Audit

CHARTERED ACCOUNTANCY PROFESSIONAL III
(CAP-III)
Compilation of Suggested Answers
Paper 3: Advanced Auditing

(Dec 2003 - June 2019)
Updated as per amendments up to August 2019
Education Department
The Institute of Chartered Accountants of Nepal
Publisher: The Institute of Chartered Accountants of Nepal
ICAN Marg, Satdobato, Lalitpur, P.O. Box: 5289
Tel: 977-1-5530832, 5530730, Fax: 977-1-5550774
E-mail: ican@ntc.net.np, Website: www.ican.org.np
© The Institute of Chartered Accountants of Nepal
This compilation of suggested answers is prepared by the Institute of Chartered Accountants of

Nepal. Permission of the Council of the Institute is essential for reproduction of any portion of this
paper.
All rights reserved. No part of this publication may be reproduced stored in a retrieval system, or
transmitted, in any form, or by any means, electronic, mechanical, photocopying, printing,
recording or otherwise, without prior permission, in writing, from the publisher.
The compilation of suggested answers is prepared by the Institute with a view to assist the students
of ICAN in their study. The suggested answers presented here are indicative and not exhaustive.
Students are expected to apply their knowledge and write the answer in the examinations taking the
suggested answers as guidance.
Due care has been taken to compile the suggested answers. In case students need any clarification,
creative feedbacks or suggestions for the further improvement on the material, any error or
omission on the material, they may forward to the email educationdepartment@ican.org.np at
Education Department of the Institute.
Further, printed book for the compilation of suggested answer will be available at the Institute and
the same shall be notified in website. Students willing to have the printed books may purchase from
the store of the Institute after the publication of notice.
September 2019
Education Department
The Institute of Chartered Accountants of Nepal
Contents
Chapter 1 Auditing ......................................................................................................................................... 1
Chapter 2-Ethics ......................................................................................................................................... 103
Chapter 3 Governance ................................................................................................................................ 139
Chapter 4-Engagement Procedure .............................................................................................................. 147
Chapter 5-Planning and Risk Assessment .................................................................................................. 152
Chapter -Audit Test .................................................................................................................................... 189
Chapter 7Audit Report ................................................................................................................................ 212
Chapter 8 Audit of specialized enterprises ................................................................................................. 241
Chapter 9 Assurance and related services ................................................................................................... 286
Chapter 10-Audit Under Computerized environment................................................................................. 338
Chapter 11-CAAT ...................................................................................................................................... 357
Chapter 12-Fraud and Auditors Liability.................................................................................................... 365
Chapter 13 -Audit of Fair Values ............................................................................................................... 369
Chapter 14-NAS, NFRS and IFRS ............................................................................................................. 370
CAP III Paper 3: Advanced Auditing
Chapter 1 Auditing
Question No 1
An Auditor is required to consider materiality and its relationship with audit risk while conducting
an audit. Describe the matters, which you will consider in this regard.
(6 Marks June 2004)
Answer
Answer should base on NSA 320. The answer should specifically deal following points in brief:
a) Define materiality.
b) Consideration at planning level:
 Establishing an acceptable materiality level.

 Misstatements of relatively small amounts, which, cumulatively, can affect financial
statements materially.
 Materiality should be considered at both the overall financial statement level and in
relation to individual account balances, clauses of transaction and disclosures.
 Nature, timing and extent of audit procedures should be determined on evaluation of the
effect of misstatements.
c) Relationship between materiality and audit risk:
 As the time of evaluation of audit evidence.

 Effects of misstatements.
Question No. 2
Write shorts notes on following: (6 Marks June 2004)
a. Using other experts by professional accountants.
Note should deal with conditions which require use of other experts‘ qualification and skill and
competence of expert., auditor's liability in such cases, reference in audit report. Consider the
provisions of NSA 620.
b. Inherent risk.
Refer to NSA 240 which describes inherent limitations of auditor. There are many circumstances
which involve unavoidable rule even if audit is planned and executed properly.
Inherent risk is the susceptibility of an account balance or clause of transaction to misstatement that
could be material, individually or when aggregated with misstatements in other balances or clauses,
assuming that there were no related internal controls. It is a function of the entity's business and its
environment and the nature of the account balance or clause of transactions. For example, such as a
complex accounting estimate, or that involve highly desirable and movable assets, such as
© The Institute of Chartered Accountants of Nepal 1

jewelers, or that are particularly susceptible to changes in consumer demand or technology that
could affect their value, will involve more inherent risk than other accounts.
Although inherent risk cannot be controlled by auditor, the auditor should assess them and design
substantive procedures to produce an acceptable level of detection risk.
c. Using the work of an expert. (4 Marks December 2004)

Answer
During the audit the auditor may seek to obtain, in conjunction with the client or independently,
audit evidence in the form of reports, opinions, valuations and statements of an expert.
The auditors education and experience enable the auditor to be knowledgeable about the business
matters in general, but the auditor is not expected to have the expertise of a person trained for or
qualified to engage in the practice of another profession or occupation, such as advocate or
engineer.
An expert may be engaged by the entity, engaged by the auditor, employed by the entity, or
employed by the auditor.
Question No. 3
As an auditor state your views on the following situations: (4 Marks June 2004)
The auditor find that the company has made certain secured loans and advances to a sister
concern at a rate of interest of 5% per annum, from out of the funds raised through a public issue
of 14% non-convertible debentures.
The auditor should enquiry whether the rate of interest and other terms of the loan ae prejudicial to the
interest of the company prima facie it seems so. If, based on the available evidence (including the
explanations of the management in the matter), the auditor is of the opinion that the terms of the loan
are prejudicial to the interest of the company, he should report this matter. When management refused
to adjust, auditor suitably modify his opinion as per NSA 705.
Question No. 4
During the course of audit, you encounter following situations: (4 Marks each June 2004)
a. On your request to produce minutes of board meetings, finance director represents that there is
no need to waste time to look at the whole minutes of the year. Instead you may ask for the copy
of the minutes deemed necessary to verify.
Since Finance Director has made only suggestion in view of saving time of auditor it should not
be considered as limitation of scope. The auditor should explain following points to convince him
for production of minute book for verification as auditor is required to obtain sufficient
appropriate audit evidence as per NSA 500.
a. Minute book is not checked just to corroborate transactions recorded in books of accounts. If
advice of finance director is followed, it will only help to corroborate with financial
transactions.
b. Verification of minute book is necessary to check whether the decisions of the BoD are
reflected in financial statements.

c. Verification of minute book may provide information on contingent liabilities not disclosed
by the management.
b. You receive a letter from the Managing Director of the company under audit, asking you to give
a copy of your entire file containing working papers and the audit program. He argues that
since these papers contains information concerning his company, he has a right to ask for the
documents. Moreover, the audit program will help the company in coordinating its own related
activities and thus result in a more effective audit next year.
NSA 230 requires the auditor to maintain appropriate documentation for future reference.
Documents prepared, acquired or brought into being by the professional accountant solely for his
own purpose as principal belongs to him. Thus, documents prepared by the professional
accountant are regarded as exclusive property of him. So, the auditor should refuse to give the
entire file to the Managing Director of the company.
Question No. 5
How do you express your view as an auditor in the following cases?
(5 Marks each December 2004)
a. M/S XYZ & Co. Chartered Accountants and was working as an auditor of CD Ltd. for four
years. During these four years period, the firm was doing such audit with a detail audit
planning and programming and Mr. Y was the partner in charge during the period. Whereas
for carrying out the audit of Financial Year X0X5, Mr. X was assigned as a partner in charge
to carry out the audit. In this year, Mr. X did not prepare the audit plan and programme and
followed up the previous year's audit planning and programming.
b. Mr. BRK was appointed as an audit assistant of the Auditor General (AG) of Nepal to carry out
the audit of Nepal Telkom Ltd., an HMG owned undertaking, for the Financial Year 20X4.
Further, AG ordered him to follow the directives to the auditors of the Public Sector
Enterprises, but it was not mentioned in the letter of appointment to follow the Nepalese
Standards on Auditing. Consequently, Mr. BRK did not follow the Standards on Auditing and
again did not issue the audit engagement letter for the acknowledgment of the management.
Again, he argued that he was not appointed by the Shareholders of Telkom Ltd., but was an
assistant of the Auditor General, so he need not issue an audit engagement letter while carrying
out the audit of Telkom Ltd.
c. During the finance year 200X the statutory auditor observed the following information while
auditing the financial statements of an ABC Co. Ltd.:
Share Capital (Issued, Subscribed, Called and Paid up) Rs. 5 Million
Reserve and Surplus (including undistributed profit) Rs. 10 Million
Term Loan and Current Liabilities Rs. 20 Million
Fixed Assets at Book value Rs. 10 Million
Current Assets Rs. 10 Million
Profit and Loss Account (Loss) (Rs. 15 Million)
d. Mrs. Z a leading practicing Chartered Accountant was appointed as an auditor of N. Ltd. for
the year ending 20X0. She has compiled and signed the balance sheet of the company for
submission to A bank to get an overdraft loan. The company again asked her to compile and
sign another balance sheet on the same date, inflating the value of assets by 10% for
submission to B bank to get a term loan. Both the balance sheets were not in conformity with
the books of accounts of the company corresponding to the respective date.

Answers:
a. Answer:
NSA 300 states that audit planning is necessary to conduct an effective audit in an efficient and
timely manner. It should be noted that the audit plans should be based on knowledge of client's
business.
As per NSA 300, 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.
In establishing the overall audit strategy, the auditor shall:
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.
Planning is a continuous process and changes in conditions of unexpected results of audit

procedures may cause revisions of the overall plan as well as the detailed audit programme.
b. Answer:
Term of Engagement is required to reduce expectation gap as it defines the roles and
responsibilities of the auditor and management. Terms of Engagement are required to establish the
pre-conditions for audit. Irrespective of whether an audit is being conducted in the private or
public sector, the basic principles of audits remain the same.
What may differ for audits carried out in the public sector is the audit objective and scope. These
factors are often attributable to differences in the audit mandate and legal requirements or the
form of reporting. The mandates and requirements may also affect, for example, the extent of the
auditors' discretion in establishing materiality, in reporting fraud and error, and in the form of the
audit report. Differences in audit approach and style may also exist.
However, these differences would not constitute a difference in the basic principles and essential
procedures in auditing. In this case, though he is an assistant of the Auditor General of Nepal, he
needs to follow the Standards on auditing in additions to the directives to the auditors.
c. Answer:
Here, Calculate the Net worth of the company, Net worth is ≤ 0.
Comment: In this case, the auditor observes that an adequate disclosure is made in the financial
statements and the auditor need not express and qualify his opinion as all above information are
drawn up from the financial statements. However, he should, in his report, add a paragraph that
highlights the going concern problem by drawing attention to the note in the financial statement
that discloses:
i. adequately, describe the principal conditions that raise substantial doubt about the entity's
ability to continue in operation for the foreseeable future. (NSA 570)
ii. state that there is significant uncertainty that the entity will be able to continue as a going
concern and, therefore, may be unable to realize its assets and discharge its liabilities in the
normal course of business. (NSA 570)

d. Answer:
While the auditor is responsible for forming and expressing an opinion on the financial
statements, the responsibility for preparing and presenting the financial statements is that of the
management of the entity. The audit of the financial statements does not relieve management of its
responsibility.
Again, the auditor should comply with ethical principles governing professional responsibilities:
Integrity, Objectivity and independence: the auditor should be straight forward, honest and sincere
in rendering professional services. The auditor must be fair and should not allow prejudice, bias or
influence of others to override his or her objectivity. The auditor should maintain an impartial
attitude, and both be and appear to be free of any interest which might be regarded., Whatever its
actual effect, as being incompatible with integrity, objectivity and independence. The auditor
should be independent in fact and appearance.
It is; therefore, she should not depart from her professional integrity and in these situations her
services are deemed to be professionally misconduct.
Question No. 6
The statutory auditor is not required to evaluate the professional competence or independence of the
branch auditor, except in situations, which create doubt about the professional competence or
independence of the auditor. Briefly explain.
(6 Marks December 2004)
Answer:
Where the statutory auditor's report is other than unqualified, the principal auditor should also
document how he has dealt with the qualifications or adverse remarks contained in the branch auditor's
report in framing his own report. There should be sufficient liaison between the principal auditor and
the branch auditor. For this purpose, the principal auditor may find it necessary to issue a written
communication to the branch auditor. The branch auditor, knowing the context, in which his work is to
be used by the principal auditor, should cooperate with his and assist him actively, for example, y
bringing to the principal auditor's immediate attention any significant findings requiring to be dealt
with the relevant statutory requirements. The principal Auditor would not be responsible in respect of
the work entrusted to the branch auditors, except in circumstances, which should have roused his
suspicion about the reliability of the work performed by the branch auditors. When the principal auditor
has to base his opinion on the financial statements of the entity as a whole relying upon the statements
and reports of the other auditors, his report should state clearly the division of responsibility for the
financial statements of the entity by indicating the extent to which the financial statements of branches
audited by the other auditors have been included in the financial statements of the entity.
Question No. 7
Give your opinion as an auditor in the following cases with specific reference to criteria on which
your opinion is based.
Mr. RR Pradhan, a Chartered Accountant is attending to the tax matters of Apex Hotel Ltd. for the
fiscal year 2060/61. For this purpose, he has to attend to the company from 9 a.m. to 1 p.m. on all
working days and sometimes he also has to present before tax officer in the Inland Revenue Office at
Babar Mahal. He is paid Rs. 30,000/- per month for the same.
Apex Hotel Ltd. intends to appoint Mr. RR Pradhan as its statutory auditor at the annual general
meeting. Advice Mr. RR Pradhan giving reasons whether he can accept the appointment as per the
companies‟ act 2063 (5 Marks June 2005)

Answer:
An employee or worker of the company cannot be appointed as auditor of the company by virtue of
provision of Sec 112 of the Companies Act, 2063.
In the given case, it is not clear whether Mr. RR Pradhan is an employee of the company on part time
basis or is a consultant on retainer basis for tax matters. An auditor may render services to the company
in matters relating to taxation, finance, management consultancy or other related area as along as his
contract is ―for service‖ and not ―of service‖.
With regard to charging professional fee on monthly fees by the statutory auditor for the other services
on retainership basis, there is no specific prohibition in the Nepal Chartered Accountant Acts, 1997 and
the Regulations. Further, another fact, which has to be borne in mind that Mr. RR Pradhan, is attending
the company from 9 a.m. to 1 p.m. on all working days. It should be seen that he is not bound by the
office timings but is attending to tax matters regularly within the office hours according to his own
convenience. Therefore, having regard to the exact nature of Mr. RR Pradhan‘s existing relationship as
may be seen from the terms of appointment with Apex Ltd, he can be appointed as the auditor.
Question No. 8
Mr. ABC, a practicing Chartered Accountant audited the financial statements of M/s AP Finance
Company Ltd. for the F/Y 2060/61 and issued audit report on Aswin 28, 2061. The audited financial
statements made a provision of proposed cash dividend of 20%. Mr. XYZ, managing director of that
company then submitted the audited financial statements to Nepal Rastra Bank along with long form
audit report for getting permission to hold Annual General Meeting of that company for that year on
Kartik 25, 2061. The director of Nepal Rastra Bank after reviewing Financial Statements of that
company found that interest income booked for the period of 3 months ended on Ashad end 2061
which was not actually received on that date has also not in fact received till the NRB review date.
Therefore, the directors from NRB issue a direction to make a provision for interest suspense that
have not been actually received borrowers till the date of NRB review. As a result of which NRB
issued a direction to allow distributing cash dividend of 10% only instead of 20%. After receiving
such direction form NRB, Managing Director requested Mr. ABC to alter the audited Balance Sheet
as per the NRB direction. Give your view on above.
(5 Marks June 2005)
Answer
The auditor should review the compliance of directives issued by the regulatory authority. In the above
case, it appears that Mr. ABC, a practicing-chartered accountant, auditor of M/s AP Finance Company
Ltd. has reviewed the compliance of NRB directives till the signing date. Therefore, the interest
suspense account as directed by NRB on the basis of subsequent non-recovery of interest income from
borrower would not attract auditor responsible for the year. However, the adjustment of proposed
dividend as per the NRB direction after adjustment of interest suspense account can be done in the
following year (i.e. 2061/62) only instead of adjusting the same in the audited financial statements of
F/Y 2061/62.
Question No. 9
your opinion is based. (4 Marks each June 2005)
a. Mr. Lok Raj Pandey, CEO of M/s PK Co. Ltd. requested you to provide suggestion on the
utilization of revaluation reserve for issue of bonus share.
Answer
The revaluation reserve arises only out of book adjustments, i.e. excess of the revalued amount over
the net book value of fixed assets. The revaluation reserve represents expert‘s opinion of value and
does not represent realized gain.

Share capital represents the amount of money or money‘s worth received from the owners and
capitalization of earned profits or other gains out of arm‘s length transactions. The main principle is
that only such profits, which are earned whether in revenue account or capital account, can be
capitalized.
Therefore, bonus share cannot be issued out of capitalization of revaluation reserve. The auditor
should qualify his report in the event of utilization of such reserve for issue of bonus shares.
b. Mr. A. Shrestha, a practicing Chartered Accountant, received a major professional assignment. In

order to complete such assignment within the deadline, he needed additional five computers. Due
to his financial crises, he could not afford to buy such computers and decided to borrow funds
from a firm where one of his article clerks and his father were interested. Is Mr. Shrestha
committed misconduct under the Institute of Chartered Accountants of Nepal, Regulation 2061?
Answer
In the given case, Mr. Shrestha had taken a loan to buy five computers from a firm where an articled
clerk and his father were interested. Regulation 39 of the Institute of Chartered Accountants of Nepal
Regulations, 2061 states, …
No financial benefit allowed: The principle shall not take benefit of any kind of fee, donation, charge,
loan, security or any other kind of financial advantage or facility from an articled trainee.
Mr. Shrestha will be held guilty of professional misconduct if it can be proved that the engagement of
article clerk is dependent upon this fact. As it appears from the facts of the case, the articled clerk has
already been engaged and serving his article ship and thus, normally, Mr. Shrestha will not be held
guilty of professional misconduct.
c. Mr. Ram Singh Bania, a Chartered Accountant in practice had confirmed in the application
made by his articled clerk Mr. Raja Ram Rauniyar to the Council for permission to study that
the normal working hours of his office were 10 am. to 5 p.m. and the hours during which Mr.
Raja Ram Rauniyar was required to attend college classes in the morning session which started
from 6.30 a.m. to 9.30 a.m. On inquiry form Principal of college, it was revealed that Mr. Raja
Ram Rauniyar used to attend classes from 10 a.m. to 1.30 p.m. Mr. Ram Singh Bania, pleaded
ignorance about his articled clerk, Mr. Raja Ram Rauniyar, attending the college classes
during office hours. Will Mr. Ram Singh Bania be held guilty of professional misconduct?
Answer:
A member shall hold guilty of professional misconduct if he contravenes any provision of the Nepal
Chartered Accountants Act or the Regulations made thereunder.
As per ICAN Regulations, 2061, Rule 35 states that the working hour of an articled trainee in articled
training service shall be of 40 hours a week within 9 a.m. to 5 p.m.
The Chartered Accountant as per Regulation is also expected to impart proper practical training. In
this given case, Mr. Raja Ram Rauniyar would not have been attending a firm on regular basis and the
explanation of Mr. Ram Singh Baniya, cannot be accepted particularly in view of the fact that Mr.
Ram Singh Baniya did not obtain certificate from the principal to confirm the timings. Under the
circumstances Mr. Ram Singh Baniya is guilty of professional misconduct in regard to the discharge
of his professional duties.
Question No. 10
While conducting the audit of the financial statements, you come across the certain matters of
Governance Interest. Explain what matters you think need to be considered for communication. Is it
necessary to design audit performance in such a manner as would enable identification of all matters
that may be relevant to those charged with governance? Explain in the light of NSA 260.
(8 Marks June 2005)

Answer:
The auditor should consider audit matters of governance interest that arise from the audit of the
financial statements and communicate them with those charged with governance. Ordinarily such
matters include:
 The general approach and overall scope of the audit, including any expected limitations
thereon, or any additional requirements;
 The selection of, or changes in, significant accounting policies and practices that have, or
could have, a material effect on the entity‘s financial statements;
 The potential effect on the financial statements of any significant risks and exposures, such
as pending litigation. That are required to be disclosed in the financial statements;
 Audit adjustments, whether or not recorded by the entity that have, or could have, a
significant effect on the entity‘s financial statements;
 Material uncertainties related to events and conditions that may cast significant doubt on the
entity‘s ability to continue as a going concern.
 Disagreements with management about matters that, individually or in aggregate, could be
significant to the entity‘s financial statements or the auditor‘s report. These communications
include consideration of whether the matter has, or has not, been resolved and the
significance of the matter,
 Expected modifications to the auditor‘s report;
 Other matters warranting attention by those charged with governance, such as material
weaknesses in internal control, questions regarding management integrity, and fraud
involving management;
 Any other matters agreed upon in the terms of the audit engagement.
As part of the auditor‘s communications those charged with governance are informed that;
 The auditor‘s communications of matters include only those audit matters of governance
interest that have come to the attention of the auditor as a result of the performance of the
audit;
 An audit of financial statements is not designed to identify all matters that may be relevant
to those charged with governance. Accordingly, the audit does not ordinarily identify all
such matters
Question No. 11
What are audit sampling and other selective testing factors that you employ in an audit of an entity
registered under Companies Act 2063? (8 Marks December 2005)
Answer:
NSA 530 Audit Sampling 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.
As per the said NSA, when designing audit procedures, the auditor should determine appropriate means
for selecting items for testing so as to gather audit evidence to meet the objectives of audit tests.
In accordance with NSA 500 ―Audit Evidence‖, audit evidence is obtained from an appropriate mix of
tests of control and substantive procedures. The type of tests to be performed is important to an
understanding of the application of audit procedures in gathering audit evidence.
i. Tests of Control
―Risk Assessments‖ and ―Internal Control‖ tests are performed if the auditor plans to assess control
risk less than high for a particular assertion.

Based on the auditor‘s understanding of the accounting and internal control systems, the auditor
identifies the characteristics or attributes that indicate performance of a control, as well as possible
deviation conditions, which indicate departures from adequate performance. The presence or absence
of attributes can then be tested by the auditor.
Audit sampling for tests of control is generally appropriate when application of the control leaves
evidence of performance (for example, initials of the credit manager on a sales invoice indicting credit
approval, or evidence of authorization of data input to a microcomputer-based data processing
system).
ii. Substantive Procedures

Substantive Procedures are concerned with amounts and are two types: analytical procedures and tests
of details of transactions and balances. The purpose of substantive procedures is to obtain audit
evidence to detect material misstatements in the financial statements.
In obtaining evidence, the auditor should use professional judgement to assess audit risk and design
audit procedures to ensure this risk is reduced to an acceptably low level.
Audit risk is the risk that the auditor gives an appropriate audit opinion when the financial statements
are materially misstated. Audit risk consists of inherent risk – the susceptibility of an account balance
to material misstatement, assuming there are no related internal controls; control risk – the risk that a
material misstatement will not be prevented or detected and corrected on a timely basis by the
accounting and internal control systems; and detection risk – the risk that the material misstatements
will not be detected by the auditor‘s substantive procedures. These three components of audit risk are
considered during the planning process in the design of audit procedures in order to reduce audit risk
to an acceptably low level.
Sampling risk and non-sampling risk can affect the components of audit risk. For example, when
performing tests of control, the auditor may find no errors in a sample and conclude that control risk
is low, when the rate of error in the population is, in fact, unacceptably high (sampling risk). Or there
may be errors in the sample, which the auditor fails to recognize (non-sampling risk). With respect to
substantive procedures, the auditor may use a variety of methods to reduce detection risk to an
acceptable level. Depending on their nature, these methods will be subject to sampling and/ or non-
sampling risk. For example, the auditor may choose an inappropriate analytical procedure (non-
sampling risk_ or may find only minor misstatements in a test of details when, in fact, the population
misstatement is greater than the tolerable amount (sampling risk). For both tests of control and
substantive tests, sampling risk can be reduced by increasing sample size, while non-sampling risk
can be reduced by proper engagement planning, supervision and review.
Procedures for obtaining audit evidence include inspect, observation, inquiry and confirmation,
computation and analytical procedures. The choice of appropriate procedures is a matter of
professional judgement in the circumstances. Application of these procedures will often involve the
selection of items for testing form a population.
When designing audit procedures, the auditor should determine appropriate means of selecting items
for testing. The means available to the auditor are either selecting all items (100% examination) or
selecting specific items or audit sampling.
The decision as to which approach to use will depend on the circumstances, and the application of any
one or combination of the above means may be appropriate in particular circumstances. While the
decision as to which means, or combination of means, toe use is made on the basis of audit risk and
audit efficiency, the auditor needs to be satisfied that methods used are effective in providing
sufficient appropriate audit evidence to meet the objectives of the test.
The auditor should perform audit procedures appropriate to the particular test objective on each item
selected.
The auditor should consider the sample results, the nature and cause of any errors identified, and their
possible effect on the particular test objective and on other areas of the audit.

For substantive procedures, the auditor should project monetary errors found in the sample to the
population and should consider the effect of the projected error on the particular test objective and on
other areas of the audit.
The auditor should evaluate the sample results to determine whether the preliminary assessment of the
relevant characteristics of the population is confirmed or needs to be revised.
If the evaluation of sample results indicates that the preliminary assessment of the relevant
characteristic of the population needs to be revised, the auditor may:
a) Request management to investigate identified errors and the potential for further errors, and to
make any necessary adjustments‘ and/ or
b) Modify planned audit procedures. For example, in the case of a test of control, the auditor might
extend the sample size, test an alternative control or modify related substantive procedures;
and/or
c) Consider the effect on the audit report.
Question No. 12
The company demanded to hand over the external confirmations of debtors and creditors directly
circularized by you during the course of an audit of the company.
Answer:
As per NSA 230: Audit Documentation: the auditor should adopt appropriate procedures for
maintaining the confidentiality and safe custody of the working papers and for retaining them for a
period sufficient to meet the needs of the practice and in accordance with legal and professional
requirements of record retention.
Working papers are the property of the auditor. Although portions of or extracts from the working
papers may be made available to the client at the discretion of the auditor, they are not a substitute for
the client‘s accounting records.
The confirmations letters obtained by the auditor form audit documentation and are the property of the
auditor as per NSA 230. Thus, the auditor may wish to provide a copy of the same to the company.
However, the company cannot demand and force the auditor to provide the conformation certificates
received by the auditor.
Question No. 13
What are the responsibilities of an auditor with respect to fraud and error in a financial statement
being audited? (5 Marks December 2005)
Answer:
Responsibilities of an auditor with respect to fraud and error in a financial statement
As per NSA 240: The Auditor‘s Responsibilities Relating to Fraud in an Audit of Financial Statements,
when planning and performing audit procedures and evaluating and reporting the results thereof, the
auditor should consider the risk of material misstatements in the financial statements resulting from
fraud or error.
Although the primary responsibility for the prevention and detection of fraud and error rests with both
those charged with the governance and the management of an entity, there are certain responsibilities on
the part of auditors.
As described in NSA 200, ―Overall Objectives of the Independent Auditor and the Conduct of Audit In
Accordance with NSAs ", the objective of an audit of financial statements is to enable the auditor to
express an opinion whether the financial statements are prepared, in all material respects, in accordance
with an identified financial reporting framework or relevant practices. An audit conducted in
accordance with NSAs or relevant practices is designed to provide reasonable assurance that the
financial statements taken as a whole are free form material misstatement, whether cause by fraud or

error. The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be
held responsible for the prevention of fraud and error.
An auditor cannot obtain absolute assurance that material misstatements in the financial statements will
be detected. 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 NSAs. An audit does not guarantee all material
misstatements will be detected because of such factors as the use of judgement, the use of testing, the
inherent limitations of internal control and the fact that much of the evidence available to the auditor is
persuasive rather than conclusive in nature. For these reasons, the auditor is able to obtain only
reasonable assurance that material misstatements in the financial statements will be detected.
Whether the auditor has performed an audit in accordance with NSAs is determined by the adequacy of
the audit procedures performed in the circumstances and the suitability of the auditor‘s report based on
the result of these procedures.
In planning the audit, the auditor should discuss with other members of the audit team the susceptibility
of the entity to material misstatements in the financial statements resulting from fraud or error.
When planning the audit, the auditor should make inquires of management:
a) To obtain an understanding of:
i. Management‘s assessment of the risk that the financial statements may be materially
misstated as a result of fraud; and
ii. The accounting and internal control systems management has put in place to address such
risk;
b) To obtain knowledge of management‘s understanding regarding the accounting and internal
control systems in place to prevent and detect error;
c) To determine whether management is aware of any known fraud that has affected the entity or
suspected fraud that the entity is investigating; and
d) To determine whether management has discovered any material errors
The auditor may have an opportunity to seek the views of those charges with governance during, for
example, a meeting with those charged with governance to discuss the general approach and overall
scope of the audit. This discussion may also provide those charged with governance with the
opportunity to bring matters of concern to the auditor‘s attention.
Since the responsibilities of those charged with governance and management may vary by entity to
entity it is important that the auditor understand the nature of these responsibilities within an entity to
ensure that the inquires and communications described above are directed to the appropriate
individuals.
When assessing inherent risk and control risk, the auditor should consider how the financial statements
might be materially misstated as a result of fraud or error. In considering the risk of material
misstatement resulting from fraud, the auditor should consider whether fraud risk factors are present
that indicate the possibility of either fraudulent financial reporting or misappropriation of assets.
In making assessment of inherent risk and control risk affecting the nature, timing and extent of the
audit procedures, the auditor considers how the financial statements might be materially misstated as a
result of fraud or error.
Based on the auditor‘s assessment of inherent and control risks (including the results of any test of
controls), the auditor should design substantive procedures to reduce to an acceptably low level the risk
that misstatements resulting from fraud and error that are material to the financial statements taken as a
whole will not be detected. In designing the substantive procedures, the auditor should address the fraud
risk factors that the auditor has identified as being present.
When the auditor encounters circumstances that may indicate that there is a material misstatement in the
financial statements resulting from fraud or error, the auditor should perform procedures to determine
whether the financial statements are materially misstated. When the auditor identifies a misstatement,

the auditor should consider whether such a misstatement may be indicative of fraud and if there is such
an indication, the auditor should consider the implications of the misstatement in relation to other
aspects of the audit, particularly the reliability of management representations.
When the auditor confirms that, or is unable to conclude whether, the financial statements are materially
misstated as a result of fraud or error, the auditor should consider the implications for the audit.
The audit should document fraud risk factors identified as being present during the auditor‘s assessment
process and document the auditor‘s response to any such factors. If during the performance of the audit,
fraud risk factors are identified that cause the auditor to believe that additional audit procedures are
necessary, the auditor should document the presence of such risk factors and the auditor‘s response to
them.
The auditor should obtain written representations from management that:
a) It acknowledges its responsibility for the implementation and operations of accounting and
internal control systems that are designed to prevent and detect fraud and error;
b) It believes the effects of those uncorrected financial statement misstatements aggregated by the
auditor during the audit are immaterial, both individually and in the aggregate, to the financial
statements taken as a whole. A summary of such items should be included in or attached to the
written representation.
c) It has disclosed to the auditor all significant facts relating to any frauds or suspected frauds
known to management that may have affected the entity; and
d) It has disclosed to the auditor the results of its assessment of the risk that the financial
statements may be materially misstated as a result of fraud.
When the auditor identifies a misstatement resulting from fraud, or a suspected fraud, or error, the
auditor should consider the auditor‘s responsibility to communicate that information to management,
those charged with governance and, in some circumstances, to regulatory and enforcement authorities.
If the auditor has identified a material misstatement resulting from error, the auditor should
communicate the misstatement to the appropriate level of management on a timely basis and consider
the need to report it to those charge with governance.
The auditor should inform those charged with governance of those uncorrected misstatements
aggregated by the auditor during the audit that were determined by management to be immaterial, both
individually and in the aggregate, to the financial statements taken as a whole.
If the auditor has:
a) Identified a fraud, whether or not it results in a material misstatement in the financial statements;
or
b) Obtained evidence that indicates that fraud may exist (even if the potential effect on the financial
statements would not be material).
The auditor should communicate these matters to the appropriate level of management on a timely basis
and consider the need to report such matters to those charged with governance.
The auditor should also communicate to management any material weaknesses in internal control
related to the prevention or detection of fraud and error, which have come to the auditor‘s attention as a
result of the performance of the audit. The auditor should also be satisfied that those charged with
governance have been informed of any material weaknesses in internal control related to the prevention
and detection of fraud that either have been brought to the auditor‘s attention by management or have
been identified by the auditor during the audit.
Question No. 14
Your audit client has prepared its fixed asset and depreciation schedule in full compliance with the
provisions of Income Tax Act 2058 for the purpose of statutory accounts also citing that it eases

preparation of financial statements. As a statutory auditor, how would you react to this practice of
your good client? (8 Marks December 2005)
Answer:
Fixed Assets and depreciation
The students are required to mention the provisions related to depreciation as mention in NAS and
Income Tax Act 2058 at first and how the depreciation is computed under these separate standards.
As can be seen from above, there are difference treatment between NAS and IT Act with respect to:
 Classification and grouping of assets,
 Determination of cost of an asset for depreciation purpose, and
 Recognition of repair & maintenance cost and resulting gain or loss on disposal of asset.
Thus, the auditor should qualify his report accordingly of statutory purpose.
Question No. 15
How does knowledge of business help in planning and performing an audit? Base your answer on
NSA 315: Identifying and Assessing the Risk of Material Misstatement through Understanding the
Entity and Its Environment. (6 Marks June 2006)
Answer:
As per NSA 315, The auditor shall obtain an understanding of the following:
a) Relevant industry, regulatory, and other external factors including the applicable financial
reporting framework.
b) The nature of the entity, including:
i. its operations;
ii. its ownership and governance structures;
iii. the types of investments that the entity is making and plans to make, including
investments in special purpose entities; and
iv. the way that the entity is structured and how it is financed,
to enable the auditor to understand the classes of transactions, account balances, and disclosures to be
expected in the financial statements.
c) The entity‘s selection and application of accounting policies, including the reasons for
changes thereto. The auditor shall evaluate whether the entity ‘s accounting policies are
appropriate for its business and consistent with the applicable financial reporting framework
and accounting policies used in the relevant industry.
d) The entity‘s objectives and strategies, and those related business risks that may result in risks
of material misstatement.
e) The measurement and review of the entity‘s financial performance.
Following matters may be considered in a specific engagement by the auditor.
i. General Economic Factors,

ii. The Industry-Important Conditions Affecting the Client's Business
iii. The Entity's Management and ownership,
iv. The Entity's Operating Management,
v. The entity' internal controls and their operating effectiveness
Such knowledge is used by the auditor in assessing inherent and control risks and in determining the
nature, timing and extent of audit procedures.

Knowledge of the business is a frame of reference within which the auditor exercises professional
judgement. Understanding the business and using this information appropriately assists the auditor
in:
 Assessing risks and identifying problems,

 Planning and performing the audit effectively and efficiently,
 Evaluating audit evidence, and
 Providing better service to the client.
The auditor makes judgments about many matters throughout the course of the audit where
knowledge of the business is important.
The auditor should ensure that assistants assigned to an audit engagement obtain sufficient
knowledge of the business to enable them to carry out the audit work delegated to them. The auditor
would also ensure they understand the need to be alert for additional information and the need to
share that information with the auditor and other assistants.
To make effective use of knowledge about the business, the auditor should consider how it affects
the financial statements taken as a whole and whether the assertions in the financial statements are
consistent with the auditor's knowledge of the business.
Question No. 16
What are the provisions with regard to disqualification of an auditor as per Companies Act 2063?
(5 Marks June 2006)
Answer:
Disqualifications of auditor: (1) None of the following persons or the firms or companies in which
such persons are partners shall be qualified for appointment as auditor and shall, despite appointment as
auditor, continue to hold office:
a. A director, advisor appointed with entitlement to regular remuneration or cash benefit, a person or
employee or worker involved in the management of the company or a partner of any of them or and
employee of any of such partners or a close relative of a director or partner, out of them, or and
employee of such relative;
b. A debtor who has borrowed moneys from the company in any manner, or a person who has failed
to pay any dues payable to the company within the time limit and is in such arrears or close relative
of such person;
c. A person who has been sentenced to punishment for an offense pertaining to audit and a period of
five years has not elapsed thereafter;
d. A person who has been declared insolvent;
e. A substantial shareholder of the company or a shareholder holding one percent or more of the
paid-up capital of the company or his close relative;
f. A person who has been sentenced to punishment for an offense of corruption, fraud or a criminal
offense involving moral turpitude and a period of five years has not elapsed thereafter;
g. A person referred to in Sub-section (3) of Section 111;
h. In the case of a public company , any person who works, whether full time or part time , for any
governmental body or anybody owned fully or partly by the Government of Nepal or any other
company or a partner of such person or a person who is working as an employee of such partner or a

person who is authorized to sign any documents or reports to be prepared by the management of the
company;
i. A company or corporate body with limited liability;
j. A person having interest in any transaction with the company or his/her close relative or a director,
officer or substantial shareholder of another company having any interest in any transaction with the
company
Question No. 17
While asking for certain evidences, Finance Manager of your clients informs you that he will include
the matter in the management representation. Will you accept management representation as
evidence? (5 Marks June 2006)
Answer:
Auditors should not place reliance on representations where more reliable evidence would be expected.
The absence of corroboratory evidence would, in itself, be suspicious and should lead to further audit
enquiry. Moreover, written representations do not necessarily constitute sufficient evidence. The auditor
must consider at available evidence and its reliability in forming an opinion. Therefore, auditor should
not depend upon management representations only wherever other evidences may be collected. As per
NSA 580, written representations cannot be considered as sufficient appropriate audit evidence. Audit
evidence will still be collected, and the representation will support that evidence. Any contradiction
between sources of evidence should always be investigated. Therefore, Finance Managers view should
not be accepted.
Question No. 18
On re-computation of payment to a contractor you find that the contractor was paid less than amount
derived as per agreed terms. The accountant represents that the contractor has received the amount
and has not made further claim. Therefore, auditors are not concerned anymore.
(5 Marks June 2006)
Answer:
This suspected fraud is perpetrated by company and not by employees against company. The auditor's
duty of confidentiality to the company prevents them from communicating to the contractor. However,
the company has a liability under the terms of the contract, which must be provided for until
extinguished by the statute of limitations or other limitation on the rights of creditors to claim for
amount underpaid.
The auditor should seek legal advice about possibility of further claims from the contractor. Further
possibility of defrauding the contractor for pecuniary advantage may also be explored from the point of
prevailing laws. If it is a case of defrauding the contractor auditors should mention in the report about
the same.
In case short payment is not intentional, auditor should assess the materiality and should modify the
report accordingly. Further auditor should reassess inherent risk involved in the audit at the entity level.
This may lead to increased level of substantive procedures.
Question No. 19
your opinion is based.

Mr. Bhishma is appointed auditor of Test Ltd., at a total remuneration of Rs. 1,00,000/- which is
classified as under:
(i) For C Unit of the Company Rs. 45,000/-

(ii) For D Unit of the Company Rs. 60,000/-
(iii) For Central Office Rs. 25,000/-
According to the terms of appointment, Mr. Bhisma can collect his fees on progressive basis, on
completion of audit of unit (i) and/ or unit (ii).
Mr. Bhisma completed the audit of unit (ii) and recovered Rs. 60,000 on account of the audit fees
though the entire audit is not completed.
Whether Mr. Bhisma is indebted to the company and therefore disqualified?

(5 Marks June 2006)
Answer hint:
In this case, an auditor cannot be said to be indebted to the company at any stage if he recovers his fees
on a progressive basis as and when a part of the work is done without waiting for the completion of the
whole job provided such fees is recovered in accordance with the terms of his engagement with the
client. In this light, Mr. B cannot be considered to be indebted to the company and is qualified to act as a
statutory auditor.
Question No. 20
a) Explain "Reporting Consideration" while using the work of another auditor.
Answer
When the principal auditor concludes that the work of the other auditor cannot be used and the principal
auditor has not been able to perform sufficient additional procedures regarding the financial information
of the component audited by the other auditor, the principal auditor should express a qualified opinion
or disclaimer of opinion because there is a limitation in the scope of the audit.
If the other auditor issues, or intends to issue, modified auditor's report, the principal auditor would
consider whether the subject of the modification is of such a nature and significance, in relation to the
financial statements of the entity on which the principal auditor is reporting that a modification of the
principal auditor's report is required.
b) Write a short note on Management Representation Letter (4 Marks December 2006)

Answer
Management representation letter is issued by the management before signing of the auditor's report to
place on record as well as to confirm various significant representations of the management made in the
accounting statements. These letters are obtained by the auditors as a matter of audit procedure and they
act as a reminder to the management of their responsibilities. The letter in no way relieves the auditors
from carrying out their responsibilities. According to NSA 11 on Management Representations, the
main contents of such representation are as follows:
i. A statement that there have been no irregularities involving management or employees who have a
significant role in the accounting and internal control systems or that could have a material effect
on the financial statements.

ii. A statement that all books of account and supporting documentation and all minutes of meetings
of shareholders and the board of directors have been made available to the auditors.
iii. A statement that financial statements are free of materials misstatements including omissions.
iv. A statement that the company has complied with all aspects of contractual agreements and with
requirements of regulatory authorities that could have a material effect on the financial statements
in the event of noncompliance.
v. A statement that the company has satisfactory title to all assets and there are no liens or
encumbrances on the company's assets except for those disclosed in the notes to the financial
statements.
vi. A statement that all liabilities, both actual and contingent, have been recorded or disclosed, as
appropriate and all guarantees given to third parties have been disclosed in notes to the financial
statements.
It is however to be noted that the auditor has to exercise his own judgment as to the extent up to
which he can rely upon such letter of representation.
Question No. 21
a) What are the statements of facts that an auditor has to report u/s 115 of the Companies Act,
2063? (5 Marks December 2006)
b) What are the auditor's functions and duties under Company Ordinance, 2062?
c) What are the provisions for removal of Member's name from the Member's register under
Chartered Accountants' Regulations, 2060? (4 Marks December 2006)
Answer
a) Section 115 of the Companies Act, 2063, deals with contents of the audit report in which the
auditor is required to report on the following statements of fact:
 Whether such information and explanations have been made available as were required for the
completion of audit;
 Whether the books of account as required by this Act have been properly maintained by the
company in a manner to reflect the real affairs of its business;
 Whether the balance sheet, profit and loss account and cash flow statements received have
been prepared in compliance with the accounting standards prescribed under the prevailing
law and whether such statements are in agreement with the books of account maintained by
the company;
 Whether, in the opinion of the auditor based on the explanations and information made
available in the course of auditing, the present balance sheet properly reflects the financial
situation of the company, and the profit and loss account and cash flow statement for the year
ended on the same date properly reflect the profit and loss, cash flow of the company,
respectively;
 Whether the board of directors or any representative or any employee has acted contrary to
law or misappropriated any property of the company or caused any loss or damage to the
company or not;

 whether any accounting fraud has been committed in the company

 Suggestion, if any.
(b) The functions and duties of auditor under Companies Act, 2063 are as follows:
(1) The auditor shall, addressing the shareholders or the appointing authority, submit to the
company his/her report, certifying the balance sheet, profit and loss account and cash flow
statement based on the books of account, records and accounts audited by him/her.
(2) The audit report shall be prepared in accordance with the prevailing law or in consonance
with the audit standards prescribed by the competent body; and such report shall state the
matters to be set out under this Act, as per necessity.
(3) The Auditors Report shall report on the following:
 Whether such information and explanations have been made available as were required
for the completion of audit;
 Whether the books of account as required by this Act have been properly maintained by
the company in a manner to reflect the real affairs of its business;
 Whether the balance sheet, profit and loss account and cash flow statements received
have been prepared in compliance with the accounting standards prescribed under the
prevailing law and whether such statements are in agreement with the books of account
maintained by the company;
 Whether, in the opinion of the auditor based on the explanations and information made
available in the course of auditing, the present balance sheet properly reflects the
financial situation of the company, and the profit and loss account and cash flow
statement for the year ended on the same date properly reflect the profit and loss, cash
flow of the company, respectively;
 Whether the board of directors or any representative or any employee has acted contrary
to law or misappropriated any property of the company or caused any loss or damage to
the company or not;
 whether any accounting fraud has been committed in the company
 Suggestion, if any.
In the preparation of the financial statements, management has a responsibility to assess the
entity's ability to continue as a going concern even if the financial reporting framework does not
include an explicit responsibility to do so.
(c) Under Chartered Accountants Regulations 2060, The Council of the Institute of Chartered
Accountants of Nepal can remove members name from the Member's register in following
cases:
i. If the Council of Institute of Chartered Accountants of Nepal decides to cancel

membership of a member charged for a guilty considering the extent of guilty in
recommendation of Disciplinary Committee.
ii. If the member is found disqualified under Section 18 of the Chartered Accountants' Act
2053.
a. If the member does not meet the qualifications as required under Section 16 (2) & (3)
of the Nepal Chartered Accountants Act 2053.

b. If the member has not completed 21 years of age.
c. If the member is declared insolvent.
iii. If the Council of The Institute of Chartered Accountants of Nepal decides to cancel
membership of a member after finding out the following:
a. If the member is punished on charge of criminal offence involving moral turpitude.
b. If the membership fees are not paid to the Institute.
c. If the member does not abide to the professional code of conduct prescribed under the
Chartered Accountants' Act, 2053.
d.If the member suffers from mental disorder.
e. If the member dies.
iv. If the Council of Institute of Chartered Accountants of Nepal becomes aware of the
recording of membership of a member due to mistake or error and founds it to be so
after investigation.
Question No. 22 (5 Marks each June 2007)
a) M/s ABC & Co., a Chartered Accountants firm was appointed as auditor of the
Sagarmatha Ltd by the annual general meeting held on Marg 20, 2062 for the audit of
fiscal year 2062/63. The auditor submitted management letter to the Board of Directors
on Kartik 5, 2063 before the submission of audit report that contains certain serious
issues relating to the accounting and management of the company. The meeting of the
Board of Directors held on Kartik 9, 2063 decided to request the auditor to remove those
issues from the management letter. The auditor did not remove the issues from the
management letter and submitted the final management report on Kartik 22, 2063
without considering the request of the Board. The meeting of the Board held on Kartik
25, 2063 decided to remove the auditor and issued letter to the auditor accordingly. Do
you think the Board can remove the auditor?
b) The BCD Company Ltd. having paid up capital of Rs. 25 million has retained earning of
Rs. 2 million as per financial statement of the financial year 2062/63 certified by the
auditor. The company prepared the interim financial statements as of Paush 30, 2063
and the profit and loss account ended on that date shows net profit of Rs. 1.5 million.
The board of directors of the company decided to distribute interim dividend of 10
percent. Do you think the decision of the board of directors is appropriate as per
prevailing law?
c) Why should the auditor assess the professional competence and objectivity of an expert
while using the work of an expert?

Answer
a) According to the provisions of Companies Act 2063, the auditor cannot be removed before
submission of audit report of the financial year for which he has been appointed and he
holds office until the next Annual General Meeting. Such provision in the Act guarantees
independence of the auditor.
The appointed auditor can be removed only when the auditor breaches the code of conducts
of auditors or acts against the interest of the auditee or commits any act contrary to the
prevailing law, through the same process whereby he was appointed as auditor, by giving
prior information to the Institute of Chartered Accountants of Nepal and obtaining approval
of the regulatory authority of the company concerned if any or of the Company Registrar's
Office in the absence of such regulatory authority. However, the auditor should be provided
with a reasonable opportunity to defend himself while removing an auditor.
As the above situation does not exist in the given case, the auditor appointed by the annual
general meeting cannot be removed by the Board under the Companies Act 2063.
b) According to the provisions of Companies Act 2063, the Board can distribute interim
dividend out of the profits for the previous financial year provided that the articles of
association contain a provision of the distribution of interim dividend and the annual
financial statement of the financial year, out of the profits of which year interim dividend is
to be distributed, has already been certified by the auditor and approved by the board of
directors. Provided that before distribution of interim dividend depreciation for the year and
any unabsorbed losses should be fully provided in the financial statements.
The profit of the previous year in the given case is only Rs. 2 million that is less than 10
percent of the paid-up capital of the company and the profit of the current year cannot be
used for distribution of the interim dividend. Therefore, the decision of the board of
directors is not appropriate and legal as per the provisions of the Companies Act.
c) According to Nepal Standards on Auditing -620, Using the work of an expert, the auditor
has to gather sufficient audit evidence to draw the conclusions for the expression of an
audit opinion on the financial statements. As the auditor does not have expertise of other
profession except accounting and auditing, the auditor should use the work performed by
an expert to obtain sufficient appropriate audit evidence related to technical work to assure
himself that such work is adequate for the purposes of the audit and for the following
reasons:
(i) the materiality of the financial statement item being considered;
(ii) the risk of misstatement based on the nature and complexity of the matter being
considered; and
(iii) the quantity and quality of other audit evidence available.
The professional competence and the objectivity of the expert have to be assessed as they
will affect the quality of the audit evidence being collected and ultimately the audit
opinion. The professional competence of the expert depends on (a) professional
certification or licensing by, or membership in, an appropriate professional body; and (b)
experience and reputation in the field in which the auditor is seeking audit evidence.

Similarly, an expert‘s objectivity may be impaired when the expert is employed by the
entity or related in some other manner to the entity, for example, by being financially
dependent upon or having an investment in the entity.
a) The XYZ Company Ltd. having paid up capital of Rs. 100 million has accumulated loss
of Rs. 5 million up to financial year 2061/62 as per audited financial statement. The
company earned net profit of Rs. 8 million after tax in the financial year 2062/63. The
board of directors of the company proposed 5 percent dividend out of net profit of the
financial year 2062/63. Can annual general meeting of the company approve the
percentage of the proposed dividend?
b) The BCD & Co. an auditor of the DEF Company Ltd. appointed its employee, Mr. X as
an expert to assess condition and remaining life of the equipment of the company for
accounting depreciation as per Nepal Accounting Standard 16, Property, Plant and
Equipment and Depreciation. Has the BCD & Co. violated the code of ethics of the
Institute of Chartered Accountants of Nepal by appointing its own employee as an
expert?
c) What are the various procedures you would follow as an auditor in a compilation
engagement and under what circumstances you will withdraw from the engagement?
d) Disqualification of Auditors as per Company Act, 2063 (4 Marks December 2007)
Answer
a) The company has to deduct the pre-operation expenses, the depreciation to be accounted in
accordance with the accounting standards promulgated by the competent authority under
the prevailing law, any amount required to be paid or set aside out of the profits under the
prevailing law or the total amount of accumulated loss before payment or distribution of
dividend from the net profit of any fiscal year. Similarly, if the company is required to
create any reserve or fund under the prevailing law, dividend cannot be distributed without
setting aside the amount for such reserve or fund.
Accordingly, the retained profit after adjusting accumulated loss of Rs. 5 million of the
previous year from the net profit of Rs.8 million of the fiscal year 2062/063 is Rs. 3 million
only which is less than the 5 percent of the paid-up capital of the company. The Company
Act has strictly prohibited the distribution of dividend from the net profit of the current
year without setting off the accumulated loss of the previous year. Hence, the annual
general meeting cannot approve the percentage of the proposed dividend rather it can
approve the percentage of dividend sufficient to pay from the net profit after deducting the
earlier year accumulated loss.
b) According to Nepal Standards on Auditing-620, Using the Work of an Expert, an expert

means a person or firm possessing special skill, knowledge and experience in a particular
field other than accounting and auditing. An expert may be engaged by the entity or auditor
or employed by the entity or the auditor. When the auditor uses the work of an expert
employed by the auditor, that work is used in the employee‘s capacity as an expert rather

than as an assistant on the audit. However, in such circumstances the auditor will need to
apply relevant procedures to the employee‘s work and findings.
Further Code of Ethics of Institute of Chartered Accountants of Nepal (ICAN), specifies

that the Professional Accountant should be independent of a client and all its parents,
subsidiaries and affiliates and should not assume the role of employee or of management
conducting the operations of an enterprise. The appointment of an expert employed by the
auditor for the purpose of using the work of an expert is not prohibited by the Code of
Ethics. Therefore, the BCD & Co. and auditor have not violated the code of ethics of the
ICAN.
c) According to NSRS 4410 "Compilation Engagements" a practitioner should obtain a

general knowledge of the business and operations of the entity. Also, he should be familiar
with the accounting principles and practices of the industry in which the entity operates and
with the form and content of the financial information that is appropriate in the
circumstances to compile the financial statements.
The practitioner shall compile the financial information using the records, documents,
explanations and other information, including significant judgments, provided by
management.
The practitioner shall discuss with management, or those charged with governance as
appropriate, those significant judgments, for which the practitioner has provided assistance
in the course of compiling the financial information.
Prior to completion of the compilation engagement, the practitioner shall read the compiled
financial information in light of the practitioner‘s understanding of the entity‘s business
and operations, and of the applicable financial reporting framework
If, in the course of the compilation engagement, the practitioner becomes aware that the
records, documents, explanations or other information, including significant judgments,
provided by management for the compilation engagement are incomplete, inaccurate or
otherwise unsatisfactory, the practitioner shall bring that to the attention of management
and request the additional or corrected information.
If the practitioner becomes aware during the course of the engagement that:
a. The compiled financial information does not adequately refer to or describe the
applicable financial reporting framework;
b. Amendments to the compiled financial information are required for the financial
information not to be materially misstated; or
c. The compiled financial information is otherwise misleading,
the practitioner shall propose the appropriate amendments to management and If
management declines or does not permit the practitioner to make the proposed amendments
to the compiled financial information, the practitioner shall withdraw from the engagement
and inform management and those charged with governance of the reasons for
withdrawing.
d) As per Section 112 (1) of the Company Act 2063, none of the following persons or the
firms or companies in which such persons are partners shall be qualified for appointment as
auditors and shall, despite appointment as auditor, continue to hold office:

i. A director, advisor appointed with entitlement to regular remuneration or cash benefit, a

person or employee or worker involved in the management of the company or a partner
of any of them or an employee of any of such partners or a close relative of a director or
partner, out of them, or an employee of such relative;
ii. A debtor who has borrowed moneys from the company in any manner, or a person who
has failed to pay any dues payable to the company within the time limit and is in such
arrears or a close relative of such person;
iii. A person who has been sentenced to punishment for an offense pertaining to audit and a
period of five years has not elapsed thereafter;
iv. A person who has been declared insolvent;
v. A substantial shareholder of the company or a shareholder holding one percent or more

of the paid-up capital of the company or his close relative;
vi. A person who has been sentenced to punishment for an offense of corruption, fraud or a
criminal offense involving moral turpitude and a period of five years has not elapsed
thereafter;
vii. A person referred to in sub-section (3) of Section 111;
viii. In the case of a public company, any person who works, whether full time or part time,
for any governmental body or anybody owned fully or partly by the Government of
Nepal or any other company or a partner of such person or a person who is working as
an employee of such partner or a person who is authorized to sign any documents or
reports to be prepared by the management of the company;
ix. A company or corporate body with limited liability;
x. A person having interest in any transaction with the company or his close relative or a
director, officer or substantial shareholder of another company having any interest in any
transaction with the company.
Question No. 24
a) The auditor is required to take into account the aggregate of all uncorrected
misstatements including those involving estimates in his assessment of materiality in
audit. Discuss. (6 Marks June 2007)
b) M/s ITG Ltd. manufactures "X" machinery used in M/s ABC Ltd. M/s ITG Ltd. quotes
in various tenders issued by M/s ABC Ltd. As per terms of contract, full price of "X"
machinery is not released by M/s ABC Ltd., but 10% thereof is retained and paid after
one year if there is satisfactory performance of the "X" machinery supplied. The
company accounts for only 90% of the invoice value as sales income and the balance
amount in the year of receipt to the extent of actual receipt only. Give your view as the
auditor of the company. (4 Marks June 2007)

Answer
a) Nepal Standard on Auditing–450 on "Evaluation of Misstatement Identified During the
Year" requires the auditor to determine whether the uncorrected misstatements are material
individually or in aggregate.
In making this determination, the auditor shall consider:
a. The size and nature of the misstatements, both in relation to particular classes of
transactions, account balances or disclosures and the financial statements as a whole,
and the particular circumstances of their occurrence; and
b. The effect of uncorrected misstatements related to prior periods on the relevant classes
of transactions, account balances or disclosures, and the financial statements as a
whole.
The aggregate of uncorrected misstatements comprises.

i. Specific misstatements identified by the auditor including the net effect of uncorrected
misstatements identified during the audit of previous periods; and
ii. The auditor's best estimate of other misstatements which cannot be specially identified,
that is, projected errors. The analytical procedures employed by the auditor may give
him some indication about the existence of misstatements which can be further
substantiated by him through estimates process.
If the aggregate of the uncorrected mis-statements that the auditor has identified
approaches the materiality level, or if auditor determines that the aggregate of uncorrected
mis-statements causes the financial information to be materially mis-stated, he should
consider requesting the management to adjust the financial information or extending his
audit procedures. In any event, the management may want to adjust the financial
information for known misstatements. The adjustment of financial information may
involve, for example, application of appropriate disclosure of inadequately disclosed
matters. If the management refuses to adjust the financial information and the results of
extended audit procedures do not enable the auditor to include that the aggregate of
uncorrected misstatements is not material, the auditor should express a qualified or adverse
opinion, as appropriate.
b) Nepal Accounting Standard – 18 'Revenue' states that revenue from sale of goods should be
recognized when all the following conditions have been satisfied:
i. the enterprise has transferred to the buyer the significant risks and rewards of ownership
of the goods;
ii. the enterprise retains neither continuing managerial involvement to the degree usually
associated with ownership nor effective control over the goods sold;
iii. the amount of revenue can be measured reliably;
iv. it is probable that the economic benefits associated with the transaction will flow to the
enterprise; and
v. the costs incurred or to be incurred in respect of the transaction can be measured reliably.
In the case of ITG Ltd., the goods, as well as the risks and rewards of ownership have been
transferred to ABC Ltd. The invoice raised by ITG Ltd. is for the full price, but 10% less is
received as the same is kept as "Retention Money". In this case, therefore, revenue has to
be recognized at the full invoice price, i.e. 100% has to be accounted as Sales Income.
Depending on the past experience of recovering the balance 10% from ABC Ltd., ITG Ltd.

