companies Act, 2013 defines a small company. As present, is a private company which
satisfies both the following conditions
- Paid Up Share Capital ≤ 2 crores AND

- Turnover ≤ 20 crores.
The following 3 categories of Companies shall NOT be regarded as SMALL Companies:

1. A HOLDING company or a SUBSIDIARY company.
2. A company registered under SECTION 8. or
3. A company or body corporate governed by any SPECIAL ACT.

Para 2 - Auditor's report to contain matters specified in paragraphs 3 and 4.
Every report made by the auditor under section 143 of the Companies Act on the accounts of every company
audited by him, to which this Order applies, contain the matters specified in paragraphs 3 and 4, as may be
applicable
Provided this Order shall not apply to the auditor's report on consolidated financial statements except clause
(xxi) of paragraph 3.
Para 4 - Reasons to be stated for unfavourable or qualified answers.
- Where,
- in the auditor's report,
- the answer to any of the questions referred to in paragraph 3 is unfavourable or qualified,
- the auditor's report shall also state the basis for such unfavourable or qualified answer
- Where the auditor is unable to express any opinion on any specific matter,
- his report shall
- indicate such fact
- with the reasons as to why it is not possible for him to give his opinion On the same.
Para 3- Matters to be included in the auditor’s report under CARO, 2020

The auditor's report on the accounts of a company to which this Order applies shall include a statement on
the following matters, namely:-
Para 3(i)- Property, Plant and Equipment -
Proper Records
Whether the company is maintaining proper records
- showing full particulars,
- including quantitative details and
- situation of Property, Plant and Equipment;
Proper records - Intangible assets

Whether the company is maintaining proper records showing full particulars of intangible assets;
Physical Verification
Whether these Property, Plant and Equipment have been physically verified by the management at
reasonable intervals;

Material discrepancies
Whether any material discrepancies were noticed on such verification and if so, whether the same have
been properly dealt with in the books of account.
Title Deeds
Whether the title deeds of all the immovable properties
- (other than properties where the company is the lessee and the lease agreements are duly executed
in favour of the lessee)
disclosed in the financial statements are held in the name of the company, if not, provide the details thereof
in the format below
Revaluation of PPE / ITA

Whether the company has
● revalued its Property, Plant and Equipment (including Right of Use assets) or intangible assets or both
during the year and, if so,
● whether the revaluation is based on the valuation by a Registered Valuer;
● Specify the amount of change,
○ if change is 10% or more in the aggregate of the net carrying value of each class of Property,
Plant and Equipment or intangible assets;
Proceedings for benami property

● Whether any proceedings have been initiated or are pending against the company for holding any
benami property under the Benami Transactions (Prohibition) Act, 1988 (45 of 1988) and rules made
thereunder, if so,
● whether the company has appropriately disclosed the details in its financial statements;
Para 3(ii) - Inventory
Physical Verification, Coverage and Procedure.

Whether physical verification of inventory has been conducted at reasonable intervals by the management
and whether, in the opinion of the auditor, the coverage and procedure of such verification by the
management is appropriate;

Discrepancies of 10% or more

Whether any discrepancies of 10% or more in the aggregate for each class of inventory were noticed and if so,
whether they have been properly dealt with in the books of account;
Working capital limits

Whether
● during any point of time of the year,
● the company has been sanctioned working capital limits in excess of five crore rupees,
● in aggregate, from banks or financial institutions
● on the basis of security of current assets;
● whether the quarterly returns or statements filed by the company with such banks or financial
institutions are in agreement with the books of account of the Company, if not, give details;
Para 3(iii) - Investment / Guarantee / Security / Loans and Advances
a. whether during the year the company has provided loans or provided advances in the nature of loans,
or furnished guarantee, or provided security to any other entity [not applicable to companies whose principal business is to
give loans]
, if so, indicate-
○ the aggregate amount during the year, and balance outstanding at the balance sheet date
with respect to such loans or advances and guarantees or security to subsidiaries, joint
ventures and associates;
○ the aggregate amount during the year, and balance outstanding at the balance sheet date
with respect to such loans or advances and guarantees or security to parties other than
subsidiaries, joint ventures and associates;
b. whether the
○ investments made,
○ guarantees provided,
○ security given and
○ the terms and conditions of the
■ grant of all loans and advances in the nature of loans and
■ guarantees provided are not prejudicial to the company’s interest;
c. in respect of loans and advances in the nature of loans, whether the
○ schedule of repayment of principal and payment of interest has been stipulated and
○ whether the repayments or receipts are regular;
d. if the amount is overdue,
○ state the total amount overdue for more than ninety days, and
○ whether reasonable steps have been taken by the company for recovery of the principal and
interest;
e. whether any loan or advance in the nature of loan granted
○ which has fallen due during the year,
■ has been renewed or extended or
■ fresh loans granted to settle the overdues of existing loans given to the same
parties,
○ if so,
■ specify the aggregate amount of such dues renewed or extended or settled by fresh
loans and

■ the percentage of the aggregate to the total loans or advances in the nature of loans
granted during the year [not applicable to companies whose principal business is to give loans]
f. whether the company has granted any loans or advances in the nature of loans
○ either repayable on demand or
○ without specifying any terms or period of repayment, if so,
■ specify the aggregate amount,
■ percentage thereof to the total loans granted,
■ aggregate amount of loans granted to Promoters, related parties as defined in clause
(76) of section 2 of the Companies Act, 2013;

3(iv) - Sections 185 and 186
In respect of loans, investments, guarantees, and security, whether provisions of sections 185 and 186 of the
Companies Act have been complied with, if not, provide the details thereof;
3(v) - Deposit Accepted
In respect of deposits accepted by the company or amounts which are deemed to be deposits,
● whether the directives issued by the Reserve Bank of India and
● the provisions of sections 73 to 76 or
● any other relevant provisions of the Companies Act and the rules made thereunder, where applicable,
○ have been complied with,
○ if not,
■ the nature of such contraventions be stated;
● if an order has been passed by Company Law Board or National Company Law Tribunal or Reserve
Bank of India or any court or any other tribunal,
○ whether the same has been complied with or not;
3(vi) Cost Records
● Whether maintenance of cost records has been specified by the Central Government under
sub-section (1) of section 148 of the Companies Act and
● whether such accounts and records have been so made and maintained.
3 (vii) Statutory Dues
Undisputed statutory dues
a. whether the company is regular in depositing undisputed statutory dues

○ including Goods and Services Tax, provident fund, employees' state insurance, income tax,
sales-tax, service tax, duty of customs, duty of excise, value added tax, cess and
○ any other statutory dues to the appropriate authorities and
○ if not,
■ the extent of the arrears of outstanding statutory dues as on the last day of the
financial year concerned for a period of more than six months from the date they
became payable, shall be indicated;
Disputed statutory dues
b. where statutory dues referred to in sub-clause (a) have not been deposited on account of any
dispute, then the amounts involved and the forum where dispute is pending shall be mentioned (a
mere representation to the concerned Department shall not be treated as a dispute);

3(viii)
Whether any transactions

● not recorded in the books of account
● have been surrendered or disclosed
○ as income during the year in the tax assessments under the Income Tax Act, 1961 (43 of 1961),
if so, whether
● the previously unrecorded income has been properly recorded in the books of account during the
year;
3(ix) Repayment of Loan Etc
a. whether the company has defaulted in repayment of loans or other borrowings or in the payment
of interest thereon to any lender, if yes, the period and the amount of default to be reported as per
the format below
Nature of Name of lender Amount Whether No. of days delay Remarks, if

borrowin not paid on principal or or unpaid any
g, due date interest
including
debt

securities
lender wise details to

be provided in case
of defaults to banks,
financial institutions
and Government.
b. whether the company is a declared wilful defaulter by any bank or financial institution or other
lender;
c. whether term loans were applied for the purpose for which the loans were obtained;
○ if not, the amount of loan so diverted and
○ the purpose for which it is used may be reported;
d. whether funds raised on short term basis have been utilised for long term purposes,
○ if yes, the nature and
○ amount to be indicated;
e. whether the company has taken any funds from any entity or person on account of or to meet the
obligations of its subsidiaries, associates or joint ventures, if so, details thereof with nature of such
transactions and the amount in each case;
f. whether the company has raised loans during the year on the pledge of securities held in its
subsidiaries, joint ventures or associate companies, if so, give details thereof and also report if the
company has defaulted in repayment of such loans raised;


3(x) - IPO FPO etc
a. Whether moneys raised by way of initial public offer or further public offer (including debt
instruments) during the year were applied for the purposes for which those are raised, if not, the
details together with delays or default and subsequent rectification, if any, as may be applicable, be
reported;
b. Whether the company has made any preferential allotment or private placement of shares or
convertible debentures (fully, partially or optionally convertible) during the year and if so, whether the
requirements of section 42 and section 62 of the Companies Act, 2013 have been complied with and
the funds raised have been used for the purposes for which the funds were raised, if not, provide
details in respect of amount involved and nature of noncompliance;
3 (xi)
a. Whether any fraud by the company or any fraud on the company has been noticed or reported
during the year, if yes, the nature and the amount involved is to be indicated;
b. whether any report under sub-section (12) of section 143 of the Companies Act has been filed by the
auditors in Form ADT-4 as prescribed under rule 13 of Companies (Audit and Auditors) Rules, 2014
with the Central Government;

c. whether the auditor has considered whistle-blower complaints, if any, received during the year by
the company.
3(xii)
a. Whether the Nidhi Company has complied with the Net Owned Funds to Deposits in the ratio of 1:20
to meet out the liability;
b. whether the Nidhi Company is maintaining ten per cent unencumbered term deposits as specified in
the Nidhi Rules, 2014 to meet out the liability;
c. whether there has been any default in payment of interest on deposits or repayment thereof for any
period and if so, the details thereof.

3 (xiii)
Whether all transactions with the related parties are in compliance with sections 177 and 188 of Companies
Act where applicable and the details have been disclosed in the financial statements, etc., as required by the
applicable accounting standards
3 (xiv)
a. whether the company has an internal audit system commensurate with the size and nature of its
business;
b. whether the reports of the Internal Auditors for the period under audit were considered by the
statutory auditor.
3 (xv)
Whether the company has entered into any non-cash transactions with directors or persons connected with
him and if so, whether the provisions of section 192 of Companies Act have been complied with
3(xvi)
a. whether the company is required to be registered under section 45-IA of the Reserve Bank of India
Act, 1934 (2 of 1934) and if so, whether the registration has been obtained;
b. whether the company has conducted any Non-Banking Financial or Housing Finance activities
without a valid Certificate of Registration (CoR) from the Reserve Bank of India as per the Reserve
Bank of India Act, 1934;
c. whether the company is a Core Investment Company (CIC) as defined in the regulations made by the
Reserve Bank of India, if so, whether it continues to fulfil the criteria of a CIC, and in case the company
is an exempted or unregistered CIC, whether it continues to fulfil such criteria;
d. whether the Group has more than one CIC as part of the Group, if yes, indicate the number of CICs
which are part of the Group;
Core Investment Companies

● Core Investment Companies (CICs) are specialized Non-Banking Financial Companies (NBFCs).
● A Core Investment Company registered with the RBI has an asset size of above Rs 100 crore.
● Their main business is acquisition of shares and securities with certain conditions.
3(xvii) - Cash losses
- whether the company has incurred cash losses in the financial year and in the immediately preceding
financial year, if so, state the amount of cash losses

3 (xviii)
- whether there has been any resignation of the statutory auditors during the year, if so, whether the
auditor has taken into consideration the issues, objections or concerns raised by the outgoing
auditors.
3 (xix)
- on the basis of the
- financial ratios,
- ageing and
- expected dates of realisation of financial assets and
- payment of financial liabilities,
- other information accompanying the financial statements,
- the auditor’s knowledge of the Board of Directors and management plans,
- whether the auditor is of the opinion that
- no material uncertainty exists as on the date of the audit report
- that company is capable of meeting its liabilities existing at the date of balance sheet
- as and when they fall due within a period of one year from the balance sheet date.
3(xx)
a. whether,
○ in respect of other than ongoing projects,
○ the company has transferred unspent amount to a Fund specified in Schedule VII to the
Companies Act
○ within a period of six months of the expiry of the financial year
○ in compliance with second proviso to sub-section (5) of section 135 of the said Act;
b. whether
○ any amount remaining unspent under subsection (5) of section 135 of the Companies Act,
pursuant to any ongoing project,
○ has been transferred to special account in compliance with the provision of subsection (6) of
section 135 of the said Act.
3(xxi)
- whether there have been any qualifications or adverse remarks by the respective auditors in the
Companies (Auditor's Report) Order (CARO) reports of the companies included in the consolidated
financial statements,
- if yes,
- indicate the details of the companies and the paragraph numbers of the CARO report
containing the qualifications or adverse remarks.

Chapter 11 Audit Report

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● SA 800 - Special Considerations - Audits of Financial Statements Prepared in Accordance with Special
Purpose Frameworks.
● Example - Framework that does not comply with fundamental assumptions of general purpose
framework. For example financial statements prepared using a cash basis. Such financial statements
may be helpful for certain stakeholders that are interested in knowing the liquidity position of the
entity like creditors.
● Framework prepared according to taxation regulations ignoring normal accounting norms. Many
times tax regulations contradict accounting norms. If financial statements are prepared according to
guidance provided by taxation authorities then it is a special purpose financial statement based on
special purpose framework
SA 700 Forming an opinion and reporting on

financial statements
Auditor’s Objective
The objectives of the auditor are:
(a) To form an opinion on the financial statements
● based on an evaluation of the conclusions
➢ drawn from the audit evidence obtained; and
(b) To express clearly that opinion
● through a written report.
Unmodified opinion
The opinion expressed by the auditor
● when the auditor concludes that

● the financial statements are prepared,

➢ in all material respects,
➢ in accordance with the applicable financial reporting framework.
Forming an Opinion on the Financial Statements

The auditor shall form an opinion
● on whether the financial statements are prepared,
○ in all material respects,
■ in accordance with the applicable financial reporting framework.
In order to form that opinion,

● the auditor shall conclude
○ as to whether the auditor has obtained reasonable assurance about
■ whether the financial statements as a whole are free from material misstatement,
● whether due to fraud or error.
That conclusion shall take into account

(a) The auditor’s conclusion, in accordance with SA 330, whether sufficient appropriate audit evidence
has been obtained
(b) The auditor’s conclusion, in accordance with SA 450, whether uncorrected misstatements are
material, individually or in aggregate;
(c) The evaluations mentioned below
(i) whether the financial statements are prepared, in all material respects, in accordance with the
requirements of the applicable financial reporting framework. This evaluation shall include
consideration of the qualitative aspects of the entity’s accounting practices, including
indicators of possible bias in management’s judgments.
(ii) In particular, the auditor shall evaluate whether, in view of the requirements of the applicable
financial reporting framework:
(1) The financial statements adequately disclose the significant accounting policies
selected and applied;
(2) The accounting policies selected and applied are consistent with the applicable
financial reporting framework and are appropriate;
(3) The accounting estimates made by management are reasonable;
(4) The information presented in the financial statements is relevant, reliable, comparable,
and understandable;
(5) The financial statements provide adequate disclosures to enable the intended users to
understand the effect of material transactions and events on the information
conveyed in the financial statements; and
(6) The terminology used in the financial statements, including the title of each financial
statement, is appropriate.
(iii) When the financial statements are prepared in accordance with a fair presentation framework,
the evaluation shall also include whether the financial statements achieve fair presentation for
this he has to consider the following
(1) The overall presentation, structure and content of the financial statements; and
(2) Whether the financial statements, including the related notes, represent the
underlying transactions and events in a manner that achieves fair presentation.

NOTE - In this standard we issue a report on financial statements prepared as per general purpose
framework. The responsibility of auditor with respect to financial statements prepared as per special purpose
Framework are dealt with in SA 800 Series.
Special purpose Framework is used for preparation of financial statements in order to meet financial
information needs of specific users.
For example if an Indian company is listed outside India then that company is required to prepare a financial
statement as per financial reporting Framework followed in India and also financial reporting Framework
followed in the country outside India where such company is listed.
From India's point of view the financial reporting framework of India will be considered as a general purpose
framework.



Question - Descriptive Question Marks 4 MTP April 2021

"An auditor is required to make specific evaluations while forming an opinion in an audit report." State them.
Elements of Audit Report

Title
The auditor’s report shall have a title that clearly indicates that it is the report of an independent auditor.
Addressee
The auditor’s report shall be addressed, as appropriate, based on the circumstances of the engagement. Law,
regulation or the terms of the engagement may specify to whom the auditor’s report is to be addressed.
The auditor’s report is normally addressed to those for whom the report is prepared, often either to the
shareholders or to those charged with governance of the entity whose financial statements are being
audited.
Auditor’s Opinion
Auditor’s Opinion: The first section of the auditor’s report shall include the auditor’s opinion, and shall have
the heading “Opinion.”

The Opinion section of the auditor’s report shall also:

(a) Identify the entity whose financial statements have been audited;
(b) State that the financial statements have been audited;
(c) Identify the title of each statement comprising the financial statements;
(d) Refer to the notes, including the summary of significant accounting policies; and
(e) Specify the date of, or period covered by, each financial statement comprising the financial
statements.
When the auditor expresses an unmodified opinion, it is not appropriate to use phrases such as “with the
foregoing explanation” or “subject to” in relation to the opinion, as these suggest a conditional opinion or a
weakening or modification of opinion.
Basis for Opinion

The auditor’s report shall include a section, directly following the Opinion section, with the heading “Basis for
Opinion”, that:
(a) States that the audit was conducted in accordance with Standards on Auditing;
(b) Refers to the section of the auditor’s report that describes the auditor’s responsibilities under the SAs;
(c) Includes a statement that the auditor is independent of the entity in accordance with the relevant
ethical requirements relating to the audit and has fulfilled the auditor’s other ethical responsibilities
in accordance with these requirements.
(d) States whether the auditor believes that the audit evidence the auditor has obtained is sufficient and
appropriate to provide a basis for the auditor’s opinion.
The Auditor is fully satisfied with the audit of an entity in respect of its systems and procedures and wants
to issue a report without any hesitation. Discuss the type of opinion that can be given and state giving

reasoning.
ICAI RTP MAY 2021
Going Concern
Where applicable, the auditor shall report in accordance with SA 570 (Revised).
Key Audit Matters

For audits of complete sets of general purpose financial statements of listed entities, the auditor shall
communicate key audit matters in the auditor’s report in accordance with SA 701.
When the auditor is otherwise required by law or regulation or decides to communicate key audit matters in
the auditor’s report, the auditor shall do so in accordance with SA 701.
Law or regulation may require communication of key audit matters for audits of entities other than listed
entities.
Responsibilities for the Financial Statements

The auditor’s report shall include a section with a heading “Responsibilities of Management for the Financial
Statements.”
The description of management’s responsibilities in the auditor’s report includes reference to responsibilities
of Management for IC and PPFS as it helps to explain to users the premise on which an audit is conducted.
This section of the auditor’s report shall describe
● Management’s responsibility for:

○ Preparing the financial statements in accordance with the applicable financial reporting
framework,
■ and for such internal control
➢ as management determines is necessary
✓ to enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error;
○ Assessing the
■ entity’s ability to continue as a going concern and
■ whether the use of the going concern basis of accounting is appropriate
■ as well as disclosing, if applicable, matters relating to going concern.
NOTE
When those individuals who have signed the engagement agreement at the start of the audit have left the
entity, the auditor would request those who are giving the representations to acknowledge their
responsibilities
within the letter of representations.
Oversight of the financial reporting process. (Under Mgt. Respo only)

This section of the auditor’s report shall also identify
● those responsible for the oversight of the financial reporting process,

● when those responsible for such oversight are diff erent from Management.
Question
Descriptive Question Marks 4 MTP April 2021
The auditor’s report shall include a section with a heading “Responsibilities of Management for the Financial Statements.” SA
200 explains the premise, relating to the responsibilities of management and, where appropriate, those charged with
governance, on which an audit in accordance with SAs is conducted. Explain.
Auditor’s Responsibilities for the Audit of the Financial Statements

The auditor’s report shall include a section with the heading “Auditor’s Responsibilities for the Audit of the
Financial Statements.”
This section of the auditor’s report shall:

(a) State that the objectives of the auditor are to
(i) Obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error; and
(ii) Issue an auditor’s report that includes the auditor’s opinion.
(b) State that reasonable assurance is a high level of assurance, but is not a guarantee that an audit
conducted in accordance with SAs will always detect a material misstatement when it exists; and
(c) State that misstatements can arise from fraud or error, and either:
(i) Describe that they are considered material if, individually or in the aggregate, they could
reasonably be expected to influence the economic decisions of users taken on the basis of
these financial statements; or
(ii) Provide a definition or description of materiality in accordance with the applicable financial
reporting framework.