can, however, make a provision for sales income which is not likely to be realized. In the
absence of the above, the auditor will have to qualify his report.
Question No. 25
Distinguish between:
a) Corresponding figures and Comparative figures (5 Marks June 2007)
b) Positive confirmation and Negative confirmation (5 Marks June 2007)
Answer
a) Corresponding figures and Comparative figures
Under Corresponding figures amounts and other disclosures for the preceding period are
included as part of the current period financial statements and are intended to be read in
relation to the amounts and other disclosures relating to the current. These corresponding
figures are not presented as complete financial statements capable of standing alone but are
an integral part of the current period financial statements intended to be read in conjunction
with the amounts and other disclosures relating to the current period. The level of detail
presented in the corresponding amounts and disclosures is dictated primarily by its
relevance to the current period figures.
Under the comparative financial statements, the comparative financial statements for the
prior period(s) are considered separate financial statements and the amounts and other
disclosures for the preceding period are included for comparison with the financial
statements of the current period, but do not form part of the current period financial
statements. Accordingly, the level of information included in those comparative financial
statements (including all statement amounts, disclosures, footnotes and other explanatory
statements to the extent that they continue to be of significance) approximates that of the
financial statements of the current period.
Positive confirmation and Negative confirmation
A positive external confirmation request asks the respondent to reply to the auditor in all
cases either by indicating the respondent‘s agreement with the given information or by
asking the respondent to fill in information asked for. A response to a positive confirmation
request ordinarily provides reliable audit evidence but there is a risk of replying the
confirmation request without verifying the correctness of the information asked for by the
respondent. The auditor may not be able to detect occurrence of such situation. The auditor
may reduce this risk by using positive confirmation requests without stating the amount or
other information on the confirmation request and asking the respondent to fill in the
amount or furnish other information asked for. However, the use of this type of ―blank‖
confirmation request may result in lower response rates due to requirement of additional
effort of the respondents.
A negative external confirmation request asks the respondent to reply only in the event of
disagreement with the information provided in the request. There will not be explicit
evidence of receipt of confirmation request by the third parties and verification of
information provided in the request if response has not been received to a negative
confirmation request. Therefore, the use of negative confirmation requests ordinarily
provides less reliable evidence than the use of positive confirmation requests, and the

auditor has to consider performing other substantive procedures to supplement the use of
negative confirmations.
Question No. 26
Comment and give your opinion on the following issues with specific reference to criteria on
which your opinion is based: (5 Marks each June 2007)
a) A commercial bank did not make any provision for proposed dividend of 10 percent in
the financial statement of the fiscal year 2062/63. Nepal Rastra Bank approved the
financial statements for publication without knowing the intention of the bank of
declaring dividend. One of the published agenda of the annual general meeting of the
bank is approval of proposed dividend of 5 percent.
b) The Audit Committee of PST Ltd. recommended the names of possible auditor to be
appointed as auditor of the company at the remuneration of Rs. 125,000 for the financial
year 2063/64. The annual general meeting held on Kartik 7, 2063 failed to appoint the
auditor due to time constraint and delegated power to the Board to appoint the auditor
from the list of the auditors at the remuneration under the terms of condition
recommended by the Audit Committee. The Board meeting held on Kartik 30, 2063
appointed M/s. XP & Co., a Chartered Accountants firm as auditor. Do you think the
appointment is valid and if not why?
Answer
a) As per NAS 10, If an entity declares dividends to holders of equity instruments after the
balance sheet date, the entity shall not recognize those dividends as a liability at the balance
sheet date.
If dividends are declared (i.e. the dividends are appropriately authorized and no longer at
the discretion of the entity) after the balance sheet date but before the financial statements
are authorized for issue, the dividends are not recognized as a liability at the balance sheet
date because they do not meet the criteria of a present obligation. Such dividends are
disclosed in the notes in accordance with NAS 01 Presentation of Financial Statements.
Similarly, as per Bank and Financial Institution Act 2063, the bank can declare or distribute
dividend to its shareholders only after recovering all its preliminary expenses, setting off
accumulated loss up to previous year, maintaining adequate provision for capital fund, loan
losses and statutory reserve fund, and obtaining prior approval of the Nepal Rastra Bank.
In the given case, the commercial bank has not mentioned in the notes of the financial
statements as required by the Nepal Accounting Standards which is to be followed by the
commercial bank as per prevailing Act. Due to non-disclosure in the notes to the financial
statements, the Nepal Rastra Bank was not aware of the declaration of the dividend. The
prior approval of the Nepal Rastra Bank as required by the Act has also not been obtained.
Therefore, the agenda put for approval of declaration of the dividend is null and void and
annual general meeting cannot approve the agenda of dividend.
b) According to the provisions of Companies Act 2063, every company has to appoint the
auditor to have its accounts audited. The annual general meeting on recommendation of the
Audit Committee in the case of public company has the authority to appoint an auditor of
the company from amongst the auditors holding certificate of practice under the prevailing
law and the name of the auditor appointed should be forwarded to the Company Registrar's

office within fifteen days from the date of such appointment. The Act does not have any
provision of delegating power to anyone for appointment of auditor. The annual general
meeting of the public company has authority to appoint auditor at the remuneration under
the terms and conditions as recommended by the Audit Committee.
Where the annual general meeting fails to appoint an auditor for any reason or where the
annual general meeting itself cannot be held or where the auditor appointed pursuant to the
Companies Act ceases to continue his office for any reason, the Company Registrar's office
may at the request of the Board of Directors of the company appoint another auditor. In this
situation, the Board of the company can request the Company Registrar's office for the
appointment of the auditor, but the office has sole authority to appoint any auditor holding
certificate of practice at remuneration under terms and conditions decided by the office.
The Companies Act does not have provision of delegating power of the appointment of the
auditor and no one else has authority to select the auditor for appointment except the annual
general meeting and Company Registrar's Office in case of failure to appoint the auditor by
the Annual General Meeting (AGM) , the appointment of the auditor by the Board of
Directors under the delegation of authority by AGM is not valid. The Company Registrar's
office can only appoint anyone as the auditor on request of the Board of the company.
Question No. 27
M/s Raghu Manufacturing Company Ltd. has invested in the shares and debenture and other
scripts of various companies listed in Nepal Stock Exchange Ltd. During the course of audit of
the FY 2063/64, in spite of repeated reminders and follow up made by its external auditor,
company officials did not provide the details of investments in shares and various securities held
by the company at the Balance Sheet date. As a result, the external auditor came to conclusion
that he/she should issue his/her final audit report as follows;
“Subject to the verification of the value of investments held in shares and debentures and other
scripts of various companies listed in Nepal Stock Exchange Ltd., the balance sheet reflects a
true and fair view.”
Do you think the audit report to be issued by the auditor is appropriate in view of the Company
Act, 2063? Give your view. (5 Marks December 2007)
Answer
Failure to Obtain Information and Explanation:
The external auditor is required to express his opinion on the truth and fairness of the financial
statement audited by him only after examining the authenticity with reference to the information
and explanations given to him as required by Section 115 of Company Act 2063. He must
determine the extent of information which should be obtained by him before expressing an opinion
on the financial statement submitted for audit. The auditor should not express an opinion before
obtaining the required data and information.
In the given case, since the external auditor did not see the existence and also valuation of the
investments held by the company, the auditor, should not report as mentioned in the question. In
this case, the external auditor has not been able to obtain information and might not be able to
satisfy himself by adopting other audit procedure and accordingly may have to appropriately
modify the report.
The auditor may state that because of these circumstances, he has been unable to form an opinion.
But, reporting by the auditor that,‖ subject to verification of the existence and value of the
investments held in shares and debenture and other scripts in the various companies listed in the
Nepal Stock Exchange Ltd., the Balance Sheet shows a true and fair view‖, the auditor is not
providing information but only means to information. By reporting in the above manner auditor is

not conveying any information rather the auditor is arousing the suspicion of users of financial
statements. In case the auditor has not been able to obtain relevant information or explanations as
required by the provisions of the Company Act, 2063, he may have to qualify his opinion on the
truth and fairness of the information or explanations or express his inability to give an opinion in
the matter. In view of above, the auditor‘s report which he is going to issue, as stated above in the
question, is not appropriate in as per the provisions of the Company Act, 2063. Besides as per the
requirements of NSA 705, while qualifying the report the auditor has to quantify the effect of the
matter reported.
Question 28
a) Explain the composition of the Audit Committee as per the Company Act 2063. How an
audit committee can contribute to the enterprise for maintaining good corporate
governance? (5 Marks June 2008)
b) Explain the provision relating to Registration of Accounting Professional Firm under
the Nepal Chartered Accountants Act, 2053 (with amendment). (5 Marks June 2008)
Answer
a) Section 164 of Company Act 2063 provides for composition of the Audit Committee. As
per the said section, any company having paid up capital of Rs. 3 crores or more or an
undertaking of government (fully or partly owned) shall have an audit committee
comprising of at-least 3 members headed by a non-executive director. Any close relative of
the chief executive shall not be the member of the committee. One member of the
committee shall be professionally qualified in accounting or any person having bachelor's
degree in accounts, finance, management or economics and relevant experience in accounts
of finance.
Section 165 provides for the authority, duties and responsibilities of the audit committee
and most of their duties are directed towards good governance. As per the act, board shall
act upon the recommendation of the committee and if anything cannot be implemented, it
shall be mentioned in the annual reports with reasons.
Since the audit committee comprised of non-executive director, independent and

professional persons and had power to recommend for effective and efficient use of
resources to the Board, it helps in maintaining good governance of the company.
b) Section 28a of Nepal Chartered Accountants Act 2053, regarding Registration of Auditing
Firms requires that: (1) Members, holding Certificate of Practice and willing to carry on
audit business under the name of an accounting firm, shall apply to the Institute, in a
prescribed format, for registration of such firm.
(2) The other procedures relating to the registration of accounting firms shall be as
prescribed.
(3) The Council, after completion of the procedures mentioned in subsection (2), shall issue
Certificate of Firm Registration in a prescribed format.
Accordingly, Rule 57 of Nepal Chartered Accountants Rules, 2061, Registration of

Accounting Firm has prescribed following procedures for registration of firm:
(i) Member desiring to practice accountancy profession shall have to register his/her sole
proprietorship firm or firm in partnership with one or more partners of his/her own
class with the Institute.

(ii) To register a firm of sole proprietorship or in partnership according to sub rule (i) an
application shall be made in the prescribed format in Schedule-32 with applicable fees
fixed by the council and a copy of the deed of partnership between /among partners
shall be attached.
(iii) The partnership deed according to sub–rule (ii) among other things must contain the
following subjects:
(a) The number of shares of each partner,
(b) The process of admission and retirement of a partner,
(c) Conditions of dissolution of partnership
(d) Conditions about continuity/discontinuity of the name after the dissolution of
partnership.
(e) Distribution of business, assets and liabilities after the dissolution of partnership.
(f) Liability of a partner who gives up partnership
Question No. 29
Briefly describe the auditor‟s responsibility regarding subsequent events.
(5 Marks June 2008)
Answer
When the auditor draws up his audit plan, checking of subsequent events is an important audit
procedure irrespective to the level of test checks employed for checking of the transactions during
the year. In fact, more detailed check is normally required for subsequent events to confirm certain
assertions contained in the financial statements, e.g. the payment made by debtors after the close of
accounting period would confirm that outstanding debtors on the date of the balance sheet date
have been realized. NSA 560 on Subsequent Events establishes standards on the auditor‘s
responsibility regarding the subsequent events. NSA 560 states that the term subsequent events
refer to significant events occurring between the balance sheet date and the date of the auditor‘s
report.
NAS 10 on Events After the Reporting Date deals with all those significant events both favorable
and unfavorable events that occurred between the balance sheet date and the date on which the
financial statements are approved by the board of directors in case of a company and by the
corresponding approving authority in case of any other entity. As per NAS 10 events can be
identified as adjustable events which provide further evidence of conditions that existed at balance
sheet date and non-adjusting events are those which are indicative of conditions that arose
subsequent to the balance sheet date. NAS 560 lays down that the auditor should consider the
effect of subsequent events on the financial statement and on the auditor‘s report. When the time
between the close of the year end and the adoption of accounts is about to take place, examination
of subsequent events gains more importance.
The auditor should perform procedures designed to obtain sufficient appropriate audit evidence
that all events up to the date of the auditor‘s report that may require adjustment of, or disclosure in,
the financial statements have been identified. These procedures are in addition to routine
procedures which may be applied to specific transactions occurring after period end to obtain audit
evidence as to account balances as at period end, for example, the testing of inventory cutoff and
payments to creditors. The auditor is not, however, expected to conduct a continuing review of all
matters to which previously applied procedures have provided satisfactory conclusions.

The procedures to identify events that may require adjustment of, or disclosure in, the financial
statements would be performed as near as practicable to the date of the auditor‘s report and
ordinarily include the following:
 reviewing procedures management has established to ensure that subsequent events are
identified,
 reading minutes of the meetings of shareholders, the board of directors and audit and executive
committees held after period end and inquiring about matters discussed at meetings for which
minutes are not yet available,
 reading the entity‘s latest available interim financial statements and, as considered necessary
and appropriate, budgets, cash flow forecasts and other related management reports,
 inquiring, or extending previous oral or written inquiries, of the entity‘s lawyers concerning
litigation and claims and
 inquiring of management as to whether any subsequent events have occurred which might
affect the financial statements. Examples of inquiries of management on specific matters are:
 the current status of items that were accounted for on the basis of preliminary or
inconclusive data,
 whether new commitments, borrowings or guarantees have been entered into,
 whether sales of assets have occurred or are planned,
 whether 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 government or destroyed, for example, by
fire or flood, or earthquake, or made unproductive without complete destruction,
 whether there have been any developments regarding risk areas and contingencies,
 whether any unusual accounting adjustments have been made or are contemplated, and
 whether any events have occurred or are likely to occur which will bring into question the
appropriateness of accounting policies used in the financial statements as would be the
case, for example, if such events call into question the validity of the going concern
assumption.
When the auditor becomes aware of events which materially affect the financial statements, the
auditor should consider whether such events are properly accounted for in the financial statements.
When the management does not account for such events that the auditor believes should be
accounted for, the auditor should express qualified option or an adverse opinion as appropriate.
Question No. 30
Explain what is meant by “representation by management” and indicate to what extent an
auditor can place reliance on such representation. (8 Marks December 2008)
Answer
The management is responsible for appropriate preparation and presentation of the financial
information. Thus, it is quite natural that during the course of audit, management would be
required to make several representations on various matters relating to financial statements. These
representations may be made by the management either orally or in writing to the auditor. For
example, the auditor may ask the management to confirm about the existence of contingent

liability and disclosure thereof, etc. In other words, the representation by the management
constitutes the acknowledgement by the management about its responsibility for the preparation
and approval of the financial information. A written representation may either take the form of a
letter from the management or letter by the auditor outlining auditors understanding and
confirmation of the same.
Extent of reliance: NSA 580 ―Written representations‖ Written representations are necessary
information that the auditor requires in connection with the audit of the entity‘s financial
statements. Accordingly, similar to responses to inquiries, written representations are audit
evidence
However, it must be noted that representation by the management cannot be the substitute for other
audit evidence that the auditor could reasonably expected to be available. For example, a
representation by the management as to existence, quantity and cost of inventory is not substitute
for adopting the audit procedure regarding verification and valuation of inventories. If a
representation by management is contradicted by other evidence, the auditor should examine the
circumstances and, when necessary, reconsider the reliability of other representations made by the
management as well.
Question No. 31
Give your opinion as an auditor in the following case with specific reference to criteria on
which your opinion is based. (5 Marks December 2008)
You are manager in-charge on the audit of the financial statements of New Nepal Limited, a
large manufacturing company, which has appointed your firm as auditors for the first time.
During the course of finalization of audit, you had various meetings with the senior management
of the Company. The management of the company is really proud of their systems, business
ethics and transparency in the financial reporting systems. Nevertheless, during discussion you
came across a situation whereby the management has refused the request of signing the general
representation letter. The chief executive and chief financial officer of the company are of the
view that all their procedures and financial reporting systems are transparent and you are given
full liberty to check and verify any information and there is no bar on providing you any
information that you may require for the purpose of your audit. Accordingly, they feel that
through a representation letter, you wish to transfer your responsibility to them. Therefore, they
are not willing to sign any sort of representations by whatever name called.
Answer
As per NSA 580: Written Representations, the auditor should obtain appropriate representations
from management. The auditor should obtain written representations from management on matters
material to the financial statements when other sufficient appropriate audit evidence cannot
reasonably be expected to exist.
During the course of an audit, management makes many representations to the auditor, either
unsolicited or in response to specific inquiries. A written statement by management provided to
the auditor to confirm certain matters or to support other audit evidence. Written representations in
this context do not include financial statements, the assertions therein, or supporting books and
records. Further, representation by management can neither substitute for other audit evidence that
the auditor could reasonably expect to be available nor it transfer auditor's liability to the
management.

If management does not provide one or more of the requested written representations, the auditor
shall:
a. Discuss the matter with management;
b. Reevaluate 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
c. Take appropriate actions, including determining the possible effect on the opinion in the
auditor‘s report in accordance with NSA 705 (Revised).
Thus, the auditor shall make it clear to the management that obtaining of representations helps
them to establish their responsibilities to fair presentation of financial statements, confirmations of
representations made to them and it constitute an audit evidence to base their audit opinion. It will
not in any way transfer the responsibility of auditors to the management but refusal of the same
may lead to qualification of auditor's report as scope limitation.
Question No. 32
Express your views in the following case (5 Marks each June 2009)
a. An auditor of ABC Ltd. was not able to get the confirmation about the existence and value of
certain machineries. However, the management gave him a certificate to prove the existence
and value of the machinery as appearing in the books of account. The auditor accepted the
same without any further procedure and signed the audit report. Is he right in his approach?
Answer
The physical verification of fixed assets is the primary responsibility of the management. The
auditor, however, is required to examine the verification programme adopted by the
management. He must satisfy himself about the existence, ownership and valuation of fixed
assets. In the case of ABC Ltd., the auditor has not been able to verify the existence and value
of some machinery despite the verification procedure followed in routine audit. He accepted
the certificate given to him by the management without making any further enquiry.
As per NSA 580 Written Representations, when representation relate to matters which are
material to the financial information, then the auditor should seek corroborative audit evidence
for other sources inside or outside the entity. He should evaluate whether such representations
are reasonable and consistent with other evidences and should consider whether individuals
making such representations can be expected to be well informed on the matter.
―Representation by Management" cannot be a substitute for other audit evidence that the
auditor could reasonably expect to be available. If the auditor is unable to obtain sufficient
appropriate audit evidence that he believes would be available regarding a matter, which has or
may have a material effect on the financial information, this will constitute a limitation on the
scope of his examination even if he has obtained a representation from management on the
matter. Therefore, the approach adopted by the auditor is not right.
b. A firm of a father and a son is receiving Rs. 2 lakhs towards job work done for XYZ Ltd.
during the year ended on 15th July 2007. The total job work charges paid by XYZ Ltd. during
the year are over Rs. 50 lakhs. The father is a Managing Director of XYZ Ltd. having
substantial holding. The Managing Director told the auditor that since he is not involved in
the activities of the firm and since the amount paid to it is insignificant; there is no need to
disclose the transaction. He further contended that such a payment made in the last year was
not disclosed. Is Managing Director right in his approach?

Answer
NAS 24 and NSA 550, ―Related Party‖ applies to the facts of the case. NSA 550 requires
disclosure of party relationship and transactions between a reporting enterprise and its related
parties. The parties are considered to be related if at any time during the reporting period, one
party has the ability to control the other party or exercise significant influence over the other
party in making decisions. As per the explanation given in NAS 28, significant influence is
said to exist in case the investing party has 20% or more voting power in the enterprise. In the
instant case, the managing director of XYZ Ltd. is a partner in the firm with his son, which has
been paid Rs. 2 lakhs as job work charges. The managing director is having a substantial
holding in the firm. The case is squarely covered by the standard. The approach of the
managing director is not tenable under the law and accordingly all disclosure requirements
have to be complied. Accordingly, the approach followed by the Managing Director is not
right. Under the circumstances, the auditor shall have to modify his report.
Question No. 33
You are appointed as a statutory auditor of M/s Unreliable Company Limited for the FY
2064/65. When you come across the cases where it is not possible to continue performing the
audit and not able to complete the audit engagement as a result of a misstatement resulting from
fraud or suspected fraud. What would be your course of action as an auditor of that company?
(5 Marks June 2009)
Answer
As per para 38 of NSA 240, 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:
a. 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;
b. Consider whether it is appropriate to withdraw from the engagement, where withdrawal is
possible under applicable law or regulation; and
c. If the auditor withdraws:
i. 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
ii. 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.
Because of the variety of the circumstances that may arise, it is not possible to describe definitely
when withdrawal from an engagement is appropriate. Factors that affect the auditor‘s conclusion
include the implications of the involvement of a member of management or of those charged with
governance (which may affect the reliability of management representations) and the effects on the
auditor of continuing association with the entity.
The auditor has professional and legal responsibilities in such circumstances and these
responsibilities may vary by entity. For example, the auditor may be entitled to, or required to,
make a statement or report to the person or persons who made the audit appointment or, in some
cases, to regulatory authorities. Given the exceptional nature of the circumstances and need to
advice when deciding whether to withdraw from an engagement and in determining an appropriate
course of action.

Question No. 34
Answer the following:
Auditor's responsibilities regarding comparatives (5 Marks June 2009)
Answer
NSA 710, ―Comparative Information Corresponding Figures and Comparative Financial
Information‖, establishes standards on the auditor‘s responsibilities regarding comparatives. The
auditor responsibilities laid down are as under:
i. The auditor shall determine whether the financial statements include the comparative
information required by the applicable financial reporting framework and whether such
information is appropriately classified
ii. If the auditor‘s report on the prior period, as previously issued, included a qualified opinion, a
disclaimer of opinion, or an adverse opinion and the matter which gave rise to the modification
is unresolved, the auditor shall modify the auditor‘s opinion on the current period‘s financial
statements.
iii. If the auditor obtains audit evidence that a material misstatement exists in the prior period
financial statements on which an unmodified opinion has been previously issued, and the
corresponding figures have not been properly restated or appropriate disclosures have not been
made, the auditor shall express a qualified opinion or an adverse opinion in the auditor‘s report
on the current period financial statements, modified with respect to the corresponding figures
included therein
iv. If the financial statements of the prior period were audited by a predecessor auditor and the
auditor is not prohibited by law or regulation from referring to the predecessor auditor‘s report
on the corresponding figures and decides to do so, the auditor shall state in an Other Matter
paragraph in the auditor‘s report:
a. That the financial statements of the prior period were audited by the predecessor
auditor;
b. The type of opinion expressed by the predecessor auditor and, if the opinion was
modified, the reasons therefore; and
c. The date of that report.
Question No. 35
Describe Auditor‟s responsibility regarding subsequent events. (5 Marks December 2009)
Answer
The auditor should consider the effect of subsequent events on the financial statements and on the
auditor‘s report. Both favorable and unfavorable event can occur after the balance sheet date
materially affecting the financial statement.
The auditor should obtain sufficient appropriate evidence that all events occurring after balance
sheet date have been identified, adjusted/disclosed where required in the financial statements by
employing the following procedures:
 Review of management procedures to identify subsequent events

 Reading of minutes of meeting of board of directors, shareholders etc.
 Reading the latest available interim financial information, budgets, forecasts etc.

 Inquiring the lawyers of the entity as to the litigation and claims

 Inquiring management as to any subsequent events after the balance sheet date affecting the
financial statements
In case of subsequent events materially affecting the financial statements, the auditor should
consider whether such events have been properly accounted for in the financial statements. Where
the management has not accounted for such events, the auditor should qualify the report.
When after the date of the auditor‘s report but before the financial statements are issued, the
auditor becomes aware of a fact which may materially affect the financial statement and the
auditor should consider whether the financial statements need amendment, should discuss the
matter with management and should take the appropriate actions.
When after the financial statements have been issued, the auditor becomes aware of a fact which
existed at the date of the auditor‘s report and which if known at that date may have caused the
auditor to modify the auditor‘s report, the auditor should consider whether the financial statements
need revision, should discuss with management and should take action accordingly
Question No. 36
Describe the contents of a standard Management Letter issued to the management containing
the findings observed during the course of the audit and recommendations to overcome it? Give
examples for each component. (5 Marks December 2009)
Answer
A standard management letter contains the following components:
 Condition – it shows what is the issue? For example- fixed assets register not
maintained.
 Criteria – it describes the criteria that what should be there? For example-As stipulated
in the financial policy the logistic department should maintain a comprehensive fixed
asset register.
 Impact – it describes the results/ impact due to the condition. For example-in the
absence of the fixed assets register the existence of the assets could not be ensured.
 Cause – why does it happen? It includes the reason for the condition. For example- the
management is unaware of the provision.
 Recommendation – the Auditors‘ recommendation address to the issue. For example –
the management should maintain a comprehensive fixed asset register as described in
the financial policies.
 Management comments – the management response to the auditors‘ recommendation.
For example – the management will initiate action to maintain a comprehensive fixed
asset register.
 Auditors‟ subsequent comments – if the management response contradicts the issue
but the evidence supports the findings then the auditor can put subsequent comments and
stand by with the observation. However, this is unlikely.
Question No. 37
Express your opinion as an auditor on the following cases with specific reference to the criteria
on which your opinion is based: (5 Marks each June 2010)
a) The accountant of Kathmandu Ltd. has requested you, not to send balance confirmations to
a particular group of debtors since the said balances are under dispute and the matter is
pending in the court.

b) While the refrigeration units were undergoing modernization, ABC & Co. outsourced all its
cold storage requirements to Dinesh & Co. Warehousing Services. At 31 March 2009 it was
not possible to physically inspect ABC‟s inventory held by Dinesh & Co. due to health and
safety requirements preventing unauthorized access to cold storage areas. ABC‟s
management has provided written representation that inventory held at 31 March 2009 was
Rs. 10.1 million (2008 – Rs. 6.7 million). This amount has been agreed to a costing of
Dinesh & Co.‟s monthly return of quantities held at 31 March 2009.
c) In the course of audit of Hytide Company Limited, you come across a case where one of
your audit assistants had been paid Rs. 50,000/- by the company in the previous year for
providing some sales related information of Medico Company Limited. Medico Company
Limited is also your audit client and both Companies are manufacturer of medicines. Give
your opinion in this regard with reference to the Nepal Standards on Auditing.
a) Answer
NSA 505, ―External Confirmations‖, establishes standards on the debtor‘s use of external
confirmation as a means of obtaining audit evidence. It requires that the auditor should employ
external confirmation procedures in consultation with the management. The auditor may come
across certain situations in which the management may request him not to seek external
confirmation from certain parties because of dispute with the debtors, etc. The management, for
example, might make such a request on the grounds that due to a dispute with the particular debtor,
the request for confirmation might aggravate the sensitive negotiations between the entity and the
debtor. In such cases, when an auditor agrees to management‘s request not to seek external
confirmation regarding a particular debtor, the auditor should consider validity of grounds for such
a request and assess management‘s integrity and obtain evidence to support the same. The auditor
should also ask the management to submit its request in a written form, dealing therein the reasons
for such a request. If the auditor agrees to management‘s request not to seek external confirmation
regarding a particular matter, the auditor should document the reasons for acceding to the
management‘s request and should apply alternative procedures to obtain sufficient appropriate
evidence regarding that matter. While considering the validity of request, in case the auditor
reaches at a conclusion that the same was not valid, he may appropriately modify the report.
b) Answer
Inability to inspect inventory may amount to a limitation in scope if the auditor cannot obtain
sufficient audit evidence regarding quantity and its condition. This would result in an ‗except for‘
opinion. Although Dinesh & Co.‘s monthly return provides third party documentary evidence
concerning the quantity of inventory it does not provide sufficient evidence with regard to its
valuation. Inventory will need to be written down if, for example, it was contaminated by the
leakage (before being moved to Dinesh & Co.‘s cold storage) or defrosted during transfer. ABC‘s
written representation does not provide sufficient evidence regarding the valuation of inventory as
presumably ABC‘s management did not have access to physically inspect it either. If this is the
case this may call into question the value of any other representations made by management. In
addition to this, a copy of the health and safety regulation preventing the auditor from gaining
access to Dinesh & Co.‘s cold storage to inspect ABC‘s inventory should be taken and physical
inspection should be made for the inventory in ABC‘s refrigeration units after the balance sheet
date to confirm its condition.
c) Answer
As per NSA 200 para 17, confidentiality is one of the basic principles governing an audit. The
auditor should comply with ethical principles governing professional responsibilities. In this
context, the auditor should respect the confidentiality of information which comes to the

knowledge of the auditor during the course of performing professional services. That information
should not be used or disclosed or shared with others without proper and specific authority or
unless there is a legal or professional right or duty to disclose.
In the given case the information relating to the sales of Medico Company Limited was provided
to Hytide Company Limited which is in the same line of manufacture of medicine. This act is
against the basic ethical principles governing professional responsibilities of an auditor. Thus,
action should be initiated against the audit assistant. The auditor should also make appropriate
mechanism for checking these types of unethical activities of the audit staff so as to ensure
confidentiality of information obtained during the course of audit.
Question No. 38
Explain the general principals of an audit of financial statements. (8 Marks June 2010)
Answers:
a) The audit of financial statements is of paramount significance. The auditor‘s opinion enhances
the credibility of the financial statements since the auditor expresses an opinion whether the
financial statements are prepared, in all material respects in accordance with an identified
financial reporting framework. Hence, the auditors should conduct their audits based upon
general principles of an audit. They are governed by certain general principles of an audit as
prescribed in Nepal Standards on Auditing, NSA 200 - Objectives and General Principles
Governing Audit of Financial Statements. The auditor should comply with ethical principles
governing professional responsibilities. They are explained here under:
i. Integrity,
The auditor should be honest, sincere and straight forward in providing his professional services
ii. Objectivity
He must be fair and should not be prejudicial, biased or influenced by others to override
objectivity. He should be impartial and independent in fact and appearance.
iii. Professional competence and due care.

The auditor should possess continued professional knowledge and skill at a level required
to ensure that he can deliver competent professional services to the client. He should
perform his audit with due care and competence.
iv. Confidentiality
The auditor should perform his duty with confidentiality of information acquired during
the course of his professional services and should not use or disclose any such information
without proper approval or unless he is legally or professionally bound to disclose.
v. Professional behavior
The auditor should perform his duty keeping in mind the good reputation of the profession
and should not involve in any activity that would discredit the profession.
Question No. 39
Comment and give your views as auditor with reasons in the light of Nepal Accounting
Standards and Nepal Standards on Auditing on each of the following case:
(5 Marks each June 2010)
a) The auditor came to know that there was a noncompliance having material effect on
the financial statements of the Bank. The auditor issued an unqualified report as the
Board of Directors of the Bank was of the view that the regulation was for the

Commercial Bank and the Bank had been upgraded as a Commercial Bank from the
Development Bank two months ago.
b) At planning stage of the audit of a new client, you, as an audit manager had a meeting
with the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) of the
company. Various matters such as company‟s performance, profitability, turnover of
staff, import of plant and machinery during the year, inventory turnover, collection from
debtors, payment to creditors, investment in marketable securities, etc. were discussed.
As a result of the discussion you were able to assess that a significant portion of the
company‟s business is conducted with parties which are closely linked with the company.
c) Mr. TN Sharma a chartered accountant in practice purchased goods worth Rs. 60,000
from M/s Giant Traders Ltd. a trading company on credit. The company has the policy of
selling goods on credit. Mr. Sharma had outstanding dues of Rs. 30,000 on 16.07.2008.
He was appointed as auditor of M/s Giant Traders Ltd. for the F.Y. 2008-09. Without
knowing about his appointment as the auditor, the finance department of the company
issued reminder letter to Mr. Sharma for the payment of due amount. Mr. Sharma
verbally replied that his due can be deducted from his fees.
Answers:
a) NSA-250 on "Consideration of laws and regulations in an audit of financial statements"
states that if the auditor concludes that the non-compliance has a material effect on the
financial statements, and has not been properly reflected in the financial statements, the
auditor should express a qualified or an adverse opinion depending on the effect of
materiality. The management's contention that the regulation would not be applicable for
the bank since it had been upgraded as a commercial bank two months ago is totally wrong
as the status of the financial statements at the end of the year represents for the complete
fiscal year. The auditor has not complied with the provisions of NSA-250.
b) As per NSA 550: Related Parties, the auditor should perform audit procedures designed to
obtain sufficient appropriate audit evidence regarding the identification and disclosure by
management of related parties and the effect of related party transactions that are material
to the financial statements.
As per NSA 550, The objectives of the auditor are to obtain an understanding of related
party relationships and transactions sufficient to be able to recognize fraud risk factors, if
any, arising from related party relationships and transactions that are relevant to the
identification and assessment of the risks of material misstatement due to fraud; and to
conclude, based on the audit evidence obtained, whether the financial statements, are
presented in fair and transparent manner.
The auditor needs to have a level of knowledge of the entity‘s business and industry that
will enable identification of the events, transactions and practices that may have a material
effect on the financial statements. While the existence of related parties and transactions
between such parties are considered ordinary features of business, the auditor needs to be
aware of them because:
(a) the financial reporting framework may require disclosure in the financial statements of
certain related party relationships and transactions;
(b) the existence of related parties or related party transactions may affect the financial
statements. For example, the entity‘s tax liability and expense may be affected by the
tax laws in various jurisdictions which require special consideration when related
parties exist;

(c) the source of audit evidence affects the auditor‘s assessment of its reliability. A greater
degree of reliance may be placed on audit evidence that is obtained from or created by
unrelated third parties; and
(d) a related party transaction may be motivated by other than ordinary business
considerations, for example, profit sharing or even fraud.
Thus, the auditor shall pay special attention at the planning stage as well employ additional
audit procedures and consider the adequacy of control procedures over the authorization
and recording of related party transactions and its adequate and proper disclosures in the
financial statements.
c) Integrity, objectivity and independence are the foremost ethical principle of an audit. The
auditor must be fair and should not allow prejudice, bias or influence of others to override
his/her objectivity. The auditor should maintain an impartial attitude, and both be and
appear to be free of any interest which might be regarded, whatever its actual effect, as
being incompatible with integrity, objectivity and independence. The auditor should be
independent in fact and appearance.
In the given case two questions arises immediately i.e. whether under the circumstances
that Mr. Sharma can maintain his integrity and independence as he has not paid his due
within the credit period of the company and asking for setting off his due against fee. This
is the question of ethics. Second question arises about the legality of his appointment as per
prevailing act (Company Act 2006). In both instances answer is negative. Mr. Sharma is
not eligible for appointment as the auditor of the company on ethical ground as well as on
the ground of legal provision of section 112 of Company Act 2006.
Question No. 40
Mr. Ram Prasad, statutory auditor of XYZ Bank Ltd. while performing audit of the Bank relied
on Internal Audit Report comments and did not go through separate examination of those loan
records which has already been examined. The Internal Audit Report had no serious
observations on those loans. Subsequently, it was found that internal auditor Mr. Raju had not
taken adequate measures to establish the exact situation of various loan accounts and hence the
deficiencies in loan status were not properly reported. Please answer with reasons whether Mr.
Ram Prasad or Mr. Raju will be held liable? (4 Marks June 2010)
Answer
According to Nepal Standard on Auditing 610 on "Using the Work of an Internal Auditors", the
external auditor should perform an assessment of the internal audit function when internal audit
function when internal auditing is relevant to the external auditor's risk assessment and when
external auditors intends to use specific work of internal auditing, the external auditor should
evaluate and perform audit procedures on that work to confirm its adequacy for the external
auditor's purposes.
The external auditor shall determine whether the work of the internal audit function can be used
for purposes of the audit by evaluating the following:
a. The extent to which the internal audit function‘s organizational status and relevant
policies and procedures support the objectivity of the internal auditors;
b. The level of competence of the internal audit function; and
c. Whether the internal audit function applies a systematic and disciplined approach,
including quality control.

Since, in the given case, Mr. Ram Prasad had not gone through evaluation of audit procedures
performed by Mr. Raju, Internal Auditor, he had not complied with the NSA-610 and hence liable
for his incomplete work. In addition to this, Mr. Raju will also be held liable as he has also not
performed his duty properly and adequately with reasonable prudence.
Question No. 41
What are the documents and accounting disclosures requirement of a subsidiary company in the
annual accounts of holding company as per Company Act, 2006 (5 Marks June 2010)?
Answer
As per section 143 of the Company Act 2006, the following documents and accounting
disclosures of a subsidiary company are required to be included in the annual accounts of the
holding company:
 Annual Audited Accounts along with the report from the board of directors and Auditors
Report (Annual Report).
 The details of investment by the holding as at the end of reporting year.
 Any change of holding or rights of the holding company in the period not covered by the
annual accounts if the financial year of the holding company and that of subsidiary
company is different.
 Net accumulated profit or loss of the subsidiary company at the end of reporting year.
 Any profit or losses or contingent liabilities not reflected in the accounts of the
subsidiary company concerning the shareholders of the holding company.
 The disclosure/note, in case the Audited Balance Sheet and the profit and loss situation
of the subsidiary could not be obtained by the board of directors.
 Any loans availed by the holding company by mortgaging the fixed assets of the
subsidiary company.
Question No. 42
Express your opinion as an auditor on the following cases: (5 Marks each June 2010)
a) The annual general meeting of Curex Company Limited on Poush 25, 2066 failed to appoint
the auditor for the financial year 2066/67 due to time constraint and delegated the power to
appoint the auditor to the Board under the terms recommended by the Audit Committee. The
Board meeting held on Poush 29, 2065 appointed M/S Tibrewala & Co, a Chartered
Accountants firm as auditor remaining within the terms and conditions recommended by the
Audit Committee. Do you think the appointment of M/S Tibrewala & Co is valid?
b) At planning stage of the audit of a new client, you, as an audit manager had a meeting with
the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) of the company. The
various matters such as company‟s performance, profitability, turnover of staff, import of
plant and machinery during the year, inventory turnover, collection from debtors, payment to
creditors, investment in marketable securities, etc. were discussed.
As a result of the discussion you were able to assess that a significant portion of the
company‟s business is conducted with parties which are closely linked with the company.
Answer
a. According to Section 110 the Companies Act, 2063 every Company shall appoint an auditor
under the Act to have its accounts audited. As per Section 111 of the same Act, the general
meeting shall appoint the auditor of a company from amongst the auditors licensed to carry
out audit under the prevailing law subject to Chapter 18 of the Act, in the case of a public
limited Company. The Act also provides that the board of directors may appoint the auditor
prior to the holding of the first annual general meeting. Nowhere in the Act, there is any

provision of delegation of authority to anyone for appointment of an auditor. In the case of a

public limited company, the annual general meeting has authority to appoint auditor amongst
the proposed auditors under the terms and conditions as recommended by the Audit
Committee as per Section 165 of the same Act.
As per Section 113 of the Act, in case of failure to appoint an auditor in the annual general
meeting of the company for any reason or where the annual general meeting itself cannot be
held, the auditor is appointed by the company Registrar‘s office at the request of the Board of
directors of the Company.
Hence, the Companies Act does not have any provision of delegating power of the
appointment of the auditor and no one can appoint auditor except the annual general meeting
and Company Registrar‘s Office in case of failure to appoint the auditor by the AGM.
In the above context, the appointment of M/S Tibrewala & Co, a chartered accountant‘s firm
by the Board of Curex Company Limited at the recommendation of the Audit Committee as
per the authority delegated by the annual general meeting held on Poush 25, 2066 is not valid.
The Company Registrar‘s Office can only appoint auditor in such case at the request of the
Board of the Company.
b. As per NSA 550: Related Parties, the auditor should perform audit procedures designed to
obtain sufficient appropriate audit evidence regarding the identification and disclosure by
management of related parties and the effect of related party transactions that are material to
the financial statements.
As per NSA 550, The objectives of the auditor are to obtain an understanding of related party
relationships and transactions sufficient to be able to recognize fraud risk factors, if any,
arising from related party relationships and transactions that are relevant to the identification
and assessment of the risks of material misstatement due to fraud; and to conclude, based on
the audit evidence obtained, whether the financial statements, are presented in fair and
transparent manner.
The auditor needs to have a level of knowledge of the entity‘s business and industry that
will enable identification of the events, transactions and practices that may have a material
effect on the financial statements. While the existence of related parties and transactions
between such parties are considered ordinary features of business, the auditor needs to be
aware of them because:
(a) the financial reporting framework may require disclosure in the financial statements of
certain related party relationships and transactions;
(b) the existence of related parties or related party transactions may affect the financial
statements. For example, the entity‘s tax liability and expense may be affected by the tax
laws in various jurisdictions which require special consideration when related parties exist;
(c) the source of audit evidence affects the auditor‘s assessment of its reliability. A greater
degree of reliance may be placed on audit evidence that is obtained from or created by
unrelated third parties; and
(d) a related party transaction may be motivated by other than ordinary business
considerations, for example, profit sharing or even fraud.

Thus, the auditor shall pay special attention at the planning stage as well employ additional
audit procedures and consider the adequacy of control procedures over the authorization and
recording of related party transactions and its adequate and proper disclosures in the financial
statements.
Question No. 43
The financial statements of Modern Equipment (Pvt.) Limited reveal that the company has paid
a donation of Rs.15 million to a political party during an election where one of the directors of
the company is a central executive committee member. The company has earned a gross profit
of Rs. 40 million. The selling and administration expenses including the donation amount to Rs.
60 million and as a result the company has incurred a net loss of Rs. 20 million.
You are required to discuss the significance of the above donation to the auditor and design
appropriate audit procedures to address the issue. (7 Marks December 2010)
Answer
This is a case of related party transactions and of public interest although the company is a private
limited company. The amount of donation has been very significant and has contributed to loss
during the year. This is a material item and needs proper and adequate attention for its verification
and association with the business relation.
Thus, the auditor shall carry out following audit procedures as outlined in NSA550:
a) Authorization of payment of such a huge amount
b) Whether the issue related to related party known before the payment is made
c) Whether proper receipt of the amount has been obtained
d) Whether the same can be considered as reasonable business expenses
e) Whether the amount has been separately disclosed and a note to this effect has been given
in the financial statements
Question No. 44
Obtaining the proof of evidence is one of the principle procedures of audit. Discuss.
Answer
As per NSA 500 on Audit Evidence, the objective of the auditor is to design and perform audit
procedures in such a way as to enable the auditor to obtain sufficient appropriate audit evidence to
be able to draw reasonable conclusions on which to base the auditor‘s opinion.
The auditor shall design and perform audit procedures that are appropriate in the circumstances for
the purpose of obtaining sufficient appropriate audit evidence.
The auditor should obtain sufficient and appropriate audit evidence through the performance of
compliance and substantive audit procedure so that he in a position to draw reasonable conclusion
there from on which he could base his opinion on the cost and financial information or statements.
He begins his compliance procedures or test to obtain reasonable assurance that the internal control
devised in the client‘s organization on which audit reliance is placed are in effect. His application of
substantive audit procedures or test also seeks to obtain evidence as to the completeness, accuracy
and validity of the financial data produced by client‘s accounting system.
Auditing is an attest function. In his report, the auditor has to give his expressed opinion on the
truthfulness and fairness of the financial statements. Before submission of his report, he must have

to establish a basis for his judgment for which he has to look for evidences which will definitely
indicate the fair presentation of the client‘s financial records and accounts. Thus, he depends on
those evidences which will provide him reliability, relevancy and authenticity. For this purpose, the
auditor has to examine the books of accounts of the client with documentary evidence. He vouches
the documentary evidences by reference to their existence, legitimacy, completeness and accuracy
as essential procedure of audit.
Question No. 45
a) Roles of Audit Committee (4 Marks June 2010)
Answer
The role of audit committee is primarily of an advisory character. Its role includes co-ordination of
all audit functions and review of the feedback provided by various auditors already engaged
leading to a general review of the internal control mechanism for rectification/improvement of
management efficiency/functions. The committee is not expected to interfere in day-to-day affairs
of the company and make any decisions of its own in any areas of management functions. It
would, however, be its duty to make available its review report periodically to the Board to enable
the latter to make decisions on matters brought to it. In other words, it acts as an analyser and
purveyor of information/data not capable of being obtained from reports presented and reviewed in
an appropriate manner at a full-fledged board meeting. The functions which may be performed by
the audit committee could be broadly classified as under:
(i) To review weaknesses in internal controls, if any, reported by internal and statutory auditors
and report to the Board the recommendations relating thereto.
(ii) To review reports of Internal Audit Department and recommend to the Board to decide about
the scope of its work including examination of major items of expenditure.
(iii) To review the audit reports on financial statements and to seek clarification thereon, if
required, from the auditors.
(iv) to act as a link between statutory and internal auditors and the Board of directors.
(v) To recommend a change in the auditors if in the opinion of the Committee the auditors have
not discharged their duties properly and adequately.
b) Explain the Auditor‟s responsibilities regarding comparatives. (5 Marks June 2011)

Answer
NSA 710, ―Comparative Information, Corresponding Figures and Comparative Financial
Statements‖ establishes standards on the auditor‘s responsibilities regarding comparatives.
The auditor should evaluate whether:
a. The comparative information agrees with the amounts and other disclosures presented in the
prior period or, when appropriate, have been restated
b. The accounting policies reflected in the comparative information are consistent with those
applied in the current period or, if there have been changes in accounting policies, whether
those changes have been properly accounted for and adequately presented and disclosed.
c. If the auditor becomes aware of a possible material misstatement in the comparative
information while performing the current period audit, the auditor shall perform such
additional audit procedures as are necessary in the circumstances to obtain sufficient
appropriate audit evidence to determine whether a material misstatement exists.
d. If the auditor had audited the prior period‘s financial statements, the auditor shall also
follow the relevant requirements of NSA 560. If the prior period financial statements are
amended, the auditor shall determine that the comparative information agrees with the
amended financial statements.

e. As required by NSA 580, the auditor shall request written representations for all periods
referred to in the auditor‘s opinion. The auditor shall also obtain a specific written
representation regarding any restatement made to correct a material misstatement in prior
period financial statements that affect the comparative information.
Question No. 46
Answer the following questions:
a. Mr. Ram Prasad, a chartered accountant in practice, has been appointed as an auditor of
M/S Big Ltd. for the first time. What are the major additional audit evidences that he may
have to be considered in opening balances?
Answer
Mr. Ram Prasad should follow Nepal Accounting Standard on Auditing 510 before initial audit
engagement.
As per NSA 510 " Initial Audit Engagements- Opening Balances" 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) Determining whether the prior period‘s closing balances have been correctly brought
forward to the current period or, when appropriate, have been restated;
b) Determining whether the opening balances reflect the application of appropriate accounting
policies; and
c) Performing one or more of the following:
 Where the prior year financial statements were audited, reviewing the predecessor
auditor‘s working papers to obtain evidence regarding the opening balances;
 Evaluating whether audit procedures performed in the current period provide evidence
relevant to the opening balances; or
 Performing specific audit procedures to obtain evidence regarding the opening
balances.
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. 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 NSA 450.
b. What is joint audit? Describe how the work is performed by the joint auditors.
(6 Marks June 2011)
Answer
The term joint audit is quite widespread in big companies and corporations. It is a practice of
appointing more than one auditor as joint auditors. 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 identifiable units or specific 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 and liabilities or income or
expenditure or with reference to periods of time.
In respect of audit work divided among the joint auditors, each joint auditor is responsible for the
work allocated to him, whether or not he has prepared as separate report on the work performed by
him.

On the other hand, all the joint auditors are jointly and severally responsible:
 in respect of the audit work which is not divided among the joint auditors and is carried
out by all of them;
 in respect of decisions taken by all the joint auditors concerning the nature, timing or
extend of audit procedures to be performed by any of the joint auditors;
 in respect of matters which are brought to the notice of the joint auditors by any one of
them and on which there is agreement among the joint auditors;
 for examining that the financial statements of the entity comply with the disclosure
requirements of the relevant statute; and
 for ensuring that the audit report complies with the requirements of the relevant statute.
Normally joint auditors have to arrive at an agreed report and issue a joint audit opinion on the
financial statement.
c. Communication of audit matters those charged with governance.

Answer
Communication of audit matters those charged with governance.
The auditor should communicate audit matters of governance interest arising from the audit of
financial statements with those charged with governance of an entity. As mentioned in the NSA
260 on Communication of audit matters with those charged with governance, ―governance‖ is the
term used to describe the role of persons entrusted with the supervision, control and direction of
an entity and ―audit matters of governance interest‖ are those that arise from the audit of financial
statements and, in the opinion of the auditor, are both important and relevant to those charged
with governance in overseeing the financial reporting and disclosure process. Those charged with
governance ordinarily are accountable for ensuring that the entity achieves its objectives, financial
reporting, and reporting to interested parties. The auditor should determine the relevant persons
who are charged with governance and with whom audit matters of governance interest are
communicated.
financial statements and communicate them with those charged with governance. The
effectiveness of communications is enhanced by developing a constructive working relationship
between the auditor and those charged with governance. This relationship is developed while
maintaining an attitude of professional independence and objectivity. The auditor should
communicate audit matters of governance interest on a timely basis. This enables those charged
with governance to take appropriate action.
The audit matters of governance interest that are required to be communicated include matters
like the general approach and overall scope of the audit, including any expected limitations
thereon, or any additional requirements; the selection of, or changes in, significant accounting
policies and practices that have, or could have, a material effect on the entity‘s financial
statements; the potential effect on the financial statements of any significant risks and exposures,
such as pending litigation, that are required to be disclosed in the financial statements; audit
adjustments, whether or not recorded by the entity that have, or could have, a significant effect on
the entity‘s financial statements; material uncertainties related to events and conditions that may
cast significant doubt on the entity‘s ability to continue as a going concern; disagreements with
management about matters that, individually or in aggregate, could be significant to the entity‘s
financial statements or the auditor‘s report and other matters warranting attention by those
charged with governance, such as material weaknesses in internal control, questions regarding
management integrity, and fraud involving management.

Question No. 47
You are meeting with executives of Lily Cosmetics Company to arrange your firm‟s engagement
to audit the company‟s financial statement for the year ended 32nd Ashadh 2067. One executive
suggested that the work should be divided among three audit staff members so one person would
examine asset accounts, a second would examine liability accounts, and the third would
examine income and expenses accounts to minimize audit time, avoid duplication of staff effort
and curtail interference with company operations.
Advertising expense being the company‟s expense, and the advertising manager suggested that a
staff member of your firm whose uncle owns the advertising agency which handles the
company‟s advertising should be assigned to examine the advertising expense account. The staff
member has a thorough rather complex contract between Lily Cosmetic Company and the
advertising agency on which Lily‟s advertising are based.
To what extent should a Chartered Accountant follow his client‟s suggestions for conducting an
audit? (4 Marks June 2011)
Answer
According to NSA 200, "Overall Objectives of the Independent Auditor and the Conduct of Audit
In Accordance with NSAs" explains the scope, authority and structure of the NSAs, and includes
requirements establishing the general responsibilities of the independent auditor applicable in all
audits, including the obligation to comply with the NSAs.
NSAs are written in the context of an audit of financial statements by an auditor. They are to be
adapted as necessary in the circumstances when applied to audits of other historical financial
information.
An audit conducted in accordance with NSAs and relevant ethical requirements enables the auditor
to form the opinion.
The NSAs require that the auditor exercise professional judgment and maintain professional
skepticism throughout the planning and performance of the audit and, among other things:
 Identify and assess risks of material misstatement, whether due to fraud or error, based on an
understanding of the entity and its environment, including the entity‘s internal control.
 Obtain sufficient appropriate audit evidence about whether material misstatements exist,
through designing and implementing appropriate responses to the assessed risks.
 Form an opinion on the financial statements based on conclusions drawn from the audit
evidence obtained.
The auditor shall comply with relevant ethical requirements, including those pertaining to
independence, relating to financial statement audit engagements.
The auditor shall comply with all NSAs relevant to the audit. The NSA is relevant to the audit
when the NSA is in effect and the circumstances addressed by the NSA exist.
The objective of an audit of financial statements is to enable the auditor to express an opinion
whether the financial statements are prepared, in all material respects, in accordance with an
identified financial reporting framework. An auditor should maintain the Objectivity of his work.
A professional accountant should not allow prejudice or bias, conflict of interest or undue
influence of others to override professional or business judgments.

Also, an auditor should perform his audit with Professional Competence and Due Care. A
professional accountant has a continuing duty to maintain professional knowledge and skill at the
level required to ensure that a client or employer receives the advantage of competent professional
service based on current developments in practice, legislation and techniques.
Based on the above explanations it can be concluded that the auditors are not supposed to take
orders or advice from the client on what to do and how to do. Auditors may take client advice,
suggestion only on non- judgmental matters, on mechanical type of matters, such as where the
information available, how to get the information etc.
Question No. 48
An auditor of Babar Mahal Ltd. was not able to get the confirmation about the existence and
value of certain machineries. However, the management gave a certificate to prove the existence
and value of the machinery as appearing in the books of account. The auditor accepted the same
without any further procedure and signed the audit report. Is the auditor's approach, right?
Answer
auditor, however, is required to examine the verification programme adopted by the management.
The auditor must satisfy themselves about the existence, ownership and valuation of fixed assets.
In the case of Babar Mahal Ltd., the auditor has not been able to verify the existence and value of
some machinery despite the verification procedure followed during routine audit. The auditor
accepted the certificate given by the management without making any further enquiry. As per NSA
580, when representation relate to matters which are material to the financial information, then the
auditor should seek corroborative audit evidence for other sources inside or outside the entity. The
auditor should also evaluate whether such representations are reasonable and consistent with other
evidences and should consider whether individuals making such representations can be expected to
be well informed on the matter. ―Written Representations‖ cannot be a substitute for other audit
evidence that the auditor could reasonably expect to be available. If the auditor is unable to obtain
sufficient appropriate audit evidence that he/she believes would be available regarding a matter,
which has or may have a material effect on the financial information, this will constitute a
limitation on the scope of his examination even if he/she has obtained a representation from
management on the matter. Therefore, the approach adopted by the auditor is not correct.
Question No. 49
Mr. Rohan Sharma is a sales executive of M/s Duo Electric Company. He is involved in sales,
collection of payments and stock supervision. Managing Director of the company found that Rs.
2 lakhs were embezzled by the sales executive by overstating the receivables. How would you
deal with the situation as a statutory auditor? (5 Marks December 2011)
Answer:
The overstating of receivable by Mr. Rohan Sharma needs close examination of transaction with
the debtors. Taking confirmation from debtors is the key tool to verify the embezzlement. Once the
confirmation is received, the actual receivable can be confirmed and deviation if any, with the
books of account will lead the embezzlement by the concerned staff. As per Nepal Standard on
Auditing (NSA) 240, ―The Auditor‘s Responsibilities Relating to Fraud in an Audit of Financial
Statements,‖ the auditor should consider the risks of material misstatements in the financial
statements due to fraud while planning and performing the audit to reduce audit risk to an
acceptably low level.

Question No. 50
As an auditor, express your comments/views on the following situations:
a) During the course of statutory audit of M/s Grow More Investment Company dealing in
shares and securities, in spite of repeated reminders by the statutory auditor, the company
officials did not provide the investments held by the company at the Balance Sheet date for
verification and also did not provide the details for valuation of unlisted shares as on the
Balance Sheet date. The statutory auditor, in his final audit report to the shareholders,
reported as follows: “Subject to the verification of the existence and value of the
investments, the Balance Sheet shows a true and fair view”.
b) One of the employees of M/s Star Company Ltd. had embezzled a handsome amount of
revenue during the financial year 2062-063 to 2067-068 by submitting fraud bank voucher
and fraud bank reconciliation statement to the management. The embezzlement was traced
out only after the financial statements have been issued for the year 2067-068. What would
be the auditor's responsibility regarding such embezzlement? Justify your answer in
accordance with Nepal Standard on Auditing.
c) Arun Vegetable Ghee Company Limited has a policy of writing back unclaimed balances
(creditors/sundry payables etc.) as income if it remained for more than 3 years. During the
year 2067-68, it has written back Rs. 1,24,550 out of Rs. 2,55,000 balance in dividend
payable as the Rs. 1,24,550 was more than 5 years old.
d) In the course of audit of Sunrise Company Limited, you came across a difference of huge
amount between the control accounts and subsidiary records. The Finance Director
informed that this has happened due to huge volume of business done by the company
during the year and this has been very common. Now as an auditor of Sunrise Company
Limited what will be your opinion in such circumstance?
Answer
a) The statutory auditor is required to express his opinion on the truth and fairness of financial
statement audited by him only after examining the authenticity with reference to the
information and explanations given to him. He must determine the extent of information
which should be obtained by him before he expresses his opinion on the financial statement
submitted to him for report. He should not express an opinion before obtaining the required
data and information.
In the given case, the auditor was not provided the details of the investment held by Grow
More Investment Company and the valuation of unlisted shares. Owing to that there was a
situation that the statutory auditor could not confirm the existence and also valuation of the
investments held by the company. Since the said evidences extremely material; the non-
availability of which would highly misstate the financial position/ statement of the
company, the auditor should not state ―Subject to the verification of the existence and
value of the investments, the balance sheet shows a true and fair view.‖
In fact, as per facts given in the question, the auditor should state that because of these
circumstances, he has been unable to form an opinion. By reporting, ―subject to verification
of the existence and value of the investments, the balance sheet shows a true and fair
view‖, the auditor is not providing information but only means to information. The
situation in this case is analogous to London and General Bank‘s case. By reporting in the

above manner auditor is not conveying any information. Rather, the auditor is arousing the
suspicion of users of financial statements.
Section 115(1) of the Company Act 2063 requires the auditor to specifically, state whether
or not he has obtained all such information and explanation. If the auditor has not been able
to obtain relevant information or explanations, he may have to qualify his opinion on the
truth and fairness of the financial statements or express his inability to give an opinion in
the matter. Thus, the auditor has failed to perform his responsibilities.
b) With reference to the Nepal Standard on Auditing – 560, "Subsequent Events", the auditor
has no obligation to make any inquiry regarding such financial statements after the
financial statements have been issued. When, after the financial statements have been
issued, the auditor becomes aware of a fact which existed at the date of the auditor‘s report
and which, if known at that date, may have caused the auditor to modify the auditor‘s
report, the auditor should consider whether the financial statements need revision, should
discuss the matter with management, and should take the action appropriate in the
circumstances. When management revises the financial statements, the auditor would carry
out the audit procedures necessary in the circumstances, would review the steps taken by
management to ensure that anyone in receipt of the previously issued financial statements
together with the auditor‘s report thereon is informed of the situation, and would issue a
new report on the revised financial statements. The new auditor‘s report would be dated not
earlier than the date the revised financial statements are approved.
When management does not take the necessary steps to ensure that anyone in receipt of the
previously issued financial statements together with the auditor‘s report thereon is informed
of the situation and does not revise the financial statements in circumstances where the
auditor believes they need to be revised, the auditor would notify those persons ultimately
responsible for the overall direction of the entity that action will be taken by the auditor to
prevent future reliance on the auditor‘s report.
c) Write back of unclaimed balances unilaterally without consent of the party involved is not
in line with Nepal Accounting Standards. Therefore, the policy adopted by Arun Vegetable
Ghee Company Limited is not consistent with Accounting Standards. In case of Dividends,
Section 182 of company Act 2063 requires that the amount of dividend not
claimed/received by any Shareholder even after the expiry of a period of five years after the
date of resolution adopted by the company in its general meeting to distribute dividend
shall be credited to the investors protection fund to be established under Section 183 of the
same Act. Before crediting the amount to the fund, it shall publish a notice in a national
daily newspaper inviting the concerned to receive the dividend, within the time limit of at
least one month.
Therefore, the writing back of dividend of Rs. 124,550.00 by the company is violation of
provisions of Company Act and shall be liable.
d) The occurrence of difference of huge amount between Control accounts and subsidiary
records in the books of Sunrise Company Limited indicates that there may be chance of
material misstatements requiring detailed examination by the auditor so as to ascertain the
basic reason of difference. The view of the finance director that this has happened due to
huge volume of business done by the company during the year and this has been very
common cannot be accepted. Such a situation indicates that the accounting system of the
company has been faulty because it has failed to capture all transactions in time. It also

indicates that recording of transaction is not being done properly. There may also be
possibilities that it is a recurring phenomenon. Such a situation indicates that there may be
possibility of some material misstatements. In case the auditor encounters circumstances
that there is possibility of material misstatements, the auditor should as per NSA -240 ―The
Auditor‘s Responsibilities Relating to Fraud and Error in an audit of financial Statement‖
perform procedures to determine whether the financial statements are materially misstated.
The auditor should report appropriately in case if he comes across any material information
involving fraud or gross irregularities
Question No. 51
Mr. Parashar Koirala, a Chartered Accountant in practice is a general shareholder holding less
than one percent of the paid-up capital of Birgunj Sugar Factory Ltd. He was appointed as an
auditor for FY 2067/68. Mr. Koirala formally accepted the appointment as an auditor of the
company. Give your opinion in this respect. (4 Marks December 2011)
Answer
Section 112 of the Company Act 2063 disqualifies the person holding one percent or more of the
paid-up capital of the company from being appointed as an auditor of the company. In the given
case since Mr. Parashar Koirala holds less than one percent of the paid-up share capital of the
company, he is eligible for being appointed as an auditor of that company. Section 34 of the ICAN
Act prescribes that the members while certifying financial statements or making report thereon of
any corporate body in which he or his partner has interest, clearly mention the extent of his or his
partner's interest therein. However, being merely a shareholder in a company shall not be deemed
to have interest therein. Hence in any case the appointment of Mr. Koirala is valid.
Question No. 52
What are the fundamental principles that a professional accountant has to observe in order to
achieve the objectives of the accountancy profession? (8 Marks December 2011)
Answer
The fundamental principles that a professional accountant has to observe are:
 Integrity
A professional accountant should be straightforward and honest in performing professional
services.
 Objectivity
A professional accountant should be fair and should not allow prejudice or bias, conflict of
interest or influence of others to override objectivity.
 Professional Competence and Due Care
A professional accountant should perform professional services with due care, competence
and diligence and has a continuing duty to maintain professional knowledge and skill at a
level required to ensure that a client or employer receives the advantage of competent
professional service based on up to-date developments in practice, legislation and
techniques.
 Confidentiality
A professional accountant should respect the confidentiality of information acquired during
the course of performing professional services and should not use or disclose any such
information without proper and specific authority or unless there is a legal or professional
right or duty to disclose.