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The Auditor’s Responsibilities for the Audit of the Financial Statements section of the auditor’s report shall
further:
(a) State that, as part of an audit in accordance with SAs, the auditor exercises professional
judgment and maintains professional skepticism throughout the audit; and
(b) Describe an audit by stating that the auditor’s responsibilities are:
(i) To identify and assess the risks of material misstatement of the financial statements,
whether due to fraud or error; to design and perform audit procedures responsive to
those risks; and to obtain audit evidence that is sufficient and appropriate to provide a basis
for the auditor’s opinion.
(ii) To obtain an understanding of internal control relevant to the audit in order to design
audit procedures that are appropriate in the circumstances.
(iii) To evaluate the appropriateness of accounting policies used and the reasonableness of
accounting estimates and related disclosures made by management.
(iv) To conclude on the
■ appropriateness of management’s use of the going concern basis of
accounting ( based on the audit evidence obtained), and
■ whether a material uncertainty exists related to events or conditions that may cast
significant doubt on the entity’s ability to continue as a going concern.


37 Page No. 377
The Auditor’s Responsibilities for the Audit of the Financial Statements section of the auditor’s report also
shall:
(a) State that the auditor communicates with those charged with governance regarding,
○ among other matters,
○ the planned scope and timing of the audit and
○ significant audit findings,
○ including any significant deficiencies in internal control that the auditor identifies during the
audit;
(b) For audits of financial statements of listed entities,

○ state that the auditor provides
○ those charged with governance
○ with a statement that the auditor has complied with relevant ethical requirements
○ regarding independence and
○ communicate with them
■ all relationships and
■ other matters that may reasonably be thought to bear on the auditor’s independence,
■ and where applicable, related safeguards; and
(c) For audits of financial statements of

○ listed entities and any other entities for which key audit matters are communicated in
accordance with SA 701,
○ state that, from the matters communicated with those charged with governance,
○ the auditor determines those matters that were of most significance in the audit of the
financial statements of the current period and are therefore the key audit matters.
○ The auditor describes these matters in the auditor’s report unless law or regulation precludes
public disclosure.

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Location of the description of the auditor’s responsibilities for the audit of the financial
statements
The description of the auditor’s responsibilities for the audit of the financial statements shall be included:
(a) Within the body of the auditor’s report;
(b) Within an appendix to the auditor’s report, in which case the auditor’s report shall include a
reference to the location of the appendix; or
(c) By a specific reference within the auditor’s report to the location of such a description on a website
of an appropriate authority, where law, regulation or national auditing standards expressly permit
the auditor to do so.
Other Reporting Responsibilities

If the auditor addresses other reporting responsibilities in the auditor’s report on the financial statements
that are in addition to the auditor’s responsibilities under the SAs, these other reporting responsibilities shall
be addressed in a separate section in the auditor’s report with a heading titled- “Report on Other Legal and
Regulatory Requirements” or otherwise as appropriate to the content of the section.

37 Page No. 379
Signature
The auditor’s report shall be signed. The report is signed by the auditor (i.e. the engagement partner) in his
personal name. Where the firm is appointed as the auditor, the report is signed in the personal name of the
auditor and in the name of the audit firm.
The partner/proprietor signing the audit report also needs to mention the membership number assigned by
the Institute of Chartered Accountants of India.
They also include the registration number of the firm, wherever applicable, as allotted by ICAI, in the audit
reports
Place of Signature
The auditor’s report shall name a specific location, which is ordinarily the city where the audit report is
signed.
Date
The auditor’s report shall be dated no earlier than the date on which the auditor has obtained sufficient
appropriate audit evidence on which to base the auditor’s opinion on the Financial statements, including
evidence that:
(a) All the statements that comprise the financial statements, including the related notes, have been
prepared; and
(b) Those with the recognized authority have asserted that they have taken responsibility for those
financial statements.
The date of the auditor’s report informs the user of the auditor’s report that the auditor has considered the
effect of events and transactions of which the auditor became aware and that occurred up to that date.
The auditor’s responsibility for events and transactions after the date of the auditor’s report is
addressed in SA 560.
Misc Question
The requirements of SA 700 are aimed at addressing an appropriate balance between the need for
consistency and comparability in auditor reporting globally. Explain
ICAI RTP MAY 2021
Answer from ICAI RTP May 2021 - www.icai.org
The requirements of SA 700 are aimed at addressing an appropriate balance between the need for
consistency and comparability in auditor reporting globally and the need to increase the value of auditor
reporting by making the information provided in the auditor’s report more relevant to users. This SA
promotes consistency in the auditor’s report but recognizes the need for flexibility to accommodate
particular circumstances of individual jurisdictions. Consistency in the auditor’s report, when the audit has
been conducted in accordance with SAs, promotes credibility in the global marketplace by making more
readily identifiable those audits that have been conducted in accordance with globally recognized
standards. It also helps to promote the user’s understanding and to identify unusual circumstances when
they occur.

37 Page No. 380
AUDITOR’S REPORT PRESCRIBED BY LAW OR

REGULATION
If the auditor is required by law or regulation to use a specific layout, or wording of the auditor’s report, the
auditor’s report shall refer to Standards on Auditing only if the auditor’s report includes, at a minimum, each
of the following elements.
(a) A title.
(b) An addressee, as required by the circumstances of the engagement.
(c) An Opinion section containing an expression of opinion on the financial statements and a reference
to the applicable financial reporting framework used to prepare the financial statements.
(d) An identifi cation of the entity’s financial statements that have been audited.
(e) A statement that the auditor is independent of the entity in accordance with the relevant ethical
requirements relating to the audit, and has fulfilled the auditor’s other ethical responsibilities in
accordance with these requirements. The statement shall refer to the Code of Ethics issued by ICAI.
(f) Where applicable, a section that addresses, and is not inconsistent with, the reporting requirements
relating to going concern as per SA 570 (Revised).
(g) Where applicable, a Basis for Qualifi ed (or Adverse) Opinion section that addresses, and is not
inconsistent with, the reporting requirements relating to going concern as per SA 570 (Revised).
(h) Where applicable, a section that includes the information required by SA 701, or additional
information about the audit that is prescribed by law or regulation and that addresses, and is not
inconsistent with, the reporting requirements in that SA.
(i) A description of management’s responsibilities for the preparation of the fi nancial statements and an
identifi cation of those responsible for the oversight of the fi nancial reporting process that addresses,
and is not inconsistent with, the requirements as contained in this SA 700.
(j) A reference to Standards on Auditing and the law or regulation, and a description of the auditor’s
responsibilities for an audit of the fi nancial statements that addresses, and is not inconsistent with,
the requirements as contained in this SA 700.
(k) The auditor’s signature.
(l) The Place of signature.
(m)The date of the auditor’s report.

37 Page No. 381
SA 701 - Communicating Key Audit Matters in

the Independent Auditor’s Report
Purpose
As per SA 701, “Communicating Key Audit Matters in the Auditor’s Report”, the purpose of communicating
key audit matters is to
● enhance the communicative value of the auditor’s report by providing greater transparency about the
audit that was performed.
● Communicating key audit matters provides additional information to intended users of the financial
statements to assist them in understanding those matters that, in the auditor’s professional
judgment, were of most significance in the audit of the financial statements of the current period.
● Communicating key audit matters may also assist intended users in understanding the entity and
areas of significant management judgment in the audited financial statements.
● The communication of key audit matters in the auditor’s report may also provide intended users a
basis to further engage with management and those charged with governance about
○ certain matters relating to the entity,
○ the audited financial statements,
○ or the audit that was performed.
Applicability
This SA applies to
● audits of complete sets of general purpose financial statements of listed entities and
● circumstances when the auditor otherwise decides to communicate key audit matters in the
auditor’s report.
● This SA also applies when the auditor is required by law or regulation to communicate key audit
matters in the auditor’s report.
However, SA 705 (Revised) prohibits the auditor from communicating key audit matters when the auditor
disclaims an opinion on the financial statements, unless such reporting is required by law or regulation.
This SA is effective for audits of financial statements for periods beginning on or after April 1, 2018
Objectives
The objectives of the auditor are
● To determine key audit matters and, having formed an opinion on the financial statements,
● Communicate those matters by describing them in the auditor’s report.
Key audit Matters
Those matters that,

● in the auditor’s professional judgment,
○ were of most significance
■ in the audit of the financial statements of the current period.
● Key audit matters are selected from matters communicated with those charged with governance.

Determining Key Audit Matters

The auditor shall determine,
● from the matters communicated with those charged with governance,
● those matters that required significant auditor attention in performing the audit.
● In making this determination, the auditor shall take into account the following
a. Areas of higher assessed risk of material misstatement, or significant risks identified in
accordance with SA 315.
b. Significant auditor judgments relating to areas in the financial statements that involved
significant management judgment, including accounting estimates that have been identified
as having high estimation uncertainty.
c. The effect on the audit of significant events or transactions that occurred during the period.
Question
How would an auditor determine Key Audit Matters as per SA - 701, "Communicating Key Audit Matters in
the Independent Auditor's Report"?
November 2020 - 3 marks
Communicating Key Audit Matters

The auditor shall
● describe each key audit matter,
● using an appropriate subheading,
● in a separate section of the auditor’s report under the heading “Key Audit Matters”.
The introductory language in this section of the auditor’s report shall state that:
a. Key audit matters are those matters that, in the auditor’s professional judgment, were of most
significance in the audit of the financial statements.
b. These matters were addressed in the context of the audit of the financial statements as a whole, and
in forming the auditor’s opinion thereon, and the auditor does not provide a separate opinion on
these matters.
Communicating Key Audit Matters- not a substitute for disclosure in the

Financial Statements etc.
Communicating key audit matters in the auditor’s report is in the context of the auditor having formed an
opinion on the financial statements as a whole. Communicating key audit matters in the auditor’s report is
not:
a. A substitute for disclosures in the fi nancial statements that the applicable financial reporting
framework requires management to make, or that are otherwise necessary to achieve fair
presentation;
b. A substitute for the auditor expressing an modified opinion when required by the circumstances of a
specifi c audit engagement in accordance with SA 705
c. A substitute for reporting in accordance with SA 570 when a material uncertainty exists relating to
events or conditions that may cast significant doubt on an entity’s ability to continue as a going
concern; or

37 Page No. 383
d. A separate opinion on individual matters.
Communicating Key Audit Matters is a substitute for the auditor expressing a modified audit opinion when
required by the circumstances of a specific audit engagement in accordance with SA 705.Communicating
Key Audit Matters is a substitute for the auditor expressing a modified audit opinion when required by the
circumstances of a specific audit engagement in accordance with SA 705.
Descriptions of Individual Key Audit Matters
The description of each key audit matter in the Key Audit Matters section of the auditor’s report shall include
a reference to the related disclosure(s), if any, in the financial statements and shall address:
a. Why the matter was considered to be one of most significance in the audit and therefore determined
to be a key audit matter; and
b. How the matter was addressed in the audit.
Circumstances in Which a Matter Determined to Be a Key Audit Matter Is

Not Communicated in the Auditor’s Report
The auditor shall describe each key audit matter in the auditor’s report unless
a. Law or regulation precludes public disclosure about the matter; or
b. In extremely rare circumstances, the auditor determines that the matter should not be
communicated in the auditor’s report because the adverse consequences of doing so would
reasonably be expected to outweigh the public interest benefits of such communication. This shall
not apply if the entity has publicly disclosed information about the matter.
A matter giving rise to a modified opinion in accordance with SA 705 (Revised), or a material uncertainty
related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going
concern in accordance with SA 570 (Revised), are by their nature key audit matters.
These matters shall not be described in the Key Audit Matters section of the auditor’s report and the
requirements in Rather, the auditor shall
a. Report on these matter(s) in accordance with the applicable SA(s); and
b. Include a reference to
● the Basis for Qualified (Adverse) Opinion or
● the Material Uncertainty Related to Going Concern section(s) in the Key Audit Matters section.
If the auditor determines, depending on the facts and circumstances of the entity and the audit, that there
are no key audit matters to communicate or that the only key audit matters communicated are those
matters mentioned above, the auditor shall include a statement to this effect in a separate section of the
auditor’s report under the heading “Key Audit Matters.”
Communication with TCWG

The auditor shall communicate with those charged with governance:
a. Those matters the auditor has determined to be the key audit matters; or

37 Page No. 384
b. If applicable, depending on the facts and circumstances of the entity and the audit, the auditor’s
determination that there are no key audit matters to communicate in the auditor’s report.
Documentation
The auditor shall include in the audit documentation:
a. The matters that required significant auditor attention as determined , and the rationale for the
auditor’s determination as to whether or not each of these matters is a key audit matter.
b. Where applicable, the rationale for the auditor’s determination that there are no key audit matters to
communicate in the auditor’s report or that the only key audit matters to communicate are
i. Modified Opinion
ii. Material uncertainty related to events or conditions that may cast significant doubt on the
entity’s ability to continue as a going concern; and
c. Where applicable, the rationale for the auditor’s determination not to communicate in the auditor’s
report a matter determined to be a key audit matter.

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SA 705 - Modifications to the Opinion in the

Independent Auditor's Report
Nature of Matter Giving Rise to Auditor’s judgment about the Pervasiveness of the Effects or
the Modification Possible Effects on the Financial statements
Material but Not Pervasive Material and Pervasive
❖ Financial Statements are Qualified opinion Material and Pervasive

materially misstated
❖ Inability to obtain SAAE Qualified opinion Disclaimer of opinion

37 Page No. 391
Disclaimer of Opinion - Special Point
❖ The auditor shall disclaim an opinion when,

➢ in extremely rare circumstances involving multiple uncertainties,
➢ the auditor concludes that,
➢ notwithstanding having obtained SAAE regarding each of the individual uncertainties,
➢ it is not possible to form an opinion on the Financial Statements
■ due to potential interaction of the uncertainties and
■ their possible cumulative effect on the Financial Statements
Circumstances when a Modification to the Auditor’s Opinion is Required

● The auditor concludes that based, on the audit evidence obtained, the Financial Statements as a
whole are not free from material misstatement, may be due to following reasons:
○ Inappropriate Accounting Policies;
○ Inappropriate application of selected Accounting Policies;
○ Inappropriate or inadequate disclosures in financial statements.
● The auditor is unable to obtain sufficient appropriate audit evidence to conclude may be due to
following reasons:
○ Limitations imposed by management
○ Circumstances beyond entity control ( 🔥)
○ Circumstances related to Nature and Timing of auditor’s work

37 Page No. 392
Limitation after the auditor has Accepted the Engagement
Form and Content of the Auditor’s Report when the Opinion is modified
When the auditor modifies the audit opinion, the auditor shall use the heading “Qualified Opinion,” Adverse
Opinion,” or Disclaimer of Opinion,” as appropriate , for the Opinion section.
When the auditor modified the opinion on the Financial Statements, the auditor shall, in addition to the
specific elements as required by SA 700:
a) Amend the heading “Basis for Opinion” to “Basis for Qualified Opinion,” Basis for Adverse Opinion”, or
Basis for Disclaimer of Opinion,” as appropriate; and
b) Within this section, include a description of the matter giving rise to the modification.
Language to be Used
Qualified Opinion
● When the auditor expresses a qualified opinion due to a material misstatement in the Financial
Statements, auditor shall state that, in the auditor’s opinion, except for the effects of the matter(s)
described in the Basis for Qualified Opinion section
○ When reporting in accordance with a fair presentation framework- the accompanying
Financial Statements present fairly, in all material respects (or give a true and fair view in
accordance with applicable FRF).
○ When reporting in accordance with a compliance framework-the accompanying Financial
Statements have been prepared, in all material respects, in accordance with ( the applicable
FRF).
● When the modification arises from an inability to obtain SAAE, the auditor shall use the
corresponding phrase “except for the possible effects of the matter(S)... “For the modified opinion.

37 Page No. 393
Adverse Opinion
When the auditor expresses an adverse opinion, the auditor shall state that, in the auditor’s opinion, because
of the significance of the matters described in the Basis for Adverse Opinion section :
● When reporting in accordance with a fair presentation framework-the accompanying Financial
Statements do not present fairly (or give a true and fair view of) in accordance with the applicable FRF
● When reporting in accordance with a compliance framework the Accompanying Financial
Statements have not been prepared, in all material respect in accordance with (the applicable FRF).
Disclaimer
When the auditor disclaims an opinion due to an inability to obtain sufficient appropriate audit evidence, the
auditor shall
● State that the auditor does not express an opinion on the accompanying Financial Statements;
● State the, because of the significance of the matter(s) described, in the Basis for Disclaimer of
Opinion section, the auditor has not been able to obtain SAAE to provide a basis for an audit
opinion on the financial statements; and
● Amend the statement in the Opinion Section, which indicates that the financial statements have
been audited, to state that the auditor was engaged to audit the financial statements. (Example
in Class / Videos)
Considerations When the Auditor Disclaims an Opinion on the Financial Statements.

Unless required by law or regulation, when the auditor disclaims an opinion on the financial statements, the
auditor’s report shall not include a Key Audit Matters section in accordance with SA 701.
WHY?
Communication of any key audit matters other than the matter(s) giving rise to the disclaimer of opinion
● may suggest that the financial statements as a whole are more credible
● than would be appropriate in the circumstances,
● and would be inconsistent with the disclaimer of opinion on the financial statements as a whole.
Communication with TCWG

When the auditor expects to modify the opinion in the auditor’s report, the auditor shall communicate with
TCWG the circumstances that led to the expected modification and the wording of the modification.
Description of Auditor’s Responsibilities

When the auditor disclaims an opinion on the financial statements due to an inability to obtain sufficient
appropriate audit evidence, the auditor shall amend the description of the auditor’s responsibilities required
by SA 700 to include only the following
a. A statement that the auditor’s responsibility is to conduct an audit of the entity’s financial statements
in accordance with Standards on Auditing and to issue an auditor’s report;
b. A statement that, however, because of the matter(s) described in the Basis for Disclaimer of Opinion
section, the auditor was not able to obtain sufficient appropriate audit evidence to provide a basis for
an audit opinion on the financial statements; and

37 Page No. 394
c. The statement about auditor independence and other ethical responsibilities required by SA 700
Question - Descriptive Question Marks 4 January 2021 Exam Question
What should an auditor state in "Basis for opinion" section of the auditor's report and when the
auditor modifies the opinion on the financial statements, what amendments he should make in this
section ?

37 Page No. 395
SA 706 Emphasis of matter paragraphs & other

matter paragraphs in the independent
auditor's report
Scope
This SA addresses the relationship between key audit matters and any additional communication in the
auditor’s report in accordance with this SA.

37 Page No. 396

37 Page No. 397
Question
State clearly the objective of the Auditor as per SA 706. Also define emphasis of the matter paragraph
and other matter paragraph. MTP May 2021
SA 706 Text
As per SA 706 (Revised) on “Emphasis of Matter Paragraphs and Other Matter Paragraphs In The
Independent Auditor’s Report”, the objective of the auditor, having formed an opinion on the financial
statements, is to draw users’ attention, when in the auditor’s judgment it is necessary to do so, by way of
clear additional communication in the auditor’s report, to
a. A matter, although appropriately presented or disclosed in the financial statements, that is of such
importance that it is fundamental to users’ understanding of the financial statements; or
b. As appropriate, any other matter that is relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report.
Emphasis of Matter paragraph – A paragraph included in the auditor’s report that refers to a matter
appropriately presented or disclosed in the financial statements that, in the auditor’s judgment, is of such
importance that it is fundamental to users’ understanding of the financial statements.
Other Matter paragraph – A paragraph included in the auditor’s report that refers to a matter other than
those presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to
users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.
The Relationship between Emphasis of Matter Paragraphs and Key Audit

Matters in the Auditor’s Report
When SA 701 applies, the use of Emphasis of Matter paragraphs is
● not a substitute for a description of individual key audit matters.

37 Page No. 398
There may be a matter that is not determined to be a key audit matter in accordance with SA 701 (i.e.,
because it did not require significant auditor attention), but which, in the auditor’s judgment, is fundamental
to users’ understanding of the financial statements (e.g., a subsequent event).
If the auditor considers it necessary to draw users’ attention to such a matter, the matter is included in an
Emphasis of Matter paragraph in the auditor’s report in accordance with this SA.
Placement of Emphasis of Matter Paragraphs and Other Matter

Paragraphs in the Auditor’s Report
The placement of an Emphasis of Matter paragraph or Other Matter paragraph in the auditor’s report
● depends on the nature of the information to be communicated,
● and the auditor’s judgment
○ as to the relative significance of such information
○ to intended users compared to other elements required to be reported in accordance with
SA 700
Emphasis of Matter Paragraphs

When the Emphasis of Matter paragraph relates to the applicable financial reporting framework, the auditor
may consider it necessary to place the paragraph immediately following the Basis of Opinion section to
provide appropriate context to the auditor’s opinion.
When a Key Audit Matters section is presented in the auditor’s report,

● an Emphasis of Matter paragraph may be presented
● either directly before or
● after the Key Audit Matters section,
○ based on the auditor’s judgment
■ as to the relative significance of the information included in the Emphasis of Matter
paragraph.
The auditor may also add further context to the heading “Emphasis of Matter”,
● such as “Emphasis of Matter – Subsequent Event”,
● to differentiate the Emphasis of Matter paragraph from the individual matters described in the Key
Audit Matters section.
If the auditor is unable to obtain sufficient appropriate audit evidence regarding the opening balances, the auditor shall include
an Emphasis of Matter paragraph in the auditor’s report.
Other Matter Paragraphs

When a Key Audit Matters section is presented in the auditor’s report
● and an Other Matter paragraph is also considered necessary,
● the auditor may add further context to the heading “Other Matter”, such as “Other Matter – Scope of
the Audit”,

37 Page No. 399
● to differentiate the Other Matter paragraph from the individual matters described in the Key Audit
Matters section.
When an Other Matter paragraph is included to draw users’ attention to a matter relating to Other Reporting
Responsibilities addressed in the auditor’s report, the paragraph may be included in the Report on Other
Legal and Regulatory Requirements section.
When relevant to all the auditor’s responsibilities or users’ understanding of the auditor’s report, the Other
Matter paragraph may be included as a separate section following the Report on the Audit of the Financial
Statements and the Report on Other Legal and Regulatory Requirements.

37 Page No. 400
Case Study - Zinnia - 8 Marks (4 Questions - 2 marks Each)
(Concept Involved - Materiality Calculation, and Reporting)
Zinnia Co is a manufacturer of shoes. You are an audit manager in PK and Co and you are performing an
overall review of the financial statements for the year ended 31st March _ _ prior to the issue of the auditor’s
report.
Profit before tax for the year was Rs. 140 Crores.
As part of your overall review, you have performed analytical procedures over the draft financial statements
and have noted that the trade receivables collection period is lower than it was during the interim audit
performed . You are aware that the credit controller of Zinnia Co left the company on August 20 _ _ and that
the directors have said that, as a result, the company is experiencing difficulties in debt collection.
Your review also includes an assessment of uncorrected misstatements. These have been recorded by the
audit team as follows
1. Interest payable omitted in error - Rs. 1.6 Crores
2. Additional allowance for receivables required - Rs. 19.8 Crores
3. Error in sales invoice processing resulting in understatement of sales - Rs. 29.1 Crores
4. Write off in respect of faulty goods - 3.08 Crores
Faulty goods The adjustment for faulty goods listed as an uncorrected misstatement above relates to an
entire batch of shoes, which was produced on 12 March 20_ _ . The audit work concluded that the cost of this
inventory exceeded its net realisable value by Rs. 3.08 Crores. The directors dispute the audit team’s figures
and believe that the realisable value of the inventory still exceeds its cost.
Benchmark for Materiality - ½% revenue/ 5% of profit before tax /1% total assets,
Questions
1. Which of the following would form part of the auditor’s overall review of the financial statements?
1. Establishing whether the pre‐conditions for an audit are present
2. Assessing whether the information and explanations obtained during the audit are adequately
reflected.
3. Performing a detailed review of the audit working papers to ensure the work has been
properly performed.
4. Reviewing the adequacy of the disclosure of accounting policies
A. 1 and 3
B. 2 and 4
C. 3 and 4
D. 1 and 2
2. Which of the following is a valid explanation for the INCONSISTENCY between the results of the
analytical procedures on trade receivables and the directors’ statement regarding debt collection
problems?

37 Page No. 401
A. A change in sales mix towards high value products

B. An increase in the proportion of cash sales since August 20 _ _
C. An increase in the rate of sales tax in March 20 _ _
D. Sales growth of 1% per month over the year
3. Which of the uncorrected misstatements numbered (1), (2) and (3) by the audit team MUST be
adjusted for if the auditor is to issue an unmodified audit opinion?
A. Misstatements 2 and 3 only

B. Misstatements 1 and 3 only
C. Misstatements 1, 2 and 3
D. Misstatement 2 only
4. All adjustments required by the auditors have been made to the financial statements with the
exception of adjustment (4) relating to the faulty goods. Which of the following correctly describes
the effect of this matter on the auditor’s report?
A. Unmodified opinion with no further disclosure

B. Unmodified opinion with disclosure in an emphasis of matter paragraph
C. Qualified opinion due to material misstatement.
D. Qualified opinion due to inability to obtain sufficient appropriate audit evidence

37 Page No. 402
Bank Audit
Types of bank
Commercial banks
The most widespread banking institutions in India, that provide a number of products and services to the general
public and other segments of the economy. Two of its main functions are:-
a. accepting deposits and
b. granting advances.
Regional Rural Banks

known as RRBs are the banks that have been set up in rural areas in different states of the country to cater to the basic
banking and financial needs of the rural communities.
Examples are :- Punjab Gramin Bank , Tripura Gramin Bank , Allahabad UP Gramin Bank , Andhra Pradesh Grameen Vikas
Bank, etc.
Co-operative Banks
function like Commercial Banks only but are set up on the basis of Cooperative Principles and registered under the
Cooperative Societies Act of the respective state or the Multistate Cooperative Societies Act and usually cater to the
needs of the agricultural and rural sectors.
Examples are :- The Gujarat State Co-operative Bank Ltd. , Chhatisgarh Rajya Sahakari Bank Maryadit , etc.
Payments Banks
are a new type of banks which have been recently introduced by RBI. They are allowed to accept restricted deposits but
they cannot issue loans and credit cards. However , customers can open Current & Savings accounts and also avail the
facility of ATM cum Debit cards , Internet-banking & Mobile Banking. Examples are :- Airtel Payments Bank , India Post
Payments Bank, Paytm Payments Bank , etc.
Development Banks
It Has been conceptualised to provide funds for infrastructural facilities important for the economic growth of the
country. Examples are:- Industrial Finance Corporation of India (IFCI), Industrial Development Bank of India (IDBI), Small
Industries Development Bank of India (SIDBI) , etc.
Small Finance Banks

have been set up by RBI to make available basic financial and banking facilities to the unserved and unorganised sectors
like small marginal farmers, small & micro business units, etc. Examples are:- Equitas Small Finance Bank , AU Small
Finance Bank , etc.
Regulating Body - Reserve Bank of India
● The functioning of the banking industry in India is regulated by the Reserve Bank of India (RBI) which acts as the
Central Bank of our country.
● RBI is responsible for
○ development and supervision of the constituents of the Indian financial system (which comprises banks
and non-banking financial institutions) as well as
○ for determining, in conjunction with the Central Government, the monetary and credit policies keeping
in with the need of the hour.
Join Us on YouTube www.youtube.com/neerajarora Bank Audit | 1

● Important functions of RBI are

○ issuance of currency;
○ regulation of currency issue;
○ acting as banker to the central and state governments;
○ and acting as banker to commercial and other types of banks including term-lending institutions.
● Besides, RBI has also been entrusted with the responsibility of
○ regulating the activities of commercial and other banks.
○ No bank can
■ commence the business of banking or
■ open new branches without obtaining a licence from RBI.
○ The RBI also has the power to inspect any bank.
Independent audit of financial statements of banks is important for a healthy, safe and sound banking system.
Regulatory Framework
● Reserve Bank of India Act, 1934
● Banking Regulation Act, 1949.
● State Bank of India Act, 1955.
● Companies Act, 2013.
● State Bank of India (Subsidiary Banks) Act 1959.
● Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.
● Regional Rural Banks Act, 1976.
● Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980.
● Information Technology Act, 2000.
● Prevention of Money Laundering Act, 2002.
● Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
● Credit Information Companies Regulation Act, 2005.
● Payment and Settlement Systems Act, 2007.
Some of the different features of Bank

● Huge volumes and complexity of transactions,
● Wide geographical spread of banks’ network,
● Large range of products and services off ered,
● Extensive use of technology,
● Strict vigilance by the banking regulator etc.
Types of Bank Audit Reports to be issued

Presently, the Statutory Central Auditors (SCAs) have to furnish the following reports in addition to their main audit
report:
1. Report on adequacy and operating effectiveness of Internal Controls over Financial Reporting in case of banks
which are registered as companies under the Companies Act in terms of Section 143(3)(i) of the Companies Act,
2013 which is normally to be given as an Annexure to the main audit report as per the Guidance Note on Audit of
Internal Financial Controls over Financial Reporting issued by the ICAI.
2. Long Form Audit Report. (LFAR)
3. Report on compliance with SLR requirements. (Statutory Liquidity Ratio Statutory Liquidity Ratio or SLR is a minimum percentage of
deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities. It is basically the reserve requirement that banks are
expected to keep before offering credit to customers.)
4. Report on whether the treasury operations of the bank have been conducted in accordance with the instructions
issued by the RBI from time to time.

5. Report on whether the income recognition, asset classification and provisioning have been made as per the
guidelines issued by the RBI from time to time.
6. Report on whether any serious irregularity was noticed in the working of the bank which requires immediate
attention.
7. Report on status of the compliance by the bank with regard to the implementation of recommendations of the
Ghosh Committee relating to frauds and malpractices and of the recommendations of Jilani Committee on
internal control and inspection/credit system.
8. Report on instances of adverse credit-deposit ratio in the rural areas.
Understanding the Accounting System in Banks

There is a sea change in banking
● as use of technology
● and its continuous evolution has
○ enabled banks to reach their customers
○ providing them the convenience and
○ comfort of
■ anytime-anywhere-banking
● by letting them access their information/data
○ on real time basis,
○ as stored in a safe and secure environment
○ on the bank’s servers.
The transactions in banks have become voluminous and

● it needs to be ensured that in the
● system of
○ recording ,
○ transmission and
○ storage of information/ data
■ is optimally maintained and
● control systems
○ ensure that
○ the same is
○ free of risks of
■ errors, omissions, irregularities and frauds;
In the computerised environment, it is imperative that the auditor is familiar with and satisfied that all the
norms/parameters as per the latest applicable RBI guidelines are incorporated and built into the system that generates
information/data having a bearing on the classification/ provisions and income recognition.
The auditor should not go by the assumption that the system generated information is correct and can be relied upon
without evidence that demonstrates that the system driven information is based on the required parameters.
He should use Professional Skepticism and Prudence wherever he feels that something manually needs to be performed
to check the authenticity and consistency of the information obtained from the systems and document the results of
such activities performed.
Categories of bank on the basis of computerisation

Banks may be divided into three broad categories based on the level of computerisation:
1. Non-computerised banks :- Transactions can be done only at bank branches during working hours using paper
and pen.
2. Partially computerised banks :- Some transactions are computerised while major are non-computerised.

3. Fully computerised banks:- Core banking allows inter-connectivity between branches of the same bank and with
CBS , customers can operate their accounts as well as avail banking services from any branch of the bank over
the network
FORM AND CONTENT OF FINANCIAL STATEMENTS

● Sub-sections (1) and (2) of section 29 of the Banking Regulations Act, 1949 deal with the form and content of
financial statements of a banking company and their authentication.
● These sub-sections are also applicable to nationalised banks, State Bank of India, subsidiaries of the State Bank of
India, and Regional Rural Banks.
● Every banking company is required to prepare a Balance Sheet and a Profit and Loss Account in the forms set
out in the Third Schedule to the Act or as near thereto as the circumstances admit.
● Form A of the Third Schedule to the Banking Regulation Act, 1949, contains the form of Balance Sheet and Form
B contains the form of Profit and Loss Account.
● Every banking company needs to comply with the disclosure requirements under the various Accounting
Standards, as specified under section 133 of the Companies Act, 2013, read with Rule 7 of the Companies
(Accounts) Rules 2014, in so far as they apply to banking companies or the Accounting Standards issued by the
ICAI.
Audit of Accounts
Sub-section (1) of section 30 of the Act requires that the balance sheet and profit and loss account of a banking company
should be audited by a person duly qualified under any law for the time being in force to be an auditor of companies.
Eligibility, Qualifications And Disqualifications Of Auditor

Same as section 141 studied in Company Audit
Appointment of auditor
The auditor of a
● banking company is to be appointed
○ at the annual general meeting of the shareholders, whereas the
● auditor of a nationalised bank
○ is to be appointed by the bank concerned
○ acting through its Board of Directors.
● In either case, approval of the Reserve Bank is required before the appointment is made.
● The auditors of the State Bank of India
○ are to be appointed by the Comptroller and Auditor General of India
○ in consultation with the Central Government.
● The auditors of the subsidiaries of the State Bank of India are to be appointed
○ by the State Bank of India.
● The auditors of regional rural banks are to be appointed
○ by the bank concerned with the approval of the Central Government.
Remuneration of Auditor
The remuneration of an auditor of a banking company is to be fixed in accordance with the provisions of section 142 of
the Companies Act, 2013 (i.e., by the company in general meeting or in such manner as the company in general meeting
may determine). The remuneration of auditors of nationalised banks and State Bank of India is to be fixed by the
Reserve Bank of India in consultation with the Central Government.

POWERS OF AUDITOR
The auditor of a banking company or of a nationalised bank, State Bank of India, a subsidiary of State Bank of India, or a
regional rural bank has the same powers as those of a company auditor in the matter of access to the books, accounts,
documents and vouchers.
Auditor’s Report
In the case of a nationalised bank, the auditor is required to make a report to the Central Government in which he has to
state the following:
a. whether,in his opinion,

● the balance sheet is a
○ full and fair balance sheet
➢ containing all the necessary particulars and
➢ is properly drawn up
➢ so as to exhibit a true and fair view of the affairs of the bank,
● and in case he had called for any explanation or information,
○ whether it has been given and
○ whether it is satisfactory;
b. whether or not the transactions of the bank,
● which have come to his notice,
○ have been within the powers of that bank
c. whether or not the
● returns
○ received from the offices and branches of the bank
➢ have been found adequate for the purpose of his audit; (Returns from branch are adequate
or not)
d. whether the
● profit and loss account
○ shows a true balance of profit or loss for
➢ the period covered by such account; and
e. any
● other matter which
○ he considers
➢ should be brought to the notice of the Central Government.
The report of auditors of State Bank of India is also to be made to the Central Government and is almost identical to the
auditor’s report in the case of a nationalised bank.
Format of Report
The auditors,
● central as well as branch,
○ should also ensure that the audit report issued by them
■ complies with the requirements of
● Standards on Auditing on Audit Report.
The auditor should ensure that

● information relating to number of unaudited branches is given
● quantification of
○ advances,

○ deposits,
○ interest income and
○ Interest expense for such unaudited branches has also been disclosed in the audit report.
Long Form Audit Report
● Besides the audit report as per the statutory requirements discussed above, the terms of appointment of
auditors of public sector banks, private sector banks and foreign banks (as well as their branches), require the
auditors to also furnish a long form audit report (LFAR).
● The matters which the banks require their auditors to deal with in the long form audit report have been specified
by the Reserve Bank of India.
● The LFAR is to be submitted before 30th June every year.
● To ensure timely submission of LFAR, proper planning for completion of the LFAR is required.
Reporting to RBI
The RBI issued a Circular relating to implementation of recommendations of the Committee on Legal Aspects of Bank
Frauds applicable to all scheduled commercial banks (excluding Regional Rural Banks). Regarding liability of accounting
and auditing profession, the said circular provided as under:
“If an accounting professional, whether in the course of internal or external audit or in the process of institutional audit
finds anything susceptible to be fraud or fraudulent activity or act of excess power or smell any foul play in any
transaction, he should refer the matter to the regulator. Any deliberate failure on the part of the auditor should render
himself liable for action”.
As per the above requirement, the member shall be required to report the kind of matters stated in the circular to RBI.
2. Auditor should also consider the provisions of SA 250, “Consideration of Laws and Regulations in an Audit of Financial
Statements”. The said Standard explains that the duty of confidentiality is over-ridden by statute, law or courts.
3. SA 240, “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements“ states that an auditor
conducting an audit in accordance with SAs is responsible for obtaining reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether caused by fraud or error.
It must be noted that auditor is not expected to look into each and every transaction but to evaluate the system as a
whole. Therefore, if the auditor while performing his normal duties comes across any instance, he should report the
matter to the RBI in addition to Chairman/Managing Director/Chief Executive of the concerned bank.
Duty to report on Frauds under the Companies Act, 2013
As per sub-section 12 of section 143 of the Companies Act, 2013, if an auditor of a company,in the course of the
performance of his duties as auditor, has reason to believe that an off ence of fraud involving such amount or amounts as
may be prescribed, is being or has been committed in the company by its officers or employees, the auditor shall report
the matter to the Central Government within such time and in such manner as may be prescribed.
The member shall be required to report the matters to RBI.

It must be noted that auditor is not expected to look into each and every transaction but to evaluate the system as a
whole.
Therefore, if the auditor while performing his normal duties comes across any instance, he should report the matter to
the RBI in addition to Chairman/Managing Director/Chief Executive of the concerned bank.
Bank Audit Approach
Drawing an Audit Plan
An audit plan should be drawn up based on :-

- the nature and level of operations,
- level of compliance based on previous reports and
- audit risks based on inadequacy in or breach of internal controls and the familiarisation exercise carried out
Control Environment at the Bank
● Check whether the bank have appropriate controls to mitigate its risks, including
○ effective segregation of duties (particularly, between front and back offices),
○ accurate measurement and reporting of positions,
○ verification and approval of transactions,
○ reconciliation of positions and results,
○ setting up limits,
○ reporting and approval of exceptions,
○ physical security and
○ contingency planning.
The following are certain common questions /steps, which have to be kept in mind while undertaking/ performing
control activities
Who ● Who performs the control?

● Does the above person have requisite knowledge and authority to perform the control?
What ● What evidence is available to demonstrate /prove that the control is performed?
When ● When and with what frequency is the control performed?

● Is the frequency enough to prevent, detect and correct?
Where ● Where is the evidence of performance of the control retained?

● For how long is the evidence retained?
● Is the evidence accessible/ available for audit?
Why ● Why is the control being performed?

● What type of errors are prevented or detected through the performance of the control?
How ● How is the control performed?

● What are the control activities? (SOD, Approval, Reconciliation etc)

● Can these activities be bypassed?

● Can the bypass, if any, be detected?
● How are exceptions / deviations resolved on identification?
● What is the time frame for resolving the exceptions
Engagement Team Discussions

All personnel performing an engagement, including any experts contracted by the firm in connection with that
engagement are known to be the “ Engagement Team”.
The engagement team should hold discussions

● to gain better understanding of the bank and its environment, including internal control, and also
● to assess the potential for material misstatements of the financial statements.
All these discussions should be appropriately documented for future reference.
These discussions are ordinarily done at the planning stage of an audit.
Engagement team discussion ordinarily includes

The engagement team discussion ordinarily includes a discussion of the following matters:
a. Errors that may be more likely to occur;
b. Errors which have been identified in prior years;
c. Method by which fraud might be perpetrated by bank personnel or others within particular account balances
and/or disclosures;
d. Audit responses to Engagement Risk, Pervasive Risks, and Specific Risks;
e. Need to maintain professional skepticism throughout the audit.
f. Need to alert for information or other conditions that indicate that a material misstatement may have occurred
(e.g., the bank’s application of accounting policies in the given facts and circumstances).
Advantages of such a discussion :-

● Specific emphasis can be provided to the susceptibility of the bank’s financial statements to material
misstatement due to fraud, that enables the engagement team to consider an appropriate response to fraud
risks, including those related to engagement risk, pervasive risks, and specific risks.
● It further enables the audit engagement partner to delegate the work to the experienced engagement team
members, and to determine the procedures to be followed when fraud is identified.
● Further, audit engagement partners may review the need for specialists to address the issues relating to fraud.