 Professional Behavior
A professional accountant should act in a manner consistent with the good reputation of the
profession and refrain from any conduct which might bring discredit to the profession.
 Technical Standards
A professional accountant should carry out professional services in accordance with the
relevant technical and professional standards. Professional accountants have a duty to carry
out with care and skill, the instructions of the client or employer insofar as they are
compatible with the requirements of integrity, objectivity and, in the case of professional
accountants in public practice, independence.
In addition, they should conform with the technical and professional standards promulgated
by:
 Nepal Accounting Standards Board
 Nepal Standards on Auditing Board
 ICAN or other regulatory body; and
 relevant legislation
Question No. 53
Write Short Notes on the following
a. Date of approval of the financial statements as per NSA 560 "Subsequent Events"
(5 Marks June 2011)
"Date of approval of the financial statements‖ is the date on which those with the recognized
authority assert that they have prepared the entity‘s complete set of financial statements,
including the related notes, and that they have taken responsibility for them. In some
jurisdictions, the law or regulation identifies the individuals or bodies (for example, the
directors) that are responsible for concluding that a complete set of financial statements has
been prepared and specifies the necessary approval process. In other jurisdictions, the approval
process is not prescribed in law or regulation and the entity follows its own procedures in
preparing and finalizing its financial statements in view of its management and governance
structures. In some jurisdictions, final approval of the financial statements by shareholders is
required before the financial statements are issued publicly. In these jurisdictions, final
approval by shareholders is not necessary for the auditor to conclude that sufficient appropriate
audit evidence has been obtained. The date of approval of the financial statements for purposes
of the NSAs is the earlier date on which those with the recognized authority determine that a
complete set of financial statements has been prepared.
b. Functions and duties of auditor as per Section 115 of Companies Act, 2063 (5 Marks June
2011)
(1) The auditor shall, addressing the shareholders or the appointing authority, submit to the
company his/her report, certifying the balance sheet, profit and loss account and cash flow
statement based on the books of account, records and accounts audited by him/her.
(2) The audit report shall be prepared in accordance with the prevailing law or in consonance
with the audit standards prescribed by the competent body; and such report shall state the
matters to be set out under this Act, as per necessity.
(3) The audit report as referred to in Sub-section (2) shall also indicate the following matters,
inter alia:
a) Whether such information and explanations have been made available as were required
for the completion of audit;

b) Whether the books of account as required by this Act have been properly maintained by
the company in a manner to reflect the real affairs of its business;
c) Whether the balance sheet, profit and loss account and cash flow statements received
have been prepared in compliance with the accounting standards prescribed under the
prevailing law and whether such statements are in agreement with the books of account
maintained by the company;
d) Whether, in the opinion of the auditor based on the explanations and information made
available in the course of auditing, the present balance sheet properly reflects the
financial situation of the company, and the profit and loss account and cash flow
statement for the year ended on the same date properly reflect the profit and loss, cash
flow of the company, respectively;
e) Whether the board of directors or any representative or any employee has acted
contrary to law or misappropriated any property of the company or caused any loss or
damage to the company or not;
f) Whether any accounting fraud has been committed in the company
g) Suggestion, if any.
c. Subsequent events (5 Marks June 2012)

Subsequent events are events occurring between the date of the financial statements and the
date of the auditor's report and facts discovered after the auditor's report. An auditor should
consider the effect of subsequent events on the financial statements and the auditor's report.
An auditor should:
 Obtain from management the latest interim financial statements and compare them with the
financial statements being reviewed or with those for comparable periods from the preceding
year.
 Inquire about events after the balance sheet date that would have a material effect on the
financial statements under review and, in particular, inquire whether:
(a) Any substantial commitments or uncertainties have arisen subsequent to the balance sheet date:
(b) Any significant changes in the share capital, long term debt or working capital have occurred
up to the date of inquiry.
(c) Any unusual adjustments have been made during the period between the balance sheet date and
the date of inquiry.
 Obtain and read the minutes of meetings of shareholders, directors and appropriate committees
subsequent to the balance sheet date.
Consider the need for adjustments or disclosure in the financial statements.
d. Management Representation (3 Marks June 2012)

It is a representation made by management to the auditor during the course of an audit, either
unsolicited or in response to specific enquiries. It acknowledges its responsibility for the
implementation and operation of accounting and internal control system that are designed to
prevent and detect fraud and error. Nepal Standard on Auditing –580, Written Representations
states that the auditor should obtain appropriate representation from management evidencing
that the management acknowledges its responsibility for the fair presentation of the financial
statements in accordance with the relevant financial reporting framework. The auditor can
obtain evidence of management‘s acknowledgment of such responsibility and approval from
relevant minutes of meetings of the board of directors or similar body or by obtaining a written
representation from management or a signed copy of the financial statements. The auditor
should obtain written representations from management on matters material to the financial
statements when other sufficient appropriate audit evidence cannot reasonably be expected to
exist. The possibility of misunderstandings between the auditor and management is reduced

when oral representations are confirmed by management in writing. If a representation by

management is contradicted by other audit evidence, the auditor should investigate the
circumstances and, when necessary, reconsider the reliability of other representations made by
management.
e. Nepal Standard on Quality Control (NSQC) (3 Marks June 2012)

NSQC refers to Nepal Standard on Quality Control and applies to all firms. The firm‘s system
of quality control should include policies and procedures addressing each of the following
elements:
i) Leadership responsibilities for quality within the firm.
ii) Ethical requirements.
iii) Acceptance and continuance of client relationships and specific engagements.
iv) Human resources.
v) Engagement performance.
vi) Monitoring.
The quality control policies and procedures should be documented and communicated to the
firm‘s personnel.
f. Disqualifications of Auditors as per Companies Act, 2063 (5 Marks December 2012)

As per Section 112(1) of the Companies Act, 2063, None of the following persons or the firms or
companies in which such persons are partners shall be qualified for appointment as auditor and
shall, despite appointment as auditor, continue to hold office:
1) A director, advisor appointed with entitlement to regular remuneration or cash benefit, a
person or employee or worker involved in the management of the company or a partner of
any of them or an employee of any of such partners or a close relative of a director or partner,
out of them, or an employee of such relative;
2) A debtor who has borrowed moneys from the company in any manner, or a person who has
failed to pay any dues payable to the company within the time limit and is in such arrears or
close relative of such person;
3) A person who has been sentenced to punishment for an offense pertaining to audit and a
period of five years has not elapsed thereafter;
4) A person who has been declared insolvent;
5) A substantial shareholder of the company or a shareholder holding one percent or more of the
paid-up capital of the company or his close relative;
6) A person who has been sentenced to punishment for an offense of corruption, fraud or a
criminal offense involving moral turpitude and a period of five years has not elapsed
thereafter;
7) A person referred to in Sub-section (3) of Section 111 which mentions that no auditor or his
partner or ex-partner or employee or ex-employee can be re-employed for more than 3 times
consecutively.
8) In the case of a public company, any person who works, whether full time or part time , for
any governmental body or anybody owned fully or partly by the Government of Nepal or any
other company or a partner of such person or a person who is working as an employee of
such partner or a person who is authorized to sign any documents or reports to be prepared
by the management of the company;
9) A company or corporate body with limited liability;
A person having interest in any transaction with the company or his/her close relative or a
director, officer or substantial shareholder of another company having any interest in any
transaction with the company.

g. Corresponding figures. (4 Marks June 2015)

As per NSA 710 "Comparative", "corresponding figures" is comparative information where
amounts and other disclosures for the preceding periods are included as part of the current
period financial statements and are intended to be read in relation to the amounts and other
disclosures relating to the current period. These corresponding figures are not presented as
complete financial statements capable of standing alone but are an integral part of the current
period financial statements intended to be read only in relationship to the current period
figures.
Question No. 54
Comment on the following cases: (5 Marks each June 2012)
a) M/S XYZ & Associates, Chartered Accountants, were appointed as the statutory
auditor by the annual general meeting of LMN Company Ltd. for the financial year 2067/068.
This was their first appointment as an auditor of this company. During the course of the audit,
the auditor was unable to obtain sufficient appropriate audit evidence concerning opening
balances.
b) M/S MNY & Associates, Chartered Accountants, were the auditor of ABC Ltd. for
the financial year 2067/068. Engineering Consultants (P) Ltd. was appointed as an expert to
help them in certain technical matters. During the finalization of the audit, the audit team
decided that Engineering Consultants (P) Ltd. is the team of specialist so there is no need to
review their work.
Answer
a) As stated in NSA 510 "Initial Audit Engagements-Opening Balances", for initial audit
engagements, the auditor should obtain sufficient appropriate audit evidence that:
i. The opening balances do not contain misstatements that materially affect the current
period‘s financial statements;
ii. The prior period‘s closing balances have been correctly brought forward to the
current period or, when appropriate, have been restated; and
iii. Appropriate accounting policies are consistently applied or changes in accounting
policies have been properly accounted for and adequately presented and disclosed.
If, after performing audit procedures including those set out in Nepal Standards on
Auditing, the auditor is unable to obtain sufficient appropriate audit evidence concerning
opening balances, the auditor‘s report should include:
a. A qualified opinion,
b. A disclaimer of opinion; or
c. In those jurisdictions where it is permitted, an opinion which is qualified or
disclaimed regarding the results of operations and unqualified regarding financial
position
If the effect of the misstatement is not properly accounted for and adequately presented and
disclosed, the auditor should express a qualified opinion or an adverse opinion, as
appropriate.
b) Evaluating the Work of the Expert

As per the requirement of clause 12 of NSA 620 "Using the work of an expert", the auditor
should evaluate the appropriateness of the expert‘s work as audit evidence regarding the
assertion being considered. This will involve evaluation of whether the substance of the
expert‘s findings is properly reflected in the financial statements or supports the assertions, and
consideration of:

 Source data used;

 Assumptions and methods used and their consistency with prior periods; and
 Results of the expert‘s work in the light of the auditor‘s overall knowledge of the
business and of the results of other audit procedures.
When considering whether the expert has used source data which is appropriate in the
circumstances, the auditor would consider the following procedures:
 Inquiries of the auditor‘s expert.

 Reviewing the auditor‘s expert‘s working papers and reports.
 Corroborative procedures, such as:
 Observing the auditor‘s expert‘s work;
 Examining published data, such as statistical reports from reputable, authoritative
sources;
 Confirming relevant matters with third parties;
 Performing detailed analytical procedures; and
 Reperforming calculations.
 Discussion with another expert with relevant expertise when, for example, the findings
or conclusions of the auditor‘s expert are not consistent with other audit evidence.
 Discussing the auditor‘s expert‘s report with management.
The appropriateness and reasonableness of assumptions and methods used, and their
application are the responsibility of the expert. The auditor does not have the same expertise
and, therefore, cannot always challenge the expert‘s assumptions and methods. However, the
auditor will need to obtain an understanding of the assumptions and methods used and to
consider whether they are appropriate and reasonable, based on the auditor‘s knowledge of the
business and the results of other audit procedures.
If the results of the expert‘s work do not provide sufficient appropriate audit evidence or if the
results are not consistent with other audit evidence, the auditor should resolve the matter. This
may involve discussions with the entity and the expert, applying additional audit procedures,
including possibly engaging another expert, or modifying the auditor‘s report.
Question No. 55
While compiling the financial statements of a company, you observed that the information
supplied by the company is incomplete, incorrect and some of the Accounting Standards have
not been complied with. Describe, in brief, the procedure you will follow in this case.
(5 Marks June 2012)
Answer
Compilation of Financial Information:
As per para 32 of NSRS 4410 ―Compilation Engagements‖,
If, in the course of the compilation engagement, the practitioner becomes aware that the records,
documents, explanations or other information, including significant judgments, provided by
management for the compilation engagement are incomplete, inaccurate or otherwise
unsatisfactory, the practitioner shall bring that to the attention of management and request the
additional or corrected information.
Again as per para 33, If the practitioner is unable to complete the engagement because
management has failed to provide records, documents, explanations or other information,
including significant judgments, as requested, the practitioner shall withdraw from the engagement
and inform management and those charged with governance of the reasons for withdrawal.

Question No. 56
Answer the followings (5 Marks June 2012)
a) Mr. Rahul, partner of M/s SG & Associates, a Chartered Accountant firm, was appointed as
an auditor of Bindas Commercial Bank Ltd. One of the shareholders of the bank lodged a
complaint against the auditor for not assuming the responsibilities to comply with directives
of Nepal Rastra Bank with regards to lending to a business house. You are asked to identify
the auditors' responsibilities to consider laws and regulations in an audit of financial
statements of bank with regards to complaint lodged against the auditor.
b) Wax & Co.‟s financial statements for the year ended 31 July 2010 include the following
balances
Profit before tax Rs. 50,000

Inventory Rs. 25,000
Total assets Rs. 350,000
The inventory comprised stocks of books, diaries, calendars and greetings cards.
Explain (In relation to opening balances) the audit procedures required by NSA 510 Initial
Audit Engagements – Opening Balances and recommend the specific audit procedures to be
applied to Wax & Co.‟s opening balance of inventory.
Answer
a) In accordance with NSA 200: ―Overall Objective of the Independent Auditor and the
Conduct of an Audit in Accordance with NSAs" requires the auditor to maintain
professional skepticism. The auditor shall plan and perform an audit with professional
skepticism recognizing that circumstances may exist that cause the financial statements to
be materially misstated.
In accordance with specific statutory requirements, the auditor may be specifically required
to report as part of the audit of the financial statements whether the entity complies with
certain provisions of laws or regulations. In these circumstances, the auditor would plan to
test for compliance with these provisions of the laws and regulations.
Further, the auditor should obtain sufficient appropriate audit evidence about compliance
with those laws and regulations generally recognized by the auditor to have an effect on the
determination of material amounts and disclosures in financial statements. The auditor
should have a sufficient understanding of these laws and regulations in order to consider
them when auditing the assertions related to the determination of the amounts to be
recorded and the disclosures to be made.
As per NSA 250 'Consideration of Laws and Regulation in an audit of Financial
Statements', the auditor is not, and cannot be held responsible for preventing
noncompliance. However, when designing and performing audit procedures and in
evaluating and reporting the results thereof, the auditor should recognize that
noncompliance by the entity with laws and regulations may materially affect the financial
statements.
Here, in given situation, it is the responsibility of the management to comply with the
directives of NRB and the responsibility of Mr. Rahul ,the auditor, is to plan and perform
the audit with an attitude of professional skepticism recognizing that the audit may reveal
conditions or events that would lead to questioning whether an entity is complying with
laws and regulations He should have sufficient knowledge of statutory provisions of
lending and its reporting in prescribed format.

b) ISA 510 Initial Audit Engagements – Opening Balances requires certain audit procedures
to be carried out in an initial engagement where the prior year financial statements were not
audited or were audited by a predecessor auditor.
Firstly, it is required that the auditor shall read the most recent financial statements for
information relevant to opening balances, including disclosures.
Then the auditor shall obtain sufficient appropriate evidence about whether the opening
balances contain misstatements that materially affect the current year‘s financial
statements. This evidence is obtained by firstly determining whether the prior period‘s
closing balances have been correctly brought forward.
The auditor shall also determine whether the opening balances reflect the application of
appropriate accounting policies.
Depending on the nature of the opening balances, specific audit procedures are performed
to gain specific evidence on those opening balances. Additional procedures would be
required if it appears that the opening balances contain misstatements that could materially
affect the current period‘s financial statements.
Finally, the auditor shall obtain sufficient appropriate evidence about whether the
accounting policies reflected in the opening balances have been consistently applied in the
current period‘s financial statements, and that any changes in accounting policies have been
accounted for and disclosed in accordance with IFRS 8 Accounting Policies, Changes in
Accounting Estimates and Errors.
In relation to the opening balance of inventory, the following procedures are recommended:
 Inspection of records of any inventory counts held at the prior period year end, 31
July 2010, to confirm the quantity of items held in inventory agrees to accounting
records.
 Observation of an inventory count at the current period year end, 31 July 2011, and
reconciliation of closing inventory quantities back to opening inventory quantities.
 Analytical procedures on gross profit margins, comparing the opening and closing
gross profit margins year on year for the various types of items held in inventory.
 Verifying the sales value in the current financial year of items held in inventory at
31 July 2010 and comparing the sales value with cost. This should provide evidence
that inventory is correctly valued at the lower of cost and net realizable value.
 Inspection of management accounts for evidence of any inventory items written off
in the current financial period – this is important for inventory of calendars and
diaries which are likely to be obsolete.
 Discussion with management regarding any slow-moving items of inventory which
were included in opening inventory.
 Analytical procedures such as inventory turnover calculations to highlight slow
moving inventory from the opening balance.
Question No. 57
Explain the following: (5 Marks each June 2012)
i) Assertions about account balances at the period end as per NSA 500 "Audit Evidence".
ii) The Auditor‟s responsibilities regarding comparatives.
Answer
i) Assertions about account balances at the period end:
a. Existence—assets, liabilities, and equity interests exist.
b. Rights and obligations—the entity holds or controls the rights to assets, and liabilities
are the obligations of the entity.
c. Completeness—all assets, liabilities and equity interests that should have been recorded
have been recorded.

d. 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
ii) NSA 710, ―Comparatives‖ establishes standards on the auditor‘s responsibilities regarding
comparatives.
The auditor responsibilities laid down are as under:
i. The auditor should determine whether the comparatives comply, in all material respects
with the financial reporting framework relevant to the financial statements being
audited. Further, the auditor should obtain sufficient appropriate audit evidence that the
corresponding figures meet the requirements of the financial reporting framework.
ii. When the comparatives are presented as corresponding figures, the auditor‘s report
should not specifically identify comparatives because the auditor's opinion is on the
current period financial statements as a whole, including the corresponding figures.
iii. When the auditor‘s report on the prior period, as previously issued, included a qualified
opinion, disclaimer of opinion, or adverse opinion and the matter which gave rise to the
modification in the audit report is:
(a) unresolved and results in a modification of the auditor‘s report regarding the current
period figures, the auditor‘s report should also be modified regarding the corresponding
figures; or
(b) unresolved but does not result in a modification of the auditor‘s report regarding the
current period figures, the auditor‘s report should be modified regarding the
corresponding figures.
In such circumstances, the auditor should examine that appropriate disclosures have been
made or if appropriate disclosures have not been made, the auditor should issue a
modification report on the current period financial modified with respect to the
corresponding figures included therein.
Question No. 58
Comment and give your views as auditor with reasons in the light of Nepal Accounting
Standards, Nepal Standards on Auditing and Code of Ethics on each of the following case:
a) Raghabdhoj & Co. and Sansar Bhakta & Co. are the joint auditors of Winchester Bank
Limited. The bank had been able to cleverly conceal certain transactions that could not be
detected by both the auditors, in these circumstances, what would be their professional
responsibilities?
b) The annual general meeting of Sundarijal Company Limited on Poush 11, 2068 failed to
appoint the auditor for the financial year 2068/69 due to time constraint and delegated the
power to appoint the auditor to the Board under the terms recommended by the Audit
Committee. The Board meeting held on Poush 25, 2068 appointed M/s Bhandary & Co., a
Chartered Accountants firm as auditor remaining within the terms and conditions
recommended by the Audit Committee. Do you think the appointment of M/s Bhandary &
Co. is valid?
c) Mr. Relax was appointed as the auditor of M/s XYZ Co. Ltd. However during the course of
the audit, Mr. Q, his senior audit manager led the audit team and supervised all the audit

works of the Co. Mr. Relax was out of town at time of signing the report, and Mr. Q is Mr.
Relax‟s most reliable staff and assisting him for so many years in this profession. Hence,
Mr. Relax is of the opinion that Mr. Q should sign the audit report on behalf of him. Is Mr.
Relax correct in his decision?
d) Mr. Jamun is a chartered accountant who has been recently retired from ABC National
Bank Limited after serving for 25 years as chief finance officer of the Bank. Of late, he has
taken the certificate of practice and owns his own audit firm since his retirement (i.e. from
last 2 year 5 months). He now approached the senior management of the bank for the
statutory audit of the bank and they are agreed to appoint him the next statutory auditor of
the bank. Advise Mr. Jamun and the senior management of the Bank about his validity as
the statutory auditor.
Answer
a) The joint auditors should by mutual discussion, divide the audit work among themselves. The
division of work among them as well as areas of work to be covered by all of them should be
adequately documented and preferably communicated to the client. While dividing their work,
it has to be taken care of that they have not left any area unattended and exercised reasonable
care and skill while performing their audit. Each of the joint auditors should communicate
with each other about any matter which is relevant to the areas of responsibility of other joint
auditors and which deserve their attention. The communication should be in writing by the
submission of a report or note prior to the finalization of the audit. In the case of joint audit,
each joint auditor is responsible only for the work allocated to him, whether or not he has
prepared separate report on the work performed by him. Each joint auditor is entitled to
assume that the other joint auditor has carried out their part of the audit work in accordance
with the generally accepted audit practice.
In the given case also, if it can be ensured that the joint auditors, Raghab Dhoj & co. and
Sansar Bhakta & co. have exercised reasonable care and skill in auditing the books of
accounts of Winchester Bank Limited, and still the bank has been able to conceal certain
transactions, both the auditors cannot be held responsible for professional negligence.
However, the auditors would be responsible for professional negligence if such concealment
could have been traced out by the exercise of reasonable care and skill.
b) According to Section 110 the Companies Act, 2063 every company shall appoint an auditor
under the Act to have its accounts audited. As per Section 111 of the same Act, the general
meeting shall appoint the auditor of a company from amongst the auditors licensed to carry
out audit under the prevailing law subject to Chapter 18 of the Act, in the case of a public
limited Company. The Act also provides that the board of directors may appoint the auditor
prior to the holding of the first annual general meeting. Nowhere in the Act, there is any
provision of delegation of authority to anyone for appointment of an auditor. In the case of a
public limited company, the annual general meeting has authority to appoint auditor under the
terms and conditions as recommended by the Audit Committee as per Section 165 of the same
Act.
As per Section 113 of the Act, in case of failure to appoint an auditor in the annual general
meeting of the company for any reason or where the annual general meeting itself cannot be
held, the auditor is appointed by the company Registrar‘s office at the request of the board of
directors of the Company.

Hence, the Companies Act does not have any provision of delegating power of the
appointment of the auditor and no one can appoint auditor except the annual general meeting
and Company Registrar‘s Office in case of failure to appoint the auditor by the AGM.
In the above context, the appointment of M/S Bhandary & Co, a chartered accountant‘s firm
by the Board of Sundarijal Company Limited at the recommendation of the Audit Committee
as per the authority delegated by the annual general meeting held on Poush 11, 2068 is not
valid. The Company Registrar‘s Office can only appoint auditor in such case at the request of
the Board of the Company.
c) As per Section 116 of the Companies Act 2063, an audit report prepared by the auditor
appointed by any company under this Act shall be signed and dated by the auditor himself.
Also, it provides that where any company has appointed any accounting institution licensed
under the prevailing law to carry out audit, the member who has been authorized by a decision
of the partners of such institution shall sign and date the audit report. Also, NSA 700 requires
that the auditor‘s signature either in the name of the audit firm, the personal name of the
auditor or both.
In the given case of M/S XYZ Co. Ltd. where Mr. Relax is the auditor and Mr. Q is only his
audit manager and not his partner of his firm, only Mr. A is authorized to sign the audit report
and not his manager by virtue of the above provisions. However, he can use Mr. Q for
conducting the audit work of M/S XYZ Co., Mr. Relax by signing the report himself takes the
responsibility of the report and ensures that he has through convince on the report issued by
him.
d) As per Section 34(12) of the Chartered Accountants Act, 1997, one shall not perform audit of
accounts of any organization where he has served until the elapse of at least three years of his
leaving the service.
Here in the case of Mr. Jamun, who has served ABC National Bank Limited for twenty-five
years as Chief Finance Officer and has retired from the service. Now, by virtue of the above
clause of the Act, he is restricted from taking up the statutory auditor‘s assignment for at least
three years after his retirement. He has just completed two years and five months and hence he
should not take up the assignment or the management of the bank should not appoint him as
statutory auditor of the bank.
Question No. 59
You are auditor of Elina Garments Limited which exports Readymade garments to M/s.
Warnoff Inc., of USA for the financial Year 2067-68. The Company‟s around 75% sale
constitutes export to Warnoff Inc. and there is outstanding balance of Rs. 17 Crore in Sundry
Debtors which covers around 85% of the total debtors as at 32 Ashad, 2068. Due to global
recession, the Warnoff Inc. has filed bankruptcy in USA on 15 Ashwin, 2068 which came to
your notice during the audit. Give your opinion as an auditor.
(5 Marks June 2012)
Answer
The filing of bankruptcy of the company during the course of audit but after the balance sheet date
is subsequent event or events occurring after balance sheet date. It is seen that the debtor covers
the major portion of debtors, the debtors shown in the balance sheet may no longer be appropriate
and hence adequate provision should be made. Since, the party is major customer and covers major
portion of the debtor, the going concern assumption of the company may no longer be appropriate
if receivable amount from Warnoff Inc. is more than total amount of equity of the company.

As per NSA 570 on Going Concern, The auditor‘s responsibilities are 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, and to
conclude, based on the audit evidence obtained, whether a material uncertainty exists about the
entity‘s ability to continue as a going concern. These responsibilities exist even if the financial
reporting framework used in the preparation of the financial statements does not include an explicit
requirement for management to make a specific assessment of the entity‘s ability to continue as a
going concern.
In such circumstances, the auditor should ask the management for necessary
adjustment/provisioning in the financial statement regarding the debtor balances and necessary
disclosure thereof.
Further, the auditor should also:
a) Review management's plans for future actions based on its going concern assessment;
b) Gather sufficient appropriate audit evidence to confirm or dispel whether or not a
material uncertainty exists through carrying out procedures considered necessary,
including considering the effect of any plans of management and other mitigating
factors; and
c) Seek written representations from management regarding its plans for future action.
Based upon further assessment and actions of management, the auditor shall issue his opinion.
Question No. 60
“The reliability of audit evidence is influenced by its source and by its nature and is dependent
on the individual circumstances under which it is obtained”. Explain.
(5 Marks June 2012)
Answer
Explanatory Paragraph A31, of Nepal Standard on Auditing 500 ―Audit Evidence‖ deals with
the above statement. The following generalization about the reliability of audit evidence may
be useful:
i) Audit evidence is more reliable when it is obtained from independent sources outside
the entity.
ii) Audit evidence obtained directly by the auditor is more reliable that audit evidence
obtained indirectly or by inference.
iii) Audit evidence is more reliable when it exists in documentary form.
iv) Audit evidence provided by original documents is more reliable than audit evidence
provided by photocopies or facsimiles.
Accordingly, audit evidence in the form of original written responses to confirmation requests
received directly by the auditor from the third parties who are not related to the entity being
audited, when considered individually or cumulatively with audit evidence from other audit
procedures, may assist in reducing the risk of material misstatement for the related assertions to an

Question No. 61
Express your opinion as an auditor on the following case:
a) The accountant of C Ltd. has requested you, not to send balance confirmations to a
particular group of debtors since the said balances are under dispute and the matter is pending
in the Court.
b) The existing auditors re-appointed at the AGM of the Company, refused to accept the
appointment. Is the Board of Directors entitled to fill up the vacancy? Comment.
a) Answer
NSA 505 on ―External Confirmations‖, establishes standards on the auditor‘s use of external
confirmation as a means of obtaining audit evidence. It requires that the auditor should employ
external confirmation procedures in consultation with the management.
As Per Para 8 Of NSA 505, If management refuses to allow the auditor to send a confirmation
request, the auditor shall:
a. Inquire as to management‘s reasons for the refusal, and seek audit evidence as to their
validity and reasonableness;
b. 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
c. Perform alternative audit procedures designed to obtain relevant and reliable audit
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 NSA 260 The auditor also shall determine the implications for the audit and the
auditor‘s opinion in accordance with NSA 705 (Revised).
Therefore, it can be understood that the auditor may come across certain situations in which the
management may request him not to seek external confirmation from certain parties because of
dispute with the debtors, etc. The management, for example, might make such a request on the
grounds that due to a dispute with the particular debtor, the request for confirmation might
aggravate the sensitive negotiations between the entity and the debtor. In such cases, when an
auditor agrees to management‘s request not to seek external confirmation regarding a particular
debtor, the auditor should consider validity of grounds for such a request and assess management‘s
integrity and obtain evidence to support the same. The auditor should also ask the management to
submit its request in a written form, detailing therein the reasons for such a request. The auditor
agrees to management‘s request not to seek external confirmation regarding a particular matter, the
auditor should document the reasons for acceding to the management‘s request and should apply
alternative procedures to obtain sufficient appropriate evidence regarding that matter. While
considering the validity of request, in case the auditor reaches at a conclusion that the same was
not valid, he may appropriately modify the report.
b) Answer
Appointment not effective: when the existing auditors who have been re-appointed at the AGM
refuse to accept the appointment, it does not create a casual vacancy or vacancy by resignation.
The auditor‘s appointment has not become effective due to the refusal.

 Board not empowered: since the auditors are appointed in the AGM, the subsequent refusal
of appointment does not empower the Board of Directors to appoint Auditors in the place of
those refusing to accept.
 Conclusion: in the instant case, the Auditors appointment has not become effective. Hence
the appointment should be made properly by the Shareholders at a properly convened
AGM/EGM. It cannot be made by the Directors, since there is no question of casual vacancy.
Also, company Act provides that where at AGM, no auditors are appointed or re-appointed,
the Company Registrar Office on the request of the Board of Directors may appoint a person
to fill the vacancy.
Question No. 62
Comment on the following case: (5 Marks December 2012)
In the course of the statutory audit of Z Ltd., its statutory auditors, having determined that the
work of internal auditor is likely to be adequate for the purpose of statutory audit, wanted to use
the work of internal auditor in respect of physical verification of fixed assets. How an evaluation
of this specific work done by the internal auditor can be done?
Answer
The statutory auditor should as a part of his audit, carryout general evaluation of the internal audit
function to determine the extent to which he can place reliance upon the work of the internal
auditor.
As per NSA 610 "Using the work of Internal Auditors",
The external auditor shall determine whether the work of the internal audit function can be used
for purposes of the audit by evaluating the following:
a) The extent to which the internal audit function‘s organizational status and relevant policies
and procedures support the objectivity of the internal auditors;
b) The level of competence of the internal audit function; and
c) Whether the internal audit function applies a systematic and disciplined approach,
including quality control.
The external auditor shall perform sufficient audit procedures on the body of work of the internal
audit function as a whole that the external auditor plans to use to determine its adequacy for
purposes of the audit, including evaluating whether:
a) The work of the function had been properly planned, performed, supervised, reviewed and
documented;
b) Sufficient appropriate evidence had been obtained to enable the function to draw reasonable
conclusions; and
c) Conclusions reached are appropriate in the circumstances and the reports prepared by the
function are consistent with the results of the work performed.
Question No. 63
Answer the following questions (5 Marks each December 2012)
a. Briefly describe the auditor's responsibility regarding subsequent events.
b. What is external confirmation? Give few examples of situations where external
confirmation may be used.

Answer:
a) NSA 560 on "Subsequent Events" establishes standards on the auditor's responsibility
regarding subsequent events. NSA 560 on "Subsequent Events" states that the term "subsequent
events" refers to significant events occurring between the balance sheet date and the date of the
auditor's report. NAS 10 on " Events after the Reporting Date " deals with all those significant
events, both favorable and unfavorable, that occur between the balance sheet date and the date on
which the financial statements are approved by the Board of Directors in the case of a company
and by the corresponding approving authority in the case of any other entity. As per NAS 10,
events can be identified as adjustable events which provide further evidence of conditions that
existed at the balance sheet date; and, non-adjusting events are those which are indicative of
conditions that arose subsequent to the balance sheet date. NSA 560 lays down that the "auditor
should consider the effect of subsequent events on the financial statements and on the auditor's
report". When the time between the close of the year-end and the adoption of accounts is about to
take place, examination of subsequent events gains more importance.
NSA 560 further requires that the auditor should perform procedures designed to obtain sufficient
appropriate audit evidence that all events up to the date of auditor's report that may require
adjustment of, or disclosure in, the financial statements have been identified. The procedures to
identify events that may require adjustment of, or disclosure in, the financial statements would be
performed as near as practicable to the date of the auditor's report and ordinarily include the
following:
i. Reviewing procedures that the management has established to ensure that subsequent events
are identified.
ii. Reading minutes of the meetings of shareholders, the board of directors and audit and
executive committees held after the balance sheet date and inquiring about matters discussed
at meetings for which minutes are not yet recorded.
iii. Reading the entity's latest available interim financial statements and, as considered
iv. Necessary and appropriate, budgets, cash flow forecasts and other related management
reports.
v. Inquiring, or extending previous oral or written inquiries, of the entity's lawyers concerning
litigation and claims.
vi. Inquiring of management as to whether any subsequent events have occurred after the balance
sheet date which might affect the financial statements.
When the auditor becomes aware of events which materially affect the financial statements, the
auditor should consider whether such events are properly accounted for in the financial
statements. When the management does not account for such events that the auditor believes
should be accounted for, the auditor should express a qualified opinion or an adverse opinion as
appropriate.
b) As per Nepal Standard on Auditing 505, External confirmation is the process of obtaining
and evaluating audit evidence through a representation of information or an existing condition
directly from a third party in response to a request for information about a particular item
affecting assertions in the financial statements or related disclosures. In deciding to what extent to
use external confirmations the auditor considers the characteristics of the environment in which
the entity being audited operated and the practice of potential respondents in dealing with requests
for direct confirmation.
Few examples of situations where external confirmations may be used are:
 Bank balances and other information from bankers;
 Account receivable balances;

 Stock held by third parties at bonded warehouses or on consignment;

 Property title deeds held by lawyers or financiers for safe custody or as security;
 Investments purchased from stockholders but not delivered at the balance sheet date;
 Loan from lenders;
 Account payable balances
Question No. 64
CA. Mr. A is the auditor of M/S PQR Ltd. During the course of audit, Mr. An encounter few
instances of the risks of material misstatement due to fraud and the results of audit tests
indicate a significant risk of material and pervasive fraud. Hence, Mr. A reach to the
conclusion that he shall not continue the engagement. Suggest the procedure to be followed by
him to discontinue the engagement.
Answer
Nepal Standard on Auditing 240 “ The Auditor‟s Responsibility Relating to Fraud in an
Audit of Financial Statement” provides that 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 should consider 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, and he should consider the possibility of withdrawing from the
engagement; and if he withdraws, he should 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.
As per para 38 of NSA 240, 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:
(a) 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;
(b) Consider whether it is appropriate to withdraw from the engagement, where withdrawal is
possible under applicable law or regulation; and
c) 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.
In the given case, Mr. A is the auditor who considers the risks of material misstatement and his
audit tests also indicates a significant risk of material and pervasive fraud. Due to these reasons,
he reached to the conclusion that he shall not continue the engagement. So, the auditor should
discontinue the engagement as provided in the above paragraph of NSA 240. He should consider
whether there is a professional or legal requirement to report to the person or persons who made
the audit appointment or, to the regulatory authorities about his withdrawal from the engagement
and the reasons for the withdrawal. The auditor may consider seeking legal advice when deciding
whether to withdraw from an engagement and in determining an appropriate course of action,
including the possibilities of reporting to shareholders, regulators or others.

Question No. 65
Describe in brief “Benefits of Audit Planning” and “Materiality” (8 Marks June 2013)
Answer
Benefits of Audit Planning (reference to NSA 300)
 Main benefits from planning audit are it helps the auditor obtain sufficient appropriate
evidence for the circumstances, helps keep audit costs at a reasonable level, and helps avoid
misunderstandings with the client.
 An audit plan helps to obtain information on audit risk and inherent risk as these risks
influence how the audit is carried out and the costs involved. The audit plan establishes an
overall strategy for the audit, develops an audit plan, reduces audit risk to an acceptably low
level and helps to execute the audit work in an effective manner.
 The audit plan should allow flexibility to revise overall audit plan (and thereby the planned
nature, extent and timing of further audit procedures) when unexpected events, changed
conditions or the audit evidence achieved from audit procedures lead to information that is
significantly different from information available to the auditor when he first planned his
audit. This will save time, cost and allows develop an effective response to the risk of
material misstatement.
 Audit plan helps to assign appropriate staff, knowledgeable about the client‘s business to the
engagement.
 Experience gained from previous year‘s engagements and other assignments is properly
utilized that helps to identify potential problems are resolved on a timely basis
 Confirmation that all stages of an audit are completed with important areas of the audit
received the appropriate attention
 Audit file documentation is reviewed on a timely basis
 Ensure review of work performed by engagement members by review manager or partner.
Materiality (reference to NSA 320)

Materiality is defined in the Nepal Accounting Standard Board‘s ―Framework for the
preparation and presentation of Financial Statements‖ in the following terms:
Information is material if its omission or misstatement could influence the economic decisions
of users taken on the basis of the financial statements. Materiality depends on the size of the
item or error judged in the particular circumstances of its omission or misstatement. This
materiality provides a threshold or cut off point rather than being a primary qualitative
characteristic which information must have if it is to be useful.
The assessment of what is material is a matter of professional judgment. Judgments about
materiality are made in the light of surrounding circumstances and are affected by the auditor‘s
perception of financial information needs of users. Materiality should be considered by the
auditor when determining the nature, timing and extent of audit procedures and evaluating the
effect of misstatements.
The auditor‘s assessment of materiality, related to classes of transactions, account balances and
disclosures helps the auditor decide whether to use sampling and substantive analytical
procedures. This enables auditor to select audit procedures to reduce the audit risk to an
acceptably low level. There is an inverse relationship between materiality and the level of risk
i.e. the higher the materiality level, the lower the audit risk and vice versa.
Question No. 66
As per Section 78 of the Company Act, 2063, what is the responsibility of the statutory auditor
of a public limited company? (4 Marks June 2013)

Answer:
As per Section 78 of the Companies Act, every public limited company shall prepare a report
indicating the following matters and submit the same to the Office of the Company Registrar in
advance of at least twenty-one days before the holding of the annual meeting. Such report has to
be approved by the board of directors and certified by the statutory auditor of the company:
i) The total number of the shares allotted,
ii) Number of fully paid up and unpaid shares out of the allotted shares,
iii) Particulars of director, managing director, auditor, executive chief and manager of
the company, and the amount of remuneration, allowance and facilities paid to them,
iv) The names of individuals or corporate bodies subscribing five percent or more of the
paid-up capital of the company, and details of shares or debentures held in their
names.
v) The total proceeds of the sale of shares, and particulars of the new shares and
debentures issued and raised by the company in the financial year concerned,
vi) The amount due and payable by the director or substantial shareholder or his close
relative to the company,
vii) The details of payment made or to be made against the sale of shares or for any other
matters,
viii) The amount of loans borrowed from banks and financial institutions and of principal
and interest due and payable,
ix) The amount claimed to be receivable by the company or payable by the company to
any other person or details of lawsuits, if any, ongoing in this respect,
x) The number of employees or workers engaged in the management of the company
and at other levels,
xi) The number of expatriate employees engaged in the management of the company
and at other levels, and remuneration, allowances and facilities paid to them,
xii) Where any agreement has been entered into between the company and any foreign
body or person on investment, management or technical service or other matter for a
period of more than one year, particulars thereof and the particulars of the dividend,
commission, fee, charge and royalty as well paid under such agreement in the
financial year concerned,
xiii) A statement of the management expenditures of the company in a financial year,
xiv) The amount of dividends yet to be claimed by the shareholders,
xv) A declaration that the company has fully observed this Act and the prevailing law,
xvi) Other necessary matters.
The responsibility of auditor is to verify the above information and certify. The auditor
should ensure that the information is consistent with those of audited one.
Question No. 67
Answer the following

a) Based upon the legal opinion of a leading advocate, Kathmandu Limited made a provision
of Rs. 50 million towards income tax liability. The assessing authority has worked out the
liability at Rs. 60 million. You as the statutory auditor of Kathmandu Limited observed that
the opinion of the advocate was inconsistent with legal position with regards to certain
revenue items. Indicate the precise nature of auditor‟s liability in such situation and
support your view with authority, if any.
b) Briefly explain the Auditor‟s responsibilities regarding comparatives.

Answer:
a) NSA 620 ―Using the work of an Expert‖ provides guidance on using the work of an expert
as audit evidence. NAS-620 states that during the audit, the auditor may need to obtain, in
conjunction with the client or independently, audit evidence in the form of reports, opinions,
valuations and statement of an expert, e.g. legal opinions concerning interpretations of
agreements, statutes and regulations.
Before relying on advocate opinion:
a) The relevance and reasonableness of that expert‘s findings or conclusions, and their
consistency with other audit evidence;
b) If that expert‘s work involves use of significant assumptions and methods, the relevance
and reasonableness of those assumptions and methods in the circumstances; and
c) If that expert‘s work involves the use of source data that is significant to that expert‘s
work, the relevance, completeness, and accuracy of that source data.
If the results of the expert‘s work do not provide sufficient appropriate audit evidence or if
the results are not consistent with other audit evidence, the auditor should resolve the matter.
This may involve discussion with the entity and the expert, applying additional audit
procedures, including possibly engaging another expert, or modifying the auditor‘s report.
The question states very clearly that the opinion of the advocate was inconsistent with legal
position with regards to certain revenue items. And, as an auditor, after applying due audit
procedures on the work of an expert, I decided to suggest Kathmandu Limited for making
additional provision for income tax and issuance of unmodified audit report.
b) NSA 710, ―Comparatives‖ establishes standards on the auditor‘s responsibilities regarding

comparatives.
The auditor responsibilities laid down are as under:
i) The auditor should determine whether the comparatives comply, in all material
respects with the financial reporting framework relevant to the financial statements
being audited. The extent of audit procedures performed on the corresponding figures
is significantly less than for the audit of the current period but ensure that the figures
have been correctly reported and appropriately classified. And see that:
 Accounting policies used for corresponding figures are consistent with those of
current period or whether appropriate adjustments and/or disclosure were made
 Corresponding figures agree with the amounts and other disclosure presented in
the prior period or whether appropriate adjustment and/or disclosure were made
ii) When the financial statement of the prior period have been audited another auditor or
not audited, the income auditor assesses whether the corresponding figures meet the
condition specified in above para (i) and guidance in NSA 510.
iii) During the course of audit of current period, the auditor becomes aware of a possible
material misstatement in the corresponding figures, the audit should perform
appropriate additional audit procedures.
iv) When the auditor‘s report on the prior period, as previously issued, included a
qualified opinion, disclaimer of opinion, or adverse opinion and the matter which gave
rise to the modification in the audit report is:

 unresolved and results in a modification of the auditor‘s report regarding the

current period figures, the auditor‘s report should also be modified regarding the
corresponding figures; or
 unresolved, but does not result in a modification of the auditor‘s report regarding
the current period figures, the auditor‘s report should be modified regarding the
corresponding figures.
v) When the prior period financial statements are not audited, the incoming auditor
should state in the auditor‘s report that the corresponding figures are unaudited.
Question No. 68
Briefly explain with example, four types of audit evidence that the auditor can obtain.
(5 Marks June 2013)
Answer
Four types of audit evidence:
a. Physical examination
Inspection or count by the auditor of a tangible assets. Most often associated with cash or
inventory, but it is also applicable for verification of securities and tangible fixed assets
b. Confirmation
The receipt of a written or oral response from an independent third party verifying the
accuracy of information. Auditor has client request that the third party respond directly to
the auditor.
 Positive confirmation: Ask for response even if balance is correct.
 Negative confirmation: Ask for response only if balance is negative.
c. Documentation
Audit documentation is the principal record of auditing procedures applied, evidence
obtained, and conclusion reached by auditor.
Internal document: Prepared and used within client company and does not go outside
client.
External document: Document has been in the hands of outside party to transaction.
d. Observation:
Use of senses to assess client‘s activities. Auditor witnesses the physical activities of the
client. Differs from physical examination because physical examination counts assets,
while observation focuses on client activities.
The following are the methods to obtain audit evidence
i) Inspection – examination of records or documents in whatever form. Example:
manual, computerized, internal, external.
ii) Observation- looking at the process or procedures being carried out by others;
Example – attending the physical stock take at the year end
iii) Inquiry- seeking information from knowledgeable persons, both financial and non-
financial, within or outside the entity being audited. Example – discussion with
management /accountants.
iv) Confirmation- the process of obtaining a representation of an existing condition
from a third party. Example- bank confirmation, receivable letter
v) Recalculation – checking the mathematical accuracy of documents and records.
Example- checking calculation of staff leave liabilities
vi) Re-performance- Re-performance is the auditor‘s independent execution of
procedures or controls that were originally performed as part of the entity‘s
internal control, either manually or through the use of CAATs, for example, re
performing the aging of accounts receivable.

vii) Analytical Procedures- Evaluation of financial information made by a study of

plausible relationships among both financial and non-financial data, Example;
Ratio, trend.
Question No. 69
Comment and give your views with reasons on each of the following cases, giving consideration
to Nepal Accounting Standards, Nepal Standards on Auditing and Code of Ethics.
a) You are the auditor of XYZ Ltd, a contractor, for the year end 31 Ashadh 2070. XYZ
Ltd carried out a major construction work for ABC Pvt. Ltd. and billed work in progress
of Rs. 1 million (total accounts receivable balance at the yearend is Rs. 1.5 million)
which is yet to be paid. ABC Pvt. Ltd. has suspended the payment of contract on the
ground that work carried out is not as per contract signed and appropriate rectifications
have to be done. XYZ Ltd. has accepted the deficiencies and rectified the work in Kartik,
2070. While finalizing the audit report in Mangsir 2070, you came to know that ABC
Pvt. Ltd is not satisfied with the level of rectifications and has terminated the contract.
Assume there are no concerns other than those described above, and that going concern
is not an issue. In relation to the subsequent event issue:
i) Identify the impact (if any) on the financial report for the year ended 31 Ashadh
2070.
ii) Justify your decision in (i) above.
iii) Determine the type of audit opinion that would be issued, assuming that XYZ
management has no intention to addressing the issue in the financial report.
b) PSS & Co, Chartered Accountants, were appointed as the auditor by the annual general
meeting of Chicken Products Ltd. for the financial year 2069/70. This was their first
appointment as an auditor of this company. During the course of the audit, after
performing all required audit procedures, the auditor was unable to obtain sufficient
appropriate audit evidence concerning opening balances. Briefly outline your role as an
auditor.
Answer hint:
a)
i)
a) Subsequent event: Termination of major contract
b) Adjusting event: Revenue and receivable need to be adjusted based on subsequent
event.
ii) Account receivable and revenue no longer exist as contract has been terminated.
iii) Type of qualification: Qualified
b)
As stated in NSA 510 "Initial Engagements-Opening Balances", for initial audit engagements,
the auditor should obtain sufficient appropriate audit evidence that:
i) The opening balances do not contain misstatements that materially affect the current
period‘s financial statements;
ii) The prior period‘s closing balances have been correctly brought forward to the current
period or, when appropriate, have been restated; and

iii) Appropriate accounting policies are consistently applied or changes in accounting policies
have been properly accounted for and adequately presented and disclosed.
If, after performing audit procedures including those set out in Nepal Standards on Auditing,
the auditor is unable to obtain sufficient appropriate audit evidence concerning opening
balances, the auditor‘s report should include:
a) A qualified opinion,
b) A disclaimer of opinion; or
c) In those jurisdictions where it is permitted, an opinion which is qualified or
disclaimed regarding the results of operations and unqualified regarding
financial position.
If the effect of the misstatement is not properly accounted for and adequately presented and
disclosed, the auditor should express a qualified opinion or an adverse opinion, as appropriate.
Question No. 70
Describe few instances in which the auditor may seek to use the work of an expert during the
course of his audit. (6 Marks December 2013)
Answer:
During the audit, the auditor may seek to obtain, in conjunction with the client or
independently, audit evidence in the form of reports, opinions, valuations, and statements of
an expert as per NSA 620. Few instances are:
i) Valuations of certain types of assets, for example, land and buildings, plant and
machinery, works of arts, and precious stones.
ii) Determination of quantities or physical condition of assets, for example, mineral stored in
stockpiles, mineral and petroleum reserves and remaining useful life of plant and
machinery.
iii) Determination of amounts using specialized techniques or methods for example, an
actuarial valuation.
iv) The measurement of work completed and to be completed on contracts in progress for the
purpose of revenue recognition.
v) Legal opinion concerning interpretations of agreements, statutes regulations, notifications,
circulars etc.
Question No. 71
As an auditor of M/S XYZ Finance Company Ltd., you came across a payment of Rs. 20
million for investment in share of ABC Hydro Company Ltd. The share investment script was
not provided to you for verification. In response to the positive external confirmation from ABC
Hydro Company Ltd., you received a phone call confirming the investment of the said amount
and specifying the reason for delay in delivering the investment script on the ground that the
same is in the process of printing. However, upon your personal request, you received a written
confirmation from ABC Hydro Company Ltd. of the receipt of the said amount but with the
restrictive language „Information is furnished as a matter of courtesy without a duty to do so
and without responsibility, liability, or warranty, expressed or implied‟. Give your opinion
whether the oral confirmation and the written confirmation obtained amounts to sufficient
appropriate audit evidence.
(5 Marks June 2014)

Answer:
An oral response to a confirmation request does not meet the definition of an external
confirmation because it is not a direct written response to the auditor. Provided that the auditor
has not concluded that a direct written response to a positive confirmation is necessary to obtain
sufficient appropriate audit evidence, the auditor may take the receipt of an oral response to a
confirmation request into consideration when determining the nature and extent of alternative
audit procedures required to be performed for non-responses. The auditor may perform additional
procedures to address the reliability of the evidence provided by the oral response, such as
initiating a call to the respondent using a telephone number that the auditor has independently
verified as being associated with the entity. For example, the auditor might call the main
telephone number obtained from a reliable source and ask to be directed to the named respondent
instead of calling a direct extension provided by the client or included in the statement or other
correspondence received by the entity. The auditor may determine that the additional evidence
provided by contacting the respondent directly, together with the evidence upon which the
original confirmation request is based (for example, a statement or other correspondence received
by the entity), is sufficient appropriate audit evidence. For appropriately documenting the oral
response, the auditor may include specific details, such as the identity of the person from whom
the response was received, his or her position, and the date and time of the conversation.
However, in certain circumstances the auditor may identify an assessed risk of material
misstatement at the assertion level for which a response to a positive confirmation request is
necessary to obtain sufficient appropriate audit evidence. Such instances include the information
available to corroborate management‘s assertion is only available outside the entity or specific
fraud risk factors, such as the risk of management override of controls or the risk of collusion,
which can involve employee(s) or management, or both, prevent the auditor from relying on
evidence from the entity.
A response to a confirmation request may contain restrictive language regarding its use. Such
restrictions do not necessarily invalidate the reliability of the response as audit evidence. Whether
the auditor may rely on the information confirmed and the degree of such reliance will depend on
the nature and substance of the restrictive language. Restrictions that appear to be disclaimers of
liability may not affect the reliability of the information being confirmed.
In the case of XYZ Finance Company Ltd. as the client could not produce investment script for
physical verification, obtaining of mere oral response does not tantamount to sufficient
appropriate audit evidence. However, with regards to the written confirmation received with
restrictive language, incorporation of restrictive language on the confirmation letter does not
invalidate the reliability of the confirmation received. The substance of the confirmation letter lies
with the assertion of the confirmation of the investment in clear language with amount. Hence, if
the main content of the confirmation letter clearly substantiates the investment amount, the same
becomes sufficient appropriate audit evidence. Otherwise, other audit procedures should be
initiated.
Question No. 72
How should the auditor deal with a fraud detected during the audit? Outline the auditor‟s
specific responses in relation to the fraudulent reporting in revenue recognition.
(8 Marks June 2014)
Answer
The relevant auditing standard is NSA 240-The Auditor‘s Responsibilities relating to Fraud in an
Audit of the Financial Statement. This standard makes it clear in that the responsibility for the

detection of fraud is that of management and the directors who need to establish and maintain
internal controls suitable to safeguard the assets and activities of the business.
Where fraud is detected, standard requires the auditor to communicate, in a timely manner, the
findings that suggest the possibility of fraud. These should be communicated to the appropriate
level of management, or in the case where management is believed to be involved in the fraud, to
the appropriate higher level of governance. The auditor should consider matter of confidentiality,
whether the communication should be orally or in writing and the possible necessity of obtaining
legal advice or communicating with a regulator. NSA 260- Communications with Those Charged
with Governance also provides additional guidance to assist an auditor whether a matter should be
reported orally or in writing.
The exact nature of action and reporting will depend on the facts and circumstance of the
particular case. Common elements to report could include the tests the auditor carried out, their
findings, the reasons fraud is suspected, what further investigatory procedures, if any, have been
undertaken, and possible recommendations for action.
Specific responses – misstatement due to fraudulent reporting – revenue recognition:
 Performing substantive analytical procedures relating to revenue using disaggregated data, for
example, comparing revenue reported by month and by product line or business segment
during the current reporting period with comparable prior periods.
 Confirming with customers certain relevant contract terms and the absence of side agreements.
 Enquiring of the entity‘s sales and marketing personnel or in-house legal counsel regarding
sales or shipments near the end of the period and their knowledge of any unusual terms or
conditions associated with these transactions.
 Being physically present at one or more locations at period end to observe goods being shipped
or being readied for shipment (or returns awaiting processing) and performing other
appropriate sales and inventory cut-off procedures.
 For those situations for which revenue transactions are electronically initiated, processed, and
recorded, testing controls to determine whether they provide assurance that recorded revenue
transactions occurred and are properly recorded.
Question No. 73
In the course of audit of ABC Ltd., its management refuses to provide written representations.
As an auditor, what is your duty? (4 Marks June 2014)
Answer:
As per NSA -580 ―Written Representations‖ if the management does not provide one or more of
the requested representations the auditor shall.
(i) Discuss the matters with management.
(ii) Re-evaluate the integrity of the management and evaluate the effect that this may have
on the reliability of representations oral or written and audit evidence in general and
(iii)Take appropriate actions, including determining the possible effect on the opinion in
the auditor‘s report.
The auditor should disclaim an opinion on the financial statements if management does
not provide written representations.

Question No. 74
a) What do you mean by Working Papers? How important is working papers for an auditor to
perform an audit? (8 Marks December 2014)
b) “The risk of not detecting a material misstatement resulting from fraud is higher than the
risk of not detecting a material misstatement resulting from error and the risk of the auditor
not detecting a material misstatement resulting from management fraud is greater than that
of the employee fraud”. Explain. (4 Marks December 2014)
c) As a Statutory Auditor, how would you deal with the following?

The accountant of C Ltd. has requested you not to send balance confirmation letters to a
particular group of debtors since the said balances are under dispute and the matter is
pending in the court. (4Marks December 2014)
Answer:
a) Answer
As per the definition given in Nepal Standard on Auditing 230, ―Audit Documentation‖ means
the record of audit procedures performed, relevant audit evidence obtained, and conclusions
the auditor reached. The terms working papers or work papers are also sometimes used for
audit documentation.
Thus, working papers mean the material prepared by and for, or obtained and retained by the
auditor in connection with the performance of the audit. Working papers may be in the form
of data stored on paper, film, electronic media or other media. They assist in the planning and
performance of the audit, assist in the supervision and review of the audit work and provide
evidence of the audit work performed to support the auditor's opinion. Therefore, working
papers are very important document to the auditor while performing an audit.
Working papers are designed and organized to meet the circumstances and the auditor's needs
for each individual audit. The use of standardized working papers (for example, checklists,
specimen letters, organization of working papers) may improve the efficiency with which
such working papers are prepared and reviewed. They facilitate the delegation of work while
providing a means to control its quality.
Working papers should be sufficiently complete and detailed for an auditor to obtain an
overall understanding of the audit. The extent of documentation is a matter of professional
judgement since it is neither necessary nor practical to document every observation,
consideration or conclusion by the auditor in his working papers.
Working papers normally include:
 information concerning the legal and organizational structure of the client,
 extracts or copies of important legal documents, agreements and minutes,
 information concerning the industry, economic environment and legislative
environment within which the client operates,
 evidence of the planning process including audit programs and any changes thereto,
 evidence of the auditor's understanding of the accounting and internal control systems,
 evidence of inherent and control risk assessments and any revisions thereof,
 evidence of the auditor's consideration of the work of internal auditor and conclusions
reached,
 analyses of transactions and balances,

 analyses of significant ratios and trends,

 a record of the nature, timing and extent of audit procedures performed and the results
of such procedures.
Working paper files may be classified as permanent working paper file and current working
paper file. The basic information about the organization that normally do not change from
year to year are filed in the permanent working paper file whereas information pertaining to
the audit of particular year is filed in the current working paper file.
b) Answer
It is obvious that the risk of not detecting a material misstatement resulting from fraud is
higher than the risk of not detecting a material misstatement resulting from error 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. Such attempts at concealment may be even more difficult to detect when
accompanied by collusion. Collusion may cause the auditor to believe that evidence is
persuasive when it is, in fact, false. The auditor‘s ability to detect a fraud depends on factors
such as the skillfulness of the perpetrator, the frequency and extent of manipulation, the
degree of collusion involved, the relative size of individual amounts manipulated, and the
seniority of those involved. Audit procedures that are effective for detecting an error may be
ineffective for detecting fraud. Furthermore, the risk of the auditor not detecting a material
misstatement resulting from management fraud is greater than for employee fraud, because
those charged with governance and management are often in a position that assumes their
integrity and enables them to override the formally established control procedures. Certain
levels of management may be in a position to override control procedures designed to prevent
similar frauds by other employees, for example, by directing subordinates to record
transactions incorrectly or to conceal them. Given its position of authority within an entity,
management has the ability to either direct employees to do something or solicit their help to
assist management in carrying out a fraud, with or without the employees‘ knowledge.
Nepal Standard on Auditing 240 describes about the auditor‘s responsibility to consider fraud
in an audit of financial statements.
c) Answer
External confirmation Requests: NSA 505, ―External Confirmations‖, establishes standards
on the use of external confirmation as a means of obtaining audit evidence. It requires that the
auditor should employ external confirmation procedures in consultation with the management.
The auditor may come across certain situations in which the management may request him not
to seek external confirmation from certain parties because of dispute with the debtors, etc. The
management, for example, might make such a request on the grounds that due to a dispute
with the particular debtor, the request for confirmation might aggravate the sensitive
negotiations between the entity and the debtor. In such cases, when an auditor agrees to
management‘s request not to seek external confirmation regarding a particular debtor, the
auditor should consider validity of grounds for such a request and assess management‘s
integrity and obtain evidence to support the same. The auditor should also ask the
management to submit its request in a written form, dealing therein the reasons for such a
request. If the auditor agrees to management‘s request not to seek external confirmation
regarding a particular matter, the auditor should document the reasons for consideration to the
management‘s request and should apply alternative procedures to obtain sufficient appropriate
evidence regarding that matter. While considering the validity of request, in case the auditor
reaches at a conclusion that the same was not valid, he may appropriately modify the report.

Question No. 75
Answer the following (6 Marks each December 2014)
a) What procedures should be followed for the audit of transactions with related parties as per
the requirement of Nepal Standards on Auditing?
b) What are the procedures for obtaining Audit Evidence?

Answer:
a) As required by NAS 24 and other provision of acts/rules like Companies Act, Nepal Rastra
Bank Directives and Insurance Board Directives, the transactions with related parties are to
be identified and disclosed in the financial statements. There are certain restrictions on
transactions with related parties as per the provision of such acts and rules/directives.
As per NSA 550, the auditor should perform audit procedures designed to obtain sufficient
appropriate audit evidence regarding the identification and disclosure by management of
related parties and the effect of related party transactions that are material to the financial
statements. However, an audit cannot be expected to detect all related party transactions.
The auditor should review information provided by the directors and management identifying
the names of all known related parties and should perform the following procedures in
respect of the completeness of this information:
 review prior year working papers for names of known related parties;
 review the entity‘s procedures for identification of related parties;
 inquire as to the affiliation of directors and officers with other entities;
 review shareholder records to determine the names of principal shareholders or, if
appropriate, obtain a listing of principal shareholders from the share register;
 review minutes of the meetings of shareholders and the board of directors and other
relevant statutory records such as the register of directors ‗interests;
 inquire of other auditors currently involved in the audit, or predecessor auditors, as to
their knowledge of additional related parties; and
 review the entity‘s income tax returns and other information supplied to regulatory
agencies.
 Reviewing accounting records for large or unusual transactions or balances, paying
particular attention to transactions recognized at or near the end of the reporting period
 Performing detailed tests of transactions and balances
The auditor should obtain a written representation from management concerning:

 the completeness of information provided regarding the identification of related
parties; and
 the adequacy of related party disclosures in the financial statements
If the auditor is unable to obtain sufficient appropriate audit evidence concerning related
parties and transactions with such parties or concludes that their disclosure in the financial
statements is not adequate, the auditor should modify the auditor‘s report appropriately
.
b) Nepal Standard on Auditing 500 describes about the audit evidence. According to this
standard, ―Audit Evidence‖ is all the information used by the auditor in arriving at the
conclusions on which the audit opinion is based and also includes the information contained
in the accounting records underlying the financial statements and other information. The
auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable
conclusions for expressing his opinion on the financial statements. The auditor obtains audit

evidence by one or more of the following procedures: inspection, observation, inquiry and
confirmation, computation and analytical procedures. The timing of such procedures will be
dependent, in part, upon the periods of time during which the audit evidence sought is
available.
 Inspection
Inspection consists of examining records, documents, or tangible assets. Inspection of
records and documents provides audit evidence of varying degrees of reliability
depending on their nature and source and the effectiveness of internal controls over their
processing. Three major categories of documentary audit evidence, which provide
different degrees of reliability to the auditor, are:
a. documentary audit evidence created and held by third parties;
b. documentary audit evidence created by third parties and held by the entity; and
c. documentary audit evidence created and held by the entity. Inspection of tangible
assets provides reliable audit evidence with respect to their existence but not
necessarily as to their ownership or value.
 Observation
Observation consists of looking at a process or procedure being performed by others, for
example, the observation by the auditor of the counting of inventories by the entity's
personnel or the performance of control procedures that leave no audit trail.
 Inquiry and Confirmation
Inquiry consists of seeking information of knowledgeable persons inside or outside the
entity. Inquiries may range from formal written inquiries addressed to third parties to
informal oral inquiries addressed to persons inside the entity. Responses to inquiries may
provide the auditor with information not previously possessed or with corroborative audit
evidence. Confirmation consists of the response to an inquiry to corroborate information
contained in the accounting records. For example, the auditor ordinarily seeks direct
confirmation of receivables by communication with debtors.
 Computation
Computation consists of checking the arithmetical accuracy of source documents and
accounting records or of performing independent calculations.
 Analytical Procedures
Analytical procedures consist of the analysis of significant ratios and trends including the
resulting investigation of fluctuations and relationships that are inconsistent with other
relevant information or deviate from predicted amounts.
Question No. 76
Comment and give your views with reasons on each of the following cases.
a) While auditing Galaxy Limited, Mr. GN, the statutory auditor of the company, came to
know that some of the trade payables are outstanding as it is from previous year in the
Balance sheet of the current year. Mr.GN, therefore, requested written confirmation of
balances from trade payables. In the list of confirmations request sent, one of the trade
payables, having outstanding balance of Rs 12 lakh, sent his confirmation through an
electronic mail. You are required to explain what the further procedures are required to rely
on such responses received electronically.
b) ABC ltd entered into agreement with Mr. R on 2070/03/15, whereby it agreed to pay him
Rs. 1 lakh per month as retainership fee for consultation in IT department. However, no
amount was actually paid, and 12 lakhs was provided in the statement of profit and loss for
the year ending 2070/03/31. Management of the company uttered that need-based

consultation was obtained throughout the year. However, no documentary or other evidence
of receipt of such service was found. As the auditor of ABC ltd, what would be your
approach?
c) M/s AP & Associates, auditors of Welfare Dalit Organization, a recognized nonprofit
organization feels that the standard on auditing need not to be applied as Welfare Dalit
Organization is a non-profit making organization.
d) Mr. Raj, a fellow member of the Institute of Chartered Accountants of Nepal, working
as Manager of Ram & Associates, a Chartered Accountant firm, signed the audit report of
Om Ltd. on behalf of Ram & Associates.
a) Answer
According to NSA 505 on external confirmation, 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. Responses received electronically, for example by
facsimile or email, involve risks as to reliability because proof of origin and authority of the
respondent may be difficult to establish, and alterations may be difficult to detect. A process used
by the auditor and the respondent that creates a secure environment for responses received
electronically may mitigate these risks. If auditor is satisfied that such a process is secure and
properly controlled, the reliability of the related responses is enhanced. An electronic
confirmation process might incorporate various techniques for validating the identity of a sender
of information in electronic form for e.g. through the use of encryption, electronic digital
signatures, and procedures to verify authenticity.
The auditor is required by NSA 500 "Audit evidence" to determine whether to modify or add
procedures to resolve doubts over the reliability of information to be used as audit evidence. The
auditor may choose to verify the source and contents of a response to a confirmation request by
contacting the confirming party. E.g. the auditor may telephone the confirming party to determine
whether the confirming party did, in fact, send the response. In the given case, Mr. GN, has
received a response, through e-mail, hence the risk as to reliability of the response exists because
proof of origin and authority of the respondent is difficult to establish. He may ask the party to
incorporate some of the techniques for validity of identity and the confirmation received, like,
digital signatures etc. he may also contact the party through telephone to check the authenticity of
the confirmation received.
b) Answer
As per NSA 240 on "The Auditor's Responsibilities Relating to fraud and error in an Audit of
Financial Statements", 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. In the given case, ABC ltd has
entered into agreement with Mr. R at Year-end, for consultation in IT department. It also charged
yearly fee of Rs. 12 lakhs in the statement of profit and loss, however, no documentary or other
evidence of receipt of such service was found. It is clear that company has passed fictitious
journal entries, near year-end, to manipulate the operating results. Hence the auditor should adopt
the approach which will be based on the result of misstatement on the basis of such fictitious
journal entry, i.e. 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 shall determine the professional and legal responsibilities
applicable in the circumstances, including whether there is a requirement for the auditor to report
to the person who made the audit appointment or, in some cases, to regulatory authorities; or the

auditor may consider for appropriateness of withdrawal from such engagement, where withdrawal
from the engagement is legally permitted. In case the auditor decides to withdraw, then the
auditor should 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.
Further, the auditor is required to comply with the 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.
c) Answer
As per NSA 200 NSAs are written in the context of an audit of financial statements by an auditor.
They are to be adapted as necessary in the circumstances when applied to audits of other historical
financial information.
Provided that until any auditing standards are notified, any standard, or standards of auditing
specified by the Institute of Chartered Accountant of Nepal shall be deemed to be the auditing
standards.
Further, the preface to Standards on Auditing gives the scope of the Standards on Auditing. As
per the preface, the NSAs will apply whenever an independent audit is carried out; that is, in the
independent examination of financial statements/information of any entity; whether profit
oriented or not and irrespective of its size, or legal form (unless specified otherwise) when such
an examination is conducted with a view to expressing an opinion thereon.
Also, while discharging their attest function; it is the duty of the Chartered Accountant to ensure
that NSAs are followed in the audit of financial information covered by their audit reports.
In the given case, even though the client is a non-profit oriented entity the NSAs shall apply and
the auditor shall be guilty of professional misconduct for failing to discharge his duty in case of
noncompliance with NSAs.
d) Answer
Section 116 of the Companies Act, 2063 requires that only a person appointed as the auditor of
the company or where a firm is so appointed, the member who has been authorized by a decision
of the partners of such institution, may sign the auditor‘s report or sign or authenticate any other
document of the company required by law to be signed or authenticated by the auditor. Therefore,
Mr. Raj, a fellow member of the Institute and a manager of M/s Ram & Associates., Chartered
Accountants, cannot sign on behalf of the firm in view of the specific requirements of the
Companies Act, 2063. Further, as per Section 29 of Nepal Chartered Accountants Act 1997, to
carry out an accounting profession, Certificate of Practice (COP) is a must and the Institute of
Chartered Accountants of Nepal restricts its Chartered Accountant member in service even to
hold a COP. So, Mr. Raj cannot sign the audit report.
Question No. 77
a) Briefly explain the financial statements assertions as per NSA 500. (5 Marks June 2015)
b) What are the functions, duties and powers of the audit committee? (6 Marks June 2015)
a. Answer
As per NSA 500: Audit Evidence, financial statement assertions are assertions by
management. They are:
i. Existence: An asset or a liability exists at a given date

ii. Right and Obligations: An asset or a liability pertains to the entity at a given
date
iii. Occurrence: A transaction or event took place which pertains to the entity during
the period
iv. Completeness: There are no unrecorded or undisclosed assets, liabilities,
transactions events
v. Valuation: An asset or a liability is recorded at an appropriate carrying value
vi. Measurement: A transactions or event is recorded at the proper amount and for
proper period
vii. Presentation and disclosure: An item are disclosed, classified and described as
per requirement.
The auditor should consider the sufficiency and appropriateness of audit evidence to support
those financial statement assertions. While external confirmations may provide audit
evidence regarding these assertions, the ability of an external confirmation to provide
evidence relevant to a particular financial statement assertion varies.
b. Answer
As per section 165 of Companies Act, 2063, the functions, duties and powers of the audit
committee shall be as follows:
i. To review the accounts and financial statements of the company and ascertain the
truth of the facts mentioned in such statements;
ii. To review the internal financial control system and the risk management system of
the company;
iii. To supervise and review the internal auditing activities of the company;
iv. To recommend the names of the potential auditors for the appointment of the auditor
of the company, fix the remuneration and terms and conditions of appointment of the
auditor and present the same in the general meeting for the ratification thereof;
v. To review and supervise as to whether the auditor of the company has observed such
conduct, standards and directives determined by the competent body pursuant to
prevailing law as required to be observed in the course of doing auditing work;
vi. Based on the conduct, standard and directives determined by the competent body
pursuant to the prevailing law, to formulate the policies required to be observed by
the company in respect of the appointment and selection of the auditor.
vii. To prepare the accounts related policy of the company and enforce, or cause to be
enforced the same.
viii. Where any regulatory body has provided for the long-term audit report to be set out
in the audit report of the company, to comply with the terms required to prepare such
report;
ix. To perform such other terms as prescribed by the board of directors in respect of the
accounts, financial management and audit of the company.
Question No. 78
(4 Marks Each June 2015)
a) The books of accounts of M/s Max & co. for the accounting year 2070/71 have been
prepared estimating the useful life of a depreciable assets being 15 years. However, due
to current market scenario, it has been determined to revise the estimated useful life of
that depreciable asset to 10 years. The management of the company wants to adjust the
same through prior period adjustment. You are required to advise the management in
this regard.

b) Mr. A, a Chartered Accountant was the auditor of 'A Limited'. During the financial year
2070-71, the investment appeared in the Balance Sheet of the company of Rs.10 lakhs and
was the same amount as in the last year. Later on, it was found that the company's
investments were only Rs.25,000, but the value of investments was inflated for the purpose
of obtaining higher amount of Bank loan.
c) Mr. Shyam, a practicing Chartered Accountant, prepared a feasibility report for one of his
clients to obtain a long-term loan of Rs. 5 crores from a commercial bank and decided to
charge fees @ 5% of the loan approved. Subsequently, the bank approved the loan.
Consequent to the approval of loan by the bank, Mr. Shyam raised an invoice for his
services @ 5% of the loan approved as decided.
d) The Company auditor became aware of a matter, only after he had issued his audit
opinion. Had he become aware of the same prior to his issuing the audit report, he would
have issued a different opinion. What are his responsibilities in such a case?
a. Answer.
As per NAS 08 ―Accounting policies, changes in accounting estimates and errors‖, prior
period items are income or expenses which arise in the current period as a result of errors or
omissions in the preparation of the financial statements of one or more prior periods. The
change in estimated useful life of a depreciable asset does not constitute prior period
adjustment since it neither constitutes error nor omission but it merely involves making
estimates based on prevailing circumstances when financial statements were being prepared.
It is a mere estimate process involving judgment based on the latest information available.
An estimate may have to be revised if changes occur regarding the circumstances on which
the estimate was based, or as a result of new information, more experience or subsequent
developments. The revision of the estimate, by its nature, does not bring the adjustment
within the definitions of an extraordinary item or a prior period item.
The effect of change in an accounting estimate shall be included in the determination of net
profit or loss in:
a) the period of the change, if the change affects the period only; or
b) the period of the change and future periods if the changes affect both.
The nature and amount of a change in an accounting estimate which has a material effect in
the current period, or which is expected to have a material effect in subsequent periods, shall
be disclosed.
Further as per NSA 540 "Audit of Accounting Estimates" the auditor shall review the
outcome of accounting estimates included in the prior period financial statements or where
applicable, their subsequent re-estimation for the purpose of the current year.
In the given case, the company has prepared its books of accounts assuming estimated useful
life of a depreciable assets being 15 years for the accounting year 2070/71. However, due to
change in current market scenario, it was determined to revise the estimated useful life of that
depreciable asset to 10 years. Revision of such an estimate does not bring the resulting
amount within the definition of a prior period item. So, the intention of the management to
adjust as prior period adjustment is not correct. It‘s only a change in accounting estimate and
shall be dealt as mentioned above

b. Answer
Section 34(14) of the Nepal Chartered Accountants Act requires a member to obtain
sufficient information prior to giving any audit opinion. Similarly, Section 34(8) of the Act
requires a member to clearly indicate all the material facts or any false statements or
explanations known to him or to the best of his knowledge in order to truly present the
financial statement certified by him.
The primary duty of physical verification and valuation of investments is of the management.
However, the auditor‘s duty is also to verify the physical existence and valuation of
investments placed, at least on the last day of the accounting year. The auditor should verify
the documentary evidence for the cost/value and physical existence of the investments at the
end of the year. He should not blindly rely upon the Management‘s representation. In the
instant case, such non-verification happened for two years. It also appears that auditors failed
to confirm the value of investments from any proper source. In case auditor has simply relied
on the management‘s representation the auditor has failed to perform his duty. Accordingly,
Mr. A will be held liable for professional misconduct under the Chartered Accountants Act,
1997 in terms of Sections 34(8) and (14).
c. Answer
As per section 34 (10) of chapter VIII of Nepal Chartered Accountant Act 1997 and section
240 of Part B of code of Ethics for professional Accountant in practice, a Chartered
Accountant in practice is deemed to be guilty of professional misconduct if he charges or
offers to charge or accepts or offers to accept in respect of any professional employment fees
which are based on a percentage of profit or on any other uncertain events.
In the given case, Mr. Shyam has prepared a feasibility report for one of his clients, to obtain
a long-term loan. However, he decided to raise an invoice for his services @ 5% of the loan
to be sanctioned in the future, which is basically contingent upon the findings. Therefore, Mr.
Shyam will be held for professional misconduct under the above-mentioned clause.
d. Answer
Legal and professional perspective
(i) Right to receive notice and to attend general meeting
 The auditor has a right to receive all notices of and other communications relating
to any general meeting of a company as are sent to the members of the company.
 He can attend any general meeting like a member.
 However, he can speak only on the matters which concern him as an auditor.
(ii) NSA 560 – As per NSA 560, the auditor before issuing the audit report should
consider subsequent events i.e. events occurring from date of balance sheet to the date
on which audit report is issued.
(iii)Events subsequent to the date of audit report– The auditor, in case he becomes aware
of a matter subsequent to his audit report and such a discovery would cause the
revision of the audit report, he may bring this to the notice of shareholders.
Present case
Based on the above perspective, the auditor may attend the general meeting and bring
to the notice of shareholders the matter concerned and should communicate to them
the change in his opinion.
Question No. 79
While verifying the employees‟ records in a company, it was found that a major portion of the
labor employed was child labor. On questioning the management, the statutory auditor was told

that it was outside his scope of the financial audit to look into the compliance with other laws.
Answer
 As per NSA 250 ―Consideration of Laws and Regulation in an Audit of financial
statements‖ requires the auditor to obtain sufficient appropriate audit evidence regarding
the compliance with the provisions of those laws and regulations generally recognized to
have a direct impact on the determination of material amounts and disclosures in the
financial statements including tax and labor law.
 For the other laws, the auditor‘s responsibility is limited to undertake specified audit
procedures to help identify non-compliance with those laws and regulations that may have
a material effect on the financial statements.
 Noncompliance with other laws and regulations may result in fines, litigation or other
consequences for the entity, the cost of which may need to be provided for.
In the instant case, major portion of the labor employed was child labor. Auditor should ensure
the disclosure of above fact and provision of the cost of fines, litigation or other consequences. In
case auditor concludes that non-compliance may have a material effect on financial statements,
he should modify his opinion accordingly
Question No. 80
Answer the following: (5 Marks each December 2015)
a) While commencing the statutory audit of ABC Limited, you as an auditor undertook the
risk assessment and found that the detection risk relating to certain class of transactions
cannot be reduced to acceptable level. How would you deal with the situation?
b) The management of X Ltd. has prepared summary financial statements to be provided to its
investors. Consequently, the company wants to appoint you for conducting audit of such
summary financial statements. Mention the factors you would consider before accepting
such engagement to report on summary financial statements.
c) Mr. Shyam was appointed as the auditor of Sagarmatha Trading Limited and intends to
apply the concept of materiality for the financial statements as a whole. Guide him as to the
factors that may affect the identification of an appropriate benchmark for this purpose.
d) What are the professional obligations of an auditor who has resigned from the audit before
completion of his term due to non-co-operation of the Management in completing certain
audit procedures?
a. Answer
NSA 315 ―Identifying and Assessing the risk of material misstatement through understanding the
entity and its environment‖ and NSA 330 ― The Auditor‘s Responses to Assessed Risks‖
establishes standards on the procedures to be followed to obtain an understanding of the
accounting and internal control systems and on audit risk and its components.
NSA 315 and NSA 330 require that the auditor should use professional judgment to assess risk
of material misstatement and to design audit procedures to ensure that it is reduced to an

Risk of material misstatements comprises of inherent risk and control risk. ―Detection Risk‖ is
the risk that an auditor‘s substantive procedure will not detect a misstatement that exists in an
account balance or class of transactions that could be material.
The higher the risk of material misstatement, the more audit evidence the auditor should obtain
from the performance of substantive procedure. When both inherent and control risks are
assessed as high, the auditor needs to consider whether substantive procedures can provide
sufficient appropriate evidence to reduce detection risk, therefore audit risk, to an acceptably low
level.
The auditor should use his professional judgment to assess audit risk and to design audit
procedures to ensure that it is reduced to an acceptably low level. If it cannot be reduced to an
acceptable level, the auditor should express a qualified opinion or disclaimer of opinion as may
be appropriate.
b. Answer
As per NSA 810 ―engagement to report on summary Financial statements‖, before accepting an
engagement to report on summary financial statement an auditor shall –
(i) Determine whether the applied criteria are acceptable.
(ii) Obtained the agreement of the management that it acknowledges and understand its
responsibility
a) For the preparation of summary financial statements in accordance with the applied
criteria
b) To make the audited financial statements available to the intended users of the
summary financial statements without undue difficulty
c) To include the auditor‘s report on the summary financial statements in any document
that contains the summary financial statements and that indicates that the auditor has
reported on them.
Agree with the management the form of opinion to be expressed on the summary financial
statements.
c. Answer
NSA 320 ―Audit Materiality‖ prescribes the use of benchmarks in determining materiality for the
financial statements as a whole. Accordingly determining materiality involves the exercise of
professional judgment. A percentage is often applied to a chosen benchmark as a starting point in
determining materiality for the financial statement s as a whole. Factor that may affect the
identification of an appropriate benchmark include the following:
i. the elements of the financial statements (for example, assets, liabilities, equity,
revenue, expenses);
ii. whether there are items on which the attention of the users of the particular entity‘s
financial statements tends to be focused (for example, for the purpose of evaluating
financial performance users may tend to focus on profit, revenue or net assets);
iii. the nature of the entity, where the entity is at in its life cycle, and the industry and
economic environment in which the entity operates;
iv. the entity‘s ownership structure and the way it is financed (for example, if the entity is
financed solely by debt rather than equity, user may put more emphasis on assets, and
claims on them, than on the equity‘s earning); and
v. the relative volatility on the benchmark

d. Answer
NSA 705 ―Modifications to the opinion in the Independent Auditor‘s Report‖ provides the
consequence of an inability to obtain sufficient appropriate audit evidence due to a management -
imposed limitation after the auditor has accepted the engagement. The practicability of resigning
from the audit may depend upon the stage of completion of the engagement at the time that
management imposes the scope limitation.
When the auditor concludes that resignation from the audit is necessary because of a scope
limitation, there may be a professional, regulatory or legal requirement for the auditor to
communicate matters relating to the resignation from the engagement to regulators or the entity‘s
owners.
As per NSA 210 ―Terms of Audit Engagements‖, If the auditor is unable to agree to a change of
the engagement and is not permitted to continue the original engagement, the auditor should
withdraw and consider whether there is any obligation , either contractual or otherwise , to report
to board of directors or shareholders, the circumstances necessitating such withdrawal.
Question No. 81
Mention any four information which assists the auditor in accepting and continuing of
relationship with the client as per NSA 220. (4 Marks December 2015)
Answer
As per NSA 220 "Quality control for audits of historical financial information‖ the information
which assists the auditor in accepting and continuing of relationship with the client may include
the following:
 The integrity of the principal owners, key management and those charged with governance
of the entity;
 Competency of the engagement team to perform the audit engagement and availability of
necessary capabilities, including time and resources;
 Compliance with relevant ethical requirements by firm and the engagement team; and
 Significant matters that have arisen during the current or previous audit engagement, and
their implications for continuing the relationship.
Question No. 82
“The auditor should communicate audit matters of governance interest arising from the audit
of financial statements with those charged with the governance of an entity." Briefly state the
matters to be included in such Communication. (8 Marks June 2016)
Answer
The following are the audit matters of governance interest which are to be communicated as per
NSA 260:
i. The general approach and overall scope of the audit, including any expected
limitations thereon, or any additional requirements;
ii. the selection of, or changes in, significant accounting policies and practices that have,
or could have, a material effect on the entity‘s financial statements;
iii. The potential effect on the financial statements of any significant risks and exposures,
such as pending litigation, that are required to be disclosed in the financial statements;

iv. Audit adjustments, whether or not recorded by the entity that have, or could have, a
v. Material uncertainties related to events and conditions that may cast significant doubt
on the entity‘s ability to continue as a going concern;
vi. Disagreements with management about matters that, individually or in aggregate,
could be significant to the entity‘s financial statements or the auditor‘s report. These
communications include consideration of whether the matter has, or has not, been
resolved and the significance of the matter;
vii. Expected modifications to the auditor‘s report;
viii. Other matters warranting attention by those charged with governance, such as material
ix. Any other matters agreed upon in the terms of the audit engagement.

to respective Standards, Laws and Code of Ethics:
a. The statutory auditor of the Holding Company “XYZ Ltd.” demands for the working papers
of the auditors of the subsidiary company “ABC Ltd.” How would you deal with the given
circumstances if you are the auditor of ABC Ltd.?
b. An assistant of Ram & Associates, Chartered Accountants detected an error of Rs.15 for
interest payment which occurred number of times. The General Manager (Finance) of XYZ
Bank Ltd. advised him not to request for passing adjustment entries as individually the
errors were of small amounts. The company had 19,000 deposit accounts and interest was
paid monthly.
Answer
a) As per NSA 230 "Audit Documentation", working papers are the property of the auditor.
the auditor may at his discretion, make portion of or extracts of his working papers available
to his clients.
General Principles of Code of Ethics imposes an obligation on all professional accountants to
maintain confidentiality of information acquired as a result of professional or business
relationship unless there is legal or professional right or duty to disclose.
NSA 600, ―Special Considerations – Audit of Group Financial Statements (including the work
of component auditors)" also states that an auditor should respect the confidentiality of
information acquired during the course of his audit work and should not disclose such
information unless there is legal or professional duty to disclose.
Except to the extent stated above, the auditor is not required to provide the client or other
auditors of the same enterprise or its related enterprises such as a parent or a subsidiary,
access to his audit working papers. The statutory auditor of an enterprise does not have right
of access to the audit working papers of the branch auditor. An auditor can rely on the work of
another auditor, without having any right of access to the audit working papers of other
auditor.
Hence, statutory auditor of holding company cannot have access to audit working papers of
the subsidiary company's auditor. He can, however, ask the auditors to answer certain
questions about the manner in which the audit is conducted and certain other clarifications
regarding audit process. The auditor of subsidiary shall cooperate the holding company‘s
auditor in all material aspects and may even involve him in the audit work if required.

b) As per NSA 320 ―Materiality in planning and performing an audit‖ 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. 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. The auditor is primarily concerned with items which either
individually or as a group are material in relation to the affairs of the enterprise. Therefore, the
auditor while carrying out his audit function needs to consider the possibility of misstatements
of relatively small amounts that cumulatively could have a material effect on the financial
statements. In the instant case, an error of Rs. 15 in the interest computation, even if small
individually, will have a material effect due to the number of transactions. Therefore, the
request made by the manager is not acceptable and adjustment entry shall be passed.
Hence, the auditor should advise XYZ Bank Ltd., to make the adjustment. If XYZ Bank Ltd.,
does not accept the advice, the auditor should qualify his report with suitable quantification of
amount involved.
Question No. 84
The auditor of Mohan Ltd. was not able to get the confirmation about the existence and value
of certain machineries. However, the management gave him a certificate to prove the existence
and value of the machinery as appearing in the books of account. The auditor accepted the
same without any further procedure and signed the audit report. Is he right in his approach?
(4 Marks June 2016)
Answer
auditor, however, is required to examine the verification programme adopted by the management.
He must satisfy himself about the existence, ownership and valuation of fixed assets. In the case
of Mohan Ltd., the auditor has not been able to verify the existence and value of some machinery
despite the verification procedure followed in routine audit. He accepted the certificate given to
him by the management without making any further enquiry.
As per NSA 580 ―Written Representations‖ the representations received from management are
recognized as audit evidence, but they do not constitute Sufficient and appropriateness. Auditor is
required to seek corroborative audit evidence from other sources inside or outside the entity, to
evaluate whether such representations are reasonable and consistent with other evidences.
Representation received from Management cannot be a substitute for other audit evidence that the
auditor could reasonably expect to be available. If the auditor is unable to obtain sufficient
appropriate audit evidence that he believes would be available regarding a matter, which has or
may have a material effect on the financial information, this will constitute a limitation on the
scope of his examination even if he has obtained a representation from management on the matter.
Conclusion: The approach adopted by the auditor is not right.
Question No. 85
Answer the following: (4×5=20)
a) A company outsourced the activity of accounting data maintenance to the service
organization to achieve cost reduction. As an auditor of such company what are the
precautions that you would consider for conducting the audit? (5 Marks June 2016)
b) State the reporting responsibility of an auditor in the context of non-compliance of Law and
Regulation in an audit of Financial Statements. (5 Marks June 2016)

Answer:
a) Answer
A client may use a service organization such as one that executes transactions and maintains
related accountability or records transactions and processed related data. If a client uses a
service organization, certain policies, procedures and records maintained by the service
organization might be relevant to the audit of financial statement of the client. Consequently,
the auditor would consider the nature and extent of activities undertaken by service
organization so as to determine whether those activities are relevant to the audit and, if so, to
access their effect on audit risk.
While planning the audit, the auditor of the client should determine the significance of the
activities of the service organization to the client and their relevance to the audit. In doing so,
the auditor of the client would need to consider the following as appropriate; (NSA 402: Audit
Consideration Relating to an Entity using a service organization):
i. The nature of the services provided by the service organization and the significance of
those services to the user entity, including the effect thereof on the user entity‘s
internal control.
ii. The nature and materiality of the transactions processed, or accounts or financial
reporting processes affected by the service organization
iii. The degree of interaction between the activities of the service organization and those
of the user entity.
iv. The nature of the relationship between the user entity and the service organization,
including the relevant contractual terms for the activities undertaken by the service
organization.
b) Answer
As per NSA 250, ―Consideration of Laws and Regulations in an audit of Financial
Statements‖ the reporting responsibility of the auditor shall be as given below:
i. If in the auditor‘s Judgment, the non-compliance is believed to be intentional and/ or
material, the auditor should communicate the findings without delay.
ii. If the auditor suspects that members of senior management, including members of the
Board of Directors, are involved in non-compliance, the auditor should communicate
the matter to the next higher level of authority at the entity, such as, the audit
committee or Board of Directors, to the users of the auditors‘ report or financial
statements.
iii. If the auditor concludes that the non-compliance has a material effect on the financial
statements and has not been properly reflected in the financial statements, the auditor
should express a qualified or an adverse opinion.
iv. If the auditor is precluded by the entity from obtaining sufficient and appropriate audit
evidence to evaluate whether non-compliance is, or is likely to have occurred that have
or may have material impact on the financial statements, the auditor should express a
qualified opinion or a disclaimer of opinion on the financial statements on the basis of
a limitation on the scope of the audit.
v. If the auditor is unable to determine whether noncompliance has occurred because of
limitations imposed by the circumstances rather than by the entity, the auditor should
consider the effect on the auditor‘s report.
vi. The auditor‘s duty of confidentiality would ordinarily preclude reporting
noncompliance to a third party. However, in certain circumstances, that duty of
confidentiality is overridden by statement, law or by courts of laws.

Question No. 86
What are the elements that auditor should consider while evaluating the design of the entity‟s
control environment? (8 Marks June 2016)
Answer:
a) As per NSA 315 ―Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment‖ Para A77, the auditor should consider the
following elements while evaluating the design of the entity‘s control environment:
i. Communication and enforcement of integrity and ethical values – essential elements
which influence the effectiveness of the design, administration and monitoring of
controls.
ii. Commitment to competence – management‘s consideration of the competence levels
for particular jobs and how those levels translate into requisite skills and knowledge.
iii. Participation by those charged with governance – independence from management,
their experience and stature, the extent of their involvement and scrutiny of activities,
the information they receive, the degree to which difficult questions are raised and
pursued with management and their interaction with internal and external auditors.
iv. Management‘s philosophy and operating style – management‘s approach to taking and
managing business risks, and management‘s attitudes and actions toward financial
reporting, information processing and accounting functions and personnel.
v. Organizational structure – the framework within which an entity‘s activities for
achieving its objectives are planned, executed, controlled and reviewed.
vi. Assignment of authority and responsibility – how authority and responsibility for
operating activities are assigned and how reporting relationships and authorization
hierarchies are established.
vii. Human resource policies and practices – recruitment, orientation, training, evaluating,
counseling, promoting, compensating and remedial actions.
Question No. 87
to respective Standards, Laws and Code of Ethics:
a) The auditor of a limited company did not verify the investment; he inserted a note in the
balance sheet – “Investment not verified”. The shareholders approved and adopted the
accounts at the annual general meeting. Subsequently, it transpired that the investments
were misappropriated, and the company suffered a loss. (6 Marks December2016)
b) The statutory auditor of the Holding Company demands for the working papers of the
auditors of the subsidiary company, of which you are the auditor. How would you deal with
the situation? (4 Marks December2016)
a. Answer:
The Company Act, 2053 has clearly mentioned the functions and duties of an auditor in section
115. This section requires an auditor to carry out audit as per prevailing laws and audit standards
and give his opinion on the financial statements.
Code of Ethics: The Principle of professional competence and Due care imposes an obligation on
all professional accountants to act diligently in accordance with applicable technical and
professional standards when providing professional services.
As per Sec. 34(6) of Nepal Chartered Accountants Act 2053, member holding COP shall not
certify any financial statement or give report of any type until they or their partner or employee
check and verify it.

Further as per Sec. 34(14) of Nepal Chartered Accountants Act 2053, one should have obtained
sufficient information prior to give audit opinion.
As per NSA 700 (Forming an opinion and Reporting on financial statements)
The objectives of 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 that also describes the basis for
that opinion.
In order to form that opinion, the auditor conclude as to whether he has obtained reasonable
assurance about whether the financial statements as a whole are free from material misstatement,
whether due to fraud or error.
Verification of investments is a very important function of an auditor, since, it is an important
asset shown in the balance sheet. The auditor cannot be expected to give a report on the ‗truth and
fairness‘ of the financial statements of the company without verifying its investment. If he
specifically mentions in his audit report the fact that, he did not verify the investments, he would
not be relieved from his statutory duties. Such statutory duties can never be curbed, though they
may be extended.
Thus, the auditor will be held guilty of professional misconduct.
b. Answer
Demand of working papers: As per NSA 230, ―Audit Documentation‖ working papers are the
property of the auditor. The auditor may, at his discretion, make portion of or extracts of his
working papers available to his client. • NSA 600 ―special considerations-audit of group financial
statements(including work of component Auditors)‖ also states that an auditor should respect the
confidentiality of information acquired during the course of his audit work and should not
disclose such information unless there is a legal or professional duty to disclose. Statutory auditor
of an enterprise does not have right of access to the audit working papers of the branch auditor.
An auditor can rely on the work of another auditor, without having any right of access to the audit
working papers of other auditor.
Conclusion: Statutory auditor of Holding company cannot have access to audit working papers of
the subsidiary company‘s auditor. He can, however, asks the auditor to answer certain questions
about the manner in which the audit is conducted and certain other clarifications regarding audit.
Question No. 88
a) Explain what is meant by “Management Representations” and indicate to what extent an
auditor can place reliance on such representations. (8 Marks December 2016)
b) Kalu & Associates is auditor of Alpha Beta Ltd. for the financial year 2072/73. Audit team
has completed the audit procedures and the engagement manager is clear in respect of
providing clean audit report on the financial statements of the company but he is confused
about the manner in which to draw user‟s attention about a pending lawsuit against Alpha
Beta for which the company has made appropriate presentation and disclosure in Note 10
of the financial statement. Advise the manager as per relevant NSA guidance.
Answer:
a) AS per NSA 580 ―Written Representations‖ It is a written statement by management provided
to the auditor to confirm certain matters or to support other audit evidence. Management
representations in this context do not include financial statements, the assertions therein, or

supporting books and records. The management representations shall be in the form of a
representation letter addressed to the auditor.
Management representations are necessary information that the auditor requires in connection
with the audit, hence they are recognized as audit evidence as a response to inquiries.
Although management 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.
Extent of Reliance:
i. If the auditor has concerns about the competence, integrity, ethical values or diligence
of management, the auditor shall determine their effect on the reliability of
representations (oral or written) and audit evidence in general.
ii. In particular, if management representations are inconsistent with other audit
evidence, the auditor shall perform additional audit procedures to attempt to resolve
the matter.
iii. If the auditor concludes that the management representations are not reliable, the
auditor shall take appropriate actions, including determining the possible effect on the
opinion.
iv. If he claims that there is sufficient doubt about integrity of management, he shall
issue a disclaimer of opinion.
b) Emphasis of matter Paragraph: NSA 706: ―Emphasis of Matter Paragraph and other matter
paragraph in the independent auditor‘s report‖ provides guidance to the auditor for dealing
with additional communication in the auditor‘s report when the auditor considers it necessary
to draw users‘ attention to a matter or matters presented or disclosed in the financial
statements that are of such importance that they are fundamental to users‘ understanding of
Since the engagement manager considers it necessary to draw users‘ attention to the lawsuit
presented or disclosed in Note 10 of financial statements that, the manager should include an
Emphasis of Matter paragraph in the auditor‘s report provided the audit team has obtained
sufficient appropriate audit evidence that the matter is not materially misstated in the financial
statements. Such a paragraph shall refer only to information presented or disclosed in the
financial statements. While including an Emphasis of Matter paragraph in the auditor‘s report,
the auditor shall:
i. Include it immediately after the Opinion paragraph in the auditor‘s report;
ii. Use the heading ―Emphasis of Matter,‖ or other appropriate heading;
iii. Include in the paragraph a clear reference to the matter being emphasized and to where
relevant disclosures that fully describe the matter can be found in the financial
statements; and
iv. Indicate that the auditor‘s opinion is not modified in respect of the matter emphasized.
Extract from Independent Auditor‟s Report

Opinion
In our opinion, the financial statements present fairly, in all material respects (or give a true
and fair view of) the financial position of Alpha Beta Limited as at 31 Ashad 2073 and (of) its
financial performance and its cash flows for the year then ended in accordance with Nepal
Financial Reporting Standards.

Emphasis of Matter
We draw attention to Note 10 to the financial statements which describes the uncertainty
related to the outcome of the lawsuit filed against the company by XYZ Company. Our
opinion is not qualified in respect of this matter.
Question No. 89
a) What are the factors affecting form, contents and extent of audit documentation?
(5 Marks June 2017)
b) What do you mean by “Management Representations”? Indicate to what extent an auditor
can place reliance on such representations. (5 Marks June 2017)
Answer
a) The form and content of working papers are affected by matters such as:
i. The Nature of the engagement
ii. Form of the auditor's report,
iii. Nature and complexity of the client's business,
iv. Nature and conditions of the client's records and degree of reliance on internal
control,
v. Needs in the particular circumstances for direction, supervision and review of work
performed by assistants, and
vi. Specific audit methodology and technology used in the course of the audit.
b) AS per NSA 580 ―Written Representations‖ -it is a written statement by management
provided to the auditor to confirm certain matters or to support other audit evidence.
Management representations in this context do not include financial statements, the
assertions therein, or supporting books and records. The management representations shall
be in the form of a representation letter addressed to the auditor.
Management representations are necessary information that the auditor requires in
connection with the audit, hence they are recognized as audit evidence as a response to
inquiries. Although management 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.
Extent of Reliance:
i. If the auditor has concerns about the competence, integrity, ethical values or diligence
of management, the auditor shall determine their effect on the reliability of
representations (oral or written) and audit evidence in general.
ii. In particular, if management representations are inconsistent with other audit evidence,
the auditor shall perform additional audit procedures to attempt to resolve the matter.
iii. If the auditor concludes that the management representations are not reliable, the
auditor shall take appropriate actions, including determining the possible effect on the
opinion.
iv. If he claims that there is sufficient doubt about integrity of management, he shall issue
a disclaimer of opinion.
Question No. 90
Comment and give your views with reasons on the following cases.
You are a senior audit in-charge working for the firm Ram & Associates. You are currently
carrying out the audit of Bajra Ltd., a manufacturer of plastic bags. You are unhappy with
Bajra Ltd.‟s inventory valuation policy and have raised the issue several times with the audit

manager. He has dealt with the client for a number of years and does not see what you are
making an objection about. He has refused to meet you on site to discuss those issues.
As the audit manager has dealt with Bajra Ltd. for so many years, the other partners have
decided to leave the audit of Bajra Ltd. in his capable hands. (7 Marks June 2017)
Answer
Quality control Issues on an engagement: Several quality control issues are raised in the scenario:
Engagement partner: An engagement partner is usually appointed to each audit engagement
undertaken by the firm, to take responsibility for the engagement on behalf of the firm. Assigning
the audit to an experienced audit manager is not sufficient.
The lack of an audit engagement partner also means that several of the requirements of NSA 220
on ‗Quality control for audits of financial statements, about ensuring that engagements in relation
to independence and directing, supervising and reviewing the audit not in place.
Conflicting views: In this scenario the audit manager and senior have conflicting views about the
valuation of inventory. This does not appear to have been handled well, with the manager refusing
to discuss the issue with the senior.
NSA 220 on ―Quality control for audits of financial statements‖, requires that the audit
engagement partner takes responsibility for settling disputes in accordance with the firm‘s policy
in respect of resolution of difference of opinion required by NSQC 1 ―Nepal Standards on Quality
Control‖. In this case, the lack of engagement partner may have contributed to this failure to
resolve the disputes. In any event, at best, the failure to resolve the difference of opinion is a
breach of the firm‘s policy under NSQC 1. At worst, it indicates that the firm does not have a
suitable policy concerning such disputes required by NSQC 1.
Question No. 91
XYZ Ltd. has paid up capital of Rs. 20 million. 30% of the company‟s share is owned by
Government of Nepal. The directors of the company are in dilemma regarding the formation of
audit committee in its organization. Chief Executive Officer desires his son to be the member of
the committee as he is a Chartered Accountant by profession and has experience in the
accounting field. As an expert, provide your opinion to the company regarding whether audit
committee is actually required or not and also highlighting the qualification criteria to be its
member along with the functions to be performed by the committee.
Answer
Requirement of Audit Committee
Section 164 of Chapter 18 of Company Act 2063 mentions about the formation of Audit
Committee. As per the section, a listed company with paid up capital of thirty million rupees or
more or a company which is fully or partly owned by the Government of Nepal shall form an
audit committee under the Chairpersonship of a director who is not involved in the day-to –day
operations of the company and consisting of a least three members. Though Paid up capital of
XYZ company is only Rs. 20 million, its 30% of the share is owned by the Government of Nepal
which means there is partial ownership of government. So, the company is required to form an
Audit Committee as per Company Act.
Qualification criteria: Any person who is a close relative of the chief executive of a company
shall not be eligible to be a member of the audit committee. At least one member of the audit
committee shall be an experienced person having obtained professional certificate on accounting
or a person having gained experience in accounting and financial field after having obtained at
least bachelor‗s degree in accounts, commerce, management, finance or economics. The son of

the CEO cannot be appointed as member of the Audit Committee as he is a close relative of the
CEO.
Functions, duties and powers of audit committee:

The functions, duties and powers of the audit committee are as follows:
(a) To review the accounts and financial statements of the company and ascertain the truth
of the facts mentioned in such statements;
(b) To review the internal financial control system and the risk management system of the
company;
(c) To supervise and review the internal auditing activity of the company;
(d) To recommend the names of potential auditors for the appointment of the auditor of
the company, fix the remuneration and terms and conditions of appointment of the
auditor and present the same in the general meeting for the ratification thereof;
(e) To review and supervise as to whether the auditor of the company has observed such
conduct, standards and directives determined by the competent body pursuant to the
prevailing law as required to be observed in the course of doing auditing work;
(f) Based on the conduct, standard and directives determined by the competent body
pursuant to the prevailing law, to formulate the polices required to be observed by the
company in respect of the appointment and selection of the auditor;
(g) To prepare the accounts related policy of the company and enforce, or cause to be
enforced, the same;
(h) Where any regulatory body has provided for the long form audit report to be set out in
the audit report of the company, to comply with the terms required to prepare such
report;
(i) To perform such other terms as prescribed by the board of directors in respect of the
accounts, financial management and audit of the company.
Question No. 92
ABC Ltd. supplies stationery materials to Government Office across the country. The company
has 15 warehouses at different locations throughout the Nepal of which 8 warehouses at the
borders. The major stocks are generally supplied from the borders. ABC Ltd. appointed M/s
Ram & Associates to conduct its audit for the financial year 2072/73. Mr. Ram, partner of Ram
& Associates, attended all the physical inventory counting conducted throughout Nepal but
could not attend the same at borders due to some unavoidable reason.
You are required to advice M/s Ram & Associates: (10 Marks December 2017)
i) How sufficient appropriate audit evidence regarding the existence and condition of
inventory may be obtained?
ii) How an auditor is supposed to deal when attendance at physical inventory counting is
impracticable?
Answer:
i) Special consideration with regards to inventory: As per NSA 501 ―Audit Evidence
Specific consideration for selected items‖, is applicable in the case given. 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 instruction and procedure for recording and controlling
the results of the entity‘s physical inventory counting;
ii. Observe the performance of management‘s count procedure;

iii. Inspect the inventory; and

iv. Perform test count;
b. Performing audit procedures over the entity‘s final inventory records to determine
whether they accurately reflect actual inventory count results.
ii) Attendance at physical inventory counting not practicable: In some cases, attendance at
physical inventory counting may be impracticable. This may be due to factors such as
the nature and location of the inventory, for example where inventory is held in a
location that may pose threats to the safety of the auditor. The matter of general
inconvenience to the auditor, however, is not sufficient to support a decision by the
auditor that attendance is impracticable. Further, as explained in NSA 200 ―Overall
objectives of the independent Auditor and the conduct of an audit in accordance with
Nepal Standards on Auditing,‖ the matter of difficulty, time, or cost involved is not in
itself a valid basis for the auditor to omit an audit procedure for which there is no
alternative or to be satisfied with audit evidence that is less than persuasive.
Further, 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 some cases, though, it may not be possible to obtain sufficient appropriate audit
evidence regarding the existence and condition of inventory by performing alternative
audit procedure. In such cases, NSA 705 on ―modification to the opinion in the
Independent Auditor‘s Report‖, requires the auditor to modify the opinion in the
auditor‘s report as a result of the scope limitation.
Question No. 93
Comment and give your views with reasons.
A company wants to amend its accounts after the completion of the audit and adoption of the
Accounts by the Board, but before circulation to the shareholders. It requires its statutory
auditor to report on the amended accounts. State the steps the statutory auditor should adopt in
such a situation. (7 Marks December 2017)
Answer
As per NSA 560(Subsequent event): Management can revise its accounts after adoption on which
report has been issued by the Auditors, but before circulation to the shareholders. In the instant
case, the statutory auditor should ascertain whether the original audit report along with audited
accounts has been circulated to the shareholders. If not, he can issue a revised report on the
amended Financial Statement subject to following:
(i) Revised accounts must be re-approved by the Board of Directors of the company.
(ii) Ask the company to return all the original copies of the earlier audit report along with the
audited accounts.
(iii) The fact of revision of Financial Statement with reasons should be incorporated in the
Directors‘ Report. If it is neither included nor found adequately disclosed in the
Director‘s Report, auditor should include the fact with figures and reasons in his revised
audit report to the shareholders.
(iv) Mention specifically that it is a revised audit report.

Question No. 94
a) In the course of audit of Alibaba Ltd., its auditor Mr. Jacob observed that there was a
special audit conducted at the instance of the management on a possible suspicion of a
fraud and requested for a copy of the report to enable him to report on the fraud aspects.
Despite many reminders it was not provided. In absence of the special audit report, Mr.
Jacob insisted that he be provided with at least a written representation in respect of fraud
on/by the company. For this request also, the management remained silent. Please guide
Mr. Jacob as per the relevant provisions of Nepal Standards on Auditing.
(7 Marks June 2018)
b) Amul Ltd., dealing in manufacturing and trading of milk butter, has a benchmark in its
product for so many years. DTC Ltd., a rival company to Amul Ltd., has introduced its new
product, peanut butter. Due to being health conscious, the consumers have shifted from
milk butter to peanut butter within few months. This has resulted into massive loss during
the year to Amul Ltd. due to non-selling of perishable milk products. The company has also
started having negative net worth. It's production head, finance head and marketing head
have also left the company. The company has no sound action plan to mitigate these
situations. Kindly guide the auditor of Amul Ltd., how he should deal with the situation.
(8 Marks June 2018)
Answer:
a) Auditor‘s Responsibilities Relating to Fraud: As per NSA 240 on ―The Auditor‘s
Responsibilities Relating to Fraud in an Audit of Financial Statements‖, the auditor 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. As per NSA
580 ―Written Representations‖, 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.
In the instant case, the auditor observed that there was a special audit conducted at the
instance of the management on a possible suspicion of fraud. Therefore, the auditor
requested for special audit report which was not provided by the management despite of
many reminders. The auditor also insisted for written representation in respect of fraud
on/by the company. For this request also management remained silent. It may be noted that,
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.
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:
1. 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;
2. Consider whether it is appropriate to withdraw from the engagement, where
withdrawal from the engagement is legally permitted; and
3. If the auditor withdraws:
a. 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
b. 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.
b) Answer
i) Inability to Continue as a Going Concern:
As per NSA 570 on ―Going Concern‖, it is the responsibility of the Auditor to obtain
sufficient appropriate audit evidence about the appropriateness of management‘s use of
the going concern assumption in the preparation and presentation of the financial
statements and to conclude whether there is a material uncertainty about the entity‘s
ability to continue as a going concern.
The auditor shall evaluate management‘s assessment of the entity‘s ability to continue as
a going concern. In evaluating management‘s assessment, the auditor shall consider
whether management‘s assessment includes all relevant information of which the auditor
is aware as a result of the audit.
In the instant case, Amul Ltd. has suffered massive loss due to introduction of a
substitute of its product by its rival company, DTC Ltd., and having negative net worth
also. Besides this, its production head, finance head and marketing head have also left
the company. The company, in addition, has no action plan to mitigate these situations.
Thus, there are clear indications that there is danger to entity‘s ability to continue in
future. Considering the fact that there is no sound plan of action from the management to
mitigate these factors and to put the company back on the recovery, the going concern
assumption does not hold appropriate.
Therefore, the auditor should ask the management for its adequate disclosure in the
financial statement and include the same in his report. However, if the management fails
to make adequate disclosure, the auditor should express a qualified or adverse opinion. If
the result of the inappropriate assumption used in the preparation of financial statements
is so material and pervasive as to make the financial statements misleading, the auditor
should express an adverse opinion.
Question No. 95
i) Expert Limited has not included in the Balance Sheet as on 32/3/2075 a sum of Rs. 15
million being amount in the arrears of salaries and wages payable to the staff for the
last two years as a result of successful negotiations which were going on during the last
18 months and concluded on 30/4/2075. The auditor wants to sign the said Balance
Sheet and give the audit report on 31/5/2075. The auditor came to know the result of the
negotiations on 15/5/2075. Comment.
ii) ABC and Associates has a policy to retain working paper file for 4 years after signing of
report, due to shortage of space in its office, unless the group auditor or any law
requires the retention for a longer period.
i) Answer
As per NAS 10, "Events After the Reporting Period" adjustments to assets and liabilities are
required for events occurring after the Balance sheet date provide additional information
materially affecting the determination of the amounts relating to conditions existing at the
Balance Sheet date. Similarly, as per NAS 37, "Provisions, Contingent Liabilities and
Contingent Assets" future events that may affect the amount required to settle an obligation

should be settled in the amount of a provision where there is sufficient objective evidence that
the event will occur.
In the instant case, the amount of Rs. 15 million is a material amount and it is the result of an
event, which has occurred after the Balance Sheet date. The facts have become known to the
auditor before the date of issue of the Audit Report and Financial Statements.
The auditor has to perform the procedure to obtain sufficient, appropriate evidence covering
the period from the date of the financial statement i.e. 31/3/2075 to the date of Auditors
Report i.e. 31/5/2075. It will be observed that as a result of long pending negotiations a sum of
Rs. 15 million representing arrears of salaries of the previous 2 financial years have not been
included in the financial statements. It is quite clear that the obligation requires provision for
outstanding expenses as per NAS 10 and NAS 37.
As per NSA 560, "Subsequent Events" the auditor should assume that all events occurring
subsequent to the date of the financial statements and for which the applicable financial
reporting framework requires adjustment or disclosure have been adjusted or disclosed. So,
the auditor should request the management to adjust the sum of Rs. 15 million by making
provision for expenses. If the management does not accept the request the auditor should
qualify the audit report.
ii) Answer
Retention period of working papers: NSQC 1 (or national requirements that are at least as
demanding) requires firms to establish policies and procedures for the retention of
engagement documentation. Accordingly, the firm can establish a policy of retention period
for working paper. However, NSA 230 requires that the retention period for audit
engagements ordinarily should not be shorter than five years from the date of the auditor‘s
report, or, if later, the date of the group auditor‘s report.
On the basis of above requirements of the standards it seems that the working paper retention
policy of ABC and Associates is not appropriate and hence it can be suggested that ABC and
Associates should review its policy of retention period to meet the requirement of NSA 230.
Question No. 96
Comment and give your views with reasons on the following case:
XYZ & Associates had been appointed as external auditor of ABC Ltd. During the audit, the
auditor relied upon the procedures followed by the internal audit function of the entity and
expressed unmodified opinion on the financial statements. However, later on some
misstatements in the financial statements were revealed. The auditor is seeking relief stating
that the internal audit function of the entity was liable for the negligence. Express your opinion
regarding the situation. (8 Marks December 2018)
Answer:
Reliance on internal Audit function: NSA 610, ―Using the work of internal auditors clearly
mentions that the external auditor has sole responsibility for the audit opinion expressed, and that
responsibility is not reduced by the external auditor‗s use of the work of the internal audit
function on the engagement. Although the function may perform audit procedures similar to those
performed by the external auditor, neither the internal audit function nor the internal auditors are
independent of the entity as is required of the external auditor in an audit of financial statements
in accordance with NSA 200.