CONDUCTING AN AUDIT
The audit of banks or their branches involves the following stages –

Initial consideration by the statutory auditor
Declaration of Indebtedness
● The RBI has advised that the banks, before appointing their statutory central/branch auditors,
○ should obtain a declaration of indebtedness.
● Indebtedness refers to the situation of owing money to the bank in any case , whatsoever.
Internal Assignments in Banks by Statutory Auditors
The RBI decided that the audit firms should not undertake statutory audit assignment while they are associated with
internal assignments in the bank during the same year , like Concurrent audits (Internal Audit of Banks conducted
monthly during the year)
Planning
Standard on Auditing (SA) 300, “Planning an Audit of Financial Statements” requires that the auditor shall undertake the
following activities prior to starting an initial audit
● Performing procedures required by SA 220, “Quality Control for Audit Work” regarding the acceptance of the
client relationship and the specific audit engagement; and
● Establish understanding of terms of engagement as per SA 210, “Agreeing the Terms of Audit Engagements”.

Communication with Previous Auditor
As per Clause (8) of the Part I of the First Schedule to the Chartered Accountants Act, 1949, a Chartered Accountant in
practice cannot accept position as auditor previously held by another chartered accountant without first communicating
with him in writing. He should get a NO Objection Certificate (NOC) from the previous auditor through this
communication as to know whether he has any objections to such an appointment made, for any valid reasons.
Terms of Audit Engagements
SA 210, “Terms of Audit Engagements” requires that for each period to be audited, the auditor should agree on the terms
of the audit engagement with the bank before beginning significant portions of fieldwork.
Initial Engagements
● The auditor needs to perform the audit procedures as mentioned in SA 510 “Initial Audit Engagements-Opening
Balances” and
● if after performing that procedures,
○ the auditor concludes that the opening balances contain misstatements which materially affect the
financial statements for the current period and
■ the effect of the same is not properly accounted for and
■ adequately disclosed,
● the auditor should express a qualified opinion or an adverse opinion, as appropriate.
Assessment of Engagement Risk
● The assessment of engagement risk

○ is a critical part of the audit process and
○ should be done prior to the acceptance of an audit engagement
■ since it affects the decision of accepting the engagement and
■ also in planning decisions if the audit is accepted.
Establish the Engagement experienced Team
The assignment of qualified and experienced professionals is an important component of managing engagement risk.
The size and composition of the engagement team would depend on size, nature and complexity of the bank’s
operation.
Understanding the Bank and its Environment
SA 315 “Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its
Environment” lays down that the auditor should obtain an understanding of the entity and its environment, including its
internal control, sufficient to identify and assess the risks of material misstatement of the financial statements whether
due to fraud or error and sufficient to design and perform further audit procedures.
Identifying and Assessing the Risks of Material Misstatements
SA 315 requires the auditor to identify and assess the risks of material misstatement at the financial statement level and
the assertion level for classes of transactions, account balances and disclosures to provide a basis for designing and
performing further audit procedures.
Understanding the Bank and Its Environment including Internal Control

An understanding of the bank and its environment, including its internal control, enables the auditor:
● to identify and assess risk;
● to develop an audit plan so as to determine the operating effectiveness of the controls and to address the specific
risks.
Understanding the Bank’s Accounting Process
The accounting process produces financial and operational information for management’s use and it also contributes to
the bank’s internal control.
Thus, understanding of the accounting process is necessary to identify and assess the risks of material misstatement
whether due to fraud or not and to design and perform further audit procedures.
Understanding the Risk Management Process
Management develops controls and uses performance indicators to aid in managing key business and financial risks.
An effective risk management system in a bank generally requires the following:
1. Oversight and involvement in the control process by those charged with governance (Control
Environment)
➢ Those charged with governance (Board of Directors/Managing Director) should approve written risk
management policies.
➢ The policies should be consistent with the bank’s business objectives and strategies, capital strength,
management expertise, regulatory requirements and the types and amounts of risk it regards as
acceptable.
2. Identification, measurement and monitoring of risks (Risk assessment)
➢ Risks that could significantly impact the achievement of a bank's goals should be identified, measured
and monitored against pre-approved limits and criteria.
3. Control activities
➢ A bank should have appropriate controls to mitigate its risks including effective segregation of duties
(particularly between front and back offices), accurate measurement and reporting of positions,
verification and approval of transactions, reconciliation of positions and results, setting up limits,
reporting and approval of exceptions, physical security and contingency planning.
4. Monitoring activities
➢ Risk management models, methodologies and assumptions used to measure and mitigate risk should
be regularly assessed and updated. This function may be conducted by the independent risk
management unit.
5. Reliable information systems
Banks require reliable information systems that provide adequate financial, operational and compliance
information on a timely and consistent basis. Those charged with governance and management require risk
management information that is easily understood and that enables them to assess the changing nature of the
bank’s risk profile. source – educba.com

Engagement Team Discussions
The engagement team should hold discussions to gain better understanding of banks and its environment, including
internal control, and also to assess the potential for material misstatements of the financial statements.
Establish the Overall Audit Strategy
SA 300 “Planning an Audit of financial Statements’’ states that the objective of the auditor is to plan the audit so that it
will be performed in an effective manner. For this purpose, the audit engagement partner should:
● establish the overall audit strategy, prior to the commencement of an audit; and
● involve key engagement team members and other appropriate specialists while establishing the overall audit
strategy, which depends on the characteristics of the audit engagement.
Develop the Audit Plan
SA 300 deals with the auditor’s responsibility to plan an audit of financial statements in an effective manner. It requires
the involvement of all the key members of the engagement team while planning an audit.
Audit Planning Memorandum
The auditor should summarise the audit plan by preparing an audit planning memorandum in order to:
● Describe the expected scope and extent of the audit procedures to be performed by the auditor.
● Highlight all significant issues and risks identified during their planning and risk assessment activities, as well as
the decisions concerning reliance on controls.
● Provide evidence that they have planned the audit engagement appropriately and have responded to
engagement risk, pervasive risks, specific risks, and other matters affecting the audit engagement.
Determine Audit Materiality
The auditor should consider the relationship between the audit materiality and audit risk when conducting an audit. The
determination of audit materiality is a matter of professional judgment and depends upon the knowledge of the bank,
assessment of engagement risk and the reporting requirements for the financial statements.
Consider Going Concern
While obtaining an understanding of the bank, the auditor should consider whether there are events and conditions
which may cast significant doubt on the bank’s ability to continue as a going concern.
Assess the Risk of Fraud including Money Laundering
As per SA 240 “The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements”, the auditor’s
objective is
● to identify and assess the risks of material misstatement in the financial statements due to fraud,
● to obtain sufficient appropriate audit evidence on those identified misstatements and to respond appropriately.
The attitude of professional skepticism should be maintained by the auditor so as to recognise the possibility of
misstatements due to fraud.

The RBI has from time to time issued guidelines (“Know Your Customer Guidelines – Anti Money Laundering Standards”),
requiring banks to establish policies, procedures and controls to deter and to recognise and report money laundering
activities.
Assess Specific Risks
The auditors should identify and assess the risks of material misstatement at the financial statement level which refers to
risks that relate pervasively to the financial statements as a whole and potentially affect many assertions.
Risk Associated with Outsourcing of Activities
The modern day banks make extensive use of outsourcing as a means of both reducing costs as well as making use of
services of an expert not available internally. There are, however, a number of risks associated with outsourcing of
activities by banks and therefore, it is quintessential for the banks to effectively manage those risks.
Response to the Assessed Risks
SA 330 “The Auditor’s Responses to Assessed Risks” requires the auditor to design and implement overall responses to
address the assessed risks of material misstatement at the financial statement level. The auditor should design and
perform further audit procedures whose nature, timing and extent are based on and are responsive to the assessed risks
of material misstatement at the assertion level.
Stress Testing
Stress testing is a software testing activity that determines the robustness of software by testing beyond the limits of normal operation.
Stress testing is particularly important for "mission critical" software, but is used for all types of software (Source – Wikipedia ) .
RBI has required that all commercial banks shall put in place a Board approved ‘Stress Testing framework’ to suit their
individual requirements which would integrate into their risk management systems.
BASEL III framework
The set of agreements by the BCBS (Basel Committee on Banking Supervision ), which mainly focuses on risks to banks
and the financial system are called Basel accord.
The Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB) has undertaken an
extensive review of the regulatory framework in the wake of the subprime crisis.
In the document titled ‘Basel III: A global regulatory framework for more resilient banks and banking systems’, released
by the BCBS in December 2010, it has inter alia proposed certain minimum set of criteria for inclusion of instruments in
the new definition of regulatory capital. (Items to be included while calculating the capital adequacy ratio)
Reliance on / review of other reports
The auditor should take into account the adverse comments, if any, on advances appearing in the following-
● Previous year’s audit reports.
● Latest internal inspection reports of bank officials.
● Reserve Bank’s latest inspection report.
● Concurrent / Internal audit report.
● Report on verification of security.

● Any other internal reports specially related to particular accounts.

● Manager’s charge-handing-over report when incumbent is changed.
The above reports should be reviewed in detail. The Statutory Central Auditors must review the Annual Financial
Inspection report of RBI relating to the bank and ensure that the variations in provisions, etc. reported by RBI have been
properly considered by the bank management.
Substantive procedures
In carrying out his substantive procedures,

● the auditor should examine all large advances while other advances may be examined on a sampling basis.
● The accounts identified to be problem accounts, however, need to be examined in detail unless the amount
involved is insignificant.
● The extent of sample checking would also depend on the auditor’s assessment of efficacy of internal controls.
What constitutes a ‘large advance’ would need to be determined in the context of volume of operations of the branch e.g.
an advance may be considered to be a large advance if the year-end balance is in excess of 2 crore or 5% of the
aggregate year-end advances of the branch, whichever is less.
Advances
What are advances?

- Advances are amounts of money or credit, given as a loan from a bank to another party with an agreement that
the money will be repaid.
- Bank charges interest on advances as the consideration for advances.
- Biggest item on the asset side.
- Major source of income for banks
Auditor’s View
Auditors must have sound knowledge of the
- various functional areas of the bank/branches,
- its processes, procedures, systems
- Guidelines, rules and regulation and
- prevailing internal controls with regard to advances.
Type of Advances
- Funded
- Non-Funded


In the case of a Bank, explain the meaning of Funded loans. Also give examples.
Answer as per ICAI MTP - Source www.icai.org
Funded loans are those loans where there is an actual transfer of funds from the bank to the borrower.
Advances comprise of funded amounts by way of:
● Term loans
● Cash credits,
● Overdrafts,
● Demand Loans
● Bills Discounted and Purchased
● Participation on Risk Sharing basis
● Interest-bearing Staff Loans
Classification of Advances
SECTOR WISE
Priority Sector
RBI issues common guidelines for lending to the Priority Sector which banks are required to follow. These guidelines
cover rate of interest; service charges, receipt, sanction, rejection, disbursement Register; issue of Loan Application
Acknowledgement. RBI also issues targets for banks for lending to the Priority Sector.
Examples of Priority Sectors are Agriculture , MSME , Education , Housing , etc.

SECURITY WISE
Banks ask Security or Collateral while lending to assure that the Borrower will return the money to bank in prescribed
time else the Banks have legal authority to sell the collateral to recover its money.
Primary Security
Primary security refers to the security offered by the borrower for bank finance or the one against which credit has been
extended by the bank. This security is the principal security for an advance.
Collateral security
It is an additional security. Security can be in any form i.e. tangible or intangible asset, movable or immovable asset.
Examples of Security
Examples of most common types of securities accepted by banks are the following:
- Personal Security of Guarantor

- Goods/Stocks/Debtors/Trade Receivables
- Gold Ornaments and Bullion
- Immovable Property
- Plantations (For Agricultural Advances) Third Party Guarantees
- Bankers General Lien The term lien refers to a legal claim or legal right which is made against the assets that are held as security for
satisfying a debt
- Life Insurance Policies

- Stock Exchange Securities and Other Instruments.
Mr. A approaches a bank for financial assistance for his upcoming project. The Bank Branch Manager, after verifying the
proposal, is agreeable to financing Mr. A, but asks for the security to be offered to the bank. Discuss the nature of securities
required to be offered to the bank. (MAY 2018, ICAI CA INTER)
Banks ask Security or Collateral while lending to assure that the Borrower will return the money to bank in prescribed time.
Explain stating clearly the concept of Primary and Collateral Security. Also give examples of most common types of securities
accepted by banks.
Nature of Security:
1. Primary security refers to the security offered by the borrower for bank finance or the one against which credit has been
extended by the bank. This security is the principal security for an advance.
2. Collateral security is an additional security. Security can be in any form i.e. tangible or intangible asset, movable or
immovable asset.
Examples of most common types of securities accepted by banks are the following.
● Personal Security of Guarantor
● Goods / Stocks / Debtors / Trade Receivables
● Gold Ornaments and Bullion
● Immovable Property
● Plantations (For Agricultural Advances)
● Third Party Guarantees
● Banker’s General Lien
● Life Insurance Policies
● Stock Exchange Securities and Other Instruments

Mode of Creation of Security
Depending on the nature of the item concerned, creation of security may take the form of a mortgage, pledge,
hypothecation, assignment, set-off or lien.
Mortgage
Mortgages are of several kinds but the most important are the
● Registered Mortgage and
● Equitable Mortgage.
● Registered Mortgage
○ It can be affected by a registered instrument called the 'Mortgage Deed' signed by the mortgagor.
○ It registers the property to the mortgagee as a security.
● Equitable Mortgage. (Equitable mortgage is also known as Mortgage by deposit of title deeds )
○ Equitable mortgage, on the other hand, is effected by a mere delivery of title deeds or other documents
of title with intent to create security thereof.
Pledge
- A pledge involves bailment or delivery of goods by the borrower to the lending bank with the intention of
creating a charge thereon as security for the advance.
- The legal ownership of the goods remains with the pledger while the lending banker gets certain defined
interests in the goods.
- The pledge of goods constitutes a specific (or fixed) charge.
Hypothecation
- The hypothecation is the creation of an equitable charge, in favour of the lending bank by execution of
hypothecation agreement in respect of the moveable securities belonging to the borrower.
- Neither ownership nor possession is transferred to the bank.
- However, the borrower holds the physical possession of the goods as an agent/trustee of the bank.

- The borrower periodically submits statements regarding quantity and value of hypothecated assets (stocks,
debtors, etc.) to the lending banker on the basis of which the drawing power of the borrower is fixed.
Assignment
Assignment represents a transfer of an existing or future debt, right or property belonging to a person in favor of another
person.
Only actionable claims (i.e., claim to any debt other than a debt secured by a mortgage of immovable property or by hypothecation or
pledge of moveable property) such as book debts and life insurance policies are accepted by banks as security by way of
assignment.
An assignment gives the assignee absolute right over the money/debts assigned to him.
Set-off
Set-off is a statutory right of a creditor to adjust, wholly or partly, the debit balance in the debtor’s account against any
credit balance lying in another account of the debtor.
The right of set-off enables a bank to combine two accounts (a deposit account and a loan account) of the same person
provided both the accounts are in the same name and same right (i.e., the capacity of the account holder in both the
accounts should be the same).
For the purpose of set-off, all the branches of a bank are treated as one single entity. The right of set-off can be exercised
in respect of time-barred debts also.
Lien
Lien is creation of a legal charge with consent of the owner, which gives the lender a legal right to seize and dispose /
liquidate the asset under lien.

Prudential norms on Income Recognition, Asset Classification and

Provisioning pertaining to Advances
Non-performing Assets
An asset becomes an NPA when it ceases to generate income for the Bank.
A non-performing asset (NPA) is a loan or an advance where -:

- interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term
loan;
- the account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/ CC);
- the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted.
Out of order
An account should be treated as 'out of order' if the outstanding balance remains continuously in excess of the
sanctioned limit/drawing power for 90 days.
In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing
power, but
- there are no credits continuously for 90 days as on the date of Balance Sheet or
- credits are not enough to cover the interest debited during the same period, these accounts should be treated as
'out of order'.
Overdue
Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on the due date fixed by the bank.

Provision Requirement

Other points w.r.t Provisioning
Basis of classification
● Classification as NPA should be based on the record of recovery. Availability of security or net worth of
borrower/guarantor is not to be taken into account for the purpose of treating an advance as NPA or otherwise.
Borrower-wise and not facility-wise

● Asset classification would be borrower-wise and not facility-wise.
● For Example :- Mr. Raman has availed two Loan facilities - a Car Loan as well as a Housing Loan from XYZ Bank
Ltd. He is regular in depositing the Housing loan EMI but has not deposited the last 4 EMI’s of the Car Loan due
to paucity of funds. Hence , in this case , not only the Car loan but the Housing Loan would also be treated as an
NPA, although it is going good and there are no irregularities because the NPA classification is Borrower wise (Mr.
Raman) and not Facility wise ( Car & Housing Loan individually).
Question
Classification as NPA should be based on the availability of security and asset classification would be facility wise and not
borrower wise. - Correct/ Incorrect - November 2020 - 2 marks
Accounts regularised near the Balance Sheet Date

● The asset classification of borrower accounts where a solitary or a few credits are recorded before the balance
sheet should be handled with care and without scope for subjectivity. Where the account indicates inherent
weakness on the basis of the data available, the account should be deemed as NPA.

Government Guaranteed advances

● Central Govt. guaranteed Advances, where the guarantee is not invoked/ repudiated would be classified as
Standard Assets, but regarded as NPA for Income Recognition purpose.
● The situation would be different if the advance is guaranteed by the State Government, where advance is to be
considered NPA if it remains overdue for more than 90 days for both Provisioning and Income recognition
purposes.
Advances under consortium
Basics
Consortium advances mean advancing loans to a borrower by two or more Banks jointly by forming a Consortium.
This will help the Banks

● to consolidate the appraisal benefit of different Banks and
● reduce the risks and
● also help the Banks to keep the exposure within the permissible limit
Joint appraisal, control and monitoring will facilitate for exchange of valuable information among the Banks
Usually, a Bank with a higher share will lead the consortium. It will be called - Lead Bank.
Asset classification
Asset classification of accounts under consortium should be based on the record of recovery of the individual member
banks.
Where the remittances by the borrower under consortium lending arrangements are pooled with one bank and/or
where the bank receiving remittances is not parting with the share of other member banks, the account will be treated
as not serviced in the books of the other member banks and therefore, be treated as NPA.
The banks participating in the consortium should, therefore, arrange to get their share of recovery transferred from the
lead bank or get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset
classification in their respective books.
Drawing Power
The Lead Bank would be responsible for computing the drawing power (DP) of the borrower and allocate the same to
member banks.
In certain special circumstances, at the request of the Borrower, the Lead Bank may allot a higher or lower share of
drawing power to the member bank, as against their share of advances.