While determining whether, in which areas, and to what extent the work of the Internal Audit
Function can be used, the auditor need to evaluate the internal audit function. The external auditor
exercises professional judgment in determining whether the work of the internal audit function
can be used for purposes of the audit, and the nature and extent to which the work of the internal
audit function can be used in the circumstances.
The application of a systematic and disciplined approach to planning, performing, supervising,

reviewing and documenting its activities distinguishes the activities of the internal audit function
from other monitoring control activities that may be performed within the entity. Factors that may
affect the external auditor‗s determination of whether the internal audit function applies a
systematic and disciplined approach include the following:
 The existence, adequacy and use of documented internal audit procedures or guidance
covering such areas as risk assessments, work programs, documentation and reporting, the
nature and extent of which is commensurate with the size and circumstances of an entity.
 Whether the internal audit function has appropriate quality control policies and
procedures, for example, such as those policies and procedures in NSQC that would be
applicable to an internal audit function (such as those relating to leadership, human
resources and engagement performance) or quality control requirements in standards set
by the relevant professional bodies for internal auditors. Such bodies may also establish
other appropriate requirements such as conducting periodic external quality assessments.
Hence, in the above case, XYZ and associates were required to evaluate the internal audit
function based on above criteria during the audit. However, with regards to the opinion expressed
the full responsibility vests upon the auditor.
Question No. 97
Answer the following (4 Marks each June 2019)
a) Mahatara and Associates, a chartered accountant firm was appointed as an auditor of a
company on Ashwin 15, 2074 for the financial year 2073/74 where Kishan Kumar, one
of the partners of the audit firm, was holding 3 percent paid up shares of the company
since 2068. But, Kishan Kumar sold all his shares of the company on Ashwin 30, 2074.
It was further noted that the audit report was signed by another partner of the firm
Falgun 15, 2074 only.
Will you answer be different in case Kishan Kumar holds 0.8 percent of shares of the
company?
b) "The auditors should communicate audit matters of governance interest arising from
the audit of financial statements with those charged with the governance of an entity".
Briefly state the five major matters to be included in such communication.
a) Answer
A person or a firm, in which such person has substantial shareholding, 5% of paid up capital
of Public Company as per section 50 of Company Act 2063, which is also called basic
shareholders of the company or a shareholder holding one percent or more of the paid up
capital of the company or his/her close relative is not qualified for appointment as an auditor
as per section 112(1) of the Companies Act. So, in the present case since Kishan Kumar, a
partner of Mahatara & Associates, holds 3 percent shares of the company, Mahatara &
Associates is disqualified from appointment as an auditor as of Ashwin 15, 2074. But Kishan
Kumar disposes all his shares after the appointment as an auditor and audit report is signed

after disposal of the shares. Despite this fact as per section 112(4) of the Companies Act since
the appointment of audit is in contravention of the provision of the Companies Act, the audit
cannot be considered as valid.
Similarly, as per section 112 subsection 2 of Company Act 2063 (as amended), before
accepting the appointment every auditor to be appointed should declare in writing that he is
not ineligible for appointing as external auditor of the any particular company. In this case
audit firm, which is going to be appointed should have been declared his qualification before
appointment which was not happened.
In case, Kishan Kumar holds only 0.8 percent of the shares of the company, the appointment
of Mahatara & Associates will be valid as per section 112(1) of the Companies Act.
b) Answer
Communications of audit matters with those charged with governance:
As per NSA 260 ―Communication with Those Charged with Governance‖, the auditor shall
communicate with those charged with governance, the responsibilities of the auditor in
relation to the financial statement audit, including that:
1. The auditor is responsible for forming and expressing an opinion on the financial
statements that have been prepared by management with the oversight of those
charged with governance; and
2. The audit of the financial statements does not relieve management or those charged
with governance of their responsibilities.
The auditor shall communicate with those charged with governance the following:
1. The auditor‘s views about significant qualitative aspects of the entity‘s accounting
practices, including accounting policies, accounting estimates and financial statement
disclosures. When applicable, the auditor shall explain to those charged with
governance why the auditor considers a significant accounting practice, that is
acceptable under the applicable financial reporting framework, not to be most
appropriate to the particular circumstances of the entity;
2. Significant difficulties, if any, encountered during the audit;
3. Unless all of those charged with governance are involved in managing the entity:
 Significant matters, if any, arising from the audit that were discussed, or subject to
correspondence with management; and
 Written representations the auditor is requesting; and
4. Other matters, if any, arising from the audits that, in the auditor‘s professional
judgment, are significant to the oversight of the financial reporting process.
Question No. 98
Answer the following (7 Marks, June 2019)
Describe the main intent to introduce The Sarbanes-Oxley Act of 2002. What were the major
events contributing the adaptation of this Act in United States?
Answer
The Sarbanes-Oxley Act of 2002, also known as the "Public Company Accounting Reform and
Investor Protection Act" or "Corporate and Auditing Accountability and Responsibility Act" and
more commonly called as Sarbanes-Oxley, Sarbox or SOX, is a United States federal law that set
new or expanded requirements for all US public company boards, management and public
accounting firms. The intent of the SOX Act was to protect investors, and really all stakeholders

in a business firm, by improving the accuracy and reliability of corporate disclosures, such as
earnings reports, pursuant to securities laws and regulations.
A variety of complex factors created the conditions and culture in which a series of large
corporate frauds occurred between the years 2000 to 2002. The spectacular, highly publicized
frauds at Enron, WorldCom and Tyco exposed significant problems with conflicts of interest and
incentive compensation practices for senior management and accounting firm. It ultimately
reveals problems like inadequate oversight of accountants, lack of auditor independence, weak
corporate governance procedures, and stock analysts, conflict of interests, inadequate disclosure
provisions, and grossly inadequate funding of the Securities Exchange Commission.
Reasons for adaptation of SOX:
The following are the main reasons for the adaptation of SOX:
a. Auditor conflict of interest
b. Boardroom failures
c. Securities analysts' conflicts of interest
d. Banking practices
The SOX Act holds company CEO's and CFO's responsible for the information presented by their
company in the financial statements. It created new standards of accountability for corporations as
well as penalties of those standards of accountability are not met. SOX established new financial
reporting standards. All companies, according to SOX, must provide a year-end report about the
internal controls they have in place and the effectiveness of those internal controls.
Question No. 99
State what may be the evaluative or review procedures that the statutory auditor may do before
concluding as to relevance and reasonableness of auditor's expert work for using it for his
audit purposes? (7 Marks, June 2019)
Evaluating the Adequacy of the Auditor‘s Expert‘s Work: As per NSA 620 Using the work of an
Expert, the auditor shall evaluate the adequacy of the expert‘s work for the auditor‘s purposes,
including the relevance and reasonableness of that expert‘s findings or conclusions, and their
consistency with other audit evidence, etc.
Specific procedure to evaluate the adequacy of the expert‘s work is –
 Enquiries of the expert.
 Reviewing the expert‘s working papers and reports
 Corroborative procedure such as-
a) Observing the expert‘s work
b) Examining the published data, such as statistical reports from reputed source
c) Confirming the relevant matters with third parties
d) Performing detailed analytical procedure to see whether principles of materiality
aspects considered
e) Re performing calculations
 Discussions with another expert with relevant expertise when, for example, the findings or
the conclusion of the auditor‘s expert are not consistent with other audit evidence.
 Discussing the expert‘s report with the management.

Question No. 100

Write short notes on the following: (3 Marks each, June 2019)
i) Audit expectation gap
Auditing expectation gap or simply expectation gap is the term used to signify the difference in
expectations of users of financial statements and auditor‘s expectation concerning audited
financial statements. Although it's about expectations but still its scope and meanings have been
defined in number of ways. Difference in expectation can arise on the performance i.e. the level of
performance what users expect from auditor and how auditor actually performed.
Expectation gap can also be explained as the difference between the effectiveness of audit
engagement what users believe and what auditor believes. Expectation gap in related to audit can
also be explained as the difference between expectation of user and auditor himself on the
responsibilities of the auditor. It can also refer to difference in understanding regarding nature of
audit engagement i.e. what users believe audit is and what audit actually is.
ii) Tolerable misstatement and tolerable rate of deviation

Tolerable misstatement is the 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.
While determining the sample, the auditor determines tolerable misstatement in order to address
the risk that the aggregate of individual material misstatements may cause the financial statements
to be materially misstated and provide the margin for possible undetected misstatements.
Tolerable rate of deviation is the rate of deviation from the 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.
iii) Reporting of review engagement

The review report should contain a clear written expression of negative assurance. The auditor
should review and assess the conclusions drawn from the evidence obtained as the basis for the
expression of negative assurance. Based on the work performed, the auditor should assess
whether any information obtained during the review indicates that the financial statements do not
give a true and fair view (or are not presented fairly, in all material respects) in accordance with
the identified financial reporting framework. The report on a review of financial statements
describes the scope of engagement to enable the reader to understand the nature of the work
performed and make it clear that an audit was not performed and, therefore, that an audit opinion
not expressed.

Chapter 2-Ethics
Question No. 1
Under what circumstances a Chartered Accountant in practice shall be deemed to be guilty of
professional misconduct? (10 Marks December 2004)
Answer
Chartered accountant in practice shall be deemed to be guilty of professional misconduct if he:
 allows any person to practice in his name as a Chartered Accountant in practice and is in
partnership with or employed by himself;
 pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or
brokerage in the fees or profits of his professional business, to any person other than a
member of the Institute or a partner or a retired partner or the legal representative of a
deceased partner;
 accepts or agrees to accept any part of the profits of the professional work of a lawyer,
auctioneer, broker or other agent who is not a member of the Institute;
 enters into partnership with any person other than a chartered accountant in practice;
 secures, either through the services if a person not qualified to be his partner or by means
which are not open to a chartered accountant, any professional business;
 solicits client or professional work either directly or indirectly, by circular, advertisement,
personal communication or interview or by any other means;
 advertises his professional attainments or services, or uses any designation or expressions
other than the chartered accountant on professional documents;
 charges or offers to charge, accepts or offers to accept in respect of any professional
employment fees which are based on a percentage or profits or which are contingent upon
the findings, or results of such employment, except in cases which are permitted under
any regulations;
 engages in any business or occupation other than the profession of chartered accountants
unless permitted by the council so to engage;
 accepts a position as auditor previously held by some other chartered accountant or
registered auditor in such conditions as to constitute undercutting;
 allows a person not being a member of the institute or a member not being his partner to
sign on his behalf or on behalf of his firm, any balance sheet, profit and loss account,
report or financial statements.
Question No. 2
Give your opinion as an auditor in the following cases with specific reference to criteria on
which your opinion is based.
a. The audit of financial statements of M/s ABC Bank Ltd. has been done by M/s XYZ & Co.,
Chartered Accountants for the financial year 2060/61 and issued a clean audit report. The
audited financial statements revealed net profit of Rs. 3,00,00,000/- for that year. On the
basis of which staff bonus to the employees of that bank has been distributed as per the
Bonus Act. The audited financial statements have been sent to Nepal Rastra Bank for
permission to hold annual general meeting for that year. However, NRB after its offsite

inspection issued a direction to provide additional upward loan loss provision of NRs.
15,00, 00,000/- Comment. (5 Marks June 2005)
Answer:
In the given case, the additional loan loss provision is required in the case of M/s ABC Bank
as revealed by the NRB off site inspection. There has been significant deviation in the
financial position of the said Bank before the offsite inspection and after offsite inspection
from NRB. As a result, there has been significant loss for the year 2060/61. From the given
statement, it appears that the auditor of the bank could not find out and report on significant
deficit of loan loss provision that are required to be made as revealed from NRB off site
inspection report. Therefore, there is a lapse in the part of the auditor to report on deficiency
in loan loss provision and hence may be treated as gross negligence.
b. Mr. Hare Krishna Shrestha, a Chartered Accountant, is a statutory auditor of X Pvt. Ltd.
The turnover of this company is Rs. 15, 00,000/- for F/Y 2060/61. Mr. Shyam Kadel,
CEO of X Pvt. Ltd. requested him to update the preparation of accounting records before
he starts statutory audit for the year 2060/61 as his business is not sufficiently large to
employ adequate accounting staff. Give your view in line with ICAN Code of Ethics.
(5 Marks June 2005)
Answer
The preparation of accounting records is a service which is frequently requested of a
professional accountant in public practice, particularly by smaller clients, whose business are
not sufficiently large to employ an adequate internal accounting staff. It is unlikely that larger
clients need this service other than in exceptional circumstances. In all cases in which
independence is required and in which a professional accountant in public practice is
concerned in the preparation of accounting records for a client, the following requirements
should be observed.
a. The professional accounting in public practice should not have any relationship or
combination of relationships with the client or any conflict of interest, which would impair
integrity or independence.
b. The client should accept responsibility for the statements.
c. The professional accountant in public practice should not assume the role of employee or
of management conduction the operations of an enterprise.
d. Staff assigned to the preparation of accounting records ideally should not participate in
the examination of such records. The fact that the professional accountant in public practice
has processed or maintained certain records does not eliminate the need to make sufficient
audit test.
‗Self-review threat‘ is likely to impair independence of the auditor. As such, the auditor who
is required to give his opinion on the financial statements should not be involved in the
preparation of the book of accounts and the financial statements of his clients.
c. The chairman of the construction company asked Shri Ram Prashad Sharma, the
partner of the M/s RPS & Co., Chartered Accountants firm to quote their professional
fee on a success fee basis so as to ensure that a professional work is assigned to his firm.
(5 Marks June 2005)

Answer:
The professional services cannot and should not be offered under an agreement which entails
that fees shall be payable on success fee basis. The professional fees to receive payment in
direct proportion to the benefit receives by the client, may be tempted to exaggerate the
advantage of his service or may adopt means, which are not ethical. It will have the effect of
undermining his integrity and impairing his independence. Therefore, the remuneration based
on a percentage of the profits on the happening of a particular contingency such as the
successful outcome of an appeal in revenue proceedings is prohibited. Therefore, the action
of firm to quote professional fees on a success fee basis cannot be treated as valid and
member would be held guilty of professional misconduct under section 330 Part B of Code of
Ethics, ICAN.
Question No. 3
Discuss on the ethical conflicts encountered and state the ways to resolve them under ICAN
Code of Ethics. (10 Marks June 2005)
Answer:
i. From time to time professional accountants encounter situations which give rise to conflicts
of interest. Such conflicts may arise in a wide variety of ways ranging from the relatively
trivial dilemma to the extreme case of fraud and similar illegal activities. The professional
accountants should be constantly conscious of an alert to factors which give rise to conflicts
of interest. It should be noted that an honest difference of opinion between a professional
accountant and other party is not in itself an ethical issue. However, the facts and
circumstance of each case need investigation by the parties concerned.
ii. It is recognized however that there can be factors which occur when the responsibilities of a
professional accountant may conflict with internal or external demand of one type to another.
Hence:
 There may be the danger of pressure from an overbearing supervisor, manager, director
or partner; or when there are family or personal relationships which can give rise to the
possibilities of pressures being exerted upon them. Indeed, relationship or interest
which could adversely influence, impair or threaten a professional accountant‘s
integrity should be discouraged.
 A professional accountant may be asked to act contrary to technical and or professional
standards.
 A question of divided loyalty as between the professional accountant‘s superior and the
required professional standards of conduct could occur.
 Conflict could arise when misleading information is published which may be to the
advantage of the employer or client and which may or may not benefit the professional
accountant as a result of such publication.
iii. In applying standards of ethical conduct professional accountants may encounter problems in
identifying unethical behavior or in resolving an ethical conflict. When faced with significant
ethical issues, professional accountants should follow the established policies of the
employing organization to seek a resolution of such conflict. If those policies do not resolve
the ethical conflict, the following should be considered:

 Review the conflict problem with the immediate superior. If the problem is not resolved
with the immediate superior and the professional accountant determines to go to next
higher managerial level, the immediate superior should be notified of the decision. If it
appears that the superior is involved in the conflict problem, the professional accountant
should raise the issue with the next higher level of management. When the immediate
superior is the Chief Executive Officer (or equivalent) the next higher reviewing level
may be Executive Committee, Board of Directors, Non-Executive Directors, Trustees,
Partner Management Committee or shareholders.
 Seek counseling and advice on a confidential basis with ICAN to obtain an
understanding of possible of action.
 If the ethical conflict still exists after fully exhausting all levels of internal review, the
professional accountant a last resort may have no other recourse on significant matters
(e.g. fraud) than to resign and to submit an information memorandum to an appropriate
representative of that organization or of an external body as required under prevalent
laws and regulations in Nepal.
iv. Any professional accountant in a senior position should endeavor to ensure that policies are
established within his or her employing organization to seek resolution conflicts.
Question No. 4
What are the circumstances on the basis of which a Chartered Accountant in practice can be
indicted for professional misconduct under the Chartered Accountants Act?
Answer:
CA‟s indicted of professional misconduct
A chartered accountant in practice shall be deemed to be guilty of professional misconduct if
he/she:
i. Allows any person to practice in his name as a CA in practice and is in partnership with or
employed by himself.
ii. Pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or
brokerage in the fees or profits of his/her professional business, to any person other than a
member of the Institute or a partner or a retired partner or the legal representative of a
deceased partner.
iii. Accepts or agrees to accept any part of the profits of the professional work of a lawyer,
auctioneer, broker or other agent who is not a member of the Institute,
iv. Enters into partnership with any person other than CA in practice,
v. Secures, either through the services is a person not qualified to be his partner or by means,
which are not open to a CA, any professional business.
vi. Solicits client or professional work either directly or indirectly, by circular, advertisement,
personal communication or interview or by any other means,
vii. Advertises his professional attainments or services, or uses and designation or expressions
other than the CA on professional documents,

viii. Charges or offers to charge, accepts or offer to accept in respect of any professional
employments fees, which are based on percentage of profits or which are contingent upon
findings, or results of such employment, except in cases, which are permitted under any
regulation,
ix. Engages in any business or occupation other than the profession of CAs unless permitted
by the council so to engage,
x. Accepts a position as auditor previously held by some other CA or registered auditor in
such conditions as to constitute undercutting,
xi. Allows a person not being a member of the Institute or a member not being his/ her partner
to sign or on behalf of his/ her firm, any balance sheet, profit and loss account, report or
Question No. 5
Mr. Smart a Chartered Accountant mentions his designation in his visiting card as tax and
management consultant and mentions the list of services that his firm provides. Do you agree
with him? Comment. (5 Marks June 2006)
Answer:
As per Sec 115 of Code of Ethics 2018, When undertaking marketing or promotional
activities, a professional accountant shall not bring the profession into disrepute. A
professional accountant shall be honest and truthful and shall not make:
(a) Exaggerated claims for the services offered by, or the qualifications or experience of, the
accountant; or
(b) Disparaging references or unsubstantiated comparisons to the work of others.
If a professional accountant is in doubt about whether a form of advertising or marketing is
appropriate, the accountant is encouraged to consult with the relevant professional body.
Stationery of professional accountants in public practices should be of an acceptable professional
standard and comply with the requirements of the law and of ICAN as to names of partners,
principal and others who participate in the practice, use of professional descriptions and
designatory letters, cities or countries where the practice is represented, logotypes and so on. The
designation of any services provided by the practice as being of specialist nature should not be
permitted. Similar provisions, where applicable, should apply to nameplates.
Question No. 6
Comment and give your opinion on the following issues with specific reference to criteria on
which your opinion is based: (5 Marks each June 2007)
a) Mr. Raj Das Sharma was the statutory auditor of M/s Bhola Financial Institution Ltd.
for the financial years 2062/63 and 2061/62. The audit fee and other incidental and out
of pocket expenses charges were as follows: -

Audit fee Rs. 1,50,000

Incidental and Out-of-Pocket Rs. 4,00,000
Rs. 5,50,000
The financial position of the Financial Institution is not good. The management has
initiated a cost reduction drive. As a result, M/s Bhola Financial Institution Ltd. has
decided to appoint another auditor to reduce the audit expenses. Mr. Shiv R. Khadka, a
practicing member of ICAN accepted appointment as the statutory auditor of the Financial
Institution for the financial year 2063/64 at a audit fee and incidental and out of pocket
expenses given below:
Audit fee Rs. 1,00,000
Incidental and out of pocket Exp. Rs. 1,00,000
Rs. 2,00,000
Is there violation of Code of Ethics in the above case in the context of ICAN Code of Ethics?
b) Mr. Y, a practicing Chartered Accountant has been providing his expert opinion on tax
matters queries in a newspaper giving his personal details as tax, financial and
management consultant, professional experience, and the partner of M/s XYZ, an audit
firm.
Answer
a) The fact that a Professional Accountant in public practice secures any work by quoting a
fee lower than other is not improper. However, Professional Accountants in public
practice who obtain work at fees significantly lower than those charged by an existing
accountant, or quoted by others, should be aware that there is a risk of a perception that
the quality of work could be impaired.
In the given case, Mr. Shiv R. Khadka had agreed to accept the audit at a lower fee which
the previous auditor had been charging more in the previous year.
It is not improper for Mr. Shiv R. Khadka, a Professional Accountant in public practice to
charge M/s Bhola Financial Institution Ltd., a lower fee than has previously been charged
for similar services, provided the fee has been calculated in accordance with the notice of
ICAN.
When deciding on a fee to be quoted to a client for the performance of professional
services, Mr. Shiv R. Khadka should be satisfied that, as a result of the fee quoted:
i. the quality of work will not be impaired, and that due care will be applied to comply
with all professional standards and quality control procedures in the performance of
those services, and
ii. M/s Bhola Financial Institution Ltd., the client will not be misled as to the precise
scope of services that a quoted fee is intended to cover and the basis on which future
fees will be charged.

b) As per Sec 115 of Code of Ethics 2018, When undertaking marketing or promotional
(a) Exaggerated claims for the services offered by, or the qualifications or experience of,
the accountant; or
If a professional accountant is in doubt about whether a form of advertising or marketing
is appropriate, the accountant is encouraged to consult with the relevant professional
body.
Professional accountants in public practice are prohibited from making exaggerated
claims on services that one is able to offer, qualifications possessed, or experience gained.
This can be in quotations, firm‘s profiles or other communication to current and
prospective clients who have requested for such information
In the given case, as Mr. Y, a practicing Chartered Accountant has mentioned the
information regarding services being provided by him. Mr. Y being a practicing
Chartered Accountant has committed the professional misconduct by mentioning the
services being provided by him.
Question No. 7
Write short notes on the following:
a. Peer Review (4 Marks June 2006)
Answer:
Peer Review (PR) means an examination and review of the systems and procedures to
determine whether they have been put in place by the practicing unit (PU) for ensuring the
quality of attestation services as envisaged and implied/ mandated by the technical standards
and whether these were effective or not during the period under review. In other words, PR
involves examination of systems and procedures of the PU but does not aim to identify the
isolated cases of engagement failure.
The main objective of PR is to ensure that in carrying out their professional attestation
services assignments, the members of the Institute:
a. Comply with the Technical Standards laid down by the Institute, and
b. Have in place proper systems (including documentation systems) for maintaining the quality
of the attestation services work they perform.
Essentially, through review of records, PR identifies areas where a member may require
guidance in improving the quality of his performance and adherence to various requirements
as per applicable standards.

Although, PR has become a system in other parts of the World, it has not been formally
recognized in Nepal. The Institute of Chartered Accountants of Nepal is considering the
requirement of PR for overall upliftment of the quality of services being performed by its
members. However, there is lot of homework to be done as this system requires acceptance
by the professional bodies and formulation of procedures for PR.
b. Publicity under ICAN code of ethics. (4 Marks December 2007)

Answer
As per Sec 250, A professional accountant in public practice shall not bring the profession
into disrepute when marketing professional services. The professional accountant in public
practice shall be honest and truthful, and not:
(a) Make exaggerated claims for services offered, qualifications possessed, or experience
gained; or
(b) Make disparaging references or unsubstantiated comparisons to the work of another.
If the professional accountant in public practice is in doubt about whether a proposed form of
advertising or marketing is appropriate, the professional accountant in public practice shall
consider consulting with the relevant professional body
As per ICAN guidelines on Marketing professional Services by Professional Accountants in
public practice, Marketing is a process to communicate with the potential clients who are in
need to have the professional services of the professional accountants in public practice.
This process of marketing could be made to reach to the potential clients through advertising
in different manners and mode through newspapers, magazines, periodicals, sign boards,
television or radio, social media web site etc.
Whereas publicity which is similar to advertisement but could be meant to reach out to the
potential or even not potential clients to make them known that a particular professional
accountant seeks clients to provide them her or his professional services.
However, the provisions of Code of Ethics pronounced by both International Federation of

Accountants (IFAC) and the institute of Chartered Accountants of Nepal (ICAN) in no
uncertain terms intends to restrain and refrain professional accountants from reaching out to
potential clients by any means or manner of influencing, persuading or even coercing through
exaggerated unsubstantiated claims of qualification, experience and achievements.
c. Tax Practices under ICAN Code of Ethics (5 Marks December 2008)
Answer
If a firm is requested to perform a valuation to assist an audit client with its tax reporting
obligations or for tax planning purposes and the results of the valuation will not have a direct
effect on the financial statements, In providing tax services to an audit client, a firm may be
requested to perform a valuation to assist the client with its tax reporting obligations or for
tax planning purposes. Where the result of the valuation will have a direct effect on the
financial statements, the provisions included in paragraphs 290.172 to 290.177 relating to
valuation services are applicable. Where the valuation is performed for tax purposes only and
the result of the valuation will not have a direct effect on the financial statements (that is, the

financial statements are only affected through accounting entries related to tax), this would
not generally create threats to independence if such effect on the financial statements is
immaterial or if the valuation is subject to external review by a tax authority or similar
regulatory authority. If the valuation is not subject to such an external review and the effect is
material to the financial statements, the existence and significance of any threat created will
depend upon factors such as:
 The extent to which the valuation methodology is supported by tax law or regulation,
other precedent or established practice and the degree of subjectivity inherent in the
valuation.
 The reliability and extent of the underlying data.
 The significance of any threat created shall be evaluated and safeguards applied when
necessary to eliminate the threat or reduce it to an acceptable level. Examples of such
safeguards include:
 Using professionals who are not members of the audit team to perform the service;
 Having a professional review, the audit work or the result of the tax service; or
 Obtaining pre-clearance or advice from the tax authorities.
e. Peer Review (4 Marks December 2013)

Answer
The term peer review means review of work done by a professional, by another professional
of similar standing. It is defined as a regulatory mechanism for monitoring the performances
of professionals for maintaining quality of service expected of them for enhancing the
reliance placed by the users of financial statements for economic decision making. The
concept of peer review system has also been introduced in Nepal though relatively new and
yet to be made mandatory for all practice units.
f. Professional Negligence (4 Marks June 2016)

Answer
A professional will be deemed to be negligent only if he owes some duty to another and
failed to perform it. If the client through the action of the auditor incurs loss, his liability will
be determined on the basis of the terms of engagement. However, when a third party incurs
loss it is necessary to find out whether the auditor owed any duty to him. It is now well-
established contention to hold the auditor responsible for negligence in auditing the financial
statements, to persons whom he knew or ought to have known, to rely on those statements.
To charge a professional with breach of duty or negligence, it is necessary to prove deviation
from established performance procedures and standards. Though the auditor does not
guarantee success of his efforts, he should nevertheless exercise reasonable skill and
judgment while discharging his duties.
Question No. 8
a) Explain the various situations of financial involvement which may lead a reasonable
observer to conclude that independence has been impaired. (5 Marks December 2007)

Answer
a) : Financial involvement with a client affects independence and may lead a reasonable
observer to conclude that it has been impaired. Such involvement can arise in a number of
ways such as:
(i) By direct financial interest in a client.
(ii) By indirect material financial interest in a client, e.g., by being a trustee of any trust or
executor or administrator of any estate if such trust or estate has a financial interest in
a client company.
(iii)By loans to or from the client or any officer, director or principal shareholder of a
client company.
(iv) By holding a financial interest in a joint venture with a client or employee/s of a
client.
(v) By having a financial interest in a non-client that has an investor or investee
relationship with the client.
Independence is impaired when a professional accountant in public practice has or is
committed to acquire a direct or indirect material financial interest in a company for which
the professional accountant in public practice provides professional services requiring
independence. A direct financial interest includes an interest held by the spouse or
dependent child of the professional accountant in public practice and in some countries may
be extended to include other close relatives.
Question No. 9
Comment on the following with reference to Code of Ethics issued by the Institute of
Chartered Accountants of Nepal: (4 Marks each June 2008)
a) Mr. Smart was an auditor of a bank. During the course of the audit, he came to know
that the bank's performance was very good, and their result is about to be published. He
asked his brother who is living separately to buy shares of the bank from the market.
b) You are looking to buy a land for your residence and need Rs. 2 million financial
assistance. One of your clients of which you are current auditor is ready to finance.
However, to be on a safer side, you would like to obtain loan from a bank and the client
to guarantee the loan.
Answer
a) One of the fundamental principles of professional ethics is to maintain confidentiality of
the information obtained by a professional accountant. As per Section 114, of Code of
Ethics, confidentiality is not only a matter of disclosure of information. It also requires
that a professional accountant acquiring information in the course of performing
professional services does neither use nor appear to use that information for personal
advantage or for the advantage of a third party.
Thus, asking brother to buy shares with knowledge of good performance of the bank
tantamount to violation of professional ethics as per Code of Ethics issued by ICAN

b) As per the Code of Ethics 2018, para 200.6 A1, Self Interest Threats includes the
following:
 A professional accountant holding a financial interest in, or receiving a loan or
guarantee from, the employing organization.
 A professional accountant participating in incentive compensation arrangements
offered by the employing organization.
 A professional accountant having access to corporate assets for personal use.
 A professional accountant being offered a gift or special treatment from a supplier of
the employing organization.
Neither a professional accountant in public practice nor his or her spouse or dependent
child should make a loan to a client or guarantee a client‘s borrowings or accept a loan
from a client or have borrowings guaranteed by a client. This latter prescription does not
apply to loans to or from banks or other similar financial institutions when made under
normal lending procedures, terms and requirements; to home mortgages or to current or
deposit accounts with banks, building societies, etc.
Question No. 10
What is Peer Review? What are its main objectives? (5 Marks June 2008)
Answer
a) Peer review (PR ) means an examination and review of the systems and procedures to
determine whether they have been put in place by the practicing unit (PU) for ensuring the
quality of attestation services as envisaged and implied/ mandated by the technical
standards and whether these were effective or not during the period under review. In other
words, PR involves examination of systems and procedures of the PU but does not aim to
identify the isolated cases of engagement failure.
The main objective of PR is to ensure that in carrying out their professional attestation
services assignments, the members of the Institute:
i) comply with the technical Standards laid down by the Institute, and
ii) have in place proper systems (including documentation systems) for maintaining the
quality of the attestation services work they perform.
Essentially, through review of records, PR identifies area where a member may require
guidance in improving the quality of his performance and adherence to various
requirements as per applicable standards.
Question No. 11
Explain the meaning of the term peer review. What are the objectives of peer review?
Answer:
The term "peer" means a person of similar standing. The term "review" means conduct of re-
examination or retrospective evaluation of the subject matter. In general, for a professional, the

term "peer review" would mean review of work done by a professional, by another professional
of similar standing. ‗Peer Review‘ is defined as, a regulatory mechanism for monitoring the
performances of professionals for maintaining quality of service expected of them for enhancing
the reliance placed by the users of financial statements for economic decision-making.
As per the Statement of Peer Review (ICAN) ―Peer Review‖ means an examination and review
of the systems and procedures to determine whether they have been put in place by the practice
unit for ensuring the quality of attestation services as envisaged and implied/mandated by the
Technical Standards and whether these were effective or not during the period under review".
The main objectives of peer review are as discussed below:
(i) To ensure that members while performing attestation services comply with technical
standards laid down by the Institute;
(ii) To ensure that such a member has in place proper system (including documentation system)
for maintaining the quality of attestation services performed by him;
(iii) To ensure adherence to various statutory and other regulatory requirements; and
(iv) To enhance the reliance placed by the users of financial statements for economic decision
making.
Thus, the primary objective of peer review is not to find out deficiencies but to improve the
quality of services rendered by members of the profession. The Statement of Peer Review also
makes it clear that the peer review, "does not seek to redefine the scope and authority of the
Technical Standards specified by the Council but seeks to enforce them within the parameters
prescribed by the Technical Standards". The peer review is directed towards maintenance as well
as enhancement of quality of attestation services and to provide guidance to members to improve
their performance and adherence to various statutory and other regulatory requirements. Such an
objective of the peer review process makes it amply clear that the reviewer is not going to sit on
the judgement of the practice unit while rendering attestation services but to evaluate the
procedure followed by the practice unit in rendering such a service. Accordingly, where a
practice unit is not following technical standards, the reviewers are expected to recommend
measures to improve the procedures. To elaborate further, the key objective of peer review
exercise is not to identify isolated cases of engagement failure, but to identify weaknesses that
are pervasive and chronic in nature. For instance, absence of formal planning of an audit
represents a serious deficiency that needs to be remedied by the practice unit. An instance of the
auditor not carrying out physical verification of furniture and fixture may not attract the same
comment. However, certain items of assets are best verified through the physical verification
process and not adopting the same procedure may rightly be viewed as a systemic failure. The
conclusion, therefore, is that the peer review seeks to identify and address patterns of non-
compliance with quality control standards.
Question No. 12
Examine whether there is professional misconduct in the following circumstances as per Code
of Ethics issued by the Institute:
(i) A chartered accountant in practice appearing on television on budget proposal was
introduced to the viewers, on the basis of biodata furnished by him as the senior
partner of M/S Tick & Talk, a leading firm of Chartered Accountants, established in
Kathmandu in 2042. (4 Marks December 2008)

(ii) Mr. Unknown, a chartered accountant in practice agreed to pay Mr. Known 12 % of
the gross fees received by him from the clients referred to him by Mr. Known. It is also
agreed that the accounts will be settled at the end of each year. During the year ended
Ashadh 2065 Mr. Known had in total referred seven statutory audits of public
companies to Mr. Unknown. (3 Marks December 2008)
Answer:
i. As per section 115 of Code of Ethics 2018, When undertaking marketing or promotional
activities, a professional accountant shall not bring the profession into disrepute. A professional
accountant shall be honest and truthful and shall not make:
a. Exaggerated claims for the services offered by, or the qualifications or experience of,
the accountant; or
b. Disparaging references or unsubstantiated comparisons to the work of others.
In the instant case use of adjective such as the ―leading firm‖, ―senior most partner‖ would
amount to exaggerated claims for the qualifications or experience of, the accountant. Hence such
act is the violation of code of conduct.
Keeping this in view, the chartered accountant is guilty of professional misconduct as the
impugned announcement was made on the basis of biodata given by him.
ii. As per Sec 34 (3) of Nepal Chartered Accountant Act 1997, One shall not share or
distribute as profit the auditing fees or remuneration with any person other than a member of the
Institute; and shall not pay any commission, brokerage etc. out of the professional fees earned to
any person or member.
Also, as per Section 330 of Code of Ethics, A self-interest threat to compliance with the
principles of objectivity and professional competence and due care is created if a professional
accountant pays or receives a referral fee or receives a commission relating to a client.
A professional accountant in public practice should not, therefore, pay a commission to obtain a
client nor should a commission be accepted for referral of a client to a third party. A professional
accountant in public practice should not accept a commission for the referral of the products or
services of others.
Hence, Mr. Known is guilty of professional misconduct.
Question No. 13
Mr. S. Ram, a Chartered Accountant in practice signed an agreement with M/s Reliable
Cement Ltd. for the conduct of internal audit @ 0.25 % of the company‟s turnover. Give your
opinion in light of ICAN code of ethics. (5 Marks December 2009)
Answer
As per the provisions of Sec 240 of professional accountant in public practice shall not quote lower fees
than the previously paid fees without justifiable reasons of reduction in the volume of transactions or time
involvement; not to quote contingent fees for any professional services and also not pay or receive any
referral fees for helping other professional in procuring professional services with their help. Contingent
fees are fees calculated on a predetermined basis relating to the outcome of a transaction or the
result of the services performed. A firm shall not charge directly or indirectly a contingent fee for
an audit engagement.

Contingent fees might create threats to compliance with the fundamental principles, particularly a self-
interest threat to compliance with the principle of objectivity, in certain circumstances.
The fee charged on percentage of certain results should be regarded as contingent fees. In the given case,
the charging the fees on the percentage of turnover of the client results to the fees contingent upon the
turnover and hence Mr. S. Ram is deemed to be guilty for misconduct as he has violated provisions of
ICAN code of ethics.
Question No. 14
Your firm is a member of an internationally recognized network of accountancy firms and
provides wide range of professional services. A large multinational company, East to South
wishes to have a business presence in Nepal. Having completed the necessary regulatory
formalities, the management of the company has approached your firm for appointment as
auditors. The management has also requested you to provide the following services in the
current year:
ii) Carry out market search to identify the parties engaged in distribution business. The fee
will be dependent on the eventual appointment of the distributor by the management;
iii) Recruit professionals in the position of Head of Finance and Internal Audit;
iv) Provide a general ledger package that has been developed by your firm.
Express your opinion as an auditor. (5 Marks December 2010)
Answer
a) As per the Code of Ethics issued by ICAN, the principle of objectivity imposes the
obligation on all professional accountants to be fair, intellectually honest and free of conflicts of
interest. Professional accountants in public practice when undertaking a reporting assignment,
should be and appear to be free of any interest which might be regarded, whatever its actual
effect, as being incompatible with integrity, objectivity and independence.
When a professional accountant in public practice, in addition to carrying out an audit or other
reporting function, provides other services to a client, care should be taken not to perform
management functions or make management decisions, responsibility for which remains with the
board of directors and management.
Keeping in view the above provisions, all the services so offered are management responsibilities
and hence it is to be decided whether your firm wants to take up audit assignment or other
services offered, but not the both.
Question No. 15
Describe the provisions on the ceiling of audit to be conducted by the members of ICAN?
Answer
As per the recent circular issued by the Institute of Chartered Accountants of Nepal, members of
ICAN can conduct the audit work in a year to a maximum number as follows:
i) Companies registered under the Companies Act 2063, 100 nos. (But in case of
public Cos. maximum 10 no‘s)

ii) The above ceiling does not apply to the smaller entities having turnover of less
than 20 lakh rupees
iii) In case of partnership firm, every partner is entitled to above limits.
Question No. 16
Mr. Kailash, a chartered accountant has been paid Rs. 65,000/- as commission by Mr. Dinesh,
another chartered accountant for the referral of the statutory audit of M/s Proper Cure
Company Limited. Express your expert opinion based upon the Code of Ethics issued by the
ICAN.
(5 Marks June 2011)
Answer
As per Sec 34 (3) of Nepal Chartered Accountant Act 1997, One shall not share or distribute as
profit the auditing fees or remuneration with any person other than a member of the Institute; and
shall not pay any commission, brokerage etc. out of the professional fees earned to any person or
member.
Also, as per Section 330 of Code of Ethics, A self-interest threat to compliance with the
principles of objectivity and professional competence and due care is created if a professional
accountant pays or receives a referral fee or receives a commission relating to a client.
A professional accountant in public practice should not, therefore, pay a commission to obtain a
client nor should a commission be accepted for referral of a client to a third party. A professional
accountant in public practice should not accept a commission for the referral of the products or
services of others.
Therefore, in the case mentioned also, since the statutory audit of M/s Proper Cure Company
Limited requires professional independence, Mr. Kailash and Mr. Dinesh, both have violated the
ethical requirements under the ICAN Codes of Ethics. Hence, the council can initiate disciplinary
action on both of them at the recommendation of the Disciplinary Committee subject to the
fulfillment of petition requirements.
Question No. 17
Answer the following questions:
Mr. Gambler, a practicing-chartered accountant, fixes audit fees with a client as follows: Rs.
50,000 plus 5% of the profit made by the company during the year. Can he do so? (5 Marks
June 2011)
Answer
As per Section 34 (10) of the Nepal Chartered Accountants Act 1997, members holding
certificate of practice shall not base their remuneration as a percentage on the profit or any other
uncertain results. Hence Mr. Gambler‘s act to fix fee with a client as a percentage of profit is in
contravention of the above section and is not correct.

Question No. 18
a) X is a partner in a firm of Chartered Accountants who were appointed as statutory
auditor NA Bank. During the audit, X drew an advance of Rs. 1,50,000/- from the
bank towards expenses including travelling and daily allowances. Of this, a sum of
Rs. 70,000/- was spent and the balance remained with X. This was later adjusted by
the bank against the audit fees payable to X. Upon completion of the audit, X
forwarded to the bank the statement of expenses and accounts along with copies of
bills. Can X hold client's money in the firm?
b) Y is a chartered accountant. A complaint was made by Rohit House Occupants Welfare
Association against him on several grounds. One of the grounds was that Y, who was an
auditor of the complainant for the financial years 2065/066 and 2066/067, had also
written the books of account of the complainant for those very financial years thus
compromising his independence as a professional accountant. The complaint listed out
other specific instances of the Y having either failed to or having been grossly negligent
in the discharge of his duties as a Chartered Accountant.
a. Answer
Section 350 of the Code of Ethics for Professional Accountant ' provides:
Holding client assets creates a self-interest or other threat to compliance with the principles of
professional behavior and objectivity.
A professional accountant entrusted with money or other assets belonging to others shall:
i. Comply with the laws and regulations relevant to holding and accounting for the
assets;
ii. Keep the assets separately from personal or firm assets;
iii. Use the assets only for the purpose for which they are intended; and
iv. Be ready at all times to account for the assets and any income, dividends, or gains
generated, to any individuals entitled to that accounting.
In the given case, Mr. X neither has any legal permission to hold money nor has he deposited the
client's money separately from his personal or firm‘s money. Further he did not deposit the
money in an interest-bearing account after lapse of a reasonable period of time. So, Mr. X is
guilty of misconduct for violation of code of ethics.
b. Answer
As per Code of Ethics, 2018 Section 210, A professional accountant shall comply with the
principle of objectivity, which requires an accountant not to compromise professional or business
judgment because of bias, conflict of interest or undue influence of others.
Also, providing accounting and bookkeeping services to audit clients create threat to self-review
and risk of assuming management responsibility.
A threat to objectivity or confidentiality may be created when a professional accountant in public
practice perform services for clients whose interests are in conflict.
In the given case, Y, the auditor of the firm, has performed the accounting services for M/S Rohit
House Occupant Welfare Association which is in conflict of interest with audit work and it
cannot be reduced to acceptable level.
So, Mr. Y is guilty of professional misconduct for violation of code of ethics.

Question No. 19
Answer the following questions
a) Mr. Gopal, a practicing Chartered Accountant, appeared on a talk show of one of the
leading TV channels. During the course of the programme the Anchor introduced, on the
basis of the biodata furnished by Mr. Gopal, as the senior most partner of M/s Gopal and
Associates, a worldwide leading firm of chartered accountants and also the services
provided by the firm. Comment.
(5 Marks June 2012)
Answer
As per Sec 115 of Code of Ethics 2018, When undertaking marketing or promotional
(a) Exaggerated claims for the services offered by, or the qualifications or experience of, the
accountant; or
If a professional accountant is in doubt about whether a form of advertising or marketing is
appropriate, the accountant is encouraged to consult with the relevant professional body.
But in the instant case, Mr. Gopal deliberately provides his bio data containing the name of
the firm and services provided by the firm and advertises his firm. Thus, he is guilty of undue
publicity.
Question No. 20
You are audit manager in PR & Co., an audit firm, express your comments/views on the
following cases, in the light of Nepal Accounting Standards, Nepal Standards on Auditing and
Code of Ethics. (5 Marks each December 2012)
a) You found that several audit clients have requested that PR & Co. provide technical
training on financial reporting and tax issues. This is not a service that the firm wishes to
provide, and the firm has referred the audit clients to a training firm B & Co., which is paying
a referral fee to PR & Co. for each audit client which is referred.
b) You are planning the audit of one of your clients, ABC Financial Ltd. The directors of
ABC Financial Ltd. are planning to list ABC Financial Ltd. on the Stock Exchange within
next few months and have asked if the engagement partner can attend the meetings with
ABC's potential investors.
c) You are planning the audit of one of your client XYZ Ltd. As the company is fast
growing and the owners are involved in diversified business, there are possibilities of getting
lot more assurance assignments. XYZ Ltd. had made it clear that PR & Co. must complete the
audit quickly and with minimum questions/issues if they wish to obtain those assurance
assignments.
d) You are carrying out the audit of a finance company PST Ltd. located in Kathmandu
for the financial year 2068-69. The finance director of PST Ltd. has offered your audit team a
free weekend at Fulbari Pokhara.

Answer:
a) As per Sec 240 0f Code of Ethics, professional accountant in public practice shall not
quote lower fees than the previously paid fees without justifiable reasons of reduction in the
volume of transactions or time involvement; not to quote contingent fees for any professional
services and also not pay or receive any referral fees for helping other professional in procuring
professional services with their help.
As per the IFAC code of ethics, in certain circumstances, a professional accountant in public
practice may receive a referral fee relating to a client. For example, where the professional
accountant in public practice does not provide the specific service required, a fee may be
received for referring a continuing client to another professional accountant in public practice or
other expert. Accepting such a referral fee creates a self-interest threat to objectivity and
professional competence and due care.
So, in the given case, a self – interest threat can arise, as the audit firm gains a financial benefit
for each audit client referred to B & Co. The significance of the threat shall be evaluated, and
safeguards applied when necessary to eliminate the threat or reduce it to an acceptable level. The
referrals and payments to PR & Co. can continue, provided that safeguards are put in place. The
safeguards could include:
 Disclosing to the audit clients that referral fee arrangement exists, and the details of the
arrangement.
 Receiving conformation from the audit clients that they are aware of the referral
arrangements.
 Receiving conformation from all employees of PR & Co. that they have no interest in B &
Co.
PR & Co. may also wish to consider the quality of the training provided by B &Co. Any
problems with the training provided could cause damage to the reputation of PR & Co.
b) As per the IFAC code of ethics adopted by ICAN, Advocacy threat is the threat that a
professional accountant will promote a client‘s or employer‘s position to the point that the
professional accountant‘s objectivity is compromised. The given scenario represents an advocacy
threat as the audit firm may be perceived as promoting investment in ABC and this threatens the
objectivity of the firm. No safeguards could reduce this threat, so the engagement partner should
politely decline this request from ABC as it represents too great threat to independence.
c) As per the Code of Ethics, an intimidation threat is the threat that a professional
accountant will be deterred from acting objectively because of actual or perceived pressures,
including attempts to exercise undue influence over the professional accountant.
The given case represents an intimidation threat on the team as they may feel pressure to cut
corners and not raise issues, and this could compromise the objectivity of the audit team.
The engagement partner should politely inform the finance director that the team will undertake
the audit in accordance with the all relevant accounting and auditing standards and their own
quality control procedures. This means that the audit will take as long as is necessary to obtain
sufficient appropriate evidence to form an opinion. If any residual concerns remain or the
intimidation threat continues then PR & Co. may need to consider resigning from the
engagement.

d) As per the Code of ethics of ICAN, accepting gifts or hospitality from an audit client may
create self-interest and familiarity threats. If a firm or a member of the audit team accepts gifts or
hospitality, unless the value is trivial and inconsequential, the threats created would be so
significant that no safeguards could reduce the threats to an acceptable level. Consequently, a
firm or a member of the audit team shall not accept such gifts or hospitality.
The given case represents a self-interest threat as the acceptance of goods and services, unless
insignificant in value is not permitted. As it is unlikely that a weekend at a luxury hotel for the
whole team has an insignificant value, then this offer should be politely declined.
Question No. 21
You are audit manager of PZC & Co., a large audit firm which specializes in the audit of
retailers. The firm currently audits Alpha Co., a food retailer, but its main competitor Beta Co.
has approached the audit firm to act as auditors. Both the companies are highly competitive
and Alpha Co. is concerned that if PZC & Co. audits both the companies then confidential
information could pass across the Beta Co. You are required to explain the safeguards that
your firm should implement to ensure that this conflict of interest is properly managed.
Answer
As per Section 210 of the Code of Ethics, A threat to objectivity or confidentiality may be
created when a professional accountant in public practice performs services for clients whose
interests are in conflict. A professional Accountant in public practice shall evaluate the
significance of any threats and apply safeguards when necessary to eliminate the threats or
reduce them to an acceptable level.
Both companies should be notified that PZC & Co. would be acting as auditors for each company
and, if necessary, consent obtained. Further safeguards could be:
 Advising one or both clients to seek additional independent advice.
 The use of separate engagement teams with different engagement partners and team
members.
 Procedures to prevent access to information, for example, strict physical separation of both
teams, confidential and secure data filing.
 Clear guidelines for members of each engagement team on issues of security and
confidentiality. These guidelines could be included within the audit engagement letters.
 Potentially the use of confidentiality agreements signed by employees and partners of the
firm.
 Regular monitoring of the application of the above safeguards by a senior individual in
PZC & Co. not involved in either audit.
In case the consent has been refused by the client, then the firm shall not continue to act for one
of the parties (either Alpha or Beta).
Question No. 22
Comment and give your views as an auditor with reasons in the light of Nepal Accounting
Standards, Nepal Standards on Auditing and Code of Ethics on each of the following case:

a) You are a partner of a Chartered Accountancy Firm- ABC & Co. A small client,
Everest Pvt. Ltd. (ELL), appoints your firm to audit the financial statements of ELL for
the year ended 31stAshadh 2069.
ELL provides original documents and an incomplete trial balance to your firm for the
audit purpose. ELL is not a public interest entity. ABC & Co. prepares the general
ledger, journal entries and financial statements then carry out audit of these
statements. Consider independence issues: identify any threats to the independence and
outline safeguards to reduce the significance of the threats. (5 Marks June 2013)
b) As an auditor, you have received Rs. 500,000 from a customer of your client, XL
Holding. There is no fees in-arrear from this client. How would you deal with this
money – outline the procedures to handle client's monies in line with the Code of
Ethics. (3 Marks June 2013)
Answer:
a) Threat: Self Review
Audit firms have traditionally provided to their audit clients a range of non-assurance
services that are consistent with their skills and expertise. However, providing an audit
client with accounting and bookkeeping services, such as preparing accounting records,
preparing general ledger, making journal entries or financial statements, creates a self-
review threat when the firm subsequently audits the financial statements.
ABC & Co. may provide non-assurance services such as preparation of accounting records
and financial statements to an audit client that is not a public interest entity where the
services are of a routine or mechanical nature, so long as any self-review threat created is
reduced to an acceptable level. Such routine and mechanical nature services include:
 Providing payroll services based on client-originated data;
 Recording transactions for which the client has determined or approved the
appropriate account classification;
 Posting transactions coded by the client to the general ledger;
 Posting client-approved entries to the trial balance; and
 Preparing financial statements based on information in the trial balance.
In this case, ABC & Co., shall evaluate the significance of any threat created and to apply
necessary safeguards to eliminate the threat or reduce it to an acceptable level. Such
safeguard includes:
 Audit should make management understand that, its responsibility for the preparation
and fair presentation of the financial statements in accordance with the applicable
financial reporting framework.
 Arranging for such services to be performed by an individual who is not a member of
the audit team; or
 If such services are performed by a member of the audit team, using a partner or
senior staff member with appropriate expertise who is not a member of the audit team
to review the work performed.

b) As per sec 350 of Code of Ethics, holding client assets creates a self-interest or other threat
to compliance with the principles of professional behavior and objectivity.
A professional accountant entrusted with money or other assets belonging to others shall:
(a) Comply with the laws and regulations relevant to holding and accounting for the assets;
(b) Keep the assets separately from personal or firm assets;
(c) Use the assets only for the purpose for which they are intended; and
(d) Be ready at all times to account for the assets and any income, dividends, or gains
generated, to any individuals entitled to that accounting.
As an auditor, you should maintain separate bank accounts for clients‘ monies. Such bank
accounts may include a general client account into which the monies of a number of clients
may be paid.
This money should be deposited without delay to the credit of a client account and may
only be drawn from the account on the instructions of the client. Payments from a client
account shall not exceed the balance standing to the credit of the client.
When it seems likely that the client‘s monies remain on client account for a significant
period of time, the auditor should, with the concurrence of XL Holding, place such monies
in an interest bearing account within a reasonable time and all interest earned on clients‘
monies should be credited to the client account.
Question No. 23
Comment and give your views with reasons on each of the following cases, giving
consideration to Nepal Accounting Standards, Nepal Standards on Auditing and Code of
Ethics.
(5 Marks June 2014)
a) Mr. Sameep Kaji is a practicing Fellow Chartered Accountant. Examine whether his
following activities are in contravention of the Nepal Chartered Accountants Act 1997?
(i) He shares his profit with Mr. Swornim Kaji, his younger brother, who is CA final
year student and working in his firm. He is hopeful that Mr. SwornimKaji will
qualify very soon, and he will be 50% partner in his proprietorship firm.
(ii) He discloses the information of one of his clients gathered in the course of
professional service upon the request of Inland Revenue Department.
(iii) He fixed the audit fee as the percentage of turnover of one of his clients.
(iv) He certifies the financial statements of his client based on the fact that his employee
has checked and verified it thoroughly though he did not get enough time to review
it.
(v) He took up an audit assignment of a company in which his senior employee worked
as an employee till last year.
b) During the course of Inland Revenue Department (Government of Nepal) investigation
of M/S Ding Dong Pvt. Ltd., it was found that few expenses bills included in the books
of accounts are from those companies which are not in existence. After such results,
the management of the Co. reported to the investigation authorities that they have
gathered and included those bills on the advice of their auditor, CA. Mr. Clever; and
the same were supplied by him as well. However, they could not produce the evidence.

Answer
a. The activities of Mr. SameepKaji, FCA, should be observed and commented on the basis of
Section 34 of the Nepal Chartered Accountants Act 1997.
i) Yes, it is in contravention of Nepal Chartered Accountants Act, 1997. He cannot share

profit with SwornimKaji as per Section 34(3) of the Act.
ii) Yes, it is in contravention of Nepal Chartered Accountants Act, 1997. He cannot
disclose the information to IRD voluntarily if not compelled by the law to do so. [
Sec. 34(5)]
iii) Yes, it is in contravention of Nepal Chartered Accountants Act, 1997. He cannot do
so as per Sub Section 34(10) of the Act.
iv) No, it is not in contravention of Nepal Chartered Accountants Act, 1997. He can
certify the statements as per Section 34(6) of the Act.
v) No, it is not in contravention of Nepal Chartered Accountants Act, 1997. He can take
up the audit assignment but must ensure the independence of the audit team.
b) Mere verbal allegation by the management of M/S Ding Dong Pvt. Ltd. that the bills were
supplied by the auditor and included as per the advice of their auditor, Mr. Clever is not
sufficient basis to establish the gross negligence of the auditor and is not in any way the
non-compliance of Section 34 of the Nepal Chartered Accountants Act, other prevailing
acts or provisions of NSAs. Also, the auditor‘s report clearly states that the responsibility
of preparing the financial statements remains with the management of the company.
In the given case, the claim of the management that the bills were supplied by the auditor
and included as per the advice of their auditor is baseless. Hence, the auditor, Mr. Clever,
shall not be held guilty under any prevailing acts or practices unless sufficient evidence is
produced by the management or investigating authority against him.
Question No. 24
Smart Bahadur Nepal is a partner of SBN & Associates, Chartered Accountants. SBN &
Associates is an auditor of A Pvt. Limited. A Pvt. Limited has borrowed money from a bank
where Pretty Nepal, wife of Smart Bahadur has also signed on the letter of guarantee provided
for the purpose of the loan.
Identify the threat if any under Code of Ethics and advise Smart Bahadur if there is any
safeguard available (5 Marks December 2014)
Answer:
Sec. 100 of Handbook of the Code of Ethics for Professional Accountants issued by the Institute
of Chartered Accountants of Nepal explains about various types of threats and safeguards, if any,
available to the professional accountants. The conceptual framework approach shall be applied
by professional accountants to identify threats to fundamental principles; evaluate the
significance of the threats identified; and apply safeguards, when necessary, to eliminate the
threats or reduce them to an acceptable level. Therefore, if the firm or a member of the audit
team, or a member of that individual‘s immediate family, makes or guarantees a loan to an audit
client, the self-interest threat created would be so significant that no safeguards could reduce
the threat to an acceptable level, unless the loan or guarantee is immaterial to both (a) the firm or
the member of the audit team and the immediate family member, and (b) the client. Hence,

unless the loan or guarantee amount is immaterial, there is no safeguard available to Smart
Bahadur Nepal.
Question No. 25
Mr. Prastrut, a Chartered Accountant was invited by the Bankers Association of Nepal, to
present a paper in a symposium on the issues facing Nepalese Banking Industry. During the
course of his presentation he shared some of the vital information of his client‟s business
under the impression that it will help the Industry to cope with present problems faced by the
industry.
Answer
As per Section 140 of Part A of the Code of Ethics, the principle of confidentiality imposes an
obligation on all professional accountants to maintain confidentiality of information acquired as a
result of professional or business relationship unless there is legal or professional right or duty to
disclose.
As per this section, the exceptions where confidential information can be disclosed are:
 Disclosure is permitted by law and is authorized by the client or the employer,
 There is a professional duty or right to disclose, when not prohibited by law,
 To comply with the quality review of a member body or professional body,
 To respond to an enquiry or investigation by a member body or regulatory body,
 To protect the professional interests of a professional accountant in legal proceedings, or
 To comply with technical standards and ethics requirements.
The Code of Ethics further clarifies that such a duty continues even after completion of the
assignment.
In the given case, Mr. Prastrut has disclosed vital information of his client‘s business without the
consent of the client under the impression that it will help the industry. Thus, it is a professional
misconduct.
Question No. 26
Comment and give your views with reasons on each of the following cases:
a) Mr. Pramesh who passed his CA examination of ICAN on 18thBhadra, 2072 started his
practice from Ashwin 15, 2072. On 16th Ashwin 2072, one female candidate approached
him for articleship. In addition to monthly stipend, Mr. Pramesh also offered her 1 %
profits of his CA firm. She agreed to take both 1 % profits of the CA firm and stipend as
per the rate prescribed by the ICAN. The Institute of Chartered Accountants of Nepal sent
a letter to Mr. Pramesh objecting the payment of 1 % profits. Mr. Pramesh replied to the
ICAN stating that he is paying 1 % profits of his firm over and above the stipend to help
the articled clerk as the financial position of the articled clerk is very weak.
b) A Chartered Accountant in practice has been suspended from practice for a period of 6
months and he had surrendered his Certificate of Practice for the said period. During the
said period of suspension, though the member did not undertake any audit assignments, he
undertook representation assignments for income tax whereby he would appear before the
tax authorities in his capacity as a Chartered Accountant.

Answer a)
As per the provision of section 34 of the Nepal Chartered Accountants Act 1997, No member
shall share or distribute as profit the auditing fees or remuneration with any person other than
a member of the institute and shall not pay any commission, brokerage etc. out of the
professional fees earned to any person or member.
In view of the above provision, the objections of the Institute of Chartered Accountants of
Nepal, as given in the case, are correct and reply of Mr. Pramesh, stating that he is paying 1 %
profits of his firm over and above the stipend to help the articled clerk as the position of the
articled clerk is weak is not tenable.
Hence, Mr. Pramesh is guilty of professional misconduct.
Answer b)
In the instant case, a chartered accountant not holding certificate of practice cannot take up
any professional work because it would amount to violation of the relevant provisions of the
Nepal Chartered Accountants Act, 1997. In case a member is suspended and is not holding
Certificate of Practice, he cannot in any other capacity take up any practice separable from his
capacity to practices as a member of the Institute. This is because once a member becomes a
member of the Institute; he is bound by the provisions of the Chartered Accountants Act, 1997
and its Regulations. If he appears before the income tax authorities, he is only doing so in his
capacity as a chartered accountant and a member of the Institute. Having bound himself by the
said Act and its Regulations made there under, he cannot then set the Regulations at naught by
contending that even though he continues to be a member and has been punished by
suspension, he would be entitled to practice in some other capacity. Thus, in the instant case, a
chartered accountant would not be allowed to represent before the income tax authorities for
the period he remains suspended
Question No. 27
What are the areas excluded from the scopes of peer reviewer? (4 Marks December 2015)
Answer
The area excluded from the scope of peer reviewer are:
i. Management consultancy engagements;
ii. Representation before various authorities.
iii. Engagements to prepare tax returns or advising clients in taxation matters.
iv. Engagements for the compilation of financial statements.
v. Engagement solely to assist the client in preparing, compiling or collating information
other than financial statements.
vi. Testifying as an expert witness.
vii. Providing expert opinion on points of principle, such as Accounting Standards or the
applicability of certain laws, on the basis of facts provided by the client
viii. Engagement for due diligence.

Question No. 28
Surya Co. Limited has applied to a bank for loan facilities. The bank on studying the financial
statements of the company notices that you are the auditor and requested you to call at the
bank for a discussion. In the course of discussion, the bank asked for the opinion regarding
the company and also asked for detail information regarding a few items in the financial
statements. The information is available in your working file.
(4 Marks June 2016)
Answer
Section 34(6) of Nepal Chartered Accountants Act, 1997 states ―one shall not disclose or divulge
any information and explanations acquired in the course of professional service to any person
other than the employer employing him and the person whom he is compiled by law to do so‖. A
chartered accountant in practice shall deemed to be guilty of professional misconduct if he
disclosed information acquired in the course of his professional engagement to any person other
than his client, without the consent of the client or otherwise than required by law for the time
being in force. NSA 200 on ―Overall objective of the independent auditor and the conduct of an
Audit in accordance with Nepal Standards on Auditing‖ also reiterates that, ―the auditor should
respect the confidentiality of information acquired in the course of his work and should not
disclose any such information to a third party without specific authority or unless there is a legal
or professional duty to disclose‖. In the instant case, the bank has asked the auditor for detailed
information regarding a few items in the financial statements available in his working papers.
Having regard to the position stated earlier, the auditor cannot disclose the information in his
possession without specific permission of the client as far as working paper are concerned, NSA
230 on ―Audit Documentation‖ states ―working papers are the property of the auditor. The
auditor may at his discretion, make portions of or extract from his working papers available to his
clients‖.
Thus, there is no requirement compelling the auditor to divulge information obtained in the
course of audit and included in the working papers to any outside agency except as when
required by any law.
Question No. 29
What are the situations which give rise to conflicts of interest to the professional accountants?
(4 Marks June 2016)
Answer
Professional Accountants encounter situations which give rise to conflicts of interest in various
situations. Such conflicts may arise in a wide variety of ways confronting to extreme case of
fraud and similar illegal activities. As per Sec. 220 of the Code of Ethics, the following are the
situations where conflicts arise:
 Providing a transaction advisory service to a client seeking to acquire an audit client of
the firm, where the firm has obtained confidential information during the course of the
audit that may be relevant to the transaction.
 Advising two clients at the same time who are competing to acquire the same company
where the advice might be relevant to the parties‘ competitive positions.
 Providing services to both a vendor and a purchaser in relation to the same transaction.

 Preparing valuations of assets for two parties who are in an adversarial position with
respect to the assets.
 Representing two clients regarding the same matter who are in a legal dispute with each
other, such as during divorce proceedings or the dissolution of a partnership.
 Providing an assurance report for a licensor on royalties due under a license agreement
when at the same time advising the licensee of the correctness of the amounts payable.
 Advising a client to invest in a business in which, for example, the spouse of the
professional accountant in public practice has a financial interest.
 Providing strategic advice to a client on its competitive position while having a joint
venture or similar interest with a major competitor of the client.
 Advising a client on the acquisition of a business which the firm is also interested in
acquiring.
 Advising a client on the purchase of a product or service while having a royalty or
commission agreement with one of the potential vendors of that product or service
Question No. 30
consideration to respective Standards, Laws and Code of Ethics:
a) ABC Limited is a public company with 3 major divisions. The board of directors of the
company has decided on 20thAshadh 2073 to close one of these divisions. Management has
decided to make provision in the financial statements for 2072/73 in all the following
situations. (10 Marks December 2016)
i) Before Ashad end 2073, the decision of the board was not communicated to any of the
stakeholders likely to be affected by the decision and no further steps have been taken.
ii) The Board agreed a detailed closure plan on 30thAshadh 2073, and details were given
to customers and employees.
iii) The company is obliged for cleanup costs of Rs. 10 million for environmental damage
that has already caused
iv) The company intends to carry out future expenditures (budget Rs. 5 million) to operate
in a particular way in future.
Answer
I. Requirement of provision: As per NAS 37 (Provisions, Contingent liabilities and
Contingent Assets) A provision is a liability of uncertain timing and amount and it
should be recognized 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 shall be recognized.
So, in the given four situations, as the auditor of the company my view regarding making
provisions will be as follows.

i) The decision of the board to close down a division was not communicated to any
stakeholders and hence there is no present obligation. So, provision is not required.
ii) The decision of the board is communicated to employees and customers and hence
there is present obligation. Further other two conditions namely reliable estimate of
the obligation and possibility of outflow of resources are also met as detail closure
plan is available. Hence provision is required in this case.
iii) The company is obliged for cleanup costs of Rs. 10 million for environmental
damage that has already caused. Here the entity has a present obligation as a result of
a past event. The other two conditions are also met as there is reliable estimate of the
obligation and possibility of outflow of resources.
Hence provision is required.
iv) The company intends to carry out future expenditures to operate in a particular way
in future. Here there is no present obligation. It relates to possible future obligations.
Hence no provision required.
Question No. 31
a) What are the five categories of threats that compromise or perceived to compromise a
professional accountant‟s compliance with the fundamental principles as per Code of
Ethics issued by ICAN.
Bhal& Associates (an audit firm based at Kathmandu) is the consultant for Gama Limited
for several years and provide a range of services to the client. Bhal receives a request from
the client for service relating to the branch office located at Birgunj of Gama Limited at a
price of Rs. 10 lakhs. Due to lack of professional resources, Bhal & Associates refers this
service to another audit firm based at Birgunj at a referral fee of Rs. 1 lakh and balance
Rs. 9 lakhs to be retained by Birgunj based firm. Comment whether payment/receipt of
referral fee by professional accountant in practice is ethical as per ICAN Code of Ethics.
(3+5 Marks December 2016)
b) The manager of ABC limited approached CA. Ram in the need of a certificate in respect of
a consumption statement of raw material. Without having certificate of practice, CA. Ram
issued the certificate to the manager of the company, in the capacity of a Chartered
Accountant in practice and applied for the COP in the Institute on the very next day to
avoid any dispute. (7 Marks December 2016)
Answer:
a) Threats to Fundamental Principles: Threats may be created by a broad range of
relationships and circumstances. When a relationship or circumstance creates a threat,
such a threat could compromise, or could be perceived to compromise, a professional
accountant‘s compliance with the fundamental principles. A circumstance or relationship
may create more than one threat, and a threat may affect compliance with more than one
fundamental principle. Threats fall into one or more of the following five categories:
(i) Self-interest threat
(ii) Self-review threat

(iii) Advocacy threat

(iv) Familiarity threat and
(v) Intimidation threat
In the given case, Gama Limited seems to be quite satisfied with quality of service it
receives from Bhal& Associates and hence continues to receive the service from the
consultant for several years. However, for the recently requested service, the consulting
firm does not have adequate and appropriate resource and it refers the business to another
professional accountant in practice. Such situation creates self-interest threat to the
fundamental principle objectivity and due professional care.
As per Sec. 240 of Code of Ethics, professional accountant in public practice shall not
pay or receive any referral fees for helping other professional in procuring professional
services with their help.
Hence both Kathmandu based and Birgunj based audit firms may be subject to
professional misconduct in such situation.
b) As per the Nepal Chartered Accountants Act,1997, a member of the Institute, whether in
practice or not, shall be deemed to be guilty of professional misconduct, if he contravenes
any of the provisions of this Act or the regulations made there under or any guidelines
issued by the Council.
This clause requires every member of the Institute to act within the framework of the
Chartered Accountants Act, and the Regulations made there under. Any violation either
of the Act or the Regulations by a member would amount to misconduct.
Further, Sec. 29 of the Nepal Chartered Accountants Act, states that no member shall
carry out Accounting Profession without obtaining a Certificate of Practice.
In the given case, CA Ram has issued a certificate in respect of a consumption statement
of raw material to the manager of ABC Ltd., as a Chartered Accountant in practice when
he had not even applied for the COP to the Institute, thereby contravening the provisions
of the Nepal Chartered Accountants Act, 1997.
Hence CA. Ram will be held guilty of professional misconduct.
Question No. 32
a) Fortune Cosmetic (P) Ltd. is a retailer of fast-moving cosmetic goods. There are seven
sales executives who work for this company. The sales executives‟ remuneration is
based on the achievement of set sales targets. You are the accountant of the company.
The financial results of the company up to the end of the third quarter were not
satisfactory and this will have an impact on your annual bonus as well.
One sales executive approached you and suggested to record those orders of customers
which are confirmed (but not yet sold) by invoicing them in advance. As orders have

already been confirmed, and it is unlikely that they will be returned, you foresee this as a
good opportunity.
Required: (7 Marks June 2017)
i) List four threats to the professional ethical behavior of an accountant.
ii) Explain two fundamental principles of professional ethics that will be violated if
you are to accept the suggestion made by the sales executive.
iii) Identify the threat to your professional ethical behavior as the accountant of the
company and the safeguard available for the threat identified.
Answer
a)
i. The four threats to the professional ethical behavior of an accountant are:
a. Self-interest threat
b. Self-review threat
c. Advocacy threat
d. Familiarity threat
e. Intimidation threat
ii. The two fundamental principles of professional ethics that will be violated if the suggestion
made by the sales executive are;
Integrity- Dealing should be straightforward and honest. If I am to agree with the suggestion
of sales executive, I am violating ‗integrity‘.
Objectivity- members shall not allow bias or conflict of interest or undue influence of other
people to override their professional or business judgment.
Professional behavior- members shall comply with relevant laws and regulations (accounting
standards) and avoid any action that discredits the profession.
iii. The threat to the professional ethical behavior as the accountant of the company is Self-
interest threat- I am getting financial reward (bonus) if I agree with the sales executive.
Safeguard- commitment as the accountant to ethical behavior is the only safeguard available
and should refuse to accept the suggestion.
Question No. 33
Comment and give your views with reasons of the following case, giving consideration to
respective Standards, Laws and Code of Ethics:
Ram is a Chartered Accountant and a member of ICAN. He is employed as a Finance
Manager of a public listed company and is responsible for the financial reporting of the
company. He is also well remunerated by the company and is paid an annual bonus
determined based on the profit before tax earned during the year.
During the current year, it came to Ram‟s attention that a machine with a net book value of
Rs. 2 Crore is idling and cannot be used for the activities of the company. Also, this asset
cannot be sold to a third party. Therefore, the company is required to make adjustments in the
value of the asset for impairment. However, in addition to an increase in expenses during the

year, this adjustment will also adversely affect the profits of the company. As a result, the
annual bonus payment of Ram will be affected.
Required:
i) Explain three reasons why ethical behavior is important to Ram as a Finance
manager who is involved in financial reporting of the company.
(3 Marks June 2018)
ii) Explain the types of threat that will affect the professional ethical behavior of Ram
in this situation. (3 Marks June 2018)
iii) State the safeguard available to Ram against the threat identified above.
(2 Marks June 2018)
iv) State two fundamental ethical principles as per the Code of ethics for
professional Accountants that Ram will violate if he decides not to recognize
impairment in the value of asset during the year. (2 Marks June 2018)
Answer:
i. Ethical behavior is important to all the members of the ICAN. Ram is in the profession
of accountancy and member of ICAN and he is supposed to adhere to the professional
code of ethics. Since he is in financial reporting function, there are users of those
reporting who will rely on those and make decisions. Especially Ram is working for a
public listed company and as a result there is wider coverage of users of financial
statement. Therefore, it is Ram‘s responsibility to prepare those financial statements
accurately. The financial statements to be prepared honestly as the tax payments also
depend on these. Therefore, Ram‘s ethical behavior serves to protect public interest.
ii. Ram‘s annual bonus is determined based on the profits earned by the company. He
knows if the impairment charge is recognized there is a deterioration of profits which
will affect the bonus payment. He needs to make the correct decision, but he may be
tempted due to his financial interests. It is called ―self-interest‖. Due to his financial
benefit he can decide not to go ahead with impairment charge recognition.
iii. Protection available for Ram:
Ram has to be committed to the ethical behavior in this regard. He has to forget about his
financial interest and discharge his duties.
iv. If Ram decides not to recognize the value of asset write down during the year, he will
violate the following fundamental ethical principles as per the code of ethics for
professional Accountants.
i. Integrity
ii. Objectivity
iii. Professional behavior
Question No. 34
a) ABC Limited has applied to a bank for loan facilities. The bank on studying the
financial statements of the company notices that you are the auditor and requested
you to call at the bank for a discussion. In the course of discussion, the bank asked
for the opinion regarding the company and also asked for detail information
regarding a few items in the financial statements. The information is available in
your working file. Should you share the requested information with the bank?
(7 Marks June 2018)

b) What does the professional behavior impose by „the Code of Ethics‟ for Professional
Accountants issued by The Institute of Chartered Accountants of Nepal (ICAN) while
providing “Second Opinion”? (8 Marks June 2018)
Answer:
a) Sharing the information of an audit client with the banker of the client:
Related provisions and requirements on maintaining confidentiality of client‘s
information and the need to share information from working file is presented below:
 Section 34(5) of Nepal Chartered Accountants Act, 1997 states ―a member of ICAN
shall not disclose or divulge any information and explanations acquired in the course of
professional service to any person other than the employer employing him and the
person whom he is compelled by law to do so. A member in practice shall deemed to be
guilty of professional misconduct if he disclosed information acquired in the course of
his professional engagement to any person other than his client, without the consent of
the client or otherwise than required by law for the time being in force.
 Further one of the fundamental principle of ICAN Code of Ethics is ―to respect the
confidentiality of information acquired as a result of professional and business
relationships and, therefore, not disclose any such information to third parties without
proper and specific authority, unless there is a legal or professional right or duty to
disclose, nor use the information for the personal advantage of the professional
accountant or third parties‖.
 NSA 230 on ― Audit Documentation states ―working papers are the property of the
auditor. The auditor may at his discretion, make portions of or extract from his working
papers available to his clients.
In the instant case, the bank has asked the auditor for detailed information regarding a few
items in the financial statements available in his working papers. Having regard to the
position stated earlier, the auditor cannot disclose the information in his possession
without specific permission of the client as far as working paper are concerned. Further,
there is no requirement compelling the auditor to divulge information obtained in the
course of audit and included in the working papers to any outside agency except as when
required by any law.
So, I would not share the confidential information of the client with the bank (unless
permission is granted by the client) and explain my professional duty to the banker to
comply with CA Act and code of conduct issued by ICAN.
b) As per Sec 230 of ―The Code of Ethics for Professional Accountants" Situations where a
professional accountant in public practice is asked to provide a second opinion on the
application of accounting, auditing, reporting or other standards or principles to specific
circumstances or transactions by or on behalf of a company or an entity that is not an
existing client may create threats to compliance with the fundamental principles. For
example, there may be a threat to professional competence and due care in circumstances
where the second opinion is not based on the same set off acts that were made available to
the existing accountant or is based on inadequate evidence. The existence and significance
of any threat will depend on the circumstances of the request and all the other available
facts and assumptions relevant to the expression of a professional judgment.

When asked to provide such an opinion, a professional accountant in public practice shall
evaluate the significance of any threats and apply safeguards when necessary to eliminate
them or reduce them to an acceptable level. Examples of such safeguards include seeking
client permission to contact the existing accountant, describing the limitations surrounding
any opinion in communications with the client and providing the existing accountant with a
copy of the opinion.
If the company or entity seeking the opinion will not permit communication with the
existing accountant, a professional accountant in public practice shall determine whether,
taking all the circumstances into account, it is appropriate to provide the opinion sought.
Question No. 35
Mr. Kothari is dissatisfied with a Chartered Accountant and is willing to file complain against
the ICAN Member. He is asking you whether there is any provision to do the same. What
would be your advice to him? How is the case taken by ICAN and if found guilty, what
punishments might the member be imposed? (7 Marks December 2018)
Answer:
Complaint against member of ICAN and possible punishments upon proved guilty of
professional misconduct: Section 34 of ICAN Act 1997 mentions that Members of ICAN should
observe the code of Conduct. The concerned person may lodge complaint to the Institute of
Chartered Accountants of Nepal against any member or member holding Certificate of Practice
for not upholding the conduct mentioned in this Act or the Regulations framed under this Act or
for violation of this Act or Regulations framed under this Act. The person can give application
showing all the available evidence and paying a fee of Rs. 100. However, no fee is required if the
complainant is from any Government agencies or other entity where council has waived such fee.
The Executive Director shall, if he finds convincing information that proves any member or
member holding Certificate of Practice is not observing the conduct, submit the proposal along
with the related facts to the Council for further action against such member or member holding
Certificate of Practice. The council if finds the complaints convincing, the complaint is placed in
the disciplinary committee for further discoveries and recommendation.
Pursuant to section 14 of ICAN Act, a Disciplinary Committee, comprising of following
members, shall be constituted to recommend the Council to take necessary actions after
investigation upon complaints lodged against any action, contrary to the Chartered Accountants
Act or Regulations or code of conduct framed under this Act, rendered by any member, or the
Institute receives any information of such kind.
 A FCA member designated by council from amongst elected CA council members -
Chairman
 Three persons nominated by the Council from amongst the Council members - Member
 Two persons nominated by the Council amongst the members - Member
 One person nominated by the Auditor General - Member
The Disciplinary committee shall have the authority, similar to a judicial court, in respect of
summoning concerned person and investigating evidences and witnesses. The Disciplinary
committee shall recommend to the Council, along with its opinion and finding, for necessary

action against a member, if found guilty, and the council may, considering such are
commendation, impose any of the following punishment according to the degree of offence:
a. Reprimanding,
b. Removing from the membership for a period up to five years,
c. Prohibiting from carrying on the accounting profession for any particular period,
d. Cancellation of the Certificate of Practice (COP) or membership.
However, before imposing any punishment, the Council shall provide reasonable opportunity to
the concerned members to submit their clarification. The concerned member may, if he is not
satisfied with the decision file an appeal in the Appellate Court.
Question No. 36
(4×1.25 each =5 June 2019)
a)
i) The CFO of Alpha Limited has created provision for the first two instances out of 4
instances mentioned below after lot of deliberations with his team.
 On 1st July 2018, the board of Alpha decided to close the Delta division.
Before 16th July 2018, the decision was not communicated to any of those
affected and no other step was taken to implement the decision.
 The board agreed on detailed closure plan of Gama division on 10th July
2018 and details were given to customers and employees on 12th July 2018.
 The company is obliged to incur a cleanup cost of 50 lakh for environmental
damage (that has already been caused).
 The company intends to carry future expenditures for a new division to
operate in a particular way in future.
ii) A company produces three products (Product A, Product B and Product C) from
three different divisions. The normal production level of A, B and C are 200,000
units each. In the year under consideration, the company has produced 240,000
units of A, 200,000 units of B and 160,000 units of C respectively, the fixed
production overhead incurred for the divisions involved in production of A, B and C
are 2 crores in each division. The company has inventory of 5,000 units of each
product. The company follows FIFO method of valuation and finance manager is
unsure about the fixed production overhead to be allocated to each product for
inventory valuation. (5 Marks, June 2019)
b)
i) A case was pending in Supreme Court against XYZ limited as on 15th July 2017 for
which provision of NPR 50 lakh were made. Based on judgment issued on 1 st July
2018, the company had to pay 1 crore to the customer who sued the company. The
auditor of the company asserts that there was material misstatement in accounting
estimate of the company for the financial year 2073/74. (5 Marks, June 2019)
ii) Luthara and Associates, a Chartered Accountant firm with three partners, is the
auditor of a real estate company for last two years. The management requested the

firm to assist in first time implementation of NFRS and agreed to pay NPR 5 lakh
in addition to the audit fee for this assistance. (5 Marks, June 2019)
Answer:
a)
i)
 Decision to close a division not yet communicated to those affected: Creating
Provision by CFO in this case is not in line with NAS 37 because the decision to
close Delta division has not raised a valid expectation in those affected that it will
carry out the restructuring by starting to implement that plan or announcing its
main features to those affected by it.
 Detail closure plan of a division communicated to those affected: Creating
Provision in this case is in line with NAS 37 because the decision to close Gama
division has raised a valid expectation in those affected that it will carry out the
restructuring by starting to implement that plan or announcing its main features to
those affected by it.
 Obligation to incur cleanup costs: Not creating provision in this case is a non-
compliance with NFRS because the three basic conditions for recognition of
provision (present obligation as a result of past event, possibility of outflow of
resources to settle the obligation and reliable estimate of the obligation can be
made) are met. So, the provision should be recognized in this case.
 Future expenditure for operating in particular way: CFO has complied with NFRS
by not creating provision in this case because there is no present obligation
resulting from past event. The company can avoid the future expenditure by its
future actions, for example by changing its method of operation
ii) Answer
Allocation of fixed production overhead for inventory valuation: NAS 2 requires that
the allocation of fixed production overheads to the costs of conversion is based on the
normal capacity of the production facilities. Further, the amount of fixed overhead
allocated to each unit of production is not increased as a consequence of low
production or idle plant and in periods of abnormally high production, the amount of
fixed overhead allocated to each unit of production is decreased so that inventories are
not measured above cost. The cost of fixed production overhead to be allocated to
inventory of three products is calculated in the table below:
Particulars Product A Product B Product C
Fixed production overhead in NPR for the period (a) 20,000,000 20,000,000 20,000,000
Normal production capacity in units (b) 200,000 200,000 200,000
Actual production units © 240,000 200,000 160,000
Denominator to be considered for fixed cost allocation

as per NAS (d) 240,000 200,000 200,000
Production overhead to be allocated per unit (e=a/d) 83 100 100
Units of inventory (f) 5,000 5,000 5,000
Total fixed production overhead in NPR to be

allocated to inventory (e*f) 416,667 500,000 500,000

b)
i) Audit of accounting estimate: Generally, there is high uncertainty relating to accounting
estimate for outcome of litigation. As per NSA 540, a difference between the outcome
of an accounting estimate and the amount originally recognized or disclosed in the
financial statements does not necessarily represent a misstatement of the financial
statements. However, it may do so if, for example, the difference arises from
information that was available to management when the prior period‘s financial
statements were finalized, or that could reasonably be expected to have been obtained
and taken into account in the preparation of those financial statements. Many financial
reporting frameworks contain guidance on distinguishing between changes in
accounting estimates that constitute misstatements and changes that do not, and the
accounting treatment required to be followed.
In the given situation, if management of XYZ had estimated the amount in the financial
statements of 2073/74 based on the available information before audit reports of that
year was issued, the financial statements of 2073/74 cannot be considered as materially
misstated.
ii) Providing NFRS related service to an audit client: Management is responsible for the
preparation and fair presentation of the financial statements in accordance with the
applicable financial reporting framework. These responsibilities include:
 Determining accounting policies and the accounting treatment within those
policies.
 Originating or changing journal entries, or determining the account classifications
of transactions;
 Preparing or changing source documents or originating data, in electronic or other
form, evidencing the occurrence of a transaction (for example, purchase orders,
payroll time records, and customer orders).
Providing an audit client with accounting and bookkeeping services, such as preparing
accounting records or financial statements, creates a self-review threat when the firm
subsequently audits the financial statements. However, as per section 290 sub
subsection 290.167 of "Handbook of the Code of Ethics for Professional Accountants"
2018 version issued by ICAN says providing technical advice on accounting issues
such as the conversion of existing financial statements from one financial reporting
framework to another (for example, to comply with group accounting policies or to
transition to a different financial reporting framework such as Nepal Financial
Reporting Standards) generally, does not create threats to independence provided the
firm does not assume a management responsibility for the client.
So, based on above provisions of Code of Ethics 2018, it can be said that Luthara &
Associate can accept the engagement to assist technically the audit client in preparation
of NFRS compliant financial statements.
Question No. 37
Write short notes on the following: (3 Marks, June 2019)
Audit threshold for different class of auditors.

Answer
As per the Rule 53 of the Nepal Chartered Accountants Regulations 2061 (as amended); the
limit(threshold) for audit of entities based on volume of total assets or total liabilities has been
prescribed unlimited amount for CA member and up to Rs. 1 billion, Rs.250 million and Rs. 50
million for B, C & D class members respectively.

Chapter 3 Governance
Question No. 1
What is the corporate governance? Explain the role of audit committees in corporate
governance. (8 Marks December 2004)
Answer
Corporate governance is the system by which companies are directed and controlled by the
management in the best interest of the stakeholders and others ensuring greater transparency and
better and timely financial reporting with full compliance with law. The boards of directors are
responsible for governance of their companies.
Audit committee is one of the components of corporate governance. Committee has powers to
question the management on different matters including operation of the bank. They ensure
compliance with law; ensure the authenticity of financial statements.
Among others the committees have the following powers.

i. To investigate any activity within its terms of reference.
ii. To seek information from any employee.
iii. To obtain outside legal or other professional advice.
iv. To secure attendance of outsiders with relevant expertise, if it considers necessary.
v. Oversight of the company's financial reporting process and disclosure of its financial
information to ensure that the financial statement is correct, sufficient and credible.
vi. Recommending the appointment and removal of external auditor, fixation of audit fee and
also approval for payment for any other services.
vii. Reviewing with the management the annual financial statements before submission to the
board.
viii. Reviewing with the management, external and internal auditors, and the adequacy of
internal control systems.
ix. Reviewing the adequacy of internal audit function.
Question No. 2
Discuss relationship between Internal Audit and Audit Committee for good corporate
governance. (8 Marks December 2005)
Answer:
Basis for answer
The Institute of Internal Auditors‘ (IIA‘s) Position on Audit Committees view internal auditing as
a corporate resource, supporting the audit committee. This relationship enhances the stature and
independence of the internal auditing function and its ability to contribute to corporate success.
Internal auditing must be trusted by and works effectively with all levels of management, keeping
in mind the best interests of the organization as a whole.
The relationship between audit committees and internal auditing encompasses reporting
relationships and oversight relationships.
Reporting Relationships
To be effective, internal auditing must have organizational status sufficient to ensure a broad
range of audit coverage and adequate consideration of its findings and recommendations.
Relationship to Management
In order to ensure adequate independence and objectively in all of its activities, internal auditing
must have a reporting relationship with management at the senior level. It will be especially

important that internal auditing be independent of the chief accounting officer to ensure objective
reviews of internal accounting control and of the financial reporting process.
Relationship to the Audit Committee
Effective discharge of internal audit responsibilities in matters relating to financial reporting,
corporate governance and corporate control will also require a reporting relationship with the
board audit committee.
Only if such a relationship exists does internal auditing have any recourse in cases of misconduct
or fraud involving senior management itself.
Oversight Relationships
The audit committee should exercise an active oversight rile with respect to the internal audit
function. Oversight activities should include:
 Reviewing and approving the internal audit charter
The internal audit charter provides the functional and organizational framework within which
internal auditing provides services to management and to the board audit committee. It defines
the purpose, responsibility, authority and reporting relationships of the internal audit function.
 Concurring in the appointment or removal of the director of internal auditing
This will safeguard the independence of the internal audit function I matters falling under the
jurisdiction of the board audit committee.
 Reviewing plans and budgets
The audit committee must satisfy itself that internal audit objectives and goals, staffing plans,
financial budgets, and audit schedules provide for adequate support of the committee‘s own
goals and objectives.
The audit committee should ensure that its review of internal audit plans and budgets do not
impede or inhibit management‘s use of the internal audit function in the pursuit of operational
goals and objectives. Since management‘s use of the internal audit function often takes the
form of unplanned requests for audits or special studies, management should not be expected
to specify its need for internal audit resources in detail.
 Reviewing Audit Results
The director of internal auditing should be requiring providing summary information
concerning the results of reviews of financial reporting, corporate governance and corporate
control Specific findings and recommendations of a significant nature may also be reported.
 Requesting Audit Projects
The audit committee may request internal auditing to perform special studies, investigations or
other services in matters of interest or concern to the committee. Such project could include:
 Investigation of potential or suspected fraud or other irregularities
 Company compliance with laws and regulations
 Evaluation of external auditors
 Requesting Quality Assurance Reviews
The Institute of Internal Auditors recommends that quality assurance reviews of the internal audit
function be performed on a regular basis approximately every three years. Regular quality
assurance reviews will provide assurance to the audit committee and to management that internal
auditing activities conform the IIA‘s Standards for the Professional Practice of Internal Auditing.
Conclusion:
The tasks, responsibilities and goals of audit committees and internal auditing are closely
intertwined in many ways.
Certainly, as the magnitude of the ―corporate accountability‖ issue increases, so does the
significance of the internal auditing/ audit committee relationship.

The audit committee has a major responsibility in assuring that the mechanisms for corporate
accountability are in place functioning. Clearly, one of these mechanisms is a solid, well-
orchestrated, cooperative relationship with internal auditing.
Question No. 3
Corporate governance (3 Marks June 2006)
Answer :
Corporate governance is the system by which companies are directed and controlled by the
management in the best interest of the shareholders and others ensuring greater transparency and
better and timely financial reporting. The Board of Directors are responsible for governance have
been published internationally. Although Nepal has to see real life corporate governance code, it
has started working towards this and a number of projects are on. A notable one is changing the
codes by the Securities Board to regulate listed entities. In international level, a system of
certification by an auditor of the compliance of corporate governance clauses in the listing
agreement has already been started and Nepal has yet to follow the system. However, there has
been lots of discussion being done in this recent concept of corporate governance in Nepal too.
Question No. 4
If you are appointed as an Independent Director in a Public Ltd. company, what would be your
role in such company under good corporate governance practice?
Answer
Good corporate governance practice and the concept of independent directors have come under
the spotlight in view of the collapse of some major companies across the globe in recent years.
Independent directors are expected to bring a total transformation in the attitude and working of
the board. They are expected to bring brand credibility and better governance, contribute to
effective board functioning and lead the governance committee effectively, and ultimately
establish the professional belief in board independence. They are expected to bring an independent
judgment to key issues such as strategy, performance, resources, key appointments and standards
of conduct. It is of paramount importance that they should become active participants in boards
and not be passive advisors.
They play a key role in appointments and removal of senior management. They make sure that
financial information is accurate, and that financial controls and systems of risk management are
robust and defensible. They constructively challenge and scrutinize the management decisions and
contribute in development of strategy. They establish and ensure pay for performance schemes
among executives. Independent director‘s role is complex and requires skills, experience, integrity
and particular behavior and attributes. They should be sound in judgment, have enquiring mind,
question intelligently, debate constructively, challenge rigorously and decide dispassionately,
listen sensitively.
Independent directors should act as custodians of governance process as increased business

complexities have made it more difficult for individual shareholders to effectively hold the
management to account. Independent directors are to create blame free environment for the board.
The greater breadth of knowledge and experience they bring with them from external sources go a
long way to enhance the commitment of top management in developing practical strategies to

accomplish its goal through synergic work culture, building islands of excellence to make the
enterprise globally respected and admired entity.
The role of the independent directors or non-executive directors has twin objectives- of extending
their support to the executive management after observing CEO‘s initiatives which are fair,
equitable and promote economic benefits to all stakeholders and remaining vigilant to standup for
rights of minority shareholders in case of any potential foul play or suspected malpractices passing
through the corridor of the board room.
Question No. 5
Discuss 'Audit Matters of Governance Interest' that arise from the audit of financial statement
and are required to be communicated to those charged with governance?
(6 Marks June 2008)
Answer
financial statements and communicate them with those charged with governance. Ordinarily such
matters include:
 the general approach and overall scope of the audit, including any expected limitations
thereon, or any additional requirements;
 the selection of, or changes in, significant accounting policies and practices that have, or
could have, a material effect on the entity‘s financial statements;
 the potential effect on the financial statements of any significant risks and exposures, such
as pending litigation, that are required to be disclosed in the financial statements;
 audit adjustments, whether or not recorded by the entity that have, or could have, a
 material uncertainties related to events and conditions that may cast significant doubt on
the entity‘s ability to continue as a going concern;
 disagreements with management about matters that, individually or in aggregate, could be

significant to the entity‘s financial statements or the auditor‘s report. These
communications include consideration of whether the matter has, or has not, been resolved
and the significance of the matter;
 expected modifications to the auditor‘s report;
 other matters warranting attention by those charged with governance, such as material
 any other matters agreed upon in the terms of the audit engagement.
As part of the auditor‘s communications, those charged with governance are informed that:

 the auditor‘s communications of matters include only those audit matters of governance
interest that have come to the attention of the auditor as a result of the performance of the
audit;
 an audit of financial statements is not designed to identify all matters that may be relevant
to those charged with governance. Accordingly, the audit does not ordinarily identify all
such matters.
Alternatively,
As per NSA 260, Communication with Those Charged with Governance, the following matters
are to be communicated:
The Auditor‟sThe auditor shall communicate with TCWG the responsibilities of the auditor in
Responsibilities inrelation to the financial statement audit, including that:
Relation to the Financial a. The auditor is responsible for forming and expressing an opinion on the
Statement Audit financial statements that have been prepared by management with the
oversight of TCWG; and
b. The audit of the financial statements does not relieve management or
TCWG of their responsibilities.
Planned Scope and The auditor shall communicate with TCWG an overview of the planned scope
Timing of the Audit and timing of the audit, which includes communicating about the significant risks
identified by the auditor.
Significant Findings from The auditor shall communicate with those charged with governance:
the Audit a. The auditor‘s views about significant qualitative aspects of the entity‘s
accounting practices, including accounting policies, accounting
estimates and financial statement disclosures. If auditor is satisfied that
the prevailing accounting practice is not appropriate, he shall
communicate the same with reasons.
b. Significant difficulties, if any, encountered during the audit;
c. Unless all of those charged with governance are involved in managing
the entity:
i. Significant matters arising during the audit that were discussed, or
subject to correspondence, with management; and
ii. Written representations the auditor is requesting;
d. Circumstances that affect the form and content of the auditor‘s report, if
any; and
e. Any other significant matters arising during the audit
Auditor Independence  In the case of listed entities, the auditor shall communicate with TCWG:
a. A statement that the engagement team and others in the firm as
appropriate, the firm and, when applicable, network firms have
complied with relevant ethical requirements regarding independence;
and
b. The related safeguards that have been applied to eliminate identified
threats to independence or reduce them to an acceptable level.
Question No. 6
Describe Corporate Governance. Briefly mention basic principles of Corporate Governance in
relation to board of Directors of a Commercial Bank. (5 Marks June 2010)
Answers:
Corporate governance is a set of process of an entity's culture, policies, laws and institutional
value that affect the way a corporation is directed, administrated or controlled. It is a combination
of corporate policies and best practices adopted by corporate bodies in achieving its objectives in
relation to their stakeholders. It aims to protect shareholder‘s rights, to enhance disclosure and

transparency, to facilitate effective functioning of the board and to provide an efficient legal and
regulatory enforcement framework.
The following are basic principles of corporate governance in relation to Board of Directors of a
Commercial Bank
1. Board members should be qualified for their positions and have a clear understanding of
their role in corporate governance and be able to exercise sound judgment about the
affairs of the bank.
2. The Board of directors should approve and oversee the bank‘s strategic objectives and
corporate values that are communicated throughout the banking organization.
3. The Board of directors should set and enforce clear lines of responsibility throughout
the organization.
4. The Board should ensure that there is appropriate oversight by senior management
consistent with board policy.
5. The Board should ensure that compensation policies and practices are consistent with
the bank‘s corporate culture, long-term objectives and strategy, and control
environment
Question No. 7
Do you think it is important for an accountant to have good understanding of corporate
governance? Why? Briefly explain the major forces behind the push for the global convergence
of corporate governance practices. (10 Marks June 2017)
Answer
Corporate governance deals with the mechanism by which the shareholders (i.e. the principals) of
a company exercise control over the managers (i.e. the agents) and provide overall direction to the
company, so that shareholders‘ interests are protected. Ideally, in this situation:
 the company operates more responsibly and profitably;

 relations are enhanced between the company and all stakeholders – shareholders,
employees, suppliers and society at large;
 the quality of directors and managers is improved;
 the board and management think long-term – they are not just focused on short-term
results;
 the information needs of all stakeholders including the shareholders, board and regulators
are satisfied; and
 executive management is monitored properly in the interest of shareholders.
 The role of the accountant in this setting is to maintain proper balance between the
components of the system by ensuring that the audit and accounting tools are playing
proper governance roles, and that risk management and internal controls – the pillars of
good governance – are well established. For example, nearly every major decision a board
makes depends on the quality and accuracy of its accounting data. Similarly, a well-
conducted internal audit can uncover issues such as fraud or lax processes before they
become serious problems for the organization.
The importance of accounting in corporate governance is also highlighted in laws and guidelines
on corporate governance, such as the Companies Act, Nepal Rastra Bank Act, and OECD
Principles (2004).

The drive for good governance has been under way in many countries for a decade or more.
Perhaps most importantly, countries are beginning to adopt more universally recognized good
governance practices in order to make themselves more attractive to investors. In addition,
shareholder activists, especially large institutional shareholders like superannuation funds, have
pushed for more influence with boards.
In some locales, the drive for good governance has gained momentum from corporate scandals,
problems of product liability, and controversial commercial practices. Increasingly, board
members in some jurisdictions find themselves the objects of lawsuits or the subject of stricter
rules of director liability.
Most recently, the convergence of governance practices has been given a global push by the
global financial crisis. The result of all of these forces has been a steady stream of legislation
and regulation in countries around the world – new rules that are bringing governance practices
into line everywhere.
Another force which involves the convergence of financial reporting and accounting standards
around the world is improving the ability of investors to compare investments on a global basis.
Using a common financial reporting language (the International Financial Reporting Standards
[IFRS]) has the potential to create a new standard of accountability and greater transparency.
Question No. 8
Describe the principle of the equitable treatment of shareholders as per corporate governance
model of Organization for Economic Co-operation and Development.
Answer:
The equitable treatment of shareholders: The corporate governance framework should
ensure the equitable treatment of all shareholders including minority and foreign
shareholders. All shareholders should have the opportunity to obtain effective redress for
violation of their rights.
A. All shareholders of the same series of a class should be treated equally.

i. Within any series of a class, all shares should carry the same rights. All investors
should be able to obtain information about the rights attached to all series and class of
shares before they purchase. Any changes in the voting rights should be subject to
approval by those classes of shares which are negatively affected.
ii. Minority shareholders should be protected from abusive action by, or in the interest
of, controlling shareholders acting either directly or indirectly, and should have
effective means of redress.
iii. Votes should be cast by custodians or nominees in a manner agreed upon with the
beneficial owner of the shares.
iv. Impediments to cross border voting should be eliminated.
v. Processes and procedures for general shareholder meetings should allow for equitable
treatment of all shareholders. Company procedures should not make it unduly difficult
or expensive to cast votes.
B. Insider trading and abusive self-dealing should be prohibited.

C. Members of the board and key executives should be required to disclose to the board
whether they, directly or indirectly or on behalf of third parties, have a material interest in
any transaction or matter directly affecting the corporation.

Question No. 9
Define Corporate Governance and explain how can audit function within an entity improve
Corporate Governance structure within the entity. (2+6 Marks December 2018)
Answer:
Corporate Governance is the process and structure used to direct and manage the business and
affairs of the corporations with the objective of enhancing shareholder value, which includes
ensuring the financial viability of the business. The process and structure define the division of
power and establish mechanisms for achieving accountability among shareholders, the board
and management. These requirements are well complimented by the audit functions within a
company.
There are two types of audit functions within a company. One is audit committee overlooking
the internal audit and other control functions and the other one being statutory audit. The audit
committee composed of independent nonexecutives with clear terms of reference act as a
watch dog in monitoring the compliance with the applicable laws and regulations. It acts as a
mechanism to promote transparency, accountability and control within an organization. On the
other hand, the statutory auditor plays a central role in good corporate governance by virtue of:
 audit financial statements and other (financial) reporting;
 attest internal control statements, where applicable; and
 review or attest corporate governance statements where applicable.
Accordingly, the audit functions support the best practice of good corporate governance by
ensuring:
 Ensuring best management practices;
 Appropriate delegation of authority and responsibility;
 Compliance with the applicable laws and regulations;
 Adherence to the management policies and procedures;
 Review of internal control structures including financial, operational and compliance
controls;
 Safeguard of assets; and
 Overall transparency and accountability within an organization; and
 Timely and accurate financial reporting to the stakeholders.

Chapter 4-Engagement Procedure

Question No. 1
Write short notes on Audit Engagement Letter (4 Marks June 2005)
Answer:
The auditor and the client should agree on the terms of the engagements in order to reduce audit
expectation gap. The agreed terms would need to be recorded in an audit engagement letter or
other suitable form of contract. It is in the interest of both client and auditor that the auditors send
an engagement letter, preferably before the commitment of engagement, to help in avoiding
misunderstandings with respect to the engagement. The engagement letter documents and
confirms the auditor‘s acceptance of the appointment, the objective and scope of the audit, the
extent of the auditor‘s responsibilities to the client and the form of any reports.
The form and content of audit engagement letters may vary for each client, but they would
generally include reference to:
 The objective of the audit of financial statements.
 Management‘s responsibility for the financial statements.
 The scope of the audit, including reference to applicable legislation, regulations or
pronouncements of the Institute of Chartered Accountants of Nepal (ICAN).
 The form of any reports or other communication of results of the engagement.
 The fact that because of the test nature and other inherent limitations of an audit, together
with the inherent limitations of any accounting and internal control system, there in
unavoidable risk that even some material misstatement may remain undiscovered.
Unrestricted access to whatever records, documentation and other information requested in

connection with the audit.
As per NSA 210, auditor should issue Terms of Engagement before the start of the audit to
ensure that management acknowledges its responsibilities and the management understands the
responsibilities of the auditor.
Question No. 2
You have been appointed as an auditor of DATA Finance Company Ltd., for the financial year
2065/066. State first three points to be considered before acceptance of audit.
(4 Marks June 2010)
Answer
a) The first three points to be considered before accepting the audit are:
 Eligibility of appointment: Auditor should confirm that he / she is capable to be appointed as
auditor.
 Validity of appointment: Appointment is valid as per Companies Act and Concerned Act
(e.g. Auditor‘s name must be in panel list maintained by Nepal Rastra Bank in case of auditor
appointment for bank audit.)
 Communication with retiring auditor: Auditor should communicate to retiring auditor before
accepting audit.
Question No. 3
You are the audit manager in charge of the audit of “Everest Nepal Limited”, which is a newly
formed company engaged in the production of Iron Rods. The company‟s main shareholder is

the managing director who is also in charge of production. The company employs around 250
employees at present. There is an accountant who is semi-qualified and there are five other
staffs assigned to maintain the books of accounts.
As the Managing Director is very busy with operations, you have had various discussions with
the accountant about the scope and timetable for the audit. You have sent the draft letter of
engagement to the managing director for acceptance, but you have not yet received a response
to it.
Explain the purpose of a letter of engagement and why it is sent before any new audit
appointment is accepted. State four (4) main contents of a letter of engagement. Discuss
actions you would take in response to the non-reply by the management to your draft letter of
engagement. (7 Marks June 2018)
Answer:
The purpose of a letter of engagement is to clearly define the extent of the

auditor‘s/management responsibilities and to minimize the possibility of any misunderstanding
between the auditor and the client. If a letter of engagement is not sent to clients both new and
existing, there is scope for argument and misunderstandings about the precise extent of the
respective obligations of the clients and its auditor and directors.
The main contents of a letter of engagement are
i. The objective and scope of the audit
ii. The auditor‘s responsibilities
iii. Management‘s responsibilities
iv. Identification of the applicable financial reporting framework for the preparation of the
financial statements
v. Reference to the expected form and content of any reports to be issued by the auditor
and a statement that there may be circumstances in which a report may differ from its
expected form and content.
The auditor should make an appointment to meet the MD and clearly explain the pre-conditions
of the audit to him and ensure that the letter is signed before the commencement of the audit.
The auditor shall not accept the audit engagement or not commence any audit work until the
engagement letter is signed.
Question No. 4
Write Short Notes on
a. Audit Engagement Letter (4 Marks December 2005)
Answer:
As per NSA 210: Agreeing the Terms of Audit Engagements, the auditor and the client should
agree on the terms of the engagement. The agreed terms would need to be recorded in an audit
engagement letter or other suitable form of contract. It is in the interest of both client and auditor
that the auditor sends an engagement letter, preferably before the commencement of the
engagement, to help in avoiding misunderstandings with respect to the engagement. The
engagement letter documents and confirms the auditor‘s acceptance of the appointment, the
objective and scope of the audit, the extent of the auditor‘s responsibilities to the client and the
form of any reports.
The form and content of audit engagement letters may vary for each client, but they would
generally include reference to:
 The objective of the audit of financial statements.

 Management‘s responsibility for the financial statements.

 The scope of the audit, including reference to applicable legislation, regulations or
pronouncements of the Institute of Chartered Accountants of Nepal (ICAN)
 The fact that because of the test nature and other inherent limitations of an audit, together
with the inherent limitations of any accounting and internal control system, there is an
unavoidable risk that even some material misstatement may remain undiscovered.
 Unrestricted access to whatever records, documentation and other information requested in
connection with the audit.
The auditor may also wish to include in the letter:

 Arrangements regarding the planning of audit.
 Expectation of receiving from management written confirmation concerning representation
made in connection with the audit.
 Request for the client to confirm the terms of the engagement by acknowledging receipt of
the engagement letter.
 Description of any other letters or reports the auditor expects to issue to the client.
 Basis on which fees are computed and any billing arrangement.
When relevant, the following points could also be made:

 Arrangements concerning the involvement of other auditors and experts in some aspects of
the audit.
 Arrangements concerning the involvement of internal auditors and other client staff.
 Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit.
 Any restriction of the auditor‘s liability when such possibility exists.
 A reference to any further agreements between the auditor and the client.
On recurring audits, the auditor should consider whether circumstances require the terms of the
engagement to be revised and whether there is a need to remind the client of the existing terms of
the engagement.
The auditor may decide not to send a new engagement letter each period. However, the following
factors may make it appropriate to send a new letter.
 Any indication that the client misunderstands the objective and scope of the audit.
 Any revised or special terms of the engagement.
 A recent change of senior management, board of directors or ownership.
 A significant change in nature or size of the client‘s business
 Legal requirements.
b. Scope Limitation (4 Marks June 2010)

Answer
Limitation imposed by either the client or circumstances that prevent the auditor from applying
procedures which are considered necessary in the circumstances. An example of limitation
imposed by the client may be when the terms of engagement specify that the auditor will not
carry out the audit procedure that the auditor believes is necessary. Example of limitation
imposed by circumstances may be (1) the timing of auditor‘s appointment does not enable him to
observe the physical inventory counts. (2) Inadequacy in the client‘s accounting records does not
enable him to carry out the audit procedure that he believes is desirable.

c. Engagement partner (4 Marks June 2013)
Answer:
Engagement partner is the partner or other person in the firm who is responsible for the audit
engagement and its performance, and for the auditor‘s report that is issued on behalf of the firm,
and who, where required, has the appropriate authority from a professional, legal or regulator
body
Question No. 5
a) Temporary differences (4 Marks December 2013)
b) Peer Review (4 Marks December 2013)
c) Walk through test (4 Marks December 2013)
Answer:
a) Temporary differences
Temporary differences are differences between the carrying amount of an asset or liability in the
balance sheet and its tax base.
Types:
Temporary differences may be either:
i) Taxable temporary differences- that will result in taxable amounts in determining

taxable profit or tax loss of future periods when the carrying amount of the asset or
liability is recovered or settled, or
ii) Deductible temporary differences- that will result in amounts that are deductible in
determining taxable profit or loss of future periods when the carrying amount of the
asset or liability is recovered or settled.
b) The term peer review means review of work done by a professional, by another professional
of similar standing. It is defined as a regulatory mechanism for monitoring the performances
of professionals for maintaining quality of service expected of them for enhancing the reliance
placed by the users of financial statements for economic decision making. The concept of peer
review system has also been introduced in Nepal though relatively new and yet to be made
mandatory for all practice units.
c) A walk through is a procedure in which an auditor traces a transaction from its initiation
through the company's information systems to the point when it reflected in the financial
reports. The auditor should perform one walk through, at a minimum, for each major class of
transactions. A walk-through provides evidence to confirm that the auditor understands:
 The process flow of transactions
 The design of identified controls for internal control components, including those related
to preventing and detecting fraud
 Whether all points in the process have been identified at which misstatements related to
relevant financial statement assertion could occur.

Walk through also provide evidence to evaluate the effectiveness of the controls' design and
confirm that the controls have been placed in operation. When performing a walk-through, the
auditor should:
i. Be sure that the walk-through encompasses the complete process for each significant
process identified, including controls intended to address fraud risk.
ii. Ask the entity's personnel, at each of key stage in the process, about their understanding
of what the company's prescribed procedures require.
iii. Determine whether processing procedures are performed as expected on a timely basis
and look for any exceptions to prescribed procedures and controls.
iv. Evaluate the quality of evidence provided and perform procedures that produce a level
of evidence consistent with the auditor's objectives. The auditor should follow the
whole process, using the same documents and technology that company staff use,
asking question to different personnel at each significant stage and asking follow-up
questions to identify any abuse of controls or fraud indicators.
Once a walk-through is performed, the auditor may carry forward the documentation, noting
updates, unless significant changes make preparation of new documentation more efficient. If
such significant changes occur in the process flow of transaction or supporting computer
applications, the auditor should evaluate the nature of changes and the effect on related
accounts. The auditor should determine whether it is necessary to walk through transactions
that were processed both before and after the change.

Chapter 5-Planning and Risk Assessment
Question No. 1
How would you respond in case of the risk of material misstatements of followings?
(8 Marks June 2004)
i. Revenue recognition
ii. Inventory quantities
iii. Fraudulent financial reporting
iv. Misappropriation of assets
Answer
In case of the risk of material misstatements auditor should respond as following:
i. Revenue recognition:
(a) Confirm and reconcile customer balances.
(b) Confirm with customers regarding contract terms, side agreements etc. to the
extent possible.
ii. Inventory quantities:

(a) Receive and review inventory records.
(b) Identify locations, areas or items for specific attention.
(c) Observe physical verification on an unannounced basis.
(d) Require the client to conduct physical verification at all locations and at the
same time.
iii. Fraudulent financial reporting:

(a) Test non-standard journal entries. Nonstandard journal entries are generally
initiated by management level and are not routine or with the normal processing
of transactions.
(b) Identify fictitious entries.
(c) Check accounting disclosures and financial statement presentation.
iv. Misappropriation of assets:

(a) Audit planning should be directed towards account balances and class of
transactions.
(b) Susceptibility of assets to misappropriation e.g.
 Large amount of cash on hand.
 Small items of high value and demand.
 Easily convertible assets.
(c ) Internal control aspects.
Question No. 2
Understanding the entity and its environment and assessment of audit risk are the essential
part of the audit planning. Describe the information you will seek for the purpose.
(8 Marks June 2005)

Answer:
Audit should be planned in such a way that audit risk is minimized. Therefore, understanding the
entity and its environment is essential to plan audit. It helps auditor to decide debt of audit as
well as techniques to be adopted.
Process of understanding the entity and its environment should be initiated from industry and
regulatory information concerning the entity. It involves gathering relevant information regarding
industry, regulatory and other matters such as financial reporting framework, nature of the entity,
applicable accounting standards, objectives, financial performance and the business risks of the
industry. Information to be reviewed in the beginning may involve following:
i. Review of financial statements and information provided to regulatory authorities and stock
exchange.
ii. Press reports and publication of trade associations and regulatory authorities to establish
business trends.
iii. Review of system documentation such as account manual and financial procedures.
iv. Review of third-party information such as advisors, bankers, lawyers etc.
After review of the preliminary information as mentioned above, auditor should understand the
control environment, procedures for identifying the risks in business and recording of financial
transactions, information and monitoring systems. At this stage, analytical procedures may be
applied to understand audit risk that requires special audit considerations.
If the entity is not a new client following additional resources may be used for understanding
audit risk:
i. Prior year working paper to know issues that warrant attention in the current year.
ii. Discussions with audit managers working with the entity to identify problem areas.
iii. Discussions with client to identify problem areas.
Question No. 3
In performing an audit of financial statements, the auditor should have or obtain knowledge
of the client' business. Explain in the light of NSA 315. (8 Marks June 2005)
Answer:
Nepal Standard on Auditing (NSA) 315 ― Identifying and Assessing the Risk of Material
Misstatement Through Understanding the Entity and Its Environment‖ requires that in
performing an audit a financial statements, the auditor should have or obtain knowledge of the
business sufficient to enable the auditor to identify and understand the events, transactions and
practices that, in the auditor‘s judgement, may have a significant effect on the financial
statements or on the examination or audit report.
Such knowledge is used by the auditor in assessing inherent and control risks and in determining
the nature, timing and extent of audit procedures. The auditor can obtain knowledge of the
industry and the entity from a number of sources.
Prior to accepting an engagement, the auditor would obtain a preliminary knowledge of industry
and of the nature of ownership, management and operations of the entity to be audited, and
would consider whether a level of knowledge of the business adequate to perform the audit can
be obtained.
Following acceptance of the engagement, further and more detailed information would be
obtained. To the extent practicable, the auditor would obtain the required knowledge at the start
of the engagement. As the audit progresses, that information would be assessed and updated, and
more information would be obtained.

Obtaining the require knowledge of the business is the continuous and cumulative process of
gathering and assessing the information and relating the resulting knowledge to audit evidence
and information at all stages of the audit. For example, although information is gathered at the
planning stage, it is ordinarily refined and added to in later stages of the audit as the auditor and
assistance learn more about the business.
For continuing engagements, the auditor would update and reevaluate information gathered
previously, including information in the prior year‘s working papers. The auditor would also
perform procedures design to identify significant changes that have taken place since the last
audit.
The auditor can obtain knowledge of the industry and the entity from a number of sources. Some
of the examples are:
 Previous experience with the entity and its industry.
 Discussion with people with the entity (For example directors and seniors operating
personnel)
 Discussion with internal audit personnel and review of internal audit reports etc.
Knowledge of the business is the frame of reference within which the auditor exercises
professional judgment. Understanding the business and using this information appropriately
assists the auditors in:
 Assessing risks and identifying problems
 Planning and performing the audit effectively and efficiently
 Evaluating audit evidence.
 Providing better service to the client
To make effective use of knowledge about the business, the auditor should consider how it
affects the financial statements taken as a whole and whether the assertions in the financial
statements are consistent with auditor‘s knowledge of the business.
Question No. 4
Write short notes on Audit strategy and step involved in designing an audit strategy?
(4 Marks June 2005)
Answer:
Audit strategy is concerned with designing optimized audit approaches that seek to achieve the
necessary audit assurance at the lowest cost within the constraints of the information available.
Audit procedures should be relevant to the important assertions, and as cost effective as possible
to perform. Audit strategy generally involves the following steps:
i. Obtaining knowledge of business.
ii. Performing analytical procedures at initial stages.
iii. Evaluating inherent risk.
iv. Evaluating internal control system for strategy purpose.
v. Formulating the strategy.
As per NSA 300 on Audit Planning, in establishing the overall audit strategy, the auditor shall:
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
Question No. 5
Write short notes on Audit Risk (4 Marks June 2005)
Answer:
Audit risk is the risk that an auditor may give an inappropriate opinion on financial information
which is materially misstated. An auditor may give an unqualified opinion on financial
statements without knowing that they are materially misstated. Such risk may exist at overall
level, while verifying various transactions and balance sheet items. They are three components of
audit risk:
i. Inherent risk
It is a risk that material errors will occur. Inherent risk is the susceptibility of an account
balance or class of transactions to misstatement that could be material, individually or when
aggregated with misstatements in other balances or classes, assuming that there were no
related internal controls.
ii. Control risk

It is risk that the client‘s system of internal control will not prevent or correct such errors. To
assess control risk, the auditor should consider the accuracy of control design as well as test
adherence to control procedure.
iii. Detection risk

It is the risk that an auditor‘s procedures will not detect a misstatement that exists in an
account balance or class of transactions that could be material, individually or when
aggregated with misstatements in other balances or classes. The level of detection risk relates
directly to the auditor‘s procedures, some detection risk would always be present.
The inherent and control risks are functions of the entity‘s business and its environment and
the nature of the account balances or classes of transactions, regardless of whether an audit is
conducted. Even though inherent and control risks cannot be controlled by the auditor, the
auditor can assess them and design his substantive procedures to produce on acceptable level
of detection risk, thereby reducing audit risk to an acceptable low level.
Question No. 6
Distinguish between: Fraud and Error (5 Marks June 2007)
Answer
Error refers to an unintentional misstatement in financial statements, including the omission of
an amount or a disclosure, such as:
 a mistake in gathering or processing data from which financial statements are prepared,
 an incorrect accounting estimate arising from oversight or misinterpretation of facts and
 a mistake in the application of accounting principles relating to measurement, recognition,
classification, presentation, or disclosure.

Fraud refers to an intentional act by one or more individuals among management, those charged
with governance, employees, or third parties, involving the use of deception to obtain an unjust or
illegal advantage. Fraud involving one or more members of management or those charged with
governance is referred to as ―management fraud‖; fraud involving only employees of the entity is
referred to as ―employee fraud‖. In either case, there may be collusion with third parties outside
the entity.
Two types of intentional misstatements are relevant to the auditor‘s consideration of fraud
misstatements resulting from fraudulent financial reporting and misstatements resulting from
misappropriation of assets. Fraudulent financial reporting involves intentional misstatements or
omissions of amounts or disclosures in financial statements to deceive financial statement users.
Misappropriation of assets involves the theft of an entity‘s assets. Misappropriation of assets can
be accomplished in a variety of ways and it is often accompanied by false or misleading records
or documents in order to conceal the fraud.
Question No. 7
Explain the Fraud Risk Factors in respect of the Deposit Taking Cycle. (5 Marks June 2007)
Answer
The following risk factors may be associated in respect of the Deposit Taking Cycle. These
factors may be hiding the identity of a depositor and any other means.
 Similar or like-sounding names across various accounts.
 Offshore company depositors with no clearly defined business or about which there
are few details.
 Any evidence of deposit-taking by any other company of which there are details on
the premises whether part of the bank or not.
Risk Factors associated with the Customer Deposits Investments

 Customers with hold-mail arrangements who only have very occasional contact with
the bank.
 No independent resolution of customer complaints or review of hold-mail accounts.
Question No. 8
Define audit strategy. Describe the steps involved in designing an audit strategy.
(10 Marks June 2007)
Answer
Audit strategy is concerned with designing optimized audit approaches that seek to achieve
the necessary audit assurance at the lowest cost within the constraints of the information
available. Audit procedures should be relevant to the important assertions, and as cost
effective as possible to perform. Audit strategy generally involves the following steps:
i. Obtaining knowledge of business.
ii. Performing analytical procedures at initial stages.
iii. Evaluating inherent risk.
iv. Evaluating internal control system for strategy purpose.
v. Formulating the strategy.
i. Obtaining Knowledge of Business: NSA 315 states that in performing an audit of

financial statements, the auditor should have or obtain knowledge of the business
sufficient to enable the auditor to identify and understand the events, transactions and

practices that, in the auditor‘s judgement, may have a significant effect on the financial
statements or on the examination or audit report.
Knowledge of the business is a frame of reference within which the auditor exercises
professional judgement. Understanding the business and using this information
appropriately assists the auditor in:
 Assessing the risks and identifying problems.
 Planning and performing the audit effectively and efficiently.
 Evaluating audit evidence.
 Providing better service to the client.
The auditor should ensure that the audit staff assigned to an audit engagement obtains
sufficient knowledge of the business to enable them to carry out the audit work
delegated to them.
ii. Performing Analytical Procedures: The auditor should apply analytical procedures at
the planning and overall review stages of the audit. Analytical procedures may also be
applied at other stages.
The use of analytical procedures during the planning stage requires the extensive use of
accounting and business knowledge and experience to assess the potential for material
misstatement in the financial statements as a whole, as well as task is to identify the
relevant risk indicators and to interpret them properly. Furthermore, analytical
techniques applied during the planning stage are not generally as precise as the
analytical techniques at the substantive stage.
iii. Evaluating Inherent Risk: To assess inherent risk, the auditor would use professional
judgement to evaluate numerous factors, having regard to his experience of the entity
form previous audit engagements of the entity, any controls established by the
management to compensate for a high level of inherent risk, and his knowledge of any
significant changes which might have taken place since his last assessment. Examples
of such factors are:
At the level of Financial Statements:

 Management‘s experience and knowledge and changes in management during the
period
 Unusual pressures on management
 The nature of the entity‘s business
 Factors affecting the industry in which the entity operates.
At the level of Account Balance and Class of Transactions:
 Quality of the accounting system.
 Financial statements are likely to be susceptible to misstatement, for example.
 Accounts which required adjustment in the prior period, or which involve a high
degree of estimation.
 The complexity of underlying transactions and other events which might require
using the work of an expert.
 The degree of judgement involved in determining account balances.
 Susceptibility of assets to loss or misappropriation, for example, assets which are
highly desirable and movable such as cash.