Explain "Advances under Consortium" in the context of Prudential Norms on Income Recognition, Asset Classification and
Provisioning pertaining to Advances.
Accounts where there is erosion in the value of security / frauds

committed by borrowers

Erosion means the gradual destruction or diminution of something. It should be straight-away classified as doubtful or
loss asset as appropriate as follows :-
- Realisable value of the security is less than 50 per cent

- Erosion in the value of security can be reckoned as significant when the realisable value of the security is less
than 50 per cent of the value assessed by the bank or accepted by RBI at the time of last inspection, as the case
may be.
- Such NPAs may be straight-away classified under doubtful category and provisioning should be made as
applicable to doubtful assets.
- Realisable value of the security is less than 10 per cent of the outstanding in the borrowal accounts
- If the realisable value of the security, as assessed by the bank/ approved valuers/ RBI is less than 10 percent of
the outstanding in the borrowal accounts, the existence of security should be ignored and the asset should be
straight-away classified as loss asset. It may be either written off or fully provided for by the bank.
Advances Against Term Deposits, NSCs, KVPs/ IVPs, etc.
Advances against Term Deposits, NSCs eligible for surrender, KVP/IVP and life policies need not be treated as NPAs,
provided adequate margin is available in the accounts.
Agricultural Advances Affected by Natural Calamities
Master Circular issued by the RBI deals elaborately with the classification and income recognition issues due to
impairment caused by natural calamities.
Banks may decide on their own relief measures for example

- conversion of the short term production loan into a term loan or
- reschedulement of the repayment period and the sanctioning of fresh short term loan,
subject to the guidelines contained in RBI’s latest Master Circular on Prudential Norms on Income Recognition, Asset
Classification and provisioning pertaining to Advances.
In such cases, the NPA classification would be governed by such rescheduled terms.
Advances to Staff
Interest-bearing staff advances as a banker should be included as part of the advances portfolio of the bank.
In the case of housing loan or similar advances granted to staff members where interest is payable after recovery of
principal, interest need not be considered as overdue from the first instalment onwards.
Such loans/advances should be classified as NPA only when there is a default in repayment of instalment of principal or
payment of interest on the respective due dates.
The staff advances by a bank as an employer and not as a banker are required to be included under the sub-head
‘Others’ under the schedule of Other Assets.
Agricultural Advances
As per the guidelines, Agricultural Advances are of two types:

1. Agricultural Advances for “long duration” crops; and
2. Agricultural Advances for “short duration” crops.

The “long duration” crops would be crops with a crop season longer than one year and crops, which are not “long
duration” crops would be treated as “short duration” crops.
The crop season for each crop, which means the period up to harvesting of the crops raised, would be determined by
the State Level Bankers’ Committee in each State.
The following NPA norms would apply to agricultural advances (including Crop Term Loans):
- A loan granted for short duration crops will be treated as NPA, if the instalment of principal or interest thereon
remains overdue for two crop seasons; and
- A loan granted for long duration crops will be treated as NPA, if the instalment of principal or interest thereon
remains overdue for one crop season.
Pankaj & Co. had been allotted the branch audit of a nationalised bank for the year ended 31st March, 2018. In the
audit planning, the partner of Pankaj & Co. observed that the allotted branches are predominantly based in rural
areas and major portion of the advances were for agricultural purpose. He needs your assistance in incorporating
the criteria prescribed for determination of NPA norms in respect of agricultural advance, in audit plan.
Criteria for determination of NPA norms in respect of agricultural advances

An agricultural advance is classified as NPA if interest and / or instalment of principal is overdue for
● Two crops seasons , in case loans granted for Short Duration crops,
● One crop season, in case loans granted for Long Duration crops (i.e. More than 1 year)
For this purpose, the following points are to be considered:

1. Long duration crops mean the crop season is longer than one year.
2. Short Duration Crops means the period up to harvesting of the crops, as determined by the State Level
Bankers’ Committee in each State.
3. If natural calamities impair the repaying capacity of agricultural borrowers, banks may decide on their own as a
relief measure conversion of the short-term production loan into a term loan or reschedulement of the
repayment period; and the sanctioning of fresh short-term loan, subjects to guidelines issued by RBI.

Audit of Advances
Advances generally constitute the major part of the assets of the bank. There are a large number of borrowers to whom a
variety of advances are granted. The audit of advances requires the major attention from the auditors.
In carrying out audit of advances, the auditor is primarily concerned with obtaining evidence about the following
1. Amounts included in the balance sheet in respect of advances are outstanding at the date of the balance sheet.
2. Advances represent the amount due to the bank.
3. There are no unrecorded advances.
4. The stated basis of valuation of advances is appropriate and properly applied, and that the recoverability of
advances is recognised in their valuation.
5. Amounts due to the bank are appropriately supported by Loan documents and other documents as
applicable to the nature of advances.
6. Appropriate provisions towards advances have been made as per the RBI norms, Accounting Standards and
generally accepted accounting practices.
7. The advances are disclosed, classified and described in accordance with recognised accounting policies and
practices and relevant statutory and regulatory requirements.
8. Internal controls for sanctioning advances and reviewing them are designed, operating effectively, throughout
the period.
9. Carrying out appropriate analytical procedures.

In carrying out his substantive procedures, the auditor should examine all large advances while other advances may be
examined on a sampling basis.

The accounts identified to be problem accounts however need to be examined in detail unless the amount involved is
insignificant.

Advances which are sanctioned during the year or which are adversely commented on by RBI inspection team,
concurrent auditors, bank’s internal inspection, etc. should generally be included in the auditor’s review.
The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation of internal controls
relating to advances, and by:
- examining the validity of the recorded amounts;
- examining loan documentation;
- reviewing the operation of the accounts;
- examining the existence, enforceability and valuation of the security;
- checking compliance with RBI norms including appropriate classification and provisioning; and
- carrying out appropriate analytical procedures.
Advances generally constitute the major part of the assets of the bank. There are a large number of borrowers to whom a
variety of advances are granted. The audit of advances requires the major attention from the auditors. Explain the broad
considerations about which the auditor is primarily concerned with obtaining evidence in carrying out audit of advances. ICAI
RTP May 2021
The auditor can obtain sufficient appropriate audit evidence about advances by study and evaluation of internal controls
relating to advances. Explain in the context of Audit of Banks.
(RTP, Nov 2019, NA)

Evaluation of Internal Controls over Advances:

The auditor should examine the efficacy of various internal controls over advances to determine the nature, timing and
extent of his substantive procedures.
In general, the internal controls over advances should include, inter alia, the following:
CREDIT WORTHINESS and Sanction

The bank should make an advance only after satisfying itself as to the credit worthiness of the borrower and after
obtaining sanction from the appropriate authorities of the bank.
DOCUMENTS
All the necessary documents (e.g., agreements, demand promissory notes, letters of hypothecation, etc.) should be
executed by the parties before advances are made.
COMPLIANCE
The compliance with the terms of sanction and end use of funds should be ensured.
SUFFICIENT MARGIN
● Sufficient margin as specified in the sanction letter should be kept against securities taken so as to cover for any
decline in the value thereof.
● The availability of sufficient margin needs to be ensured at regular intervals.
SECURITIES OWNERSHIP
If the securities taken are in the nature of shares, debentures, etc., the ownership of the same should be transferred in the
name of the bank and the effective control of such securities be retained as a part of documentation.
SECURITIES REGISTRATION
All securities requiring registration should be registered in the name of the bank or otherwise accompanied by
documents sufficient to give title to the bank.
CONTENTS OF THE PACKAGE

In the case of goods in the possession of the bank, contents of the packages should be tested at the time of receipt. The
godowns should be frequently inspected by responsible officers of the branch concerned, in addition to the inspectors of
the bank.
DRAWING POWER REGISTER

Drawing Power Register should be updated every month to record the value of securities hypothecated. These entries
should be checked by an officer.
LIMIT
The accounts should be kept within both the drawing power and the sanctioned limit.
IRREGULAR ACCOUNTS
All the accounts which exceed the sanctioned limit or drawing power or are otherwise irregular should be brought to the
notice of the controlling authority regularly.
REVIEW
The operation of each advance account should be reviewed at least once a year, and at more frequent intervals in the
case of large advances.

The auditor should examine the efficacy of various internal controls over advances in case of Banks to determine the nature,
timing and extent of his substantive procedures. Explain what is included in the internal controls over advances
(RTP, Nov 2018, NA) (SA, Nov 2018, 5 Marks) (RTP, May 2019, NA) (MTP2, May 2019, 4 Marks)

COMPUTATION OF DRAWING POWER
Drawing Power generally addressed as “DP” is an important concept for Cash Credit (CC) facility available from banks and
financial institutions.
Drawing power is the limit up to which a firm or company can withdraw from the working capital limit sanctioned.
Sanctioned limit is the total exposure

The Sanctioned limit is the total exposure that a bank can take on a particular client for facilities like cash credit,
overdraft, export packing credit, non-funded exposures etc.
Drawing Power = value of primary security less margin

On the other hand, Drawing Power refers to the amount calculated based on primary security less margin as on a
particular date.
All accounts should be kept within both the drawing power and the sanctioned limit at all times. The accounts which
exceed the sanctioned limit or drawing power or are against unapproved securities or are otherwise irregular should be
brought to the notice of the Management/Head office regularly.
Ensure drawings are covered by the adequacy of the current assets

- Banks should ensure that drawings in the working capital account are covered by the adequacy of the current
assets.
- Drawing power is required to be arrived at based on the current stock statement.
- However, considering the difficulties of large borrowers, stock statements relied upon by the banks for
determining drawing power should not be older than three months otherwise it will be deemed as irregular.
Auditor’s Concern
- The stock statements, quarterly returns and other statements submitted by the borrower to the bank should
be scrutinised in detail.
- The audited Annual Report submitted by the borrower should be scrutinised properly.
- The audited statements and records submitted by the borrower should be compared and the reasons for
deviations, if any, should be ascertained.
Computation of DP
- It needs to be ensured that the drawing power is calculated as per the extant guidelines formulated by the Board
of Directors of the respective bank and agreed upon by the concerned statutory auditors.
- Special consideration should be given to proper reporting of sundry creditors for the purposes of calculating
drawing power.
Stock Audit
- The stock audit should be carried out by the bank for all accounts having funded exposure of more than 5 crores.
- Auditors can also advise for stock audit in other cases if the situation warrants the same.
- Branches should obtain the stock audit reports from lead banks in the cases where the Bank is not the leader of
the consortium of working capital.
- The report submitted by the stock auditors should be reviewed during the course of the audit and special focus
should be given to the comments made by the stock auditors on valuation of security and calculation of drawing
power.


Audit of Revenue Items (Income)
Items which are included in the income of the bank
Interest Earned
- Interest/Discount on Advances/Bills:
- Interest Income on Investments:
- Interest on Balances with RBI and Other Inter-bank Funds:
- OthersThis includes any other interest/discount income not included in the above heads
- Other Income Commission, Exchange and Brokerage
Other Income
- Commission, Exchange and Brokerage - This item comprises of the following:

- Commission on bills for collection.
- Commission/exchange on remittances and transfers, e.g. demand drafts, NEFT, RTGS, etc.
- Commission on letters of credit and guarantees, letter of comforts.
- Loan processing, arranger and syndication fees.
- Mobile banking fees.
- Credit/Debit card fee income including annual fee income, merchant acquiring income, interchange
fees, etc.
- Rent from letting out of lockers
- Commission on Government business.
- Commission on other permitted agency business including consultancy and other services. ( j) Brokerage
on securities.
- Fee on insurance referral.
- Commission on referral of mutual fund clients.
- Service/transaction banking charges including charges levied for transaction at other branches.
- Income from rendering other services like custodian, demat, investment advisory, management and other based
services.
- Profit on Sale of Investments
- Profit/Loss on Revaluation of Investments
- Profit on sale of Land, Buildings and Other Assets:
- Profit/Loss on Revaluation of Fixed Assets
- Profit on exchange transactions
- Income earned by way of dividends, etc.
- Miscellaneous income.

Audit Approach and Procedures For Income
Auditor’s Concern
In carrying out audit of income, the auditor is primarily concerned with obtaining reasonable assurance that the
recorded income arose from transactions, which took place during the relevant period and pertained to the bank,
there is no unrecorded income and the income is recorded at appropriate amounts.
RBI’s Directions - Accrual basis and Receipt Basis.

- RBI has advised that in respect of any income which exceeds one percent of the total income of the bank if the
income is reckoned on a gross basis or one percent of the net profit before taxes if the income is reckoned net
of costs, should be considered on accrual as per Accounting Standard 9.
- Other income may be recognised when received and the auditors need not qualify their report in that situation.
NPA
- Banks should not recognize income on non performing assets until it is actually realised.
- This will apply to Government guaranteed accounts also.
Advances against Securities

Interest on advances against Term Deposits, National Savings Certificates (NSCs), Indira Vikas Patras (IVPs), Kisan Vikas
Patras (KVPs) and Life policies may be taken to income account on the due date, provided adequate margin is available
in the accounts.
Bills Purchased
- In the case of bills purchased outstanding at the close of the year the discount received thereon should be
properly accounted for in the correct accounting periods.
- Interest (discount) component paid by Bank/Branch on rediscount of bills from other financial institutions, is not
to be netted off from the discount earned on bills discounted.
Bills for Collection

- In the case of bills for collection, the auditor should also examine the procedure for crediting the party on whose
behalf the bill has been collected.
- The procedure is usually such that the customer’s account is credited only after the bill has actually been
collected from the drawee either by the bank itself or through its agents, etc.
- The commission of the branch becomes due only when the bill has been collected.
Rescheduling of outstanding debts

- Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts
should be recognised on an accrual basis over the period of time covered by the re-negotiated or
rescheduled extension of credit.
- Test check the interest earned by the banks for the sample selected.
- Test check the fees and commissions earned by the banks made for commission on bills for collection, letters of
credit and bank guarantees.
Reversal of Income:
If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, the entire interest
accrued and credited to income account in the past periods, should be reversed or provided for if the same is not
realised. This will apply to Government guaranteed accounts also.
In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period
and should be reversed or provided for with respect to past periods, if uncollected.

Furthermore, the auditor should inquire if there are any large debits in the Interest Income account that have not been
explained. It should be enquired whether there are any communications from borrowers pointing out differences in
interest charge and whether appropriate action has been taken in this regard.
On leased assets
The component of finance income (as defined in AS 19 Leases) on the leased asset which was accrued and credited to the
income account before the asset became non-performing and remaining unrealised, should be reversed or provided for
in the current accounting period.
On Take-out finance
- A takeout loan is a method of financing whereby a loan that is procured later is used to replace the initial loan.
- Takeout loans are commonly used in property development ( Source :- Investopedia) In the case of take-out
finance, if based on record of recovery, the account is classified by the lending bank as NPA, it should not
recognize income unless realised from the borrower/taking-over institution (if the arrangement so provides).
All types of borrowers can get a take-out loan from a credit issuer to pay off past debts. Take-out loans can be used as a long-term
personal loan to pay off previous outstanding balances with other creditors. They are most commonly used in real estate construction to
help a borrower replace a short-term construction loan and obtain more-favourable financing terms. The take-out loan's terms can
include monthly payments or a one-time balloon payment at maturity.
Take-out loans are an important way of stabilising your financing by replacing a short-term, higher-interest-rate loan with a long-term,
lower-interest-rate one.
Example of a Take-Out Loan - Note for exams. - Source Investopedia

Assume XYZ company has received approval for plans to build a commercial real estate office building over 12 to 18 months. It may
obtain a short-term loan for the financing it needs to build the property, with full repayment required in 18 months. The property plans
are achieved ahead of schedule and the building is completed in 12 months. XYZ now has more negotiating power, because the fully
complete property is able to be used as collateral. Thus, it decides to obtain a take-out loan, which provides it with the principal to pay off
the previous loan six months early.
The new loan allows XYZ to make monthly payments over 15 years at an interest rate that is half of that of the short-term loan. With the
take-out loan, it can repay its short-term loan six months early, saving on interest costs. XYZ now has 15 years to pay its new take-out loan
at a much lower rate of interest, using the completed property as collateral.

Income Recognition On Partial Recoveries in NPAs:
Interest partly/fully realised in NPAs can be taken to income.
It should be ensured that the credits towards interest in the relevant accounts are not out of fresh/additional credit
facilities sanctioned to the borrowers concerned.
In the absence of a clear agreement between the bank and the borrower for the purpose of appropriation of recoveries in
NPAs (i.e., towards principal or interest due), banks are required to adopt an accounting policy and exercise the right
of appropriation of recoveries in a uniform and consistent manner.
The appropriate policy to be followed is to recognise income as per AS 9 when certainty attaches to realisation and
accordingly amount reversed/derecognised or not recognised in the past should be accounted for.
Memorandum Account
- On an account turning NPA, banks should reverse the interest already charged and not collected by debiting
Profit and Loss account and stop further application of interest.
- However, banks may continue to record such accrued interest in a Memorandum account in their books for
control purposes.
- For the purpose of computing Gross Advances, interest recorded in the Memorandum account should not be
taken into account.
Income from Investments
Interest Income on Investments

This includes all income derived from Government securities, bonds and debentures of corporates and other investments
by way of interest and dividend, except income earned by way of dividends, etc., from subsidiaries and joint ventures
abroad/in India. (Such dividends from subsidiaries are shown separately and not as income from investments.)
Profit on Sale of Investments

Investments are dealt in the course of banking activity and hence the net profit or loss on sale of investments is taken to
profit and loss account.
Profit/Loss on Revaluation of Investments

In terms of guidelines issued by the RBI, investments are to be valued at periodical intervals and depreciation or
appreciation in valuation should be recognised and taken to profit and loss account.

EXPENSES
Categories
Expenditure is to be shown under three broad heads:
1. Interest expense.
2. Operating expense.
3. Provisions and contingencies.
Audit Approach and Procedures Interest Expense
In carrying out an audit of interest expense, the auditor is primarily concerned with
- Reasonableness of amount of interest.
- Assessing the overall reasonableness of the amount of interest expense
- by analysing
- ratios of interest paid on different types of deposits and borrowings
- to the average quantum of the respective liabilities during the year.
- The auditor should obtain from the bank an analysis of various types of deposits outstanding at the end
of each quarter. From such information, the auditor may work out a weighted average interest rate (Rate
of interest for different categories).
- The auditor may then compare this rate with the actual average rate of interest paid on the relevant
deposits.
- If any material difference is found material then it should be further enquired into by the auditor.
- Comparison with previous year interest
- auditor should also compare the average rate of interest paid on the relevant deposits with the
corresponding figures for the previous years and analyse any material differences.
- Comparison with budget
- The auditor should also compare the interest expenses with the budgeted figures and should enquire
into material differences.
- Auditors should also obtain understanding of the budgeting procedures.
- Verify the calculation of Interest
- The auditor should, on a test check basis, verify the calculation of interest and ensure that:
- Interest has been provided on all deposits upto the date of the balance sheet;
- Interest rates are in accordance with the bank’s internal regulations, the RBI directives and
agreements with the respective deposit holder;
- Interest amounts credited on various deposits are in accordance with the rules framed by the
bank/RBI on this behalf.
- Interest on inter–branch balances has been provided at the rates prescribed by the head
office/RBI.
- Changes in the interest rate
- The auditor should ascertain whether there are any changes in interest rate on saving accounts and term
deposits during the period.
- The auditor should obtain the interest rate card for various types of deposits and analyse the interest cost
for the period accordingly.
- Completeness
- The auditor should examine the completeness that interest has been accrued on the entire borrowing
portfolio and the same should agree with the general ledgers.
Operating expenses
For audit of operating expenses, the auditor should
- IC
- Study and evaluate the system of internal control relating to expenses, including authorization
procedures in order to determine the nature, timing and extent of his other audit procedures.

- Changing Trends
- The auditor should examine whether there are any changing trends in respect of major items of
expenses.
- Substantive analytical procedures in respect of expenses
- The auditor should perform substantive analytical procedures in respect of these expenses. e.g. assess
the reasonableness of expenses by working out their ratio to total operating expenses and comparing it
with the corresponding figures for previous years.
- Verify expenses from documents and check calculations
- The auditor should also verify expenses with reference to supporting documents and check the
calculations wherever required.
Audit of Provisions and contingencies

- Ensure compliance with regulatory requirements
- The auditor should ensure that the compliances for various regulatory requirements for provisioning as
contained in the various circulars have been fulfilled.
- Understanding the computation of provision and classification of assets
- The auditor should obtain an understanding as to how the bank computes provision on standard assets
and non-performing assets.
- It will primarily include checking the basis of classification of loans and receivables into standard,
sub-standard, doubtful, loss and nonperforming assets.
- Verify the classification on sampling basis
- The auditor may verify the loan classification on a sample basis.
- The auditor should obtain the detailed breakup of standard loans, nonperforming loans and agree the
outstanding balances with the general ledger.
- Check the computation of Tax Provision
- The auditor should obtain the tax provision computation from the bank’s management and verify the
nature of items debited and credited to the profit and loss account to ascertain that the same are
appropriately considered in the tax provision computation.
- Examining other provisions
- The other provisions for expenses should be examined according in the light of
- circumstances warranting the provisioning and
- the adequacy of the same
- by discussing and obtaining the explanations from the bank’s management.

Misc Topics
Banking Operations - Conducted only at Branches

Banking operations are conducted only at the branches,
- while other offices act as controlling authorities or administrative offices
- that lay down policies, systems and internal control procedures for conduct of business, in compliance with the
statutory/ regulatory impositions and in compliance of accepted accounting principles and practices that cover
all transactions and economic events.
These controlling/ administrative offices also

- stipulate the delegation of powers and fix responsibilities and accountability and
- these are involved generally in effective supervision, monitoring and control over the business activities and
operations, including seeking faithful compliance of the bank’s laid down policies/ procedures /controls and deal
with deviations therefrom.

Chapter 13 Audit of Different types of Entities

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OBJECTIVES
1. Accounting for Public Funds:-Government audit serves as a mechanism or process for public
accounting of government funds.
2. Appraisal of Government policies:-It also provides public accounting of the operational, management,
programme and policy aspects of public administration as well as accountability of the officials
administering them.
3. Base for Corrective actions:-Audit observations based on factual data collection also serve to highlight
the lapses of the lower hierarchy, thus helping supervisory level officers to take corrective measures.
Government audit has not only adopted the basic essentials of auditing as known and practised in the
profession to suit the requirements of governmental transactions but has also added new concepts,
techniques and procedures to the audit profession. Explain stating clearly the definition of Government
auditing as discussed in U.N. Handbook on Govt Auditing and Developing Countries and also state
Objectives of Govt audit. ICAI RTP May 2021
Legal Framework and Comptroller & Auditor General
The Constitution of India contains specific provisions regarding the appointment, salary and duties and
powers of the C&AG.
Appointment
The President of India shall appoint CAG.
Removal or resignation
● He can be removed from the office only on the ground of proven misbehavior or incapacity.
● Moreover, he can be removed from office only when each house of parliament decides to do so by
a majority of at least two third of members present and voting.
Remuneration
● The parliament is competent to make laws to determine salary and other conditions of service.
● The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 passed in
pursuance of the provisions of the Constitution lays down a fixed tenure of the office prescribing that
he shall be paid a salary which is equal to the salary of the Judge of the Supreme Court thereby
further strengthening his independence.
Duties and Power

Article 149 states that the C&AG shall perform such duties and exercise such powers in relation to the
accounts of the Union and of the States and of any other authority or body as may be prescribed by or under
any law made by the Parliament.
The Comptroller & Auditor General’s (Duties, Powers and Conditions of Service) Act, 1971 defines these
functions and powers in detail.
Article 150 of the Constitution provides that the accounts of the Union and of the States shall be kept in such
form as the President may on the advice of the C&AG prescribe.

Article 150 of the Constitution provides that the accounts of the Union and of the States shall be kept
in such form as the Finance Minister may on the advice of the C&AG prescribe.
Reporting Procedures
Article 151 of the Indian Constitution states that the C&AG shall report on the accounts of the Union and of
each of the States to the President or the Governor concern and the report to be laid before the legislatures.
The reports should not only be presented to the legislatures but thereafter also publicised adequately in
order to create a proper climate of public opinion for taking remedial action where necessary, on the
findings of the Auditor General.
Study Plan
We will study the audit of following items in Government for CA Intermediate

1. Expenditure audit
2. Audit of Receipts
3. Audit of Stores
Expenditure Audit
Expenditure Audit The auditor examines the fulfillment of conditions for incurring government expenditure.
It involves examination of following:—
1. Audit of rules and orders
2. Audit of sanctions
3. Audit against provision of funds
4. Propriety audit
5. Performance audit
Audit of Rules and Orders/Audit of Regularity and Legality
( ख़र्चा Constitution, law CAG और higher authority क़े हिसाब स़े होना चाहिए) ये चेक करने के लिए auditor को कुछ चीज़ों की
Sound knowledge होनी चाहिए)
1. Its objective is to ensure whether the expenditure is in accordance with:

○ Relevant provisions of the Constitution and of the laws and rules.
○ The rules, regulations issued by CAG.
○ The orders of, or rules made by, any higher authority.
2. In this connection, auditor should have sound knowledge of rules and orders w.r.t. Following:
○ The powers to incur and sanction expenditure from the Consolidated Fund/ contingency fund
of India / State;
○ The mode of presentation of claims against government, withdrawing moneys from the
Consolidated Fund, Contingency Fund and the financial rules prescribing the procedure to be

followed by government; and (HOW CLAIMS ARE PRESENTED & HOW MONEY IS
WITHDRAWAN)
○ Regulating the conditions of service, pay and allowances, and pensions of government
servants.
Question
What is the function of audit while examining various rules, regulations and orders with regard to
Audit against Rules & Orders by C&AG?
Audit of Sanctions
(हर ख़र्चा sanctioned होना चाहिए है , और sanction proper authority से होना चाहिए )
Its objective is to ensure whether the expenditure is:

1. Properly covered by a sanction, either general or special.
2. Sanctioned by authority, which is authorized to do so.
Thus auditor should consider following
● He should have knowledge of the sanctioning powers of various authorities.
● He should examine whether all sanctions are adequately noted in the prescribed register.
● For petty expenditure, the signature of the competent authority on a bill can be regarded as a
sanction.
Audit against provision of funds

Its objective is to ensure whether the expenditure
● Is made for the purpose for which the grant and appropriation has been provided.
● Does not exceed the appropriation made.
Propriety Audit(M.imp)
● The Propriety audit is to check the expenditure in accordance with financial wisdom and
uprightness.
● It is to check to bring out the improper, avoidable, expenditure even though such expenditure has
been incurred in conformity with the existing rules and regulations.
● A transaction may satisfy all the requirements of regularity audit in so far as the various formalities
regarding rules and regulations are concerned but may still be highly wasteful.
● It is not audit of sanction or against rules.
● It is a qualitative, opinion-based expression of auditor's findings.
In this regards, the following main points should be kept for consideration:
● The expenditure should not be prima facie more than what the occasion demands. Public money
should be spent by the officers, as of their own with utmost diligence and care.

● No order for sanction of expenditure should be made by an authority which results in gains directly
or indirectly to that authority
● Public money should not be utilised for the benefit of a particular person or section of the
community unless
○ the amount of expenditure involved is insignificant; or
○ a claim for the amount could be enforced in a Court of law; or
○ the expenditure is in pursuance of a recognized policy or custom; and
● The cost of administering should not eat off the benefits of the expenditure.
Performance audit / Full Scope Audit

● Here, auditor tries to ensure that government programmes have achieved the objectives at the lowest
cost and given the intended benefits. (Achieved Objectives, Lowest Cost, Intended Benefits)
● This involves that the various programmes, schemes and projects where large financial expenditure
has been incurred are being run economically and are yielding results expected of them.
● Includes efficiency, economy and effectiveness audit.
● It seeks to identify opportunities for greater economy and effectiveness.
Question
The audit of government expenditure is one of the major components of government audit. Explain
the basic standards set for such audit of expenditure. (4 Marks)
MTP March 2021
Audit of Stores and Stocks

● Auditors should ascertain whether the internal controls over purchase, receipt, and issue of
stores are well designed and properly carried out during the year.
● He should bring to the notice of the government any deficiencies in the system of control.
● The audit of purchase of stores is conducted in the same manner as audit of expenditure.
● The auditor has to ensure that the prices paid are reasonable.
● Cases of uneconomical purchase of stores and losses due to defective or inferior quality of
stores are specifically examined.
● The certificates of quality and quantity given by expert should be examined.

● Any excess or idle stocks should be specifically mentioned in the report.
● Auditor should ensure their existence by attending physical verification of stock.
● The valuation of the stocks is also examined properly.
Audit of Receipts
The government audit also covers receipts payable in to the Consolidated Fund of India and of each
State/Union Territory. The auditor examines whether: —

● Internal checks are imposed for prompt detection and investigation of irregularities. .
● Internal procedures adequately ensure proper accounting of demands collection.
● There is effective check on assessment, collection and proper allocation of revenue.
● Such regulations and procedures are actually being carried out.
● All revenues have been correctly assessed, realized and credited to the government account.
● There is no leakage of revenue.
Question
The audit of receipts of the government is not as old as audit of expenditure but with the rapid growth of
public enterprises audit of receipts tax or non-tax has come to stay. Discuss audit of receipts with respect
to Government Audit.
Duties of Comptroller & Auditor General:
The Comptroller & Auditor General's (Duties, Powers and Conditions of Service) Act, 1971 lays down duties of
the C&AG as under:
Compile and submit Accounts of Union and States
○ The C&AG shall be responsible for

■ compiling the accounts
■ of the Union and of each State rendered
■ to the audit and accounts offices under his control
■ by treasuries, offices or departments responsible for the keeping of such account.
General Provisions Relating to Audit
○ It shall be the duty of the C&AG -

■ to audit and report
➢ on all expenditure
✓ from the Consolidated Fund of India and of each State and of each
Union Territory having a Legislative Assembly and
✓ to ascertain whether the moneys shown in the accounts as having been
disbursed were legally available for and applicable to the service or
purpose to which they have been applied or charged and
✓ whether the expenditure conforms to the authority which governs it;
■ to audit and report
➢ all transactions
✓ of the Union and of the States relating to Contingency Funds and Public
Accounts;
■ to audit and report on

➢ all trading, manufacturing profit and loss accounts and balance-sheets and
other accounts kept in any department of the Union or of a State.
Audit of Receipts and Expenditure
○ Where anybody or authority

■ is substantially financed
➢ by grants or loans
➢ from the Consolidated Fund of India or of any State or of any Union Territory
having a Legislative Assembly,
■ the Comptroller and Auditor General shall,
■ subject to the provisions of any law for the time being in force applicable to the body or
authority, as the case may be,
➢ audit all receipts and expenditure of that body or authority and to report on the
receipts and expenditure audited by him.
Audit of Grants or Loans
○ Where any grant or loan

○ is given for any specific purpose
■ from the Consolidated Fund of India or of any State or of any Union Territory having a
Legislative Assembly
■ to any authority or body,
■ the Comptroller and Auditor General shall
➢ scrutinize the procedures by which the sanctioning authority satisfies itself as
to the fulfillment of the conditions subject to which such grants or loans were
given and
➢ shall for this purpose have right of access, after giving reasonable previous
notice, to the books and accounts of that authority or body.
Audit of Receipts of Union or States
○ It shall be the duty of the Comptroller and Auditor General

○ to audit all receipts
■ which are payable into
■ the Consolidated Fund of India and of each State and of each Union Territory having a
Legislative Assembly
○ and to satisfy himself that
■ the rules and procedures in that behalf are designed
● to secure an effective check on the
○ assessment,
○ collection and
○ proper allocation of revenue and
● are being duly observed and
○ to make this purpose such examination of the accounts as he thinks fit and report thereon.
Audit of Accounts of Stores and Stock

○ The Comptroller and Auditor General shall have authority

○ to audit and report on the accounts of stores and stock kept in any office or department of the
Union or of a State.
Audit of Government Companies and Corporations

○ The duties and powers of the Comptroller and Auditor General in relation to the audit of the
accounts of government companies shall be performed and exercised by him in accordance
with the provisions of the Companies Act, 2013.
The Comptroller and Auditor General shall be responsible for compiling the accounts of the Union and of
each State from the initial and subsidiary accounts rendered to the audit and accounts offices under his
control by treasuries, offices or departments responsible for the keeping of such account. Explain. MTP 1
May 2021 (4 Marks)
Power of Comptroller and Auditor General of India in performance of

duties. (November 2014)
Powers of the Comptroller and Auditor General of India in performance of duties: The Comptroller and
Auditor General's (Duties, Powers and Conditions of Service) Act, 1971 gives the following powers to the C&AG
in connection with the performance of his duties-
1. Inspect
● To inspect any office of accounts under the control of the Union or a State Government
including office responsible for the creation of the initial or subsidiary accounts.
2. Require (ABPO)
● To require that any accounts, books, papers and other documents which deal with or are
otherwise relevant to the transactions under audit, be sent to specified places.
3. Put Question / Make Observations / Call Info
● To put such questions or make such observations as he may consider necessary
● to the person in charge of the office and to call for such information as he may require for the
preparation of any account or report which is his duty to prepare.
In carrying out the audit, the C&AG has the power to dispense with any part of detailed audit of any accounts
or class of transactions and to apply such limited checks in relation to such accounts or transactions as he
may determine.
Miscellaneous Question
Question
Government audit is neither equipped nor intended to function as an investigating agency, to pursue
every irregularity or misdemeanour to its logical end. Explain ICAI RTP May 2021
Answer as given by ICAI in RTP (www.icai.org)
Government audits are neither equipped nor intended to function as an investigating agency, to pursue
every irregularity or misdemeanour to its logical end. The main objective of audit is a combination of

ensuring accountability of administration to the legislature and functioning as an aid to administration. In

India, the function of Government Audit is discharged by the independent statutory authority of the
Comptroller and Auditor General through the agency of the Indian Audit and Accounts Department. Audit
is a necessary function to ensure accountability of the executive to Parliament, and within the executives of
the spending agencies to the sanctioning or controlling authorities. The purpose or objectives of audit
need to be tested at the touchstone of public accountability. The Comptroller and Auditor General (C&AG),
in the discharge of his functions, watches that the various authorities act in regard to financial matters in
accordance with the Constitution and the laws made by Parliament, and conform to the rules or orders
made thereunder.

Audit of Local Bodies
Background
State the background of 'Local Bodies". Draft an audit programme for audit of local bodies. (8 Marks)
Answer- Background of Local Bodies: A municipality can be defined as a unit of local self- government in an
urban area. By the term 'local self-government' is ordinarily understood the administration of a locality - a
village, a town, a city or any other area smaller than a state - by a body representing the local inhabitants,
possessing fairly large autonomy, raising at least a part of its revenue through local taxation and spending its
income on services which are regarded as local and, therefore, distinct from state and central services.
Municipal government in India covers five distinct types of urban local authorities, viz., the municipal
corporations, the municipal councils, the notified area committees, the town area committees and the
cantonment committees.
Audit Programme For Local Body
Audit Programme for local bodies
1. The Local Fund Audit Wing of the State Govt, is generally in charge of the audit of municipal accounts.
Sometimes bigger municipal corporations e.g. Delhi, Mumbai etc have power to appoint their own
auditors for regular external audit. So the auditor should ensure authenticity of his appointment.
2. The auditor while auditing the local bodies should report on the
a. fairness of the contents and presentation of financial statements,
b. the strengths and weaknesses of the system of financial control,
c. adherence to legal and/or administrative requirements;
d. upon whether value is being fully received on money spent.
e. His objective should be to detect errors and fraud and misuse of resources.
3. The auditor should ensure that the expenditure incurred conforms to the relevant provisions of the
law and is in accordance with the financial rules and regulations framed by the competent authority.
4. He should ensure that all types of sanctions, either special or general, accorded by the competent
authority.
5. He should ensure that there is a provision of funds and the expenditure is incurred from the provision
and the same has been authorized by the competent authority.
6. The auditor should check that the different schemes, programmes and projects, where large financial
expenditure has been incurred, are running economically and getting the expected results.



Features of Financial Administration of Local bodies
Describe the salient features of Financial Administration of Local Bodies
Salient Features of Financial Administration of Local Bodies
1. Budgetary Procedure: The objective of local bodies budgetary procedure are

a. financial accountability,
b. control of expenditure,
c. and to ensure that funds are raised and moneys are spent by the executive departments in
accordance with the rules and regulations and within the limits of sanction and authorisation
by the legislature or Council.
Different aspects covered in budgeting are determining the level of taxation, fees, rates, and laying
down the ceiling on expenditure, under revenue and capital heads.
2. Expenditure Control: At the State and Central level, there is a clear demarcation between the
legislature and executive. In the local body, legislative powers are vested in the Council whereas
executive powers are delegated to the officers, e.g., Commissioners. All matters of regular revenue and
expenditures are generally delegated to the executive wing. For special situations like, reduction in
property taxes, refund of security deposits, etc., sanction from the legislative wing is necessary.
3. Accounting System: Municipal Accounting System has been conventionally prepared under the cash
system. In the recent past however, it is being changed to the accrual system of accounting. The
accounting system is characterized by (a) subsidiary and statistical registers for taxes, assets, cheques
etc., (b) separate vouchers for each type of transaction, (c) compulsory monthly bank reconciliation, (d)
submission of summary reports on periodical basis to different authorities at regional and state level.
Types of Grants Received by Local Authority
Local bodies may receive different types of grants from the state administration as well. Broadly, the revenue
grants are of three categories
1. General purpose grants: These are primarily intended to substantially bridge the gap between the
needs and resources of the local bodies.
2. Specific purpose grants: These grants which are tied to the provision of certain services or
performance of certain tasks.
3. Statutory and compensatory grants: These grants, under various enactments, are given to local bodies
as compensation on account of loss of any revenue on taking over a tax by state government from
local government.
Question
Explain the different types of revenue grants which local bodies may receive.

Auditing of Leasing Transaction
What procedure may be adopted by an auditor, while auditing leasing transactions entered into by the
leasing company? (8 Marks)
Answer
In respect of leasing transaction entered into by the leasing company, the following procedures may be
adopted by the auditor.
1. The object clause of leasing company to see that the goods like capital goods, consumer durables etc.
in respect of which the company can undertake such activities. Further, to ensure that whether
company can undertake financing activities or not.
2. Whether there exists a procedure to ascertain the credit analysis of lessee like lessee's ability to meet
the commitment under lease, past credit record, capital strength, availability of collateral security, etc.
3. The lease agreement should be examined and the following points may be noted:
a. the description of the lessor, the lessee, the equipment and the location where the equipment
is to be installed. (The stipulation that the equipment shall not be removed from the described
location except for repairs. For the sake of identification, the lessor may also require plates or
markings to be attached to the equipment).
b. the tenure of lease, dates of payment, late charges, deposits or advances etc. should be noted.
c. whether the equipment shall be returned to the lessor on termination of the agreement and
the cost shall be borne by the lessee.
d. whether the agreement prohibits the lessee from assigning the subletting the equipment and
authorises the lessor to do so.
4. Examine the lease proposal form submitted by the lessee requesting the lessor to provide him the
equipment on lease.
5. Ensure that the invoice is retained safely as the lease is a long-term contract.
6. Examine the acceptance letter obtained from the lessee indicating that the equipment has been
received in order and is acceptable to the lessee.
7. See the Board resolution authorising a particular director to execute the lease agreement has been
passed by the lessee.
8. See that the copies of the insurance policies have been obtained by the lessor for his records.


Auditing of Hire Purchasing Companies
Hire-purchase agreement means an agreement under which goods are let on hire and under which the hirer
has an option to purchase them in accordance with the terms of the agreement
While checking the hire- purchase transaction, the auditor may examine the following
1. Check Memorandum of Association - Object clause to ascertain whether the hire purchase business
can be carried on by company
2. Hire purchase agreement is in writing and is signed by all parties.
3. Before signing the HP agreement credit worthiness must be evaluated, auditor will check whether
proper policy and procedure exist for the same and whether they are followed are not.
4. Hire purchase agreement specifies clearly-
a. The hire-purchase price of the goods to which the agreement relates;
b. The cash price of the goods, that is to say, the price at which the goods may be purchased by
the hirer for cash;
c. The date on which the agreement shall be deemed to have commenced;
d. The number of instalments by which the hire- purchase price is to be paid, the amount of each
of those instalments, and the date, upon which it is payable, and the person to whom and the
place where it is payable.
5. Ensure that instalment payments are being received regularly as per the agreement
6. Ensure that adequate resolution has been passed authorizing a particular director to execute the hire
purchase agreement.
7. Explain the adequacy of provision for doubtful debts against the hire purchase debtors
8. Examine the case of repossession of goods and their treatment afterwards. Check how and when
they were sold or disposed.
9. Check whether accounting treatment of amount due, amount received, loss on repossession and
other related items are done as per applicable financial reporting framework.
Auditor should also understand the following w.r.t Hire Purchase and design his audit procedures
accordingly
1. Possession of goods is delivered by the owner thereof to a person on condition that such person pays
the agreed amount in periodical instalments,
2. The property in the goods is to pass to such person on the payment of the last of such instalments.
3. Such person has a right to terminate the agreement at any time before the property so passes
Homework - Difference between Operating (Right to use ) and Finance lease. (Risk and Reward) Study
AS 19 For more details and also cover Difference between OL and FL from ICAI Auditing Study Material
Chapter 13.