 The completion of unusual and complex transactions, particularly at or near period

end.
 Transactions not subjected to ordinary processing.
iv. Evaluating Internal Control System: The auditor‘s assessment of the control
environment is crucial to the decision on whether to make an extended assessment of
controls. This is because a good control environment is conducive to the maintenance of
a reliable system of accounting and control procedures. For strategy purposes the
auditor should obtain a sufficient understanding of the control environment. The auditor
needs an understanding of the accounting systems, regardless of whether the audit
strategy will involve an extended assessment of internal accounting controls. This
should be done by:
a. Documenting the extent to which the system is computerized; and
b. Preparing or updating overview flowcharts to record the files and transactions
relating to significant systems-derived account balances.
v. Formulating the Strategy:

The auditor should develop the strategy by:
a. Considering the results of gathering or updating information about the client; and
b. Making preliminary judgements about materiality, inherent risk and control
effectiveness. These will include identification of the systems the auditor proposes
to subject to an extended assessment of controls.
The initial assessments of the quality and complexity of the client‘s systems will affect the
amount of the information the auditor needs to gather. Sometimes, on a new engagement, the
appropriate strategy may be obvious from a limited of investigative work. In other cases, the
necessary information gathering will be extensive.
Question No. 9
Describe the factors that auditor needs to consider in assessing inherent risk for purchase
and payroll assertions. (5 Marks December 2007)
Answer
a) In assessing inherent risk for purchase and payroll assertions, the auditor should consider
pervasive factor that might motivate management to misstate expenditure. These might include:
i) pressure to understate expense in order to report, falsely, the achievement of announced

profitability targets or industry norms;
ii) Pressures to understate payables in order to report a higher level of working capital in the
face of liquidity problems or going-concern doubts.
These factors primary affect the completeness assertion and reduce acceptable detection risk,
particularly in testing for understatement of payables.
Other factors that might contribute to misstatement include:
i) the high volume of transactions, which affects all assertions;

ii) temptations for employees to make unauthorized purchases and payments, or to
misappropriate purchased assets, relating to the existence or occurrence assertions;

iii)contentious accounting issues, such as whether a cost or the classification of a lease as an

operating or finance lease, which relate to the valuation or measurement assertion;
iv) Complexity of payroll computations for factory workers whose gross earnings may be
based on time and/or productivity, affecting the valuation or measurement of payroll
costs.
Payroll fraud is a major concern for the auditor. It may occur at two levels. Employees
involved in preparing and paying the payroll may process data for fictitious employees or for
employees whose services have already been terminated, and then divert the wages or pay-
cheques to their own bank account. Alternatively, management may overtly misclassify or
'paid‘ labor cost in cost plus government contract work. All of these affect the auditor‘s
assessment of risk for the existence or occurrence assertion for payroll.
In most well-established entities, management‘s own risk assessment procedures will have led
it to adopt control procedures to reduce the risk of misstatements occurring in the processing
and recording of transactions. However, the existence and effectiveness of controls pertaining
to different transaction class assertions for purchase, payments and payroll can vary
considerably among entities, and even among assertions for the same entity. Moreover, the
auditor must remain mindful of the inherent limitations of internal control, including the
possibility of management override, collusion, errors due to fatigue or misunderstanding, and
failure to adapt the control structure for changed circumstances.
Question No. 10
While conducting initial meeting with members of your audit team, you have noticed that they
are confused about use of tests of controls in the presence of risk management procedures
related to internal controls. They are of the opinion that auditor is not required to perform
tests of operating effectiveness of internal controls in each audit period. They also believe that
auditor can save much time and energy by omitting substantive procedures when controls were
in effect throughout the period under audit.
(i) Briefly discuss why tests of control are required to be performed when risk assessment
procedures have already been performed. (3 Marks June 2008)
(ii) How does an auditor rely on operating effectiveness of internal controls tested during
previous audits? (3 Marks June 2008)
(iii)Give your comments on the team's understanding about omitting substantive procedures?
(2 Marks June 2008)
Answer
i. The auditor should obtain audit evidence through tests of control to support any
assessment of control risk which is less than high. The lower the assessment of control
risk, the more support the auditor should obtain that accounting and internal control
systems are suitably designed and operating effectively.
ii. When obtaining audit evidence about the effective operation of internal controls, the
auditor considers how they were applied, the consistency with which they were applied
during the period and by whom they were applied. The concept of effective operation
recognizes that some deviations may have occurred. It is so even when prior year audit
conclusion was such that there were positive results of the tests carried out in previous
period.

Deviations from prescribed controls may be caused by such factors as changes in key
personnel, significant seasonal fluctuations in volume of transactions and human error.
When deviations are detected the auditor makes specific inquiries regarding these matters,
particularly the timing of staff changes in key internal control functions. The auditor then
ensures that the tests of control appropriately cover such a period of change or fluctuation.
iii. Team's understanding of omitting substantive checking procedures is not correct and they
shall perform substantive checking even when they are happy about the operation of
effective controls to ensure that it has really happened. However, they may reduce the
extent of substantive checking.
Question No. 11
"Management is in a unique position to perpetrate fraud because of management's ability to
directly or indirectly manipulate accounting records and prepare fraudulent financial
statements by overriding controls that otherwise appear to be operating effectively. While the
levels of risk of management override of controls vary from entity to entity, the risk is
nevertheless present in all entities and is a significant risk of material misstatement due to
fraud".
What are the procedures that an auditor should design and perform to address the risk of
management's override of controls? (8 Marks June 2008)
Answer
The control environment has an effect on the effectiveness of the specific control procedures. A
strong control environment, for example, one with tight budgetary controls and an effective
internal audit function, can significantly complement specific control procedures. However, a
strong environment does not, by itself, ensure the effectiveness of the internal control system.
Factors reflected in the control environment include:
 the function of the board of directors and its committees,
 management‘s philosophy and operating style,
 the entity‘s organizational structure and methods of assigning authority and
responsibility and
 management‘s control system including the internal audit function, personnel policies
and procedures and segregation of duties.
As an auditor, one should always keep in mind that because of the organizational placement and
system of evaluation of the staff by the senior level management, junior level staff may tend to
oblige the instructions of the senior level management even by breaking the control systems and
procedures. The auditor shall perform following additional procedures to minimize risks of
management overrides of controls:
 Review of transactions trails
 Review of material transaction where there is involvement of higher officials,
 Action taken by the management to its staff and any waiver there off.
 Any favoritism to staff without proper performance evaluation.
 Detailed substantive checking of transactions involving higher authorities.

Question No. 12
Write short notes Audit Risks and Auditor's roles. (5 Marks December 2008)
Answer
that is materially misstated. For example, an auditor may give an unqualified opinion on
financial statements without knowing that they are materially misstated. Such risk may exist at
overall level or while verifying various transactions and balance sheet items. Low risk areas are
those which require the application of routine audit procedures in the ordinary course of
vouching, casting, checking, etc. At both compliance and substantive stages, usually occupying
up to 80% of all audit effort. High risk areas are those which should be the primary concern of
partners and senior managers and will include such matters as: adequacy of provisions, full
disclosure of liabilities, including contingent liabilities, company legislation etc. The components
of audit risk are:
i) Inherent risk (risk that material error will occur)

ii) Control risk (risk that the client‘s system of internal control will not prevent or correct
such errors); and
iii) Detection risk (risk that any remaining material errors will not be detected by the
auditor.
Question No. 13
Explain Fraud Risk factors in respect of the Loan Lending Cycle. (10 Marks December 2008)
Answer
a) Loans to fictitious Borrowers/ Transactions with connected companies.
The loan files with sketchy, incomplete financial information, poor documentation or
management claim the borrower is wealthy and undoubtedly creditworthy.
Valuation which seem high, valuers used from outside the usually permitted area or the
same valuer used on numerous applications.
Generous extensions or revised items when the borrower defaults. A bank deposit is made
by another bank, which is then used to secure a loan to a beneficiary nominated by the
fraudulent staff member of the first bank who hides the fact that the deposit is pledged.
 Pledges over deposits (disclosed by confirmations which have specifically requested

such pledges to be disclosed).
 Documentation of files held in directors of senior managers‘ offices outside the usual
filing areas; deposits continually rolled over or made even when liquidity is tight.
b) Use of nominee companies / transactions with connected companies.
 Complex structures which are shrouded in secrecy.

 Several customers with sole contact that is, handled exclusively by one member of
staff.
 Limited liability partnerships without full disclosure of ownership or with complex
common ownership structures.

c) Kickbacks and Inducements

 Excessive amounts of business generated by particular loan officers.
 Strong recommendation by director or lending officer but missing data or
documentation on credit file.
 Indication of week documentation controls, for example providing funding before
documentation is complete.
d) Use of parallel Organizations

(Companies under the common control of directors/ shareholders)
 Unexpected settlement of problem loans shortly before the period end or prior to an
audit visit or unexpected new lending close to the period end.
(Methods used to conceal the use of the bank funds to make apparent loan payments.)
 Loans which suddenly become performing shortly before the period end or prior to an
audit visit.
 Transactions with companies within a group or with its associated companies where
the business purpose is unclear.
 Lack of cash flow analysis that supports the income generation and repayment ability
of the borrower.
Interpretation and false information on loan application / double pledging of collateral /

fraudulent valuations/ forged or valueless collateral.
 No on-site appraisal or visit by the borrower.

 Difficulty in obtaining corroboration of the individual's credentials, inconsistent of
missing documentation and inconsistencies in personal details.
 Valuer from outside the area in which the property is situated.
 Valuation is ordered and received by the borrower rather than the lender.
 Lack of verification of liens to substantiate lien positions and priorities.
 Lack of physical control of collateral that requires physical procession to secure a
loan (for example, jewelry, bearer bonds and artwork).
Question No. 14
“Surprise Checks” help the auditors to ascertain whether the internal control system is
operating effectively in a company or not. Discuss. (15 Marks June 2009)
Answer
(NSA) 315 ―Identifying and Assessing the Risk of Material Misstatement Through
Understanding the Entity and Its Environment‖, prescribes that the auditor should obtain an
understanding of the accounting and internal control systems sufficient to plan the audit and
develop an effective audit approach. The auditor should use professional judgment to assess audit
risk and to design audit procedures to ensure that it is reduced to an acceptably low level.
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.

The understanding of the accounting and internal control system can be obtained in several ways
including inspection of documents making inquiries of appropriate management, observation of
activities, etc. It is in this context; surprise checks intend to ascertain whether the system of
internal control is operating effectively and whether the accounting and other records are
prepared concurrently and kept up to date. Particularly, the observation of the entity‘s activities
and operations including observation of the organization of computer operations, personnel
performing control procedures and the nature of transaction processing on a surprise visit would
reveal the exact manner in which the activities are being performed in the manner prescribed by
the management. It has often been found that manipulations and frauds are facilitated under a
system of book-keeping, which does not give proper emphasis to the need to keep the books up-
to date. Errors in book-keeping are often indicative of weaknesses in internal control which may
be taken advantage of in order to perpetrate frauds or manipulations. Surprise checks are a useful
method of determining whether or not such errors exist and where they exist, of bringing the
matter promptly to the attention of the management so that corrective action is taken
immediately. Consequently, surprise visits by the auditor can exercise a good moral check on the
client‘s staff.
Surprise checks are a part of the normal audit and the results of such checks are therefore
important primarily to the auditor himself in deciding the scope of his audit and submitting his
report thereon. The need for and frequency of surprise checks is obviously a matter to be decided
having regard to the circumstances of each audit. It would depend upon the extent to which the
auditor considers the internal control system as adequate, the nature of the clients‘ transaction,
the locations from which he operates and the relative importance of items like cash, investments,
stores etc. However, wherever feasible a surprise check should be made at least once in the
course of an audit. If this surprise check reveals any weaknesses in the system of internal control
or any fraud or error or the fact that any book or register has not been properly maintained or
kept up-to-date, the auditor should communicate the same to the management and ensure that
action is taken on the matters communicated by him. It does not necessarily follow that all or any
of the matters communicated to the management should form part of the auditor‘s report on the
accounts. Thus ―surprise checks‖ help the auditors, during the course of their audit, to ascertain
whether the internal control is operating effectively in a company or not.
Question No. 15
Distinguish between Control Risk and Detection Risk (5 Marks June 2010)
Answer
Control Risk means risk that the client's system of internal control will not prevent or correct
such errors whereas Detection Risk means risk that any remaining material errors will not be
detected by the auditor.
Control Risk is the risk that misstatement that could occur in an account balance or class of
transactions and that could be material, individually or when aggregated with mis-statement in
other balances or classes, will not be prevented or detected on a timely basis by the system of
internal control.
Detection Risk is the risk that an auditor's procedures will not detect a misstatement that exists in
an account balance or class of transactions that could be material, individually or when
aggregated with misstatements in other balances or classes.
There will always be some control risk because of intrinsic limitation of any system of internal
control whereas the level of detection risk relates directly to the auditor's procedures.

Control risk exists independently of an audit of financial information. Control risk is function of
the entity's business and its environment and the nature of the account balances or classes of
transactions, regardless of whether an audit is conducted.
Detection risk is dependent on appropriateness of audit procedures, application of the audit

procedures and appropriate interpretation of the audit results.
Question No. 16
"Auditor's assessment of materiality may be different at the time of planning the engagement
than at the time of evaluating the results of his audit procedures." Comment.
(6 Marks June 2010)
Answer
NSA 320 on "Audit materiality" recommends that the auditor should consider materiality and its
relationship with audit risk when conducting an audit. While formulating an overall audit plan,
NSA-300 on "Planning an audit of financial statements" also requires the auditor to consider the
setting of materiality levels for audit purposes right from the planning stage. Accordingly, the
auditor has to assess the materiality aspect right from the initial stages of audit planning and
throughout the process of conducting the audit till the audit opinion is formulated. However, the
auditor's assessment of materiality may be different at the time of planning the engagement than
at the time of evaluating the result of his audit procedures. Since audit materiality and audit risk
are closely related to each other, the auditor's preliminary assessment of materiality related to
specific account balances and classes of transactions, helps the auditor decide such questions as
what items to examine and whether to use sampling and analytical procedures. This enables the
auditor to select audit procedures that, in combination, can be expected to support the audit
opinion at an acceptably low degree of audit risk. Such selection of audit procedures would
undergo a change as audit work progresses. The assessment of materiality and audit risk at the
stage of evaluating the results of audit procedures would also change because of a change in
circumstances or a change in the auditor's knowledge as a result of the audit. For example, if the
audit is planned prior to period end, the auditor will anticipate the results of operations and the
financial position. If actual results of operations and financial position are substantially
different, the assessment of materiality and audit risk may also change. Accordingly, the auditor
may, in planning the audit work, intentionally set the acceptable cut-off level for verifying
individual transactions at a lower level than is intended to be used to evaluate the results of the
audit. This may be done to cover a larger number of items and thereby reduce the likelihood of
undiscovered miss-statements and to provide the auditor with the margin of safety when
evaluating the effect of misstatements discovered during the audit.
Question No. 17
Distinguish between Audit procedures and Audit Programme (4 Marks June 2010)
Answer
Audit procedures are audit techniques in gathering audit evidence to substantiate the reliability of
the accounting records. The auditor evaluates whether the information presented is logical and
reasonable. Examples of auditing procedures are observing assets to verify existence and amount
(e.g., fixed assets), collecting independent confirmations from external parties (e.g., bank
confirmation), evaluating internal control, appraising management's activities, and obtaining
management representations.

Audit programme is a list of examination and verification steps to be applied in such a way that
the inter-relationship of one step to another is clearly shown and designed, keeping in view the
assertions discernible in the statements of account produced for audit or on the basis of an
appraisal of the accounting records of the client. In other words, an audit programme is a detailed
plan of applying the audit procedures in the given circumstances with instructions for the
appropriate techniques to be adopted for accomplishing the audit objectives. Businesses vary in
nature, size and composition; work which is suitable to one business may not be suitable to
others; efficiency and operation of internal controls and the exact nature of the service to be
rendered by the auditor are the other factors that vary from assignment to assignment.
Question No. 18
Define materiality and determine how the level of materiality is assessed.
Answer
Materiality is defined as ‗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.‘
In assessing the level of materiality there are a number of areas that should be considered.
Firstly, the auditor must consider both the amount (quantity) and the nature (quality) of any
misstatements, or a combination of both. The quantity of the misstatement refers to the relative
size of it and the quality refers to an amount that might be low in value but due to its prominence
could influence the user‘s decision, for example, directors‘ transactions.
In assessing materiality, the auditor must consider that a number of errors each with a low value
may when aggregated amount to a material misstatement.
The assessment of what is material is ultimately a matter of the auditors‘ professional judgment,
and it is affected by the auditors‘ perception of the financial information and needs of users of the
In calculating materiality, the auditor should also consider setting the performance materiality
level. This is the amount set by the auditor, it is below materiality, and is used for particular
transactions, account balances and disclosures.
Question No. 19
Explain the audit procedures that the auditor should perform in assessing whether or not the
company is a going concern. (5 Marks December 2010)
Answer
The auditor should perform at least the following procedures:
 Obtain the company‘s cash flow forecast and review the cash in and out flows. Assess the
assumptions for reasonableness and discuss the findings with management to understand if
the company will have sufficient cash flows.
 Perform a sensitivity analysis on the cash flows to understand the margin of safety the
company has in terms of its net cash in/out flow.
 Review any bank correspondence to assess the likelihood of the bank renewing the overdraft
facility.
 Review any current agreements with the bank to determine whether any key ratios have been
breached.
 Discuss with the directors whether they have contacted any alternative banks for finance to
assess whether they have any other means of repaying the bank overdraft.

 Review the company‘s post year-end sales and order book to assess if the levels of trade are
likely to increase and if the revenue figures in the cash flow forecast are reasonable.
 Review post year end correspondence with suppliers to identify if any further restrictions in
credit have arisen, and if so ensure that the cash flow forecast reflects an immediate payment
for trade creditors.
 Inquire of the lawyers of the company as to the existence of litigation and claims; if any exist
then consider their materiality and impact on the going concern basis.
 Perform audit tests in relation to subsequent events to identify any items that might indicate
or mitigate the risk of going concern not being appropriate.
 Review the post year end board minutes to identify any other issues that might indicate
financial difficulties for the company.
 Review post year end management accounts to assess if in line with cash flow forecast.
 Consider whether any additional disclosures in relation to material uncertainties over going
concern should be made in the financial statements.
 Obtain a written representation confirming the director‘s view that the entity is a going
concern.
Question No. 20
Briefly describe the following relating to risk-based auditing: (3 Marks each December 2010)
a) Risk criteria
b) Risk retention
c) Risk sharing
d) Risk treatment
Answer
a) Risk criteria
Risk criteria means the terms of reference by which the significance of risk is assessed.
NOTE: Risk criteria can include associated cost and benefits, legal and statutory requirements,
socioeconomic and environmental aspects, the concerns of stakeholders, priorities and other
inputs to the assessment.
b) Risk retention
It means the acceptance of the burden of loss, or benefit of gain, from a particular risk:
NOTE 1: Risk retention includes the acceptance of risks that have not been identified.
NOTE 2: The level of risk retained may depend on risk criteria
c) Risk sharing
It means sharing with another party the burden of loss or benefit of gain from a particular risk.
NOTE 1: Legal or statutory requirements can limit, prohibit or mandate the sharing of some
risks.
NOTE 2: Risk sharing can be carried out through insurance or other agreements.
NOTE 3: Risk sharing can create new risks or modify an existing risk.
d) Risk treatment
It means the process of selection and implementation of measures to modify risk:
NOTE 1: The term ‗risk treatment‘ is sometimes used for the measures themselves.
NOTE 2: Risk treatment measures can include avoiding, modifying, sharing or retaining risk.

Question No. 21
You are the audit manager in the firm of Deva & Co., an audit firm with ten national offices.
One of your clients, Shreha & Sons, purchases diamond jewelry from three manufacturers.
The jewelry is then sold from Shreha & Sons‟s four shops. This is the only client your firm has
in the diamond industry.
You are planning to attend the physical inventory count for Shreha & Sons. Inventory is the
largest account on the balance sheet with each of the four shops holding material amounts.
Due to the high value of the inventory, all shops will be visited, and test counts performed.
With the permission of the directors of Shreha & Sons, you have employed Umang Jewelers
(UJ), a firm of specialist diamond valuers who will also be in attendance. UJ will verify that
the jewelers are, in fact, made from diamonds and that the jeweler is saleable with respect to
current trends in fashion. UJ will also suggest, on a sample basis, the value of specific items of
jewelry.
Counting will be carried out by shop staff in teams of two using pre-numbered count sheets.
Required:
a) List and explain the reason for the audit procedures used in obtaining evidence in
relation to the inventory count of inventory held in the shops. (10 Marks June 2011)
b) Explain the factors you should consider when placing reliance on the work of UJ.
(5 Marks June 2011)
c) Describe the audit procedures you should perform to ensure that jewelry inventory is
valued correctly. (5 Marks June 2011)
Answer
a) Audit procedure
Audit procedure – Physical count Reason for procedure
 Perform an overall review with client staff  Check that client‘s physical count
ensures that they are following the client‘s instructions are being followed as this will
physical count instructions. Specifically help to ensure that the count is complete
ensure that: and accurate
 Inventory is divided into appropriate  Confirms a clear layout of inventory
sections for recording – perhaps by type of ensuring. items are not missed
jewelry
 Staff are counting in pairs with one person  Prevents collusion and provides a check
checking the inventory and another over security of inventory (jewelry is high
recording details value) and. that the count sheets are not
falsified
 Appropriate checks are in place to ensure  Check to ensure that inventory is not
that each item of jewelry is only counted double counted
once
 The shop is closed during the count  To ensure that there is no confusion
regarding which items are sold
 Count sheets are pre-numbered  To ensure that no count sheets are lost
 Obtain a sample of inventory items already  Check to ensure that the inventory
recorded on the inventory sheets and agree recorded on the inventory sheets actually
to the jewelry inventory exists
 For a sample of jewelry in the shop, agree  Check to ensure that all inventory is
to the count sheets. recorded on the inventory sheets– check
for completeness of recording

 Obtain a sample of count sheets,  To check that details on the count sheets
photocopy and place on the audit file are not amended post physical count and
for agreement to the final inventory sheets
to ensure quantities are recorded correctly
 Check all count sheets are returned after  Ensures that all sheets are accounted for
the physical inventory count and inventory. is therefore not understated
 Obtain last inventory receipt note and sales  To ensure that cut off is correct.
invoice numbers Subsequent checking should show that
goods received notes post physical count
are not included in payables for the year,
and sales invoices after the physical
inventory are not included in sales for the
year
 Review the condition of the jewelry with  To check that any inventory which is
the independent valuer. Ensure that there damaged or unsaleable is correctly valued
are no reasons why the inventory could be
obsolete (e.g. due to changes in fashion) or
damaged
 Form an opinion regarding the overall  To confirm that inventory quantities have
accuracy of the physical count been correctly. recorded.
(b) Factors to consider when placing reliance on the work of UJ:
Deva & Co. need to confirm that they actually need an expert. It is not clear whether Deva & Co.
have the necessary skills in-house. However, given that Shreha & Sons is the only client in the
diamond industry, then some assistance would be expected as valuing diamonds is difficult.
Check that the specialist has relevant experience in valuing diamond jewelry. Part of the
appointment process will include checking the work portfolio of UJ to show that they have
valued diamonds in other situations.
Ensure that UJ is a member of an appropriate professional body. This will help ensure that UJ
follow the appropriate ethical standards as these will be enforced by their professional body.
Check that UJ cannot be influenced by the client – for example because they are employed by
Shreha & Sons. Being employed by the client would imply less independence and limit the value
of the specialist‘s report.
Check that the report produced by the specialist regarding the valuation of the diamonds appears
to be reasonable. Although Deva & Co. do not have any other clients retailing diamonds, basic
price comparisons for a given weight of diamond could still be obtained from other shops or
Internet site to prove the accuracy of UJ‘s figures.
(c) Audit evidence
The jewelry inventory should be valued at the lower of cost and net realizable value.
For a sample of jewelry on the final inventory sheets, trace the cost of those items to the original
purchase invoice, ensuring that the description of goods on the invoice matches the jewelry.

For jewelry sold after the end of the year, check a sample of sales invoices back to the final
inventory sheets ensuring that the sales value exceeds the cost. Where sales value is less than
cost, ensure that the jewelry is stated at the realizable value on the inventory sheet.
Review the report of the professional valuer. Ensure that the inventory is genuine. For the items
checked by the valuer, agree the valuation to the items of jewelry on the inventory statements.
Where there is a difference, for example due to age of the inventory or where it is unlikely to be
sold due to changes in fashion, discuss with the client and agree a realistic valuation. In these
situations, the value should be that provided by the professional valuer.
Where an item has been in inventory for a long period of time (perhaps over one year), check the
valuer‘s report to find out whether any allowance is required.
Question No. 22
While entering into a contract with UNDP for the Audit of Nationally Executed Programme of
UN funded programme in Nepal, M/S. Chamatkar & Associates, Chartered Accountants
approached to BC Corporate bank Ltd. to provide a bank guarantee for the period of 9 months
effective from Baishakh to Poush 2068 and the bank accordingly issued a bank guarantee of
Rs. 2 Million for the same period on 2nd Baishakh 2068. In the forthcoming Annual General
Meeting of BC Corporate Bank ltd, held on Jestha 15th, appointed M/S. Chamatkar &
Associates as an auditor of the bank for the Fiscal Year 2067/68. Does the bank guarantee
create a threat to the independence of auditor, i.e. M/S. Chamatkar & Associates?
(4 Marks June 2011)
Answer
A loan, or a guarantee of a loan, to the firm from an assurance client that is a bank or a similar
institution, would not create a threat to independence provided the loan or guarantee, is made
under normal lending procedures, terms and requirements and the loan is immaterial to both firm
and the assurance client. If the loan amount or the guarantee is material to the assurance client or
the firm it may be possible, through the application of safeguards, to reduce the self-interest
threat created to an acceptable level. Such safeguards might include involving an additional
professional accountant from outside the firm, or network firm, to review the work performed.
Conclusion: considering the materiality level of guarantee, it does not create a threat to the
independence of auditor as the transaction with the bank is occurred in a normal course of
business procedures.
Question No.23
As an internal auditor for a large manufacturing concern, you are asked to verify whether
there are adequate records for identification and valuation of plant and machinery, tools and
dies and whether any of these items have become obsolete and not in use. Draft a suitable
audit program for the above. (5 Marks December 2011)
Answer
The Internal Audit Program in connection with the identification and valuation of plant and
machinery and tools and dies:
i. Check the maintenance of separate register for hired assets, leased assets and jointly owned
assets and whether these are appropriately maintained or not.
ii. Check the maintenance of register of property, plant and equipment and reconciling to
physical inspection of property, plant and equipment and to nominal ledger.

iii. Examine accurate recordings for all the movements of assets including additions and
disposals.
iv. Examine the system of authorization for – (i) declaring a property, plant and equipment
scrapped, (ii) selling a property, plant and equipment.
v. Ensure Verification for additions to property, plant and equipment register and checking by
a competent authority.
vi. Check the procedures for the purchase of new property plant and equipment, including
written authority, work order, voucher and other relevant evidence.
vii. Examine the system of regular review of adequate security arrangements.
viii. Review the registers and records of plant, machinery, etc. showing clearly the date of
purchase of assets, cost price, location, depreciation charged, etc.
ix. Cost Report and Journal Register: Review the cost relating to each plant and machinery and
to verify items which have been capitalized.
x. Code Register: Ensure each item of plant and machinery has been given a distinct code
number to facilitate identification and verify the maintenance of Code Register.
xi. Conduct Physical Verification of assets
xii. Verify (a) whether a Movement Register for movable equipment and (b) logbooks in case
of vehicles, etc. are being maintained properly.
xiii. Review whether assets have been disposed of after proper technical and financial advice
and sales/disposal/retirement, etc. of these assets are governed by authorization, sales
memos or other appropriate documents.
xiv. Check the Maintenance of a separate register of tools, spare parts for each plant and
machinery.
xv. Scrutinizing the program for an actual periodical servicing and overhauling of machines
and to examine the extent of utilization of maintenance department services.
xvi. Scrutinizing whether expert‘s opinion have been obtained from time to time to ensure
purchase of technically most useful efficient and advanced machinery after a thorough
study.
xvii. Review R&D activity and ascertain the extent of its relevance to the operations of the
organization, maintenance of machinery efficiency and prevention of early obsolescence.
Question No. 24
"Designing an Audit Strategy" is the backbone of the Audit planning process. Discuss.
(5 Marks June 2012)
Answer
a) Audit strategy is concerned with designing optimized audit approaches that seeks to achieve
the necessary audit assurance at the lowest cost within the constraints of the information
available. The formulation of audit strategy as shall be evident from the process as explained
in the following paragraphs in fact shall form the basis of audit planning to achieve the audit
objectives in the most efficient and effective manner. Audit strategy generally involves the
following steps:
(i) Obtaining Knowledge of Business:

In performing an audit of financial statements, the auditor should have or obtain knowledge
of the business sufficient to enable the auditor to identify and understand the events,
transactions and practices that, in the auditor‘s judgement, may have a significant effect on
the financial statements or on the examination or audit report. Knowledge of the business is
a frame of reference within which the auditor exercises professional judgement.
Understanding the business and using this information appropriately assists the auditor in

assessing risks and identifying problems, planning and performing the audit effectively and
efficiently. It also ensures that the audit staff assigned to an audit engagement obtains
sufficient knowledge of the business to enable them to carry out the audit work delegated to
them. This would also ensure that the audit staff understands the need to be alert for
additional information and the need to share that information with the auditor and the other
audit staff.
(ii) Performing Analytical Procedures:

The purpose of analytical procedures at the planning stage is attention-directing;
corroboration is not normally necessary at this stage. The use of the analytical procedures
during the planning stage requires the extensive use of accounting and business knowledge
and experience to assess the potential for material misstatement in the financial statements
as a whole, because the key aspect of the task is to identify the relevant risk indicators and
to interpret them properly. Furthermore, analytical techniques applied during the planning
stage are not generally as precise as the analytical techniques at the substantive stage.
(iii) Evaluating Inherent Risk:

To assess inherent risk, the auditor would use professional judgement to evaluate numerous
factors such as quality of accounting system, unusual pressure on management, etc. having
regard to his experience of the entity from previous audit engagements of the entity, any
controls established by management to compensate for a high level of inherent risk, and his
knowledge of any significant changes which, might have taken place since his last
assessment.
(iv) Evaluating Internal Control:

The auditor‘s assessment of the control environment is crucial to the decision on whether to
make an extended assessment of controls. This is because a good control environment is
conducive to the maintenance of a reliable system of accounting and control procedures.
For strategy purposes, the auditor should obtain a sufficient understanding of the control
environment. The auditor needs an understanding of the accounting systems, regardless of
whether the audit strategy will involve an extended assessment of internal accounting
controls. This is done by:
a) considering the results of gathering or updating information about the client; and
b) making preliminary judgements about materiality, inherent risk and control
effectiveness. These will include identification of the system(s) the auditor proposes
to subject to an extended assessment of controls.
Thus, the audit strategy is evolved after considering the engagement objectives, the results
of the business review, preliminary judgements as to materiality and identified inherent
risks. Audit strategy also considers main points relating to planning and controlling the
audit or comments on adequacy of the existing arrangements. Thus, the overall audit plan
involving determination of timing, manpower, coordination and the directions in which the
audit work has to proceed is dependent upon the audit strategy formulated by the audit firm.
Question No. 25
Express your opinion as an auditor on the following case: (5 Marks each December 2012)
While the refrigeration units were undergoing modernization Apple & Co. outsourced all its
cold storage requirements to Dugar & Co. Warehousing Services. At 31st March 2009, it was
not possible to physically inspect Apple‟s inventory held by Dugar & Co. due to health and

safety requirements preventing unauthorized access to cold storage areas. Apple‟s

management has provided written representation that inventory held at 31 st March 2009 was Rs.
10.1 million (2008 - Rs. 6.7 million). This amount has been agreed to a costing of Dugar &
Co.‟s monthly return of quantities held at 31st March 2009.
Answer
Outsourced Matters to be considered: Audit evidence:
cold storage  Inventory at 31 March 2009 represents 21%  A copy of the health and safety
of total assets (10·1/48·0) and is therefore a regulation preventing the auditor
very material item in the balance sheet. from gaining access to Dugar &
 The value of inventory has increased by 50% Co.‘s cold storage to inspect
though revenue has increased by only 7·5%. Apple‘s inventory.
Inventory may be overvalued if no allowance  Analysis of Dugar & Co.‘s monthly
has been made for slow-moving/perished returns and agreement of
items in accordance with NAS. significant movements to
 Inventory turnover has fallen to 6·6 times per purchase/sales invoices.
annum (2008 – 9·3 times). This may indicate  Analytical procedures such as
a buildup of unsaleable items. month-on-month comparison of
Assumption: In the absence of cost of sales gross profit percentage and
information, this is calculated on revenue. It inventory turnover to identify any
may also be expressed as the number of days trend that may account for the
sales in inventory, having increased from 39 to increase in inventory valuation
55 days. (e.g. if Apple has purchased
 Inability to inspect inventory may amount to replacement inventory but spoiled
a limitation in scope if the auditor cannot items have not been written off).
obtain sufficient audit evidence regarding  Physical inspection of any
quantity and its condition. This would result inventory in Apple‘s refrigeration
in an ‗except for‘ opinion. units after the balance sheet date to
 Although Dugar & Co.‘s monthly return confirm its condition.
provides third party documentary evidence  An aged-inventory analysis and
concerning the quantity of inventory it does recalculation of any allowance for
not provide sufficient evidence with regard to slow-moving items.
its valuation. Inventory will need to be  A review of after-date sales
written down if, for example, it was invoices for large quantities of fish
contaminated by the leakage (before being to confirm that fair value (less costs
moved to Dugar & Co.‘s cold storage) or to sell) exceed carrying amount.
defrosted during transfer.  A review of after-date credit notes
Apple‘s written representation does not for any returns of
provide sufficient evidence regarding the contaminated/perished or otherwise
valuation of inventory as presumably substandard fish.
Apple‘s management did not have access to
physically inspect it either. If this is the case
this may call into question the value of any
other representations made by management.
 Whether, since the balance sheet date,
inventory has been moved back from Dugar
& Co.‘s cold storage to Apple‘s refrigeration
units. If so, a physical inspection and roll-
back of the most significant fish lines should
have been undertaken.

Assumption: Credit will be awarded for other

relevant accounting issues. For example, a
candidate may question whether, for example,
cold storage costs have been capitalized into the
cost of inventory. Or whether inventory moves
on a FIFO basis in deep storage (rather than
LIFO).
Question No. 26
Distinguish between Audit Planning and Audit Program. (4 Marks December 2012)
Answer:
Audit planning and audit program

Audit planning is one of the basic principles of auditing. The auditor plans his work to enable
him to conduct an effective audit in an efficient and timely manner. Plan should be based on
knowledge of the client‘s business. Audit planning is a continuous process throughout the audit
engagement and covers developing an overall plan for the expected scope and conduct of the
audit and developing an audit program showing the nature, timing and extent of audit procedures.
Audit program is nothing but a list of examination and verification steps to be applied set out in
such a way that the inter-relationship of one step to another in clearly shown and designed,
keeping in view the assertions discernible in the statements of account produced for audit or on
the basis of an appraisal of the accounting records of the client. In other words, an audit program
is a detail plan of applying the audit procedures in the given circumstances with instructions for
the appropriate techniques to be adopted for accomplishing the audit objectives.
Question No. 27
How do you assess the Audit Risk? Explain as an auditor. (4 Marks June 2013)
Answer:
Audit risk is fundamental to the audit process because auditors cannot and do not attempt to
check all transactions. Thus, the audit risk is the risk that auditor express an inappropriate audit
opinion when the financial statements are materially misstated. Audit risk is a function of
material misstatement and detection risk. The risk of material misstatement has two components,
inherent risk and control risk.
Inherent risk this is the susceptibility of an assertion about a class of transaction, account
balance, or disclosure to a misstatement that could be material, either individually or when
aggregated with other misstatements, before consideration of any related controls.
Control risk, this is the risk that a misstatement could occur in an assertion about a class of
transaction, account balance or disclosure, and that the misstatement could be material, either
individually or when aggregated with other misstatements, and will not be prevented or detected
and corrected, on a timely basis, by the entity‘s internal control.
Detection risk is the risk that an auditor‘s procedures will not detect a misstatement that exists in
an account balance or class of transactions that could be material, individually or when
directly to the auditor‘s procedures. Some detection risk would always be present even if an
auditor were to examine 100 percent of the account balance or class of transaction because, for

example, the auditor may select an inappropriate audit procedure, misapply an appropriate audit
procedure or misinterpret the audit results.
Question No. 28
You have been appointed as the auditor of QFX Cinema Pvt. Ltd. Draw an audit programme
in respect of its revenue and expenditure. (5 Marks December 2013)
Answer
a) Audit Programme of revenue and expenditure of QFX Cinema Pvt. Limited are as follows:
i) Review of the Memorandum and Article of Association of the entity.
ii) Ensure the object clause permits the entity to engage in this type of business.
iii) In the case of income from sales of tickets:
a) Verify the control system as to how it is ensured that the collections on sale of
tickets of various shows are properly accounted.
b) Verity the system of relating to online booking of various shows and the system
of realization of money.
c) Check that there is overall system of reconciliation of collection with the
number of seats available for different shows on a day.
d) Ensure that the fund collected are properly accounted and deposited in bank
account.
iv) Verify the internal control system and its effectiveness relating to the income from
cafes shop, pubs etc. located within the Cinema Hall.
v) Verify the system of control exercised relating to the income receivable from
advertisement exhibited within the premises and inside the hall such as hoarding,
banners, slides, short films etc.
vi) Verify the system of collection from the parking areas in respect of the vehicles
parked by the customers.
vii) In the case of payment to distributors verify the system of payments which may be
either though outright payment or percentage of collection or a combination of both.
Ensure at the time of settlement any payment of advance made to the distributor is
also adjusted against the amount due.
viii) Verify the system of payment of salaries and other benefits to the employees and
ensure that statutory requirements are complied with.
ix) Verify the payments effected in respect of the maintenance of the building and
ensure the same is in order.
Question No. 29
“The audit of financial statements relieves management of its responsibilities”.
Comment. (6 Marks December 2013)
Answer:
Basically, it is the management of an enterprise, which is responsible for preparation of financial
statements. Management‘s responsibilities include maintaining an adequate accounting system,

proper internal control system, selection and application of accounting policies and safeguarding
the assets of the enterprise. Under no circumstances, the audit of financial statements would
relieve the management of its responsibilities. It must be understood clearly that the role of
auditor is to express an independent opinion on the financial statements prepared by the
management of an enterprise. In fact, it is the management which is entrusted with the
responsibility by the shareholders to manage the enterprise in the most efficient and effective
manner. Therefore, it is the primary responsibility of the management to maintain books of
account and prepare financial statements in a manner so that same portray a true and fair picture
of the enterprise. Thus, the basic responsibilities of the management are much broader which in
any case cannot be reduced by audit.
Question No. 30
Define “Audit Risk”. What are the risk assessment procedures? (8 Marks December 2014)
Answer
Audit Risk
The risk that the auditor expresses an inappropriate audit opinion when the financial statements
are materially misstated is called audit risk. Audit risk is a function of material misstatement and
detection risk.
Audit risk is fundamental to the audit process because auditors cannot and do not attempt to
check all transactions. It would be impossible to check all of these transactions, hence the
importance of risk-based approach towards auditing has been realized. Auditors should direct
audit work to the key risks – significant risks where it is more likely that errors in transactions
and balances will lead to a material misstatement in the financial statements.
The auditor should obtain an understanding sufficient to assess audit risks, and these risks must
then be considered when designing the audit plan.
There are three types of risks:
(i) Inherent Risk
This is the susceptibility of an assertion about a class of transactions, account balance or
disclosure to a misstatement that could be a material, either individually or when aggregated
with other misstatements, before consideration of any related controls.
(ii) Control risk
This is a risk that a misstatement could occur in an assertion about a class of transaction,
account balance or disclosure and that the misstatement could be material, either
individually or when aggregated with other misstatements and will not be prevented or
detected and corrected on a timely basis, by the entity‘s internal control.
(iii)Detection risk
This is the risk that the procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement that exists and that could be material
either individually or when aggregated with other misstatements.
Risk Assessment procedures
The auditor should perform risk assessment procedures to provide a basis for the identification
and assessment of risks of material misstatement in the financial statement. Auditor should
identify the following risk assessment procedures:
(i) Making inquiries of management and others within the entity
Auditors must have discussions with the client‘s management about its objectives and
expectations and its plans for achieving those goals.
(ii) Analytical procedures

Analytical procedures performed as risk assessment procedures shall help auditor in

identifying unusual transactions or positions. They may identify aspects of the entity of
which the auditor was unaware and may assist in assessing the risks of material
misstatement in order to provide a basis for designing and implementing responses to the
assessed risks.
(iii) Observation and inspection
Observation and inspection may also provide information about the entity and its
environment. It may include inspection of entity‘s operations, documents and reports
prepared by management and also entity‘s premises and plant facilities.
Risk assessment procedures should, at a minimum, comprise a combination of the above
three procedures and the auditor should assess the susceptibility of the entity‘s financial
statements to material misstatement.
Question No. 31
What are the factors relevant in evaluation of inherent risk? (4 Marks December 2014)
Answer
As per the Nepal Standard on Auditing 300, the auditor should develop an audit plan in order to
reduce audit risk to an acceptably low level. The audit plan includes the nature, timing and extent
of audit procedures to be performed in order to obtain sufficient appropriate audit evidence to
reduce audit risk to an acceptably low level. While developing an overall audit plan, the auditor
is required to assess inherent risk at financial statement level and is then required to relate his
assessment to material account balances and the class of transactions. The auditor should ensure
that the major account balances are not misstated in the financial statements and also the
transactions are classified properly. To assess inherent risk, the auditor would use professional
judgment to evaluate numerous factors, having regard to his experience of the entity from
previous audit engagements of the entity, any controls established by management to compensate
for a high level of inherent risk, and his knowledge of any significant changes which might have
taken place since his last assessment. Normally, an auditor evaluates inherent risk by assessing
factors such as integrity of the management, experience and knowledge of the management,
turnover of key management personnel, circumstances which may motivate the management to
misstate the financial statement when its financial performance is not satisfactory, nature of
entity‘s business prone to rapid technological obsolescence, dealing with large number of related
parties etc. Once the assessment of the level of inherent risk is made, the auditor modifies his
initial audit plan and also may include some additional audit procedures to respond to the
assessed inherent risks.
Question No. 32
SSP Associates has been appointed as auditor of XYZ Pvt Ltd for the year ended 32 nd Ashad
2071. You are audit manager of the SSP Associates and advised to develop the overall audit
plan outlining the expected scope and conduct of the audit of XYZ Pvt Ltd.
(8 Marks June 2015)
Answer
As an auditor of XYZ Pvt Ltd, an overall audit plan should be developed and documented
describing the expected scope and conduct of the audit. While the record of the overall audit plan
will need to be sufficiently detailed to guide the development of the audit program, its precise
form and content will vary depending on the size of the entity, the complexity of the audit and
the specific methodology and technology used in this process.

As per NSA 300, the audit plan shall include following matters:
(a) Knowledge of the Business of XYZ Ltd
 General economic factors and industry conditions affecting the XYZ‘s business.
 Important characteristics of the XYZ, its business, its financial performance and its
reporting requirements including changes since the date of the prior audit.
 The general level of competence of management.
(b) Understanding the Accounting and Internal Control Systems

 The accounting policies adopted and changes in those policies.
 The effect of new accounting or auditing pronouncements.
 Knowledge of the accounting and internal control systems and the relative emphasis
expected to be placed on tests of control and substantive procedures.
(c) Risk and Materiality

 The expected assessments of inherent and control risks and the identification of
significant audit areas.
 The setting of materiality levels for audit purposes.
 The possibility of material misstatement, including the experience of past periods, or
fraud.
 The identification of complex accounting areas including those involving accounting
estimates.
 Nature, Timing and Extent of Procedures

 Possible change of emphasis on specific audit areas identified.
 The effect of information technology to be used on the audit.
 The work of internal auditing and its expected effect on external audit procedures.
(d) (Coordination, Direction, Supervision and Review

 The involvement of other auditors in the audit of components, for example,
 subsidiaries, branches and divisions if any.
 The involvement of experts.
 The number of locations.
 Audit staffing requirements.
(e) Other Matters

 The possibility that the going concern assumption may be subject to question.
 Conditions requiring special attention, such as the existence of related parties.
 The terms of the engagement and any statutory responsibilities.
 The nature and timing of reports
Question No. 33
Mention briefly the conditions or events, which increase the risk of fraud or error leading to
material misstatement in Financial Statements. (5 Marks June 2015)
Answer.
NSA 240 "The Auditors responsibility relating to fraud in an audit of financial statements" states
that in planning and performing his examination, the auditor should take into consideration the
risk of material misstatements of the financial information caused by fraud or error. Appendix 3
to NSA 240 provides examples of circumstances that indicate the risk of fraud or error leading to
material misstatement in Financial Statements. Such circumstances are:

i) Unrealistic time deadlines for audit completion imposed by management.

ii) Reluctance by management to engage in frank communication with appropriate third
parties, such as regulators.
iii) Limitation in audit scope imposed by management.
iv) Identification of important matters not previously disclosed by management.
v) Significant difficult - to-audit figures in the accounts.
vi) Aggressive application of accounting principles.
vii) Conflicting or unsatisfactory evidence provided by management or employees.
viii) Unusual documentary evidence such as handwritten alternations to documentation, or
handwritten documentation which is ordinarily electronically printed.
ix) Information provided unwillingly or after unreasonably delay.
x) Seriously incomplete or inadequate accounting records.
xi) Unsupported transactions.
xii) Unusual transactions, by virtue of their nature, volume or complexity, particularly if
such transactions occurred close to the year end.
xiii) Transactions not recorded in accordance with managements general or specific
authorization.
xiv) Significant unreconciled differences between control accounts and subsidiary records or
between physical count and the related account balance which were not appropriately
investigated and corrected on a timely basis.
xv) Inadequate control over computer processing.
xvi) Significant differences from expectations disclosed by analytical procedures.
xvii) Fewer confirmation responses than expected or significant differences revealed by
confirmation responses.
xviii) Evidence of an unduly lavish lifestyle by officers or employees.
xix) Un-reconciled suspense accounts.
xx) Long outstanding account receivable balances.
Question No. 34
Describe the steps involved in designing of an audit strategy. (5 Marks June 2016)
Answer
The designing of an audit strategy generally involves following steps:
i) Obtaining knowledge of business: Understanding the business and using this information
appropriately assists the auditor in assessing risks, identifying problems, planning and
performing audit effectively and efficiently, evaluating audit evidence and provide better
service to the client.
ii) Performing analytical procedure at initial stages: The use of analytical procedures during
the planning stage requires the extensive use of accounting and business knowledge and
experience to assess the potential for material misstatement in the financial statements as
a whole, for identifying the relevant risk indicators and to interpret them properly.
iii) Evaluating inherent risk: To access inherent risk, the auditor would use professional
judgment to evaluate numerous factors, having regard to his experience of the entity from
previous audit engagements, any controls established by the management to compensate
for a high level of inherent risk, and the knowledge of any significant changes which
might have taken place since his last assignment.
iv) Evaluating Internal Controls: The auditor needs an understanding of the accounting
systems, regardless of whether the audit strategy will involve an extended assessment of
internal accounting controls.

v) Formulation of strategy: The auditor should develop the strategy by:
a. Considering the results of gathering or updating information about the client, and
b. Making preliminary judgments about materiality, inherent risk and control
effectiveness.
Question No. 35
What are the major sources of obtaining information about the client‟s business?
(5 Marks June 2016)
Answer
Information about the client‘s business: The auditor can obtain information about client‘s
business from the following sources:
(i) The client‘s annual reports to shareholders;
(ii) Minutes of meetings of shareholders, board of directors and important committees;
(iii) Internal financial management report for current and previous periods, including
budgets, if any;
(iv) The previous year‘s audit working papers, and other relevant files;
(v) Firm personnel responsible for non-audit services to the client who may be able to
provide information on matters that may affect the audit;
(vi) Discussions with the client;
(vii) The client‘s policy and procedures manual;
(viii) Relevant publications of the Institute of Chartered Accountants of Nepal and other
professional bodies, industry publication, trade Journals, magazines, newspapers or
textbooks;
(ix) Consideration of the state of the economy and its effects on the client‘s business;
(x) Visits to the client‘s premises and plant facilities to the management.
Question No. 36
a) You are the senior audit in charge of the client ABC Securities Ltd., which deals in trading
of securities. The financial year ended 31stAshadh 2073 is the first year of operations of
ABC. You do not have previous experience in auditing a securities company but there are
several securities companies that are audited by your firm. Your manager has advised that
you must plan and perform the audit with an attitude of professional skepticism.
Required:
i) Explain why professional skepticism needs to be maintained throughout the audit.
ii) Outline procedures that you can use to identify the risk of material misstatements in
the financial statements of ABC Securities Ltd.
b) In the course of audit of A Ltd. you suspect the management has indulged in
fraudulent financial reporting. State the possible sources of such fraudulent financial
reporting.
a) Answer
i) Professional skepticism is necessary for the critical assessment of audit evidence. This
includes questioning contradictory audit evidence and the reliability of documents and
responses to inquiries and other information obtained from management and those
charged with governance. It also includes consideration of the sufficiency and

appropriateness of audit evidence obtained in the light of the circumstances, for

example, in the case where fraud risk factors exist and a single document of a nature
that is susceptible to fraud, is the sole supporting evidence for a material financial
statement amount.
Maintaining professional skepticism throughout the engagement is necessary if the
practitioner is, for example, trying to reduce the risks of:
1. Overlooking unusual circumstances
2. Over-generalizing when drawing conclusions from observations.
3. Using inappropriate assumptions in determining the nature, timing and extent of the
procedures and evaluating the results thereof.
ii) Outline procedures to identify risk of material misstatements.
Observation
1) Consider information obtained from the client acceptance process is relevant for
identifying risks of material misstatement.
2) Obtain an understanding of the industry through publications or websites related to
the industry.
Inquiry
3) Obtain an understanding of the industry through inquiries of management and
internal audit.
4) Inquiry from those charged with governance such as audit committee and board of
directors.
5) Discussion with audit partners, managers and staff who have handled audits of
other securities company within the firm.
Inspection
6) Review of reports prepared by management (such as quarterly management report
and interim financial statements) and those charged with governance (such as
minutes of meetings of the board of directors).
7) Review of documents (such as business plans and strategies), records, and internal
control manuals.
Analytical Procedures
8) Analytical procedures using anticipated results of the entity from budgets or
forecasts or industry information.
b) Answer
As per NSA 240, ―The Auditor‘s responsibilities relating to Fraud in an Audit of
Financial Statements‖, fraudulent financial reporting involves intentional misstatements
or omissions of amounts or disclosures in financial statements to deceive financial
statement users. It may be accomplished by manipulation, falsification, or alteration of
accounting records or supporting documents from which the financial statements are
prepared or Misrepresentation in, or intentional omission from, the financial statements
of events, transactions or other significant information or intentional misstatements
involve intentional misapplication of accounting principles relating to measurement,
recognition, classification, presentation, or disclosure etc. It often involves management
override of controls, misappropriation of assets etc. that otherwise may appear to be
operating effectively. Fraud can be committed by management overriding controls
using such techniques as:
1) Recording fictitious journal entries, particularly close to the end of an accounting
period, to manipulate operating results or achieve other objectives.
2) Inappropriately adjusting assumptions and changing judgments used to estimate
account balances.

3) Omitting, advancing or delaying recognition in the financial statements of events

and transactions that have occurred during the reporting period.
4) Concealing, or not disclosing, facts that could affect the amounts recorded in the
5) Engaging in complex transactions that are structured to misrepresent the financial
position or financial performance of the entity.
6) Altering records and terms related to significant and unusual transactions.
7) Embezzling receipts (for example, misappropriating collections on accounts
receivable or diverting receipts in respect of written-off accounts to personal bank
accounts).
8) 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).
9) Causing an entity to pay for goods and services not received
10) Using an entity‘s assets for personal use.
Question No. 37
a) Manoj, a member of the board of Swift Tires Limited (STL), has emphasized the
following at a recent board meeting:
“Risk is the main cause of uncertainty in any organization. Thus, we need to increase
our focus on identifying risks and managing them before they affect the business”.
The board of directors was in agreement with Manoj. The board concluded that there
should be a formal process of identifying and responding to the risks faced by the
company.
Further, the directors agreed to implement necessary measures to address the prevailing
internal control weaknesses identified by the internal auditor of the company.
i) Identify the ways of responding to risks faced by a business organization.
ii) Explain the responsibilities of the following persons for internal controls of the
company:
a. the board of directors and
b. the internal auditor
Answer:
a)
i) A business organization may identify various ways to respond to the risks faced by it.
Following are the most common ways to respond risks:
 Risk avoidance – this removes the possibility of a negative risk outcome. All risks
cannot be avoided. To avoid risks, the management may refrain from making risk
decisions on new investments, developing new products etc.
 Risk acceptance- Accepting the existing amount of risks, without the need for further
measures to treat the risk. For instance, after considering the benefits/rewards the
management may accept certain risks, e.g. in the economy there is an increase in the
interest rate. However, in the long term there is an expectation of a reduction in the
interest rate. Therefore, management may borrow at a variable rate.

 Risk transfer – Transferring the risk to someone else. Insurance is a very common
measure taken by many business organizations to transfer risk. (insurance on fire,
disaster etc.)
 Risk reduction – Management may decide to reduce the risk if it is too high and
unacceptable. The methods of reducing risk depend on the nature of the risk. For
instance, diversification of operations, business contingency planning are few ways of
reducing risks.
ii)
a. Responsibility of Board of directors for internal controls (3 marks)
The board of directors of the company is the governing body. The directors have final
responsibility for the effectiveness of the internal controls of the company. This means the
board of directors are ultimately responsible to the shareholders of the company.
The board of directors of STL has a responsibility to ensure that the company has an
effective control system in order to comply with applicable regulatory requirements,
preparation and presentation of Financial Statements and safeguard the investments and
the assets of STL. In discharging its responsibility, the board may get the assistance of the
internal auditor to ensure that the controls are operating effectively.
b. Responsibility of Internal auditor for Internal controls (3 marks)

The internal auditor provides management with assurance and consulting services
regarding effectiveness of internal control system, risk management and governance
process to improve the business operations and to add value to the business. Internal
auditor provides information and recommendations about internal controls. He/she does
not have direct responsibility for internal controls of STL.
Internal auditors evaluate control systems and report to the board of directors of STL (as
per information provided in scenario) on findings and recommendations. These testing and
the areas of testing are determined as per the agreed internal audit charter of the company.
Question No. 38
Write short notes on the following:)
a. Audit Risk (4 Marks December 2005)

Answer:
Audit risk means the risk that the auditor gives an inappropriate audit opinion when the
financial statements are materially misstated. Audit risk has three components: inherent risk,
control risk and detection risk.
Inherent risk is the susceptibility of an account balance or class of transactions to misstatement
that could be material, individually or when aggregated with misstatements in other balances or
classes, assuming that there were no related internal control systems.
Control risk is the risk that a misstatement that could occur in an account balance or class of
transactions and that could be material individually or when aggregated with misstatement in
other balances or classes, will not be prevented or detected and corrected on a timely basis by the
accounting and internal control systems.

Detection risk is the risk that an auditor‘s substantive procedures will not detect a misstatement
that exists in an account balance or class of transactions that could be material, individually or
when aggregated with misstatements in other balances or classes.
b.Factors relevant in evaluation of inherent risk (4 Marks June 2006)

Answer:
While developing an overall audit plan, the auditor is required to assess inherent risk at financial
statement level and is then required to relate his/ her assessment to material account balances and
the class of transactions. To assess inherent risk, the auditor would use his/ her professional
judgment to evaluate numerous factors, having regard to his/ her experience of the entity from
previous audit engagements of the entity, any controls established by management to compensate
for a high level of risk, and his/ her knowledge of any significant changes which might have taken
place since his/ her last assessment. Normally, an auditor evaluates inherent risk by assessing
factors such as:
 Integrity of the management,
 Experience and knowledge of the management,
 Turnover of key management personnel,
 Circumstances which may motivate the management to misstate the financial statement
when its financial performance is not satisfactory.
 Nature of entity's business prone to rapid technological obsolescence dealing with large
number of related parties, etc.
c. Materiality (4 Marks June 2007)

Answer
Materiality is a threshold or cut-off point for qualitative and qualitative information required to
enable the auditor to express an opinion whether the financial statements are prepared, in all
material respects, in accordance with an identified financial reporting framework. Information is
material if its omission or misstatement could influence the economic decisions of users taken on
the basis of the financial statements. Materiality depends on the size of the item or error judged in
the particular circumstances of its omission or misstatement.
The auditor should consider materiality to (i) determine the nature, timing and extent of audit
procedures; and (ii) evaluate the effect of misstatements on the fair presentation of financial
statements. The assessment of material is a matter of professional judgement.
The auditor should establish an acceptable materiality level while designing audit plan to detect
amount (quantity) and nature (quality) of material misstatements. The inadequate or improper
description of an accounting policy is an example of qualitative misstatements when it is likely
that a user of the financial statements would be misled by the description.
The auditor has to consider cumulative material effect of relatively small amounts on the financial
statements. The auditor should consider materiality at the overall financial statement level and in
relation to individual account balances, classes of transactions and disclosures.
Materiality may be influenced by considerations such as legal and regulatory requirements and
considerations relating to individual financial statement account balances and relationships. This

process may result in different materiality levels depending on the aspect of the financial
statements being considered.
d. Sampling risks (5 Marks June 2008)

Answer
As per NSA 530, "Sampling risk" arises from the possibility that the auditor's conclusion, based
on a sample may be different from the conclusion reached if the entire population were subjected
to the same audit procedure. There are two types of sampling risk:
(i) the risk the auditor will conclude, in the case of a test of control, that control risk is lower
than it actually is, or in the case of a substantive test, that a material error does not exist when
in fact it does. This type of risk affects audit effectiveness and is more likely to lead to an
inappropriate audit opinion; and
(ii) the risk the auditor will conclude, in the case of a test of control, that control risk is higher
than it actually is, or in the case of a substantive test, that a material error exists when in fact
it does not. This type of risk affects audit efficiency as it would usually lead to additional
work to establish that initial conclusions were incorrect.
The mathematical complements of these risks are termed confidence levels.
e. Field work (5 Marks December 2009)

Answer
Fieldwork is the process of gathering evidence and analyzing and evaluating that evidence as
identified in the Audit Planning process. Field work is basically the actual conduct of the audit
(performance of audit procedures) at the client‘s business establishment and its various offices
and branches where records are kept and daily business (operations) take place.
The purpose of fieldwork is to accumulate sufficient, competent, relevant, and useful evidence to
reach a conclusion concerning audit performance expectations, and to support the audit comments
and recommendations. Audit evidence is sufficient when it is factual and would convince an
informed person to reach the same conclusion. Evidence is competent if it consistently produces
the same outcomes. It is relevant when it is directly related to the audit comments,
recommendations, and conclusions.
f. Disadvantages of the use of an audit program.