Audit of Partnership
You are approached by a partnership firm to list out the advantages that will accrue to them, if the
accounts are audited. State five important advantages.
Advantages of audit of accounts of a partnership firm: Advantages are as follows (any five):
1. Audited accounts provide a convenient and reliable means of settling accounts between the partners
and thereby possibility of dispute among them is mitigated.
2. On the retirement/death of a partner, audited accounts constitutes a reliable evidence for computing
the
amount due to the retiring partner or representative of deceased partner.
3. Audited accounts are generally accepted by the Income tax authorities for computing the assessable
income.
4. Audited accounts are relied upon by banks for advancing loan.
5. Audited accounts can be helpful in the negotiation for sale or admission of a new partner.
6. It is an effective safeguard against any undue advantage being taken by a working partner
Mention important points which auditors will consider while conducting audit of accounts of a
partnership firm
Important points which auditors will consider while conducting audit of accounts of a partnership firm are:
1. Confirming that the letter of appointment, signed by a partner, duly authorised, clearly states the
nature and scope of audit contemplated by the partners, specially the limitation, if any, under which
the auditor shall have to function.
2. Studying the minute book, if any, maintained to record the policy decision taken by partners specially
the minutes relating to authorisation of extraordinary and capital expenditure, raising of loans;
purchase of assets extraordinary contracts entered into and other such matters as are not of a routine
nature.
3. Verifying that the business in which the partnership is engaged is authorised by the partnership
agreement; or by any extension or modification thereof agreed to subsequently.
4. Examining whether books of account appear to be reasonable and are considered adequate in
relation to the nature of the business of the partnership.
5. Verifying generally that the interest of no partner has suffered prejudicially by an activity engaged in
by the partnership which, it was not authorised to do under the partnership deed or by any violation
of a provision in the partnership agreements.
6. Confirming that a provision for the firm's tax payable by the partnership has been made in the
accounts before arriving at the amount of profit divisible among the partners.
7. Verifying that the profits and losses have been divided among the partners in their agreed
profit-sharing ratio.

Audit of Hospitals
The special steps involved in such an audit are as follows:
1. Vouch the Register of patients with copies of bills issued to them. Verify bills for a selected period with
the patients' attendance record to see that the bills have been correctly prepared. Also see that bills
have been issued to all patients from whom an amount was recoverable according to the rules of the
hospital.
2. Check cash collections as entered in the Cash Book with the receipt, counterfoils and other evidence
for example, copies of patients bills, counterfoils of dividend and other interest warrants, copies of rent
bills, etc.
3. See by reference to the Property and Investment Register that all income that should have been
received by way of rent on properties, dividends and interest on securities settled on the hospital has
been collected.
4. Ascertain that legacies and donations received for a specific purpose have been applied in the
manner agreed upon.
5. Trace all collections of subscription and donations from the Cash Book to the respective Registers
Reconcile that total subscriptions due (as shown by the Subscription Register and the amount
collected and that still outstanding).
6. Vouch all purchases and expenses and verily that the capital expenditure was incurred only with the
prior sanction of the Trustees or the Managing Committee and that appointments and increments to
staff have been duly authorised.
7. Verify that grants, if any, received from Government or local authority have been duly accounted for.
Also that refund in respect of taxes deducted at source has been claimed.
8. Compare the totals of various items of expenditure and income with the amount budgeted for them
and report to the Trustees or the Managing Committee significant variations which have taken place.
9. Examine the internal check as regards the receipts and issue of stores; medicines, lines, apparatus,
clothing, instruments, etc. so as to insure that purchases have been properly recorded in the Stock
Register and that issues have been made only against proper authorisation.
10. See that depreciation has been written off against all the assets at the appropriate rates.
11. Inspect the bonds, share scripts, title deeds of properties and compare their particulars with those
entered in the Property and Investment Register.
12. Obtain inventories, specially of stocks and stores as at the end of the year and check a percentage of
the items physically, also compare their total values with respective ledger balances.

Audit of Cinemas
The special steps involved in its audit are as follows:-
1. Verify
a. that entrance to the cinema hall during show is only through printed tickets;
b. that they are serially numbered and bound into books;
c. that for advance booking a separate series of tickets is issued;
d. and that the stock of tickets is kept in the custody of a responsible official.
2. Confirm that at the end of show, a statement of tickets sold is prepared and cash collected is agreed
with it.
3. Verify that a record is kept of the 'free passes' and that these are issued under proper authority.
4. Reconcile the amount of Entertainment Tax collected with the total number of tickets issued for each
class.
5. Verify the charges collected for advertisement slides by reference to the Register of Slides kept at the
cinema as well with the agreements, entered into with advertisers in this regard.
6. Vouch the expenditure incurred on advertisement, repairs and maintenance. No part of such
expenditure should be capitalised except redecoration, and that should be adjusted as deferred
revenue expenditure the expenditure on extensive redecoration, and that should be adjusted as
deferred revenue expenditure.
7. Vouch payments on account of film hire with bills of distributors and in the process, the agreements
concerned should be referred to.
8. Examine unadjusted balance out of advance paid to the distributors against film hire contracts to see
that they are good and recoverable. If any film in respect of which an advance was paid has already
run, it should be enquire as to why the advance has not been adjusted. The management should be
asked to make a provision in respect of advances that are considered irrecoverable.
9. The arrangement for collection of the share in the restaurant income should be enquired into either a
fixed sum or a fixed percentage of the taking may be receivable annually. In case the restaurant is run
by the Cinema, its accounts should be checked. The audit should cover sale of various items of
foodstuffs, purchase of foodstuffs, cold drink, cigarettes, etc. as in the case of club.
Cinescreen Multiplex Ltd. is operating cinemas in different locations in Mumbai and has appointed you as an internal auditor.
What are the areas that need to be verified in relation to receipts from sale of Tickets?

NGO





As an Auditor of NGO, how do you check/verify at least four receipts of income during the year?

Audit of LLP
Audit of LLP - Basics
Question
Every LLP is required to submit a Statement of Account and Solvency in Form 8, which shall be filed within
a period of sixty days from the end of three months of the financial year to which the Statement of Account
and Solvency relates. - Correct / Incorrect

Question -
Correct / Incorrect Marks 2 MTP April 2021 LLP need not file a “Statement of Accounts and
Solvency”.
Incorrect - A LLP shall be under obligation to maintain annual accounts reflecting true and fair view of its
state of affairs. A “Statement of Accounts and Solvency” in prescribed form shall be filed by every LLP with
the Registrar every year.
Every LLP would be required to file annual return in Form 11 with ROC within 60 days of closer of financial
year. The annual return will be available for public inspection on payment of prescribed fees to Registrar.

Audit of LLP - Appointment of Auditor

Advantage or purpose of Audit

Auditor’s duty regarding Audit of LLP

Audit of Co-Operative Society -





The Multi-State Co-operative Societies Act, 2002

Power and duties of Auditors Section 73
Every auditor of a Multi-State co-operative society shall have a

● right of access

○ at all times
○ to the books accounts and vouchers of the Multi-State co-operative society,
○ whether kept at the head office of the Multi-State co-operative society or elsewhere, and
● shall be entitled to require
○ from the officers or other employees of the Multi- State co-operative society
○ such information and explanation
○ as the auditor may think necessary for the performance of his duties as an auditor.
As per section 73(2), the auditor shall make following inquiries:
a. Whether loans and advances made by the Multi-State co-operative society on the basis of security
have been properly secured and whether the terms on which they have been made are not
prejudicial to the interests of the MultiState co- operative society or its members,
b. Whether transactions of the Multi-State co-operative society which are represented merely by book
entries are not prejudicial to the interests of the Multi-State co-operative society,
c. Whether personal expenses have been charged to revenue account, and
d. Where it is Stated in the books and papers of the Multi-State co-operative society that any shares
have been allotted for cash, whether cash has actually, been received in respect of such allotment,
and if no cash has actually been so received, whether the position as stated in the account books and
the balance sheet as correct regular and not misleading.
Content of Auditor’s Report
The auditor shall make a report

● to the members of the Multi-State co-operative society
● on the accounts examined by him and on every balance-sheet and profit and loss account and on
every other document required to be part of or annexed to the balance-sheet or profit and loss
account,
● which are laid before the Multi-State co-operative society in general meeting during his tenure of
office,
● and the report shall state whether, in his opinion and to the best of his information and according to
the explanation given to him,
● the said account
○ give the information required by this act in the manner so required,
○ and give a true and fair view:
■ In the case of the balance-sheet, of the state of the Multi-State co-operative society’s
affairs as at the end of its financial year; and
■ In the case of the profit and loss account, of the profit or loss for its financial year.
■ The auditor’s report shall also state
● Whether he has obtained all the information and explanation which to the
best of his knowledge and belief were necessary for the purpose of his audit.
● Whether, in his opinion, proper books of account have been kept by the Multi-
State co-operative society so far as appears from his examination of these books
and proper returns adequate for the purpose of his audit have been received
from branches or offices of the Multi-State cooperative society not visited by
him.
● Whether the report on the accounts of any branch office audited by a person
other than the Multi-State co-operative society’s auditor has been forwarded to
him and how he has dealt with the same in preparing the auditor’s report.

● Whether the Multi-State co-operative society’s balance sheet and profit and
loss account dealt with by the report are in agreement with the books of
account and return.
Where any of the matters referred above is answered in the negative or with a qualification, the auditor’s
report shall state the reason for the answer.
Power of Central Government to direct special audit in certain cases -

Section 77
Where the Central Government is of the opinion

● that the affairs of any Multi-State co-operative society are not being managed in accordance with
self-help and mutual deed and co-operative principles or prudent commercial practices or with
sound business principles; or
● that any Multi-State co-operative society is being managed in a manner likely to cause serious injury
or damage to the interests of the trade industry or business to which it pertains; or
● that the financial position of any Multi-State co-operative society is such as to endanger its solvency.
The Central Government may at any time by order direct that a special audit of the Multi-State co-operative
society’s accounts for such period or periods as may be specified in the order shall be conducted.
It may appoint either a chartered accountant or the Multi-State co-operative society’s auditor himself to
conduct the special audit.
However, Central Government shall order for special audit only if that Government or the State Government
either by itself or both hold fifty-one percent or more of the paid-up share capital in such Multi-State
co-operative society.
Special Auditor's Powers , Duties & Report
The special auditor shall have the same powers and duties in relation to the special audit as an auditor of a
MultiState co-operative society has under section 73.
A special auditor makes the report to the Central Government.
The report of the special auditor shall include all the matters required to be included in the auditor’s report
under section 73 and any other matter as directed by the Central Government.
Action by the Central Government
On receipts of the report of the special auditor the Central Government may take such action on the report
as it considers necessary in accordance with the provision of the Act or any law for the time being in force.
However, if the Central Government does not take any action on the report within four months from the
date of its receipt, that Government shall send to the MultiState Co- operative society either a copy of, or
relevant extract from, the report with its comments thereon and require the Multi-State Co-operative society
either to circulate that copy or those extracts to the members or to have such copy or extracts read before
the Multi-State Co-operative society at its next general meeting.

Expenses pertaining to the Special Audit
The expenses of, and incidental to, any special audit under this section (including the remuneration of the
special auditor) shall be determined by the Central Government which determination shall be final and paid
by the Multi-State Co-operative society and in default of such payment, shall be recoverable from the
Multi-State Co-operative society as an arrear of land revenue.
Inquiry by Central Registrar under Section 78
When & Who?

The Central Registrar may, on a request from :-
● a federal co-operative to which a Multi- State Co-operative society is affiliated or
● a creditor or
● not less than one-third of the members of the board or
● not less than one-fifth of the total number of members of a Multi-state co-operative society,
● Hold an inquiry or
● direct some person authorized by him
○ by order in writing in his behalf
○ to hold an inquiry into the
■ constitutions,
■ working and
■ financial condition of a Multi-State Co-operative society.
Opportunity of being Heard - OOBH

However, before holding such inquiry fifteen days notice must be given to the Multi-State co-operative
society.
Powers in case of investigation

The Central Registrar or the person authorized by him shall have the following powers, namely:
Free access and Summon
○ he shall at all reasonable times have free access
○ to the books, accounts, documents, securities, cash and other properties belonging to or in the
custody of the Multi-State co-operative society and
○ may summon any person in possession or responsible for the custody of any such books,
accounts, documents, securities, cash or other properties to produce the same at any place
specified by him.
Call General Meeting

○ He may,
■ notwithstanding any bye-law specifying the period of notice for a general meeting of
the Multi-State co-operative society,
○ require the officers of the society to call a general meeting of the society
○ by giving notice of not less than seven days
■ at such time and place at the headquarters of the society
○ to consider such matters as may be directed to him, and where the officers of the society refuse
or fail to call such a meeting, he shall have power to call it himself.
Summon
○ he may summon any person

■ who is reasonably believed by him to have any knowledge

■ of the affairs of the Multi-State co-operative society
○ to appear before him
○ at any place
■ at the headquarters of the society or
■ any branch thereof and
○ may examine such person on oath.
Follow up
The Central Registrar shall,
● within a period of three months of the date of receipt of the report,
● communicate the report of inquiry
○ to the MultiState co-operative society,
○ the financial institutions, if any, to which the society is affiliated,
○ and to the person or authority, if any at whose instance the inquiry is needed.
Inspection of Multi-State Co-operative societies under - Section 79
When & Who?
The Central Registrar may, on a request from

● federal co-operative to which a Multi- State Co-operative society is affiliated or
● a creditor or
● not less than one-third of the members of the board or
● not less than one-fifth of the total number of members of a Multi-State co-operative society
By general or special order in writing in this behalf inspect or direct any person authorized by him by order in
writing in this behalf to make an inspection into the constitution, working and financial condition of a Multi-
State co-operative society.
Opportunity of Being heard
No inspection shall be made unless a notice of not less than fifteen days has been given to the multi-state
co-operative society.
Powers available
The Central Registrar or the person authorized by him shall have the following powers:
Access, Taking into custody , Verify, Calling of Meeting

He shall at all times
● have access to all books, accounts, papers, vouchers, securities, stock and other property of that
society and may,
● in the event of serious irregularities discovered during inspection, take them into custody and
● shall have power to verify the cash balance of the society and subject to the general or special order of
the central registrar to call a meeting of the society where such general meeting is, in his opinion necessary.

Entitled to Required Information
Every officer or member of a Multi-State Co-operative society shall furnish such information with regard to
the working of the society as the central registrar or the person making such inspection may require.
Inspection Report
A copy of the report of inspection under this section shall be communicated to

● the Multi-State Co-operative society
● within a period of three months from the date of completion of such inspection.
Question
You are appointed as an auditor of the co-operative society. State the special features of the co-operative
audit to be borne in mind by the auditor, concerning:
1. Audit classification of society.

2. Discussion of draft audit report with the management committee.

SA 250 Consideration of Laws and Regulation in an

Audit of Financial Statements
Responsibility of Management for Compliance with Law and Regulations

It is the responsibility of management,
● with the oversight of those charged with governance,
● to ensure that the entity’s operations are conducted in accordance with the provisions of laws and
regulations,
● including compliance with the provisions of laws and regulations that determine the reported
amounts and disclosures in an entity’s financial statements.
Policies are Procedures Implemented by Management to assist in the

prevention and detection of non-compliance with laws and regulations
The following are examples of the types of policies and procedures an entity may implement to assist in the
prevention and detection of non-compliance with laws and regulations:
1. Monitoring legal requirements and ensuring that operating procedures are designed to meet these
requirements.
2. Instituting and operating appropriate systems of internal control.
3. Developing, publicising and following a code of conduct.
4. Ensuring employees are properly trained and understand the code of conduct.
5. Monitoring compliance with the code of conduct and acting appropriately to discipline employees
who fail to comply with it.
6. Engaging legal advisors to assist in monitoring legal requirements.
7. Maintaining a register of significant laws and regulations with which the entity has to comply within
its particular industry and a record of complaints.
Responsibility of the Auditor

The requirements in this SA are designed
● to assist
● the auditor
● in identifying material misstatement of the financial statements
● due to non-compliance with laws and regulations.
However, the auditor is not responsible for preventing non-compliance and cannot be expected to detect
non-compliance with all laws and regulations.
This SA distinguishes the auditor’s responsibilities in relation to compliance with two different categories of
laws and regulations as follows:
1. The provisions of those laws and regulations generally recognised to

● have a direct effect
● on the

Join Us on Telegram https://t.me/neerajaroraclasses Page No. 481 SA 250 | 1
■ determination of material amounts

■ and disclosures in the financial statements
■ such as tax and labour laws. ; and
The auditor’s responsibility is to

➔ obtain sufficient appropriate audit evidence
➔ about compliance with the provisions of those laws and regulations.
2. Other laws and regulations

● that do not have a direct effect on the determination of the amounts and disclosures in the
financial statements,
● but compliance with which may be
● fundamental
● to the
■ operating aspects of the business,
■ to an entity’s ability to continue its business, or
■ to avoid material penalties
■ (for example, compliance with the terms of an operating license, compliance with
regulatory solvency requirements, or compliance with environmental regulations);
● non-compliance with such laws and regulations may therefore have a material effect on the
financial statements.
The auditor’s responsibility is limited to

➔ undertaking specified audit procedures
➔ to help identify non-compliance with those laws and regulations
➔ that may have a material effect on the financial statements.
Indications of Non-Compliance with Laws and Regulations

1. Investigations by regulatory organisations and government departments or payment of fines or
penalties.
2. Payments for unspecified services or loans to consultants, related parties, employees or government
employees.
3. Sales commissions or agent’s fees that appear excessive in relation to those ordinarily paid by the
entity or in its industry or to the services actually received.
4. Purchasing at prices significantly above or below market price.
5. Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers
to numbered bank accounts.
6. Unusual payments towards legal and retainership fees.
7. Unusual transactions with companies registered in tax havens.
8. Payments for goods or services made other than to the country from which the goods or services
originated.
9. Payments without proper exchange control documentation. (without compliance with laws on
foreign exchange movement)
10. Existence of an information system which fails, whether by design or by accident, to provide an
adequate audit trail or sufficient evidence.

11. Unauthorised transactions or improperly recorded transactions.

12. Adverse media comment.
The Auditor’s Consideration of Compliance with Laws and Regulations

● The auditor should obtain a general understanding of
○ The legal and regulatory framework applicable to the entity and the industry or sector in
which the entity operates; and
○ How the entity is complying with that framework.
● SAAE - COMPLIANCE
○ The auditor shall obtain sufficient appropriate audit evidence regarding compliance with the
provisions of those laws and regulations that have
■ a direct effect on the
★ determination of material amounts and
★ disclosures in the financial statements.
● AUDIT PROCEDURE - IDENTIFY INSTANCES OF NON COMPLIANCE

○ The auditor shall perform the following audit procedures to help identify instances of
non-compliance with other laws and regulations
■ that may have a material effect on the financial statements
★ Inquiring of management and, where appropriate, those charged with
governance, as to whether the entity is in compliance with such laws and
regulations; and
★ Inspecting correspondence, if any, with the relevant licensing or regulatory
authorities
● ALERT
○ During the audit, the auditor shall remain alert
○ to the possibility
○ that other audit procedures applied
○ may bring instances
■ of non-compliance or
■ suspected non-compliance
○ with laws and regulations to the auditor’s attention.
● WRITTEN REPRESENTATIONS for instances of Non-Compliance and Suspected Non Compliance

○ The auditor shall request management and, where appropriate, those charged with
governance to provide written representations that
○ all known instances of non-compliance or suspected non-compliance with laws and
regulations
○ whose effects should be considered when preparing financial statements
○ have been disclosed to the auditor.

Audit Procedures When Non-Compliance is Identified or Suspected

1. The auditor becomes aware of information concerning an instance of non-compliance or suspected
non-compliance with laws and regulations, the auditor shall obtain:
a. An understanding of the nature of the act and the circumstances in which it has occurred; and
b. Further information to evaluate the possible effect on the financial statements.
2. If the auditor suspects there may be non-compliance, the auditor shall discuss the matter with
management and, where appropriate, those charged with governance. If management or, as
appropriate, those charged with governance do not provide sufficient information that supports that
the entity is in compliance with laws and regulations and, in the auditor’s judgment, the effect of the
suspected non-compliance may be material to the financial statements, the auditor shall consider the
need to obtain legal advice.
3. If sufficient information about suspected non-compliance cannot be obtained, the auditor shall
evaluate the effect of the lack of sufficient appropriate audit evidence on the auditor’s opinion.
4. The auditor shall evaluate the implications of non-compliance in relation to other aspects of the audit,
including the auditor’s risk assessment and the reliability of written representations, and take
appropriate action.

Reporting of Identified and suspected non compliance



SA 299 - Joint Audit of Financial Statements

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How Audit Work Will be Divided?

Where joint auditors are appointed, they should, by mutual discussion, divide the audit work among
themselves.
● The division of work would usually be in terms of audit of identifiable units or specified areas.
● In some cases, due to the nature of the business of the entity under audit, such a division of work may
not be possible.
○ In such situations, the division of work may be with reference to items of assets or liabilities or
income or expenditure.

● Certain areas of work, owing to their importance or owing to the nature of the work involved, would
often not be divided and would be covered by all the joint auditors.
For your ready reference - Text From SA 300
Preliminary Activities
The auditor shall undertake the following activities at the beginning of the current audit engagement
a. Performing procedures required by SA 220 , “Quality Control for an Audit of Financial Statements” regarding the
continuance of the client relationship and the specific audit engagement;
b. Evaluating compliance with ethical requirements, including independence, as required by SA 220 ; and
c. Establishing an understanding of the terms of the engagement, as required by SA 210.
Performing the preliminary engagement activities at the beginning of the current audit engagement assists the auditor in identifying
and evaluating events or circumstances that may adversely affect the auditor’s ability to plan and perform the audit engagement.
Performing these preliminary engagement activities enables the auditor to plan an audit engagement for which, for example:
● The auditor maintains the necessary independence and ability to perform the engagement.
● There are no issues with management integrity that may affect the auditor’s willingness to continue the engagement.
● There is no misunderstanding with the client as to the terms of the engagement.

Quick Chart For Joint Audit Plan and Factors to be considered for the same.
Work Allocation Document
After identification and allocation of work among the joint auditors, the work allocation document shall be
signed by all the joint auditors and the same shall be communicated to those charged with governance of
the entity.

The documentation of allocation of work helps in avoiding any dispute or confusion which may arise
among the joint auditors regarding the scope of work to be carried out by them.
Further, the communication of allocation of work to the entity helps in avoiding any dispute or confusion
which may arise between the entity and the joint auditors.



What are the advantages and disadvantages of Joint Audit?
Advantages
● Pooling and sharing of expertise
● Reduced workload
● Better performance
● Improved service to the client
● Local firms can conduct audit in a better manner especially in case of multinational companies.
● A sense of healthy competition towards better performance.
● Low cost (in terms of development of staff and conducting audit)
Disadvantages
● The fees being shared.
● Psychological problem where firms of different standing are associated in the joint audit.
● General superiority complexes of some auditors.
● Problems of coordination of the work.
● Areas of work of common concern being neglected,
● Uncertainty about the liability for the work done,
● Lack of clear definition of responsibility.
Question Answers
QUESTION
E and S were appointed as Joint Auditors of X and Y Ltd. What will be their professional responsibility in a
case where the company has cleverly concealed certain transactions that escaped the notice of both the
Auditors?
ANSWER
Joint Audit of Financial Statements
In conducting a joint audit, the auditor(s) should bear in mind the possibility of existence of any fraud or error
or any other irregularities in the accounts under audit.
The principles laid down in SA 200, SA 240 and SA 299 need to be read together for arriving at any
conclusion.
The principle of joint audit involves that each auditor is entitled to assume that other joint auditor has carried
out his part of work properly. However, in this case, if it can be assumed that the joint auditors E and S have
exercised reasonable care and skill in auditing the accounts of X & Y Ltd. and yet the concealment of
transaction has taken place, both joint auditors cannot be held responsible for professional negligence.

However, if such concealment could have been discovered by the exercise of reasonable care and skill, the
auditors would be responsible for professional negligence. Therefore, it has to be seen that while dividing the
work, the joint auditors have not left any area unattended and exercised reasonable care and skill while
doing their work.
QUESTION TRUE/FALSE
A branch auditor is a joint auditor according to SA299 and his relationship with the company auditor is
governed by the said Standard.
False: Branch auditor is not a joint auditor within the meaning of SA 299 “Joint Audit of Financial
Statements”. He is another auditor within the meaning of SA 600 “Using the Work of Another Auditor”.
QUESTION TRUE/FALSE
If there is difference of opinion among the joint auditors with regard to any matter, majority joint auditors
opinion will prevail while reporting.
False: As per SA 299 “Joint Audit of Financial Statements”, where the joint auditors are in disagreement with
regard to any matters to be covered by the report, each one of them should express their own opinion
through a separate report. A joint auditor is not bound by the views of majority of joint auditors regarding
matters to be covered in the report
and should express his opinion in a separate report in case of a disagreement.
QUESTION TRUE/FALSE
All the joint auditors are jointly and severally responsible for the work, which is not divided and carried on
jointly by all the joint auditors.
Answer
True: As per SA 299 on “Joint Audit of Financial Statements”, all the joint auditors are jointly and severally
responsible for the audit work which is not divided and carried on jointly by all the joint auditors.
QUESTION TRUE/FALSE
A joint auditor is not bound by the views of the majority of the joint auditors regarding matters to be covered
in the auditor's report.
Answer
Correct: As per SA 299 “Joint Audit of Financial Statements”, if a joint auditor is not bound by the views of
majority of joint auditors regarding matters to be covered in the report and should express his opinion in a
separate report in case of a disagreement.
QUESTION
'A Joint Auditor is not bound by the views of the majority of the joint auditors regarding matters to be
covered in the report.' Justify this statement in the light of responsibilities of Joint Auditors under SA 299.

SA 560 - Subsequent Events

SUBSEQUENT EVENTS
Events occurring between the date of the financial statements and the date of the auditor's report, and facts
that become known to the auditor after the date of the auditor's report.
OBJECTIVE
● Obtain Sufficient And Appropriate Evidence about whether events occurring between the date of the
financial statements and the date of the auditor's report that require adjustment of, or disclosure in,
the financial statements are appropriately reflected in those financial statements; and
● Respond appropriately to facts that become known to the auditor after the date of the auditor's
report, that, had they been known to the auditor at that date, may have caused the auditor to amend
the auditor's report.
TYPES OF SUBSEQUENT EVENTS

Type I
Those events that provide additional evidence with respect to conditions that existed on the date of balance
sheet and affect the estimation made in the preparation of the financial statements. The statement should
be adjusted for any change in estimates resulting from the use of evidence of subsequent events.
For example
● Debtors as on balance sheet date are declared insolvent after the balance sheet date but before
auditor's report
● Settlement of legal disputes before audit report date, which arose before balance sheet date
Type II
Those events which provide evidence with respect to conditions that did not exist on the date of the balance
sheet being reported on but arose subsequent to the date. These events should not result in adjustments of
the financial statements. Some of these events however may be of such a nature that disclosure of them is
required to keep the financial statements from not being misleading.
For example
● Purchase of business
● Sale of shares and debentures
● Loss of plant or inventory as a result of fire

AUDIT PROCEDURES FOR SUBSEQUENT EVENTS
This standard requires that the auditor should perform procedures designed to obtain sufficient and
appropriate audit evidence that all the events up to date of the auditor’s report that may require adjustment
of (type-l events) or disclosure (type- ll event’s) the financial statements have been identified.
The following procedures may be followed to identify the subsequent events:

● Review the procedures that management followed to identify the subsequent events.
● Inquiring of management and, where appropriate, those charged with governance as to whether any
subsequent events have occurred which might affect the financial statements.
● Read the minutes of meeting of board of directors, executive committee, meeting of shareholders
held after balance sheet date
● Read latest interim financial statements
● Inquire, read about and the latest position of legal cases
● Management representation that all subsequent events are identified

INQUIRIES OF MANAGEMENT REGARDING SUBSEQUENT EVENTS

The auditor may inquire as to the current status of items that were accounted for on the basis of preliminary
or inconclusive data and may make specific inquiries about the following matters:
● Whether new commitments, borrowings or guarantees have been entered into.
● Whether sales or acquisitions of assets have occurred or are planned.
● Whether there have been increases in capital or issuance of debt instruments such as the issue of
new shares or debentures, or an agreement to merge or liquidate has been made or is planned.
● Whether any assets have been appropriated by the government or destroyed, fc example, by fire or
flood.
● Whether there have been any developments regarding contingencies.
● Whether any unusual accounting adjustments have been made or are contemplated.
● Whether any events have occurred or are likely to occur that will bring in question the
appropriateness of accounting policies used in the finance statements, as would be the case, for
example, if such events call into question the validity of the going concern assumption.
● Whether any events have occurred that are relevant to the measurement estimates or provisions
made in the financial statements.
● Whether any events have occurred that are relevant to the recoverability assets.
SUBSEQUENT EVENTS AND BRANCH AUDITOR'S REPORT

If branch auditor has already audited the branch and submitted the report to principal auditor, the principal
auditor would follow audit procedures in respect events occurring between the date of signing of the audit

report of the auditor of branch and the date of signing of his (principal) report.
Facts Which Become Known To The Auditor After The Date Of The
Auditor's Report But Before The Date The Financial Statements Are
Issued


Facts Which Become Known To The Auditor After The Financial

Statements Have Been Issued

SA 570 - GOING CONCERN

Under the going concern basis of accounting, the financial statements are prepared on the assumption
that the entity is a going concern and will continue its operations for the foreseeable future.
General purpose financial statements are prepared using the going concern basis of accounting, unless
management either
● intends to liquidate the entity or to cease operations,
● or has no realistic alternative but to do so.
When the use of the going concern basis of accounting is appropriate, assets and liabilities are recorded on
the basis that the entity will be able to realize its assets and discharge its liabilities in the normal course of
business.
Under the going concern basis of accounting, the financial statements are prepared on the assumption
that the entity is a going concern and will continue its operations for the foreseeable future. Explain. RTP
May 2021
Responsibilities of management
It is management's responsibility to assess the entity's ability to continue as a going concern even if the
financial reporting framework does not include an explicit requirement to do so.
Objectives of the auditor

The objectives of the auditor regarding Going Concern are
1. To obtain sufficient appropriate audit evidence regarding, and conclude on, the appropriateness of
management’s use of the going concern basis of accounting in the preparation of the financial
statements;
2. To conclude, based on the audit evidence obtained, whether a material uncertainty exists related to
events or conditions that may cast significant doubt on the entity’s ability to continue as a going
concern; and
3. To report in accordance with this SA.
Most Important – As per SA 200 The absence of any reference to going concern uncertainty in an auditor's
report cannot be viewed as a guarantee as to the entity's ability to continue as a going concern. (SA 200)
The potential effects of inherent limitations on the auditor’s ability to detect material misstatements are
greater for future events or conditions that may cause an entity to cease to continue as a going concern. The
auditor cannot predict such future events or conditions.
Discuss the objectives of an auditor regarding Going concern as per relevant standard on auditing. RTP
May 2021
Risk assessment procedures and related activities

When performing risk assessment procedures as required by SA 315, the auditor shall consider whether
events or conditions exist that may cast significant doubt on the entity’s ability to continue as a going
concern.
In so doing, the auditor shall determine whether management has already performed a preliminary
assessment of the entity’s ability to continue as a going concern, and:
● If such an assessment has been performed,

○ the auditor shall discuss the assessment with management and
○ determine whether management has identified events or conditions that, individually or
collectively, may cast significant doubt on the entity’s ability to continue as a going concern
and,
■ if so, management’s plans to address them; or
● If such an assessment has not yet been performed,
○ the auditor shall discuss with management the basis for the intended use of the going
concern basis of accounting, and
○ inquire of management whether events or conditions exist that, individually or collectively,
may cast significant doubt on the entity’s ability to continue as a going concern.
● The auditor shall remain alert throughout the audit for audit evidence of events or conditions that
may cast significant doubt on the entity's ability to continue as a going concern.
● There may be following types of indicators
Financial indicators
➔ Negative Net worth/working capital;

➔ Arrears / discontinuance of Dividends;
➔ Adverse financial ratio;
➔ Substantial operating losses;
➔ Borrowings approaching maturity without any chance of renewal/ repayment;
➔ Short term borrowing for long term asset financing;
➔ No payment to creditors on due date.
➔ Non-compliance with terms in loan agreement;
➔ Negative cash flow from operations;
➔ Rearrangement with creditors for reduction in liability; or
➔ Change from creditors to cash on delivery transaction with supplier.
Operating indicators
➔ Loss of key management and no replacement available;

➔ Loss of major market or supplier;
➔ Labour unrest, strikes etc; or
➔ Loss of major licence, franchise, etc.
Other indicators
➔ Pending legal proceedings;
➔ Change in Govt. Policy affecting the entity adversely; or

➔ Non- compliance with Statutory requirements
However, such indications may be mitigated by some positive factors.

For example: loss of some major supplier may be compensated by availability of some alternate source of
supply.
Additional audit procedures when events or conditions are identified
When events or conditions have been identified that may cast significant doubt on the entity's ability to
continue as a going concern, the auditor shall perform procedures as follows:
● Request management to make its assessment of the entity's ability to continue as a going concern.
● Evaluating management's plans for future actions.
● When the entity has prepared a cash flow forecast, then consider its reliability.
● Considering whether any additional facts or information have become available since the date on
which management made its assessment.
● Requesting written representations from management or those charged with governance, regarding
their plans for future action and the feasibility of these plans.
Auditor Conclusions
Appropriateness of management’s use of the going concern
The auditor shall evaluate whether sufficient appropriate audit evidence has been obtained regarding, and
shall conclude on, the appropriateness of management’s use of the going concern basis of accounting in
the preparation of the financial statements.
(क्या SAAE OBTAIN कर लिए है और conclude करे गा ON…………………………….)
Existence of Material Uncertainty
Based on the audit evidence obtained, the auditor shall conclude whether, in the auditor’s judgment, a
material uncertainty exists related to events or conditions that, individually or collectively, may cast
significant doubt on the entity’s ability to continue as a going concern.
(Evidence के Basis पर conclude करे गा …………………………………)
Material Uncertainty
A material uncertainty exists when the
● magnitude of its potential impact and
● likelihood of occurrence
● is such that,
● in the auditor’s judgment,
● appropriate disclosure of the nature and implications of the uncertainty is necessary

Implications for the Auditor’s Report
Use of Going Concern Basis of Accounting Is Inappropriate

● If the financial statements have been prepared using the going concern basis of accounting but,
○ in the auditor’s judgment, management’s use of the going concern basis of accounting in the
preparation of the financial statements is inappropriate,
○ the auditor shall express an adverse opinion.
Use of Going Concern Basis of Accounting Is Appropriate but a Material Uncertainty

Exists
Adequate Disclosure of a Material Uncertainty Is Made in the Financial Statements

● If adequate disclosure about the material uncertainty is made in the financial statements,
● the auditor shall express an unmodified opinion and
● the auditor’s report shall include a separate section under the heading “Material Uncertainty Related
to Going Concern” to
○ Draw attention to the note in the financial statements that discloses the matters.
○ State that these events or conditions indicate that a material uncertainty exists that may cast
significant doubt on the entity’s ability to continue as a going concern and that the auditor’s
opinion is not modified in respect of the matter.
Adequate Disclosure of a Material Uncertainty Is Not Made in the Financial Statements

● If adequate disclosure about the material uncertainty is not made in the financial statements, the
auditor shall
○ Express a qualified opinion or adverse opinion, as appropriate, in accordance with SA 705
○ In the Basis for Qualified (Adverse) Opinion section of the auditor’s report, state
■ that a material uncertainty exists that may cast significant doubt on the entity’s ability
to continue as a going concern and
■ that the financial statements do not adequately disclose this matter.
Management Unwilling to Make or Extend Its Assessment

If management is unwilling to make or extend its assessment when requested to do so by the auditor, the
auditor shall consider the implications for the auditor’s report.
Significant Delay in the Approval of Financial Statements
If there is significant delay in the approval of the financial statements by management or those charged with
governance after the date of the financial statements,
● the auditor shall inquire as to the reasons for the delay.
● If the auditor believes that the delay could be related to events or conditions relating to the going
concern assessment,
● the auditor shall perform those additional audit procedures necessary,
● as well as consider the effect on the auditor’s conclusion regarding the existence of a material
uncertainty.

Adequacy of Disclosures When Events or Adequacy of Disclosures When Events or

Conditions Have Been Identified and a Conditions Have Been Identified but No
Material Uncertainty Exists Material Uncertainty Exists
The auditor shall determine whether the financial The auditor shall evaluate whether, in view of the
statements.
requirements of the applicable financial
● Adequately disclose the
reporting framework, the financial
○ principal events or conditions statements provide adequate disclosures about
■ that may cast significant doubt these events or conditions.
on
■ the entity’s ability to continue
as a going concern
○ andmanagement’s plans to
deal with these events or conditions;
and
● Disclose clearly that
○ there is a material
uncertainty related to events or
conditions
○ that may cast significant doubt on
the entity’s ability to continue as a
going concern and,
○ therefore, that it may be unable to
realize its assets and
discharge its liabilities in the
normal course of business.




"Management's assessment of the entity's ability to continue as a going concern involves making a
judgement about inherently uncertain future outcomes of events or conditions. What are relevant factors
to that judgement?"
Answer as per ICAI’s Suggested Answers - Source & Details On www.icai.org
Management’s assessment of the entity’s ability to continue as a going concern involves making a
judgment, at a particular point in time, about inherently uncertain future outcomes of events or
conditions. The following factors are relevant to that judgment:
● The degree of uncertainty associated with the outcome of an event or condition increases
significantly the further into the future an event or condition or the outcome occurs. For that
reason, most financial reporting frameworks that require an explicit management assessment
specify the period for which management is required to take into account all available information.
● The size and complexity of the entity, the nature and condition of its business and the degree to
which it is affected by external factors affect the judgment regarding the outcome of events or
conditions.
● Any judgment about the future is based on information available at the time at which the
judgment is made. Subsequent events may result in outcomes that are inconsistent with
judgments that were reasonable at the time they were made.

SA 610 Using the work of Internal Auditor








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About the Faculty: Neeraj Arora

Neeraj Arora is an Indian Teacher & an Angel Investor.

By far, he has taught more than 1,00,000 students of

He has invested in around 8 Start-ups.

Subjects he is passionate to teach are Income Tax,

Besides teaching the subjects in the course

He is one of the most loved CA and ACCA faculty in India.

Cumulatively his social media following is above 2 million.

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Thinking Bridge (www.thinkingbridge.in)

Learn Personal Finance (www.learnpersonalfinance.in)

1 Basics of Auditing, nature, Scope and Objective of Audit 20

2 Audit Strategy, Audit Planning & Audit Programme 65

3 Audit Documentation and Audit Evidence 86

4 Risk Assessment and Internal Control 125

5 Fraud and Responsibilities of the Auditor in this regard 166

6 Audit in Automated Environment 183

7 Audit Sampling 196

8 Analytical Procedure 211

9 Audit of items of Financial Statements 219

10 Company Audit 283

11 Audit Report 366

12 Bank Audit 403

13 Audit of Different Types of Entities 440

14 Other SAs 481

Neeraj Arora | EDU91

Rules and Regulation For Accounting and Auditing

Lines Taken From ICAI Study Mat - www.icai.org

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A brief About Audit

Following things must be clearly understood before we start studying audit

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0.1 Q1. Define Audit.

0.1 Q2. Correct / Incorrect

Overall Objectives of Auditor

For auditor's opinion, reasonable Assurance is an absolute level of assurance (T/F)

Misstatements can arise from error or fraud.

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Question - Fraud is more difficult detect than error (True or False)

Misstatements, including omissions, are considered to be material

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● Effect is pervasive when it is not confined to a specific element

Those charged with governance

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0.4 Q1. Management and TCWG can be same Correct / Incorrect

Pre- Conditions for an audit

0.5 Q1. Discuss the pre-conditions of an Audit

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Auditor’s Responsibilities / Role

0.6 Q1. Define Internal Control

Professional judgment is essential to the proper conduct of an audit.

● Materiality and audit risk.

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How Audit Is Conduct

Framework to conduct audit

Risk Assessment and Risk Assessment Procedures