(3 Marks December 2011, 5 Marks June 2012)
Answer
Disadvantages of the use of an audit program.
The possible disadvantages of the use of an audit program are:
i) 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.
ii) 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.
iii) 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.
iv) A hard & fast audit program may kill the initiative of efficient and enterprising assistants.

v) Preparation of audit program without preliminary depth assessment of client‘s business

and without considering scope of work to be carried out by auditor will not provide
objectivity of the audit work.
g. Components of audit risk (3 Marks June 2011)

that is materially misstated. Such risk may exist at overall level or while verifying various
transactions and balance sheet items. The three components of audit risk are:
1) Inherent risk: Inherent risk is the susceptibility of an assertion to a misstatement that
could be material, either individually or when aggregated with other misstatements,
assuring that there are no related controls.
2) Control risk: Control risk is the risk that a misstatement that could occur in an assertion
and that could be material, either individually or when aggregated with other
misstatements, will not be prevented, or detected and corrected, on a timely basis by the
entity‘s internal control.
3) Detection Risk: Detection risk is the risk that the auditor will not detect a misstatement
that exist in an assertion that could be material either individually or when aggregated with
other misstatements. Detection risk is a function of the effectiveness of an audit procedure
and of its application by the auditor.
Question No. 39
a. Detection risk (5 Marks June 2012)
It is the risk that an auditor‘s procedures will not detect a misstatement that exists in an
account balance or class of transactions that could be material, individually or when
directly to the auditor‘s procedures, some detection risk would always be present. Some
detection risk would always be present even if an auditor were to examine 100 percent of the
account balances.
The inherent and control risks are functions of the entity‘s business and its environment and
the nature of the account balances or classes of transactions, regardless of whether an audit is
conducted. Even though inherent and control risks cannot be controlled by the auditor, the
auditor can assess them and design his substantive procedures to produce on acceptable level
of detection risk, thereby reducing audit risk to an acceptable low level.
b. Inherent Limitations of an Audit (5 Marks December 2012)

An auditor cannot obtain absolute assurance that material misstatements in the financial
statements will be detected. 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 NSAs.
An audit does not guarantee all material misstatements will be detected because of such
factors as the use of judgment, the use of testing, the inherent limitations of internal control
and the fact that much of the evidence available to the auditor is persuasive rather than
conclusive in nature. For these reasons, the auditor is able to obtain only reasonable assurance
that material misstatements in the financial statements will be detected.

c. Audit trail (4 Marks June 2013)
1) Audit Trail can be defined as those documents, records, journals, ledgers, master files etc.
that enables an auditor to trace the transactions from the source document to the summarized
total in accounting reports or vice-versa.
2) Audit trail is the visible means whereby the auditor may have a business transaction through
all the stages in which it features in the records of the business. For example, sequentially
numbered sales invoice copies would normally be listed in a register or daybook and
subsequently filed either in numerical or chronological sequence. It would then be possible to
trace a particular invoice from the daybook to the or signal file or vice-versa by reference to
the number or date of the invoice.
3) In a manual accounting system, it is possible to relate the recoding of a transaction at each

successive stage enabling an auditor to locate and identify all documents from beginning to
end for the purposes of examining documents, totaling and cross-totaling referencing.
4) However, in an EDP environment, the use of exception reporting by management has

effectively eliminated the audit trail between input and output. Frequently computer-
generated totals, analysis and balances are not printed out in detail because the management
is not exercising control through verification of the individual items processed.
d. Risk of material misstatement (4 Marks June 2014)

Risk of material misstatement
The risk of material misstatement refers to the risk that the financial statements are materially
misstated and do not present true and fair view. The risk of material misstatement is assessed
at two levels (i) financial statements level and (ii) assertions level. Risks of material
misstatement at the financial statement level may be especially relevant to the auditor's
consideration of the risk of material misstatement due to fraud whereas risk of material
misstatement at the assertion level consists of inherent risk and control risk.
Material misstatement is related to the information present in the financial statement which
leads the financial statement users suffering from the economic loss. Misstatement means the
information suggested to be in there in financial statement is not actually what is written in
there. The overall risk increases when such cases arise and thus increasing the risk of
financial misstatement. Misstatements may be classified as fraud, other illegal acts such as
non-compliance with laws and regulations or errors. It could be intentional or unintentional.
In an audit of financial statements, audit risk is the risk that the auditor expresses an
inappropriate audit opinion when the financial statements are materially misstated, i.e., the
financial statements are not presented fairly in conformity with the applicable financial
reporting framework. Audit risk is a function of the risk of material misstatement and
detection risk.
e. Performance materiality (5 Marks June 2017)

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 exceeds materiality for the financial statements as
a whole. If applicable, performance materiality also refers to the amount or amounts set by

the auditor at less than the materiality level or levels for particular classes of transactions,
account balances or disclosures.
Risk of material misstatement

The risk of material misstatement refers to the risk that the financial statements are materially
misstated and do not present true and fair view. The risk of material misstatement is assessed
at two levels (i) financial statements level and (ii) assertions level. Risks of material
misstatement at the financial statement level may be especially relevant to the auditor's
consideration of the risk of material misstatement due to fraud whereas risk of material
misstatement at the assertion level consists of inherent risk and control risk.
Material misstatement is related to the information present in the financial statement which
leads the financial statement users suffering from the economic loss. Misstatement means the
information suggested to be in there in financial statement is not actually what is written in
there. The overall risk increases when such cases arise and thus increasing the risk of
financial misstatement. Misstatements may be classified as fraud, other illegal acts such as
non-compliance with laws and regulations or errors. It could be intentional or unintentional.
In an audit of financial statements, audit risk is the risk that the auditor expresses an
inappropriate audit opinion when the financial statements are materially misstated, i.e., the
financial statements are not presented fairly in conformity with the applicable financial
reporting framework. Audit risk is a function of the risk of material misstatement and
detection risk.
f. Sampling Risk (3 Marks December 2018)

Sampling risk: ―Sampling risk‖ arises from the possibility that the auditor‘s conclusion,
based on a sample may be different from the conclusion reached if the entire population were
subjected to the same audit procedure. There are two types of sampling risk:
i) The risk the auditor will conclude, in the case of a test of controls, that controls are more
effective than they are, or in the case of a test of details, that a material error does not
exist when in fact it does. This type of risk affects audit effectiveness and is more likely
to lead to an inappropriate audit opinion; and
ii) The risk the auditor will conclude, in the case of a test of controls, that Controls are less
effective than they are, or in the case of a test of details, that a material error exists when
in fact it does not. This type of risk affects audit efficiency as it would usually lead to
additional work to establish that initial conclusions were incorrect.
The mathematical complements of these risks are termed as confidence levels
Question No. 40
a) Everest Pharmaceuticals Products (EPP) Pvt. Ltd. is a pharmaceutical company. The
management of EPP has decided to introduce a new vitamin capsule to its product
range.
EPP operates the production facility in its own building. Adequate safety measures
have been taken to ensure that the products are manufactured to the expected quality
standards. Sophisticated large machinery as well as various types of easily moveable
equipment is used in the manufacturing process. In addition, various electrical

equipment, computers, laptops and motor vehicles for distribution are used by EPP. All
of these are considered as non-current assets of EPP.
Required: (3+3+2=8 June 2019)
i) Identify three (03) risks related to the non-current assets of EPP.
ii) Identify controls that EPP can implement to mitigate the risks identified in (i) above.
iii) List two (02) ways EPP can facilitate physical identification of non-current assets.
Answer
i)
 Building/Other assets: Damage to the building and thereby pose risk of illegal entry
to the building and factory premises.
 Other assets such as machinery, other electrical systems and motor vehicles are all
liable to break down and accidents.
 The entity has small moveable items that are non-current assets. These could be
stolen if not properly protected.
ii)
Risk Physical control
Building- damage to the building and risk Strong locks on doors, protection of windows
of illegal entry to the building and factory against breakage, burglar alarms, fire alarms,
premises CCTV cameras, security guards, insurance
policies.
Other assets such as machinery, other Protection against the risk of breakdown
electrical systems and motor vehicles are should be provided by regular maintenance.
all liable to break down.
The entity has small moveable items that These should be kept is a secure place, such as
are non-current assets. These could be a lockable place, when not being used. When
stolen if not properly protected. employees take non-current assets such as
laptops away from the office, they should be
required to sign a document as evidence that
they are in possession of the asset or monitor
the physical access through CCTV cameras.
iii) Physically identification of non-current assets:

 A manual sticker may be pasted to each fixed asset, containing the asset's unique
identification number.
 A barcode label may be attached to each fixed asset, containing data that identifies
the individual asset, including its unique identification number.
 Assets may also be identified using radio-frequency identification (RFID) tags.
 Motor vehicles - vehicle registration or chassis number.
 Other equipment (laptops, desktops etc.) - serial number

Chapter -Audit Test

Question No. 1
Describe the role of internal auditor in dealing with the risk fraud and error in an entity.
(8 Marks June 2005)
Answer:
Traditionally internal auditing has been viewed as confined merely to ensure that the accounting
and allied records are properly maintained; that the assets of the enterprise are properly
safeguarded and that the policies and procedures laid down by the management are complied with.
The modern concept suggests that internal auditing need not be confined to financial transactions
and that its scope be extended to the overall corporate governance function of an entity. Corporate
governance objectives also include the prevention and identification of frauds and errors in the
financial transactions.
The work of internal auditor focuses on the adequacy and effectiveness of internal control
procedures for the prevention, detection and reporting of fraud and error. Internal auditor is
concerned with reporting on financial information production system and year-end adjustments.
Internal auditor helps management in dealing with the risk of fraud and error in an entity by:
i. Commenting on the control procedures of the entity to identify and classify specific fraud
and errors. The internal auditor may also help in developing such procedure.
ii. Commenting on the appropriateness and effectiveness of actions taken by management to
manage the risks identified. In some cases, internal auditor can be highly helpful in
developing appropriate actions in this regard.
iii. Periodically auditing or reviewing systems or operations to determine whether the risks of
fraud and error are being effectively managed.
iv. During the course of internal auditing, internal auditor may identify and report cases of
fraud and error for timely action.
v. Monitoring the incidents of fraud and error investigating serious cases and making
recommendations for appropriate actions.
vi. Many fraud and errors especially frauds related with the high-level staff of the entity are
not controlled by the internal control. Internal auditor can report these types of frauds as
well.
Question No. 2
Write short Notes on Analytical review procedures (5 Marks June 2005)
Answer:
Analytical procedures are the analysis of significant ratios and trends including the resulting
investigation of fluctuations and relationships that are inconsistent with other relevant information
or which deviate from predicted amounts. Analytical procedures include comparison of financial
information with prior period information, anticipated results, such as budgets and similar industry
information. Analytical procedures are used for the following purposes.
To assess the auditor in planning the nature and extent of audit procedures;
As a substantive test to obtain evidential matter related to account balances or classes or
transactions; and as an overall review of the financial information in the review stage of the audit.

The auditor should apply analytical procedures at the planning stage to assist in understanding the
business and in identifying area of potential risk. Application of analytical procedures may
indicate aspects of the business of which the auditor was unaware and will assist in determining
the nature, timing and extent of other audit procedures.
Question No. 3
What are the ways of obtaining audit evidence in performing compliance and substantive
procedures? (10 Marks June 2006)
Answer:
As per NSA 500: Audit Evidence, the auditor should obtain sufficient appropriate audit evidence
to be able to draw reasonable conclusions on which to base the audit opinion. Audit evidence is
obtained from an appropriate mix of tests of control and substantive procedures. In some
circumstances, evidence may be obtained entirely from substantive procedures.
The auditor obtains audit evidence by one or more of the following procedures: inspection,
observation, inquiry and confirmation, computation and analytical procedures. The timing of such
procedures will be dependent, in part, upon the periods of time during which the audit evidence
sought is available.
a. Inspection
Inspection consists of examining records, documents, or tangible assets. Inspection of records and
documents provides audit evidence of varying degrees of reliability depending on their nature and
source and the effectiveness of internal controls over their processing. Three major categories of
documentary audit evidence, which provide different degrees of reliability to the auditor, are:
i. Documentary audit evidence created and held by third parties;
ii. Documentary audit evidence created by third parties and held by the entity; and
iii. Documentary audit evidence created and held by the entity. Inspection of tangible assets
provides reliable audit evidence with respect to their existence but not necessarily as to
their ownership or value.
b. Observation
Observation consists of looking at a process or procedure being performed by others, for example,
the observation by the auditor of the counting of inventories by the entity's personnel or the
performance of control procedures that leave no audit trail.
c. Inquiry and Confirmation

Inquiry consists of seeking information of knowledgeable persons inside or outside the entity.
Inquires may range from formal written inquiries addressed to third parties to informal oral
inquires addressed to persons inside the entity. Responses to inquires may provide the auditor with
information not previously possessed or with corroborative audit evidence.

Confirmation consists of the response to an inquiry to corroborate information contained in the

accounting records. For example, the auditor ordinarily seeks direct confirmation of receivables
by communication with debtors.
d. Computation
Computation consists of checking the arithmetical accuracy of source documents and accounting
records or of performing independent calculations.
e. Analytical Procedures
Analytical procedures consist of the analysis of significant ratios and trends including the
resulting investigation of fluctuations and relationships that are inconsistent with other relevant
information or deviate from predicted amounts.
f. Recalculation
Recalculation consists of checking the mathematical accuracy of documents or records.
Recalculation may be performed manually or electronically.
g. 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
The nature, timing and extent of substantive procedures will vary depending on the assertions.
Question No. 4
What do you understand by the term 'going-concern basis' in relation to the preparation of
financial statements of a company?
(3 Marks June 2006)
Answer:
When financial statements are prepared on a going concern basis then:
 Assets are recorded on the basis that the company will be able to realize or recover them
at or above recorded amounts in the normal course of business.
 Liabilities are recognized and recorded on the basis that they will be discharged in the
normal course of business.
We can define the going-concern concept as meaning that the enterprise will continue in
operational existence for the foreseeable future. This means that the financial statements are
prepared on the assumption that there is no intention or necessity of liquidate or curtail
significantly the scale of operation.
Question No. 5
List out four factors, which might cast doubt on the going-concern status of a company.
(4 Marks June 2006)

Answer:
The following are examples of factors which might cast doubt on the going-concern status of a
company. These are also known as indicators for assessing the going concern as per NSA 570:
Financial Indicators
 Net liability or net current liability position.
 Fixed-term borrowings approaching maturity without realistic prospects of renewal or
repayment; or excessive reliance on short-term borrowings to finance long-term assets.
 Indications of withdrawal of financial support by creditors.
 Negative operating cash flows indicated by historical or prospective
 financial statements.
 Adverse key financial ratios.
 Substantial operating losses or significant deterioration in the value of assets used to
generate cash flows.
 Arrears or discontinuance of dividends.
 Inability to pay creditors on due dates.
 Inability to comply with the terms of loan agreements.
 Change from credit to cash-on-delivery transactions with suppliers.
 Inability to obtain financing for essential new product development or other essential
investments.
Operating Indicators
 Management intentions to liquidate the entity or to cease operations.
 Loss of key management without replacement.
 Loss of a major market, key customer(s), franchise, license, or principal supplier(s).
 Labor difficulties.
 Shortages of important supplies.
 Emergence of a highly successful competitor.
Other Indicators
 Non-compliance with capital or other statutory or regulatory requirements, such as
solvency or liquidity requirements for financial institutions.
 Pending legal or regulatory proceedings against the entity that may, if successful, result in
claims that the entity is unlikely to be able to satisfy.
 Changes in law or regulation or government policy expected to adversely affect the entity.
 Uninsured or underinsured catastrophes when they occur.
Question No. 6
Is it necessary for an auditor to satisfy himself about the sufficiency and appropriateness of
Opening balances to ensure that they are free form material misstatements? What steps will you
perform for the purpose when financial statements were audited last year by another auditor?

Answer
As per NSA 510: Initial Audit Engagements-Opening Balances, for Initial audit engagements, the
auditor should obtain sufficient appropriate audit evidence that:
 the opening balances do not contain misstatements that materially affect the current period's
financial statements;
 the prior period's closing balances have been correctly brought forward to the current period
or, when appropriate, have been properly accounted for and adequately disclosed.
 appropriate accounting policies are consistently applied or changes in accounting policies
have been properly accounted for and adequately disclosed.
Opening balances brought forward for previous year also subject to an audit and verification as
the closing balances are formed taking into account of the opening balances. Thus, an auditor
needs to satisfy himself about the sufficiency and appropriateness of opening balances to ensure
that they are free from material misstatements.
 Ordinarily, the current year auditor can place reliance on the closing balances contained in
the audited financial statements of the preceding year. Sufficient audit evidence will be
obtained for verifying opening balances, which are closing balances of the earlier period by
perusing the copies of the audited financial statements.
 If during the performance of audit for the current year the possibility of misstatements in
opening balance is indicated, some indirect audit evidence can be obtained as part of the
audit procedures performed during the current year. For example, opening balances in
creditors and debtors could be verified by way of collection during the current period.
Question No. 7
What are the procedures that the auditor should follow to identify the events that require
adjustment of or disclosures in the financial statements? (7 Marks June 2007)
Answer
The auditor should ordinarily follow the following procedures to identify subsequent events that
may require adjustment of, or disclosure in, the financial statements and these procedures would
be performed as near as practicable to the date of the auditor‘s report:
(i) reviewing procedures management has established to ensure that subsequent events are
identified,
(ii) reading minutes of the meetings of shareholders, the board of directors and audit and
executive committees held after period end and inquiring about matters discussed at
meetings for which minutes are not yet available,
(iii) reading the entity‘s latest available interim financial statements and, as considered
necessary and appropriate, budgets, cash flow forecasts and other related management
reports,
(iv) inquiring, or extending previous oral or written inquiries, of the entity‘s lawyers
concerning litigation and claims and
(v) Inquiring of management as to whether any subsequent events have occurred which
might affect the financial statements. Examples of inquiries of management on specific
matters are:

(a) the current status of items that were accounted for on the basis of preliminary or
inconclusive data,
(b) whether new commitments, borrowings or guarantees have been entered into,
(c) whether sales of assets have occurred or are planned,
(d) whether the issue of new shares or debentures or an agreement to merge or
liquidate has been made or is planned,
(e) whether any assets have been appropriated by government or destroyed, for
example, by fire or flood, or earthquake, or made unproductive without complete
destruction,
(f) whether there have been any developments regarding risk areas and contingencies,
(g) whether any unusual accounting adjustments have been made or are contemplated,
and
(h) whether any events have occurred or are likely to occur which will bring into
question the appropriateness of accounting policies used in the financial statements
as would be the case, for example, if such events call into question the validity of
the going concern assumption.
If the division or branch or subsidiary is audited by another auditor, the auditor should inform the
other auditor of the planned date of the auditor‘s report and consider the other auditor‘s
procedures regarding events after period end.
Question No. 8
Distinguish between: Statistical and Non-statistical sampling. (5 Marks June 2007)
Answer
In statistical sampling, probability theory is used to determine sample size and to interpret the
results. Statistical sampling does not replace judgement. It provides a decision model within
which auditor's judgements as to the acceptable level of detection risk, testing materiality and
other variables are the inputs. Given the acceptable level of both sampling risk and materiality for
the audit procedures, the model specifies the sample size and evaluates the sample results in terms
of sampling risk and materiality. The interpretation of result is, therefore, only as reliable as the
values placed on the sampling risk and testing materiality. In non-statistical sampling, the auditor
uses judgement directly both to determine sample size in the light to the planned level of detection
risk and of testing materiality, and to interpret the results against the audit objective.
The choice of non-statistical or statistical sampling does not affect the selection of auditing
procedures to be applied to a sample. Moreover, it does not affect the appropriateness of evidence
obtained about individual sample items or the appropriate response by the auditor to errors found
in sample items. These matters require the exercise of professional judgement.
Question No. 9
Distinguish between Adjusting events and non-adjusting events. (5 Marks December 2007)

Answer
Adjusting events are those events after the balance sheet date that provide evidence of conditions
that existed at the balance sheet date and non-adjusting events are those that are indicative of
conditions that arose after the balance sheet date.
An enterprise should adjust the amounts recognized in its financial statements to reflect adjusting
events after the balance sheet date. However, an enterprise should not adjust the amounts
recognized in its financial statements to reflect non-adjusting events after the balance sheet date.
The following are examples of adjusting events after the balance sheet date that require an
enterprise to adjust the amounts recognized in its financial statements, or to recognize items that
were not previously recognized:
 the resolution after the balance sheet date of a court case;
 the receipt of information after the balance sheet date indicating that an asset was
impaired at the balance sheet date;
 the bankruptcy of a customer which occurs after the balance sheet date usually confirms
that a loss already existed at the balance sheet date;
 the sale of inventories after the balance sheet date may give evidence about their net
realizable value at the balance sheet date;
 the determination after the balance sheet date of the cost of assets purchased, or the
proceeds from assets sold, before the balance sheet date;
 the determination after the balance sheet date of the amount of profit sharing or bonus
payments, if the enterprise had a present legal or constructive obligation at the balance
sheet date to make such payments as a result of events before that date; and
 the discovery of fraud or errors that show that the financial statements were incorrect, etc.
An example of a non-adjusting event after the balance sheet date is a decline in market value of
investments between the balance sheet date and the date when the financial statements are
authorized for issue. The fall in market value does not normally relate to the condition of the
investments at the balance sheet date but reflects circumstances that have arisen in the following
period. Therefore, an enterprise does not adjust the amounts recognized in its financial statements
for the investments.
Question No. 10
Distinguish between Audit Principles and Audit Techniques.
(5 Marks June 2006,5 Marks December 2008)
Answer
The principles of auditing refer to fundamental considerations that sustain the audit function and
direct its activities, Basic auditing principles which govern the auditor's professional
responsibilities, and which should be compiled with whenever any audit is carried out. It also
states that "Compliance with the basic principles requires the application of auditing procedures
and reporting practices appropriate to particular circumstances." The basic principles listed are in
respect of the following areas;
i. Integrity, objectivity and independence
ii. Confidentiality
iii. Skills and competence
iv. Work performed by others

v. Documentation
vi. Planning
vii. Audit evidence
viii. Accounting System and internal control and
ix. Audit conclusion and reporting.
On the other hand, auditing techniques refer to both the methods and means adopted by an auditor
for both collection and evaluation of audit evidence in different auditing situations. Some of the
significant techniques relate to physical examination, confirmation, inquiry, ration calculations,
posting, reconciliation etc.
The auditing principles are of fundamental nature which underlies the conduct of the audit. These
principles are not liable to change frequently while audit techniques may vary according to the
nature of proportions to be tested. For instance, audit technique to test the existence of cash in
hand will be different from the method to verify recoverability of sundry debtors. Further the audit
techniques may vary from organization to organization depending upon nature of business, but the
principles of auditing will remain the same irrespective of nature of organization.
Question No. 11
i. Explain the requirement to maintain the audit working papers under OAG/N directives.
(2 Marks June 2009)
ii. Explain the characteristic of Working papers. (3 Marks June 2009
Answer
i) The auditor must properly maintain and store the working papers for a period of three years
from the completion of audit and shall provide to OAG/N for inspection when requested
during that period.
ii) Audit working papers should exhibit the following characteristics:

 Completeness and accuracy – to show the nature and extent of audit work performed and to
provide proper support for contents of the audit report.
 Clarity and conciseness without requiring supplementary oral support. The legend to tick
marks or the symbols used to document performance of audit tests should be explained.
 Ease of preparation
 Legibility and neatness with adequate space for additional data, notes and comments
 Relevance – should contain information that is important and useful with respect to the
objectives established for the examination
 Organization- files should be systematically organized, indexed and cross referenced
 Ease of review
Question No. 12
Explain Audit Trail. (4 Marks June 2009)

Answer
Audit Trail can be defined as those documents, records, journals, ledgers, master files etc. that
enables an auditor to trace the transactions from the source document to the summarized total in
accounting reports or vice-versa.
Audit trail is the visible means whereby the auditor may have a business transaction through all
the stages in which it features in the records of the business. For example, sequentially numbered
sales invoice copies would normally be listed in a register or daybook and subsequently filed
either in numerical or chronological sequence. It would then be possible to trace a particular
invoice from the daybook to the original file or vice-versa by reference to the number or date of
the invoice.
In a manual accounting system, it is possible to relate the recoding of a transaction at each
successive stage enabling an auditor to locate and identify all documents from beginning to end
for the purposes of examining documents, totaling and cross-totaling referencing.
However, in an EDP environment, the use of exception reporting by management has effectively
eliminated the audit trail between input and output. Frequently computer-generated totals, analysis
and balances are not printed out in detail because the management is not exercising control
through verification of the individual items processed.
Question No. 13
Write short notes on the following
a. Professional Skepticism (4 Marks December 2007)
Answer
It is an attitude of the auditor that represents a questioning mind and critical assessment of
audit evidence. The auditor plans and performs an audit with an attitude of professional
skepticism. Such an attitude is necessary for the auditor to identify and properly evaluate
matters that increase the risk of material misstatement in the financial statements resulting
from fraud or error, circumstances that make the auditor suspect that the financial statements
are materially misstated, evidence obtained that brings into question the reliability of
management representations.
However, unless the audit reveals evidence to the contrary, the auditor is entitled to accept
records and documents as genuine. Accordingly, an audit performed in accordance with
auditing standards generally accepted rarely contemplate authentication of documentation, nor
are auditors trained as, or expected to be, experts in such authentication.
b. Cut-off procedure (5 Marks December 2008, 4 Marks June 2010, 5 Marks December 2011,4
Marks December 2015, 3 Marks June 2018)
Answer
Cut-off procedures means the procedure employed to ensure the separation of transactions at
the end of one year from those in commencement of next year. Usually, the problem of
overlapping is found in inventory accounting since quite often goods are sold but passed on to
the buyer only after the year is over or goods are bought but received only after the close of
the year. The situation may create considerable problem for the proper stock taking of
inventory. Therefore, the principal area of application of cut-off procedures involves sales,

purchases and stock. The auditor should satisfy himself by examination and test check that
these procedures adequately ensure that:
- Goods purchased for which property has been passed to the client have in fact been included
in inventories and liability if any, has been provided for.
- Goods sold have been excluded from the inventories and credit has been taken for sales.
The auditor may examine a sample of documents evidencing the movement of stocks into and
out of stores, including documents pertaining to period shortly before and after the cut-off
date, and check whether the stocks represented by those documents were included or
excluded, as appropriate, during the stock taking.
c. Assertions used by the auditor (5 Marks June 2011,4 Marks December 2009)
Assertions used by the auditor fall into the following categories:

(1) Assertions about classes of transactions and events for the period under audit:
i. Occurrence—transactions and events that have been recorded have occurred and
pertain to the entity.
ii. Completeness—all transactions and events that should have been recorded have
been recorded.
iii. Accuracy—amounts and other data relating to recorded transactions and events have
been recorded appropriately.
iv. Cutoff—transactions and events have been recorded in the correct accounting
period.
v. Classification—transactions and events have been recorded in the proper accounts.
(2) Assertions about account balances at the period end:

i. Existence—assets, liabilities, and equity interests exist.
ii. Rights and obligations—the entity holds or controls the rights to assets, and
liabilities are the obligations of the entity.
iii. Completeness—all assets, liabilities and equity interests that should have been
recorded have been recorded.
iv. 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.
(3) Assertions about presentation and disclosure:
i. Occurrence and rights and obligations—disclosed events, transactions, and other
matters have occurred and pertain to the entity.
ii. Completeness—all disclosures that should have been included in the financial
statements have been included.
iii. Classification and understandability—financial information is appropriately
presented and described, and disclosures are clearly expressed.
iv. Accuracy and valuation—financial and other information are disclosed fairly and
at appropriate amounts

d. Permanent audit file (4 Marks June 2010)

In a recurring audit, the file of working papers that are relevant to more than one audit
engagement or core documents are often kept separately in a file known as permanent file.
Permanent file is updated regularly with information of continuing importance to succeeding
audit. As mentioned in Nepal Standards on Auditing-Documentation (NSA03) a permanent
audit file normally includes:
 Information concerning the legal and organizational structure of the client. In the case of
a company, this includes the memorandum and articles of association. In the case of a
statutory corporation, this includes the Act and Regulations under which the corporation
operates.
 Extracts or copies of important legal documents, agreements and minutes relevant to the
audit.
 A record of the study and evaluation of the internal controls related to the accounting
system.
 Copies of audited financial statements of previous years.
 Analysis of significant ratios and trends.
 Copies of management letters issued by the auditor if any
 Record of communication with the retiring auditor, if any before acceptance of the
appointment as an auditor
 Notes regarding significant accounting policies and
 Significant audit observations of earlier years.
e. Going Concern Concept and its significance in an audit (5 Marks December 2010)
Under the going concern assumption an entity is ordinarily viewed as continuing in business for
the foreseeable future with neither the intention nor the necessity of liquidation, ceasing trading
or seeking protection from creditors pursuant to laws or regulations. Accordingly, 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.
NSA 570 requires the auditor to consider the appropriateness of management‘s use of the going
concern assumption in the preparation of the financial statements because this has implications
for the basis of preparation of the financial statements and/or disclosures in the financial
statements. If the going concern basis is not appropriate, then the breakup basis will have to be
used and this will have to be disclosed in the notes to the financial statements.
This will have implications for the amounts at which items are included in the financial
statements, in particular,
 assets may need to be written down to recoverable amounts or reclassified;
 liabilities may need to be restated to reflect changes in amount or date of maturity; and
 additional liabilities for losses/redundancies may arise.
If there is uncertainty about the going concern status, then the going concern basis may be used
but there should be a note in the financial statements. If the note is adequate, then the auditor can

give an unqualified report which will be modified with an emphasis of matter paragraph. If
financial statements are prepared using an inappropriate basis the audit opinion will be qualified
– probably an adverse opinion.
f. Walk Through Tests (5 Marks December 2010)

A walk through is a procedure in which an auditor traces a transaction from its initiation through
the company‘s information systems to the point when it is reflected in the financial reports. The
auditor should perform one walk through, at a minimum, for each major class of transactions. A
walk-through provides evidence to confirm that the auditor understands (1) the process flow of
transactions, (2) the design of identified controls for internal control components, including those
related to preventing and detecting fraud, and (3) whether all points in the process have been
identified at which misstatements related to relevant financial statement assertion could occur.
Walk through also provide evidence to evaluate the effectiveness of the controls‘ design and
confirm that the controls have been placed in operation.
When performing a walk-through, the auditor should:
i. Be sure that the walk-through encompasses the complete process (initiation, authorization,
recording, processing and reporting) for each significant process identified, including
controls intended to address fraud risk.
ii. Ask the entity‘s personnel, at each of key stage in the process, about their understanding of
what the company‘s prescribed procedures require.
iii. Determine whether processing procedures are performed as expected on a timely basis and
look for any exceptions to prescribed procedures and controls.
iv. Evaluate the quality of evidence provided and perform procedures that produce a level of
evidence consistent with the auditor‘s objectives. The auditor should follow the whole
process, using the same documents and technology that company staff use, asking
questions of different personnel at each significant stage and asking follow- up questions
to identify any abuse of controls or fraud indicators.
such significant changes occur in the process flow of transactions or supporting computer
applications, the auditor should evaluate the nature of changes and the effect on related accounts.
The auditor should determine whether it is necessary to walk through transactions that were
processed both before and after the change.
Question No. 14
Write short notes on Analytical review procedures (5 Marks December 2009)
Answer
Analytical Review Procedures may be defined as substantive tests of financial information made
by a study of comparisons and relationship among data. Analytical procedures include comparison
of financial information with:
 Comparable information for a prior period or periods

 Anticipated results, such as budgets or forecasts and

 Similar industry information, such as a comparison of the entity‘s ratio of sales to account
receivable with industry averages etc.
Analytical procedures ensure that the various items of the financial statements are consistent with
each other and are in known trends within the auditor's knowledge of business.
While conducting the analytical review procedures, the auditor has to establish,
 The data, ratio and statistics which are significant for the business
 The yardstick for the comparisons
 The variances
Analytical procedures are used for the following purposes:

 to assist the auditor in planning the nature, timing and extent of other audit procedures
 as a substantive test to obtain evidential matter about particular assertions related to
account balances or classes of transaction
 as an overall review of the financial information in the final review stage of the audit
Question No. 15
You have been appointed as an auditor of Gilbert Company Limited for the first time. In this
context, do you think it necessary to satisfy yourself about the sufficiency and appropriateness
of opening balances to ensure that they are free from material misstatements? What audit
procedures would you perform for this purpose?
(7 Marks June 2010)
Answer
When an auditor is appointed for the first time, he cannot be sure during his initial engagement
about the correctness of the opening balances brought forward from the books of accounts.
Opening balances mean those account balances which exist at the beginning of the financial year.
Opening balances are the closing balances of the preceding year brought forward to the current
year and reflect the effect of transaction and other events of the preceding periods and accounting
policies applied in the preceding periods.
Therefore, once I am appointed as an auditor for the first time by Gilbert Company Limited, for
my initial audit engagement I need to obtain sufficient appropriate audit evidence so as to satisfy
myself that the opening balances are free from material misstatements. Nepal Standards on
Auditing (NSA-510) relating to Initial Engagements- Opening Balances covers this aspect. As per
NSA-510, the auditor should obtain sufficient appropriate audit evidence that:
a) The closing balances of the preceding period have been correctly brought forward to the
current period,
b) The opening balances do not contain misstatements that materially affect the financial
statements for the current year and
c) Appropriate accounting policies are consistently applied.
Generally, in an initial audit engagement, the auditor will not have previously obtained audit
evidences supporting the opening balances. Being the initial auditor, I need to gather information

about the following aspects so as to establish the sufficiency and appropriateness of the audit
evidences regarding the opening balances:
i) The accounting policies followed by Gilbert Company Limited.
ii) Whether the previous years‘ auditors‘ report have an unqualified opinion, a qualified
opinion, and adverse opinion.
iii) The nature of the opening balances, including the risk of their misstatement in the
financial statement for the current year.
iv) The materiality of the opening balances.
In this process, as an auditor, I need to consider whether the accounting policies relating to the
opening balances where appropriate and they had been consistently followed in the financial
statements for the current period. I also would ensure that wherever such accounting policies are
not appropriate, the same have been changed in the current period and has been disclosed
appropriately. In the same process, I would gather the copies of the audited financial statements
for the previous period for necessary perusal so as to obtain sufficient appropriate audit evidence
regarding the opening balances.
But in a situation where the financial statements of the preceding period have not been audited or
where I am not satisfied with the audit evidence obtained through perusal of previous years‘
financial statements, I may go for obtaining some audit evidences by the audit procedures
followed during the audit of current period in the case of current assets and liabilities. Similarly, in
the case of other assets and liabilities such as fixed assets, investments and long-term debt, I
would ordinarily examine the records underlying the opening balances. I can also use the direct
confirmation mechanism from third parties. After performing above mentioned audit procedures,
if I am satisfied with the audit evidences and unable to obtain sufficient appropriate audit
evidences regarding opening balances, I would express as appropriate a qualified or a disclaimer
of opinion.
I may also express a qualified opinion or an adverse opinion as appropriate; if the opening
balances contain misstatements which affect the financial statements materially for the current
period and the effect of the same has not been properly accounted for and properly disclosed.
Question No. 16
An auditor believes that substantive procedures have no limitation. Therefore, it is sufficient for
him to perform extensive substantive procedures and there is no need to evaluate internal
control system while auditing a medium-sized company. Do you agree with this approach.
(4 Marks June 2010)
Answer
The audit can be made more efficient if the nature, timing and extent of substantive audit
procedures are determined on the basis of an evaluation of the effectiveness of the internal control
system. However, if, in the circumstances of a particular audit, the auditor decides not to rely on
internal controls, he would have to collect sufficient appropriate audit evidence through
substantive procedures only. His substantive procedures in this case would be much more
extensive than would be the case otherwise.
Question No. 17
The company has accounted for management fee of US$ 25,000 payable to its holding company
during the year. Describe the essential audit evidence that is required for such expenditure.
(5 Marks June 2010)

Answer
To claim expenditure in the financial statement needs proper supporting documents and approval
from appropriate authorities. In this case the following documents are essential to allow charging
such expenditure:
 A formal agreement entered into with the holding company for management fee;
 Authorization from Board of Directors approving the agreement;
 Approval from Department of Industries to regularize the agreement;
 Proper computation of the management fee in accordance with the terms of the
agreement; and
 Withholding of tax at the appropriate rate while making provision for the management
fee.
Question No. 18
Distinguish between Statistical and Non-statistical sampling (4 Marks June 2010)
a) Statistical and Non-statistical sampling
Answer
In statistical sampling, probability theory is used to determine sample size and to interpret the
results. Statistical sampling does not replace judgment. It provides a decision model within which
auditor's judgments as to the acceptable level of detection risk, testing materiality and other
variables are the inputs. Given the acceptable level of both sampling risk and materiality for the
audit procedures, the model specifies the sample size and evaluates the sample results in terms of
sampling risk and materiality. The interpretation of result is, therefore, only as reliable as the
values placed on the sampling risk and testing materiality. In non-statistical sampling, the auditor
uses judgment directly both to determine sample size in the light to the planned level of detection
risk and of testing materiality, and to interpret the results against the audit objective.
The choice of non-statistical or statistical sampling does not affect the selection of auditing
procedures to be applied to a sample. Moreover, it does not affect the appropriateness of evidence
obtained about individual sample items or the appropriate response by the auditor to errors found
in sample items. These matters require the exercise of professional judgement.
Question No. 19
Distinguish between Compliance procedures and substantive procedures.
Answer
Compliance procedures are those tests designed to obtain reasonable assurance that those internal
controls on which audit reliance is to be placed are in effect. In other words, compliance
procedures are audit tests which are designed to check the degree of compliance with prescribed
internal controls. In obtaining audit evidence from compliance procedures, the auditor is
concerned with assertions that the control exists, the control is operating effectively, and the
control has so operated throughout the period of intended reliance. The results of compliance
procedures determine, to a large extent, the nature, timing and extent of substantive procedures.

Substantive procedures are tests designed to obtain evidence as to the completeness, accuracy and
validity of the data produced by accounting system. They are of two types: tests of details of
transactions and balances and analysis of significant ratios and trends including the resulting
enquiry of unusual fluctuations and items. An auditor undertakes substantive procedures in order
to obtain reasonable assurances that there is the existence of assets or a liability at a given date,
there are no unrecorded assets, liabilities or transactions, a transaction is accounted for at a proper
amount and revenue or expenses are allocated to the proper period, etc.
Question No. 20
You have recently joined a medium size-chartered accountants‟ firm as their audit manager.
While reviewing the firm‟s audit methodology, you have observed that the firm follows a
standard set of audit work program. These work program have been used by the firm for the
last many years and rely extensively on traditional judgment sampling. You are of the opinion
that by following the statistical sampling techniques, you would be able to carry out a more
effective and efficient audit.
You are required to write a memo to the partner-in-charge citing the advantages and
disadvantages of judgmental and statistical sampling. (5 Marks December 2010)
Answer a)
Partner-in-charge
…… Chartered Accountants
Re: Suggestions for improvement in firm‟s audit methodology
Dear Sir:
As you know that I have joined this firm very recently, I went through the systems and audit
methodology being implemented by the firm. I came to know that work programs being used by
the firm since many years have been based on judgmental sampling basis. Sir, in my opinion,
judgmental sampling has many disadvantages and there are other sampling techniques available,
e.g. statistical sampling which helps to carry out audit in more effective and efficient manner.
I have cited below advantages and disadvantages of judgmental and statistical sampling. As per
NSA530: Audit Sampling, when designing audit procedures, the auditor should determine
appropriate means for selecting items for testing so as to gather audit evidence to meet the
objectives of audit tests. Audit sampling can use either a statistical or a non-statistical approach.
The decision whether to use a statistical or non-statistical sampling approach is a matter for the
auditor's judgment regarding the most efficient manner to obtain sufficient appropriate audit
evidence in the particular circumstances. For example, in the case of tests of control the auditor's
analysis of the nature and cause of errors will often be more important than the statistical analysis
of the mere presence or absence (that is, the count) of errors. In such a situation, non-statistical
sampling may be most appropriate.

When applying statistical sampling, the sample size can be determined using either probability
theory or professional judgment. Moreover, sample size is not a valid criterion to distinguish
between statistical and non-statistical approaches.
Thus, I would like to suggest that we shall shift to statistical sampling from judgmental sampling
to reduce risk at acceptable low level.
Thanking you,
Yours sincerely,
Question No. 21
Your shops Pvt. Limited manufactures a range of consumer products and stored in a nearby
rented warehouse. The products are perishable nature with an average shelf life of 2 weeks.
The financial year ends on 31st Ashadh 2069. It is now mid Kartik 2069 and the auditor has not
issued a report. The following event has just come to the auditor's attention, on 1 st Kartik 2069,
a fire in the rented warehouse has destroyed 55% of the inventory held for sale.
Describe the additional audit procedure you as an auditor will carry out. (5 Marks June 2013)
Answer:
a) Audit procedure:
This is the case of subsequent events or transactions that provide evidence with respect to
conditions that did not exist at the date of the balance sheet being reported on but arose
subsequent to that date. These events should not result in adjustment of the financial statements.
The following audit procedures shall be applied:
 Discuss the matter with the directors checking whether the company has sufficient
inventory to continue trading in the short term
 Enquire that directors are satisfied that the company can continue to trade in the longer
term. Obtain a letter of representation to this effect.
 Obtain a schedule showing the inventory destroyed and if possible, check this is
reasonable given past production records and inventory valuations
 Enquire that the insurers have been informed. Review correspondence from the insurer
confirming the amount of insurance claim.
 Consider whether or not Your-shop can continue as a going concern, given the size of
inventory destroyed and potential damage to the company‘s reputation if the
customers‘ order cannot be fulfilled.
Question No. 22
Explain how the results of analytical review can influence the nature and extent of other audit
work. (4 Marks June 2014)
Answer
The analytical review of financial statements can influence the audit work undertaken at each of
three main stages of the audit as given below:

i) Planning Stage: At this stage, an analytical review applied to the initial management
accounts would indicate any areas where figures are either higher or lower than
might have been expected, possibly indicating an area of higher audit risk. The result
at this stage may influence the selection of areas to be tested in some depth and may
also influence sample sizes, either increasing the size of sample if an unexpected
figure is noted or decreasing it if the results is in line with expectations.
ii) Substantive testing stage: At this stage, the results of analytical review will often
confirm results obtained by other substantive tests, possibly allowing the appropriate
audit conclusion to be reached after reducing audit testing. However, contradictory
conclusions would result if more testing is done.
iii) Final Review Stage: At this stage, in reviewing the final financial statement
including detailed income statement, the analytical review should be part of overall
‗reasonableness‘ check, ensuring that any discrepancies have been resolved and
explained satisfactorily.
Question No. 23
While planning the audit of a Company, you want to apply sampling techniques. What are the
risk factors you should keep in mind? (4 Marks June 2014)
Answer:
As per NSA 530 ―Audit Sampling‖, sampling risk arises from the possibility that the auditor‘s
conclusion based on a sample may be different from the conclusion if the entire population were
subjected to the same audit procedure. There are two types of sampling risk:
i) The risk the auditor will conclude, in the case of a test of controls, that control risk is
lower than it actually is, or in the case of a substantive test, that a material error does
not exist when in fact it does. This type of risk affects audit effectiveness and is more
likely to lead to an inappropriate audit opinion; and
ii) The risk the auditor will conclude, in the case of a test of controls, that control risk is
higher than it actually is, or in the case of a substantive test, that a material error exists
when in fact it does not. This type of risk affects audit efficiency as it would usually
lead to additional work to establish that initial conclusion was incorrect.
Question No. 24
What are the considerations to be kept in mind while performing analytical procedures on data
prepared by the client? (6 Marks June 2014)
Answer
When the auditor intends to perform analytical procedures on data prepared by the client, he
should consider the following:
 Nature of the entity and the degree to which information can be disaggregated, for
example, analytical procedures may be effective when applied to financial information on
individual sections of an operation or to financial statements of components of a
diversified entity, than when applied to the financial statements of the entity as a whole.

 Availability of information, both financial, such as budgets or forecasts, and non-financial

such as the number of units produced or sold.
 Reliability of the information available.
 Relevance of the information available.
 Sources of information available
 Comparability of the information available.
 Knowledge gained by the auditor during previous examinations.
Testing the controls over the preparation of non-financial information, if any, used in applying
analytical procedures.
Question No. 25
Distinguish between Statistical Sampling and Non-Statistical Sampling Approaches.
Answer:
Nepal Standard on Auditing 530 describes about the audit sampling and other means of testing.
The statistical sampling and non-statistical sampling approaches are methods used by the auditor
to apply audit sampling. Statistical sampling refers to a sampling method which is based on the
statistic i.e. figures whereas non-statistical sampling means method which does not have the basis
of figures.
The decision whether to use a statistical or non-statistical sampling approach is a matter for the
auditor‘s judgment regarding the most efficient manner to obtain sufficient appropriate audit
evidence in the particular circumstances. For example, in the case of test controls the auditors‘
analysis of the nature and causes of errors will often be more important than the statistical analysis
of mere presence or absence of errors. In such a situation, non-statistical sampling may be more
appropriate. When applying statistical sampling, the sample size can be determined using either
probability theory or professional judgment. Moreover, sample size is not a valid criterion to
distinguish between statistical and non-statistical approaches.
Question No. 26
What is meant by the expression „examination in depth‟ and illustrate by reference to the
verification of a payment made to a creditor for goods supplied. (5 Marks June 2015)
Answer
Examination in depth‘ involves the tracing of a transaction through the different stages from its
initiation to its conclusion. The records and supporting vouchers applicable at each successive
stage are examined to an appropriate extent, bearing in mind the quality of internal check
operating at that stage.
For example, the verification of a payment made to a trade creditor for goods supplied is
frequently carried out by simply examining the paid cheque returned from the bank ensuring that
it is drawn in favor of the creditor and restrictively crossed. Verification of this transaction ‗in
depth‘, however, would involve examination of the following further items:
(a) A copy of the original order and the authority thereof.

(b) The goods received not and evidence that the goods have been examined to ensure
their conformity with the original order, both as to quantity and quality.
(c) The supplier‘s invoice and statement of account.
(d) Evidence in the stock records of the inclusion of the goods into stock.
Question No. 27
What do you mean by assertions? The statement of financial position of a company as at 31
Ashadh 2074 presents Plant and Machinery under non-current asset at carrying amount of Rs.
200 million. As an auditor of the company what assertions do you draw from above
information? (8 Marks December 2017)
Answer:
Assertions: Assertions are the implicit or explicit claims and representations made by the
management responsible for the preparation and presentation of the financial statements regarding
the appropriateness of the various elements of the financial statements and disclosures. Assertions
are also known as management assertions and financial statements assertions. The auditor
evaluates the assertions made by the management during the audit.
As an auditor of the company, I can draw the following assertions from the balance of Plant and Machinery
presented at Rs 200 million in the statement of financial position as at 31 Ashad 2074:
i) Existence: The Plant and Machinery recognized in the statement of financial position exist
as at 31 Ashadh 2074
ii) Completeness: All plant and machinery controlled by the company are included within
the carrying amount of Rs 200 million.
iii) Rights: The Company owns and controls the plant and machinery.
iv) Valuation: The plant and machinery are valued accurately in accordance with the
measurement basis.
Question No. 28
Write short notes on the following
a. Risk based auditing. (3 Marks December 2011, 3 Marks December 2018)
Answer
An approach to plan the audit work on the basis of the assessment of likely risk existence of
material errors, discrepancies, etc., in financial statements as a whole as well as in specific
accounts and balances is the Risk Based Auditing Approach. When planning and performing
audit procedures and evaluating and reporting the result there of, the auditor should consider
the risk of the material misstatements in the financial statements resulting from fraud and
error. The underlying idea is to develop an audit approach that enable to use the most efficient
combination of audit tests in the context of the circumstances of the enterprise under audit.
The basic objective is to avoid over auditing in low risk situations and under auditing in high
risk situations. The approach suggests in designing an audit program, the assessment of the
risk involved in a situation is the most important consideration as it affects the nature, timing

and extent of the audit procedures. In this circumstance, the extent of auditing procedures may
be relatively small where an auditors‘ assessment shows that risk is low in a particular
situation. Similarly, auditing procedures would be elaborate in a situation where the auditors‘
assessment shows that risk in a particular situation is very high.
b. Analytical review procedure (3 Marks June 2011)

Answer
Analytical review procedure means evaluations of financial information through analysis of
plausible relationships among both financial and non-financial data. Analytical procedures
also encompass such investigation as is necessary of identified fluctuations or relationships
that are inconsistent with other relevant information or that differ from expected values by a
significant amount. Analytical review procedure consists of the analysis of significant ratios
and trends including the resulting investigation of fluctuations and relationships that are
inconsistent with other relevant information or deviate from predicted amounts. Analytical
review procedure provides guidance on the auditor‘s use of this technique. The auditor shall
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.
c. Characteristics of suitable criteria (5 Marks December 2011)

Answer
Suitable criteria exhibit the following characteristics:
(i) Relevance: relevant criteria contribute to conclusions that assist decision making by
the intended users.
(ii) Completeness: criteria are sufficiently complete when relevant factors that could affect
the conclusions in the context of the engagement circumstances are not omitted.
Complete criteria include, where relevant, benchmarks for presentation and disclosure.
(iii) Reliability: reliable criteria allow reasonably consistent evaluation or measurement of
the subject matter including, where relevant, presentation and disclosure, when used in
similar circumstances by similarly qualified practitioners.
(iv) Neutrality: neutral criteria contribute to conclusions that are free from bias.
(v) Understandability: understandable criteria contribute to conclusions that are clear,
comprehensive, and not subject to significantly different interpretations.
d. Sample selection method (5 Marks June 2012)

Answer
The principal methods of selecting samples are as follows:
(i) Use of a computerized random number generator (through CAATs) or random number
tables.
(ii) Systematic selection, 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.

(iii) Haphazard selection, in which the auditor selects the sample without following a
structured technique. Although no structured technique is used, the auditor would nonetheless
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.
(iv) Block selection involves selecting a block(s) of contiguous 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 valid inferences about the entire population based on the sample.
(v) Stratification, the process of dividing a population into subpopulations, each which is a
group of sampling units which have similar characteristics.
e. Walk through test (4 Marks December 2013, 3 Marks June 2018)

Answer
A walk through is a procedure in which an auditor traces a transaction from its initiation
through the company's information systems to the point when it reflected in the financial
reports. The auditor should perform one walk through, at a minimum, for each major class of
transactions. A walk-through provides evidence to confirm that the auditor understands:
 The process flow of transactions
 The design of identified controls for internal control components, including those related
to preventing and detecting fraud
 Whether all points in the process have been identified at which misstatements related to
relevant financial statement assertion could occur.
Walk through also provide evidence to evaluate the effectiveness of the controls' design and
confirm that the controls have been placed in operation. When performing a walk-through, the
auditor should:
a) Be sure that the walk-through encompasses the complete process for each significant
process identified, including controls intended to address fraud risk.
b) Ask the entity's personnel, at each of key stage in the process, about their understanding of
what the company's prescribed procedures require.
c) Determine whether processing procedures are performed as expected on a timely basis and
look for any exceptions to prescribed procedures and controls.
d) Evaluate the quality of evidence provided and perform procedures that produce a level of
evidence consistent with the auditor's objectives. The auditor should follow the whole
process, using the same documents and technology that company staff use, asking question
to different personnel at each significant stage and asking follow-up questions to identify
any abuse of controls or fraud indicators.
such significant changes occur in the process flow of transaction or supporting computer

applications, the auditor should evaluate the nature of changes and the effect on related
accounts. The auditor should determine whether it is necessary to walk through transactions
that were processed both before and after the change.
f. Examination in depth (4 Marks December 2015)

Answer
Examination in Depth implies examination of a few selected transactions from the beginning
to the end through the entire flow of the transaction, i.e., from initiation to the completion of
the transaction by receipt of payment of cash and delivery or receipt of the goods. This
examination consists of studying the recording of transactions at the various stages through
which they have passed. At each stage, relevant records and authorities are examined; it is also
judged whether the person who has exercised the authority in relation to the transactions is fit
to do so in terms of the prescribed procedure. For example, if payment to a creditor is to be
verified ―in depth‖, it would be necessary to examine the following documents:
 The invoice and statement of account received from the supplier.
 The entry in the stock record showing that the goods were received.
 The Goods Received Note and Inspection Certificate showing that the goods on receipt
were verified and inspected.
 The copy of the original order and authority showing that the goods in fact were ordered
by an authority which was competent to do so.
g. Audit notebook (5 Marks June 2017)

Answer
An audit notebook is usually a bound book in which a large variety of matters observed during
the course of audit are recorded. Audit notebooks form part of audit working papers and for
each year a fresh audit notebook is maintained. In case an auditor classifies his working paper
into permanent and current, then audit notebook shall form part of the current file. It is in any
case a part of the permanent record of the auditor available for reference later on, if required.
The audit notebook also provides a valuable help to the auditor in picking up the links of work
when the concerned assistant is away, or the work is stopped temporarily. It is also used for
recording the various queries raised in the course of the work and their state of disposal. In
respect of disposed queries, explanation obtained, and evidence seen would is used be
recorded in the said book, while queries remaining undisposed of would be noted for follow
up.

Chapter 7Audit Report
Question No. 1
Briefly explain the circumstances that may result in the auditor forming an audit opinion in the
financial statements other than an unqualified opinion. (6 Marks December 2004)
Answer
Circumstances that may result in forming an audit opinion in the financial statements other than
an unqualified opinion:
 Limitation of scope: A limitation on the scope of the auditor's work may sometimes be
imposed by the clients or may be imposed by circumstances. When in the opinion of the
auditors the accountings records maintained by the clients are inadequate or he/she is unable
to carry out an audit procedure that he believes desirable.
 Disagreement with the management: The auditor may disagree with the management as to
the acceptability of the accounting policies selected or the method of their application
including the adequacy of disclosure in the financial statements or the compliance of the
financial statements with relevant regulations and statutory requirements.
 Uncertainty: If a significant uncertainty affecting the financial statements, for example,

litigation involving legal claims, etc. the result of which is dependent upon the resolution of
the future events may cause the auditor to qualify his opinion or to disclaim an opinion.
Question No. 2
a. Write Short Notes on Long Form Audit Report (LFAR). (4 Marks December 2004)
Answer
An auditor has to submit a long form audit report of a bank to Nepal Rastra Bank after submitting
the audit report to the bank. The matters that the bank requires their auditors to deal with in the
LFAR have been specified by the NRB. Main objectives of LFAR is to find and record the
following information:
 Auditors' audit planning, audit team, audit preparations, sampling method, timing,
branches coverage;
 A brief analysis of financial position of the bank;
 Existing internal control system of the bank;
 Follow up of legal provisions, regulations and directives;
 Fraud and forgery in the bank; and
 Strength and constraints of the bank; etc.
b. Adverse audit opinion. (4 Marks December 2004)

Answer
NSA 705: ―Modification to the opinion in independent auditor‘s report‖
Para 8:
The auditor shall express an adverse opinion when the auditor, having obtained sufficient
appropriate audit evidence, concludes that misstatements, individually or in the aggregate, are
both material and pervasive to the financial statements. An adverse opinion should be expressed

when the effect of a disagreement is so material and pervasive to the financial statements that the
auditor concludes that a qualification of the report is not adequate to disclose the misleading or
incomplete nature of financial statements.
Para 18
When the auditor expresses an adverse opinion, the auditor shall state that, in the auditor‘s
opinion, because of the significance of the matter(s) described in the Basis for Adverse Opinion
section:
(a) 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 financial reporting framework]; or
(b) When reporting in accordance with a compliance framework, the accompanying financial
statements have not been prepared, in all material respects, in accordance with [the applicable
financial reporting framework].
Whenever the auditor expresses an opinion that is unqualified, a clear description of all the
substantive reasons should be include in the report and, unless impracticable, a quantification of
the possible effects on the financial statements. Ordinarily, this information would be set out in a
separate paragraph preceding the opinion or disclaimer of opinion and may include a reference to
a more extensive discussion, if any, in a note to the financial statements.
The auditor may disagree with the management about matters such as the acceptability of
accounting policies selected, the method of their application, or the adequacy of disclosures in the
financial statements. If such disagreements are material to the financial statements, the auditor
should express a qualified or an adverse opinion.
Example: (opinion paragraph of audit report)
In our opinion, because of the effects of the matters discussed in the Basis for Adverse Opinion
Paragraph, the financial statements do not give a true and fair view of (or do not present fairly)
the financial position of the Co. as of Ashad end of 20XX, and of the results of its operations and
its ash flows the year and comply with company act 2053 etc.
Question No. 3
Distinguish between Notes and Qualifications. (4 Marks June 2005)
Answer:
All qualification should be contained in the auditor‘s report itself and should appeared at one
place in order to give the reader a clear view thereof.
Notes to accounts normally represent explanatory statements given by the directors elucidating a
clarifying various item of accounts. A large number of notes, including those giving specific
information required under various directives / rules, usually appear on the accounts. Examples of
matters which are disclosed as notes are: arrears of dividends on preference shares, capital
commitments, computation of managerial remuneration, etc. If the qualifications made by the
auditor are also included in the numerous notes, or if the auditor qualifies his report by making his
reference to the notes, or if the auditor qualifies his report by making his reference to the notes,
the readers may be unable to appreciate the significance of such qualifications.
It is, therefore, required that the notes to accounts should not contain the opinion of the auditor.
Further, the auditors should reproduce the notes of a qualificatory nature in their report to enable
the reader to know the importance of these qualifications. Where notes of a qualificatory nature
appear in the accounts, the auditor should state all qualifications independently in his report in an

adequate manner so as to enable a reader to assess the significance of these qualifications. For
these purposes, where a note has already been given in detail by the management, it is not
necessary to reproduce it verbatim in the audit report and brief self-explanatory statement may be
sufficient
Question No. 4
Distinguish between Audit Certificate and Audit Report. ( 4 Marks June 2005)
Answer:
A certificate is a written confirmation of accuracy of the facts stated therein and does not involve
any estimate or opinion. The term ‗certificate‘ is therefore, used where the auditor verifies the
accuracy of facts. An auditor may, thus certify the circulation figures of a newspaper or the value
of imports or exports of a company. An auditor‘s certificate represents that he has verified certain
figures and is in a position to vouchsafe their accuracy as per his examination of documents and
books of account. Reports, on the other hand, is a formal statement usually made after an
enquiry, examination or review of specified matters under report and includes the reporting
auditor‘s opinion thereon. Thus, when a reporting auditor issues a certificate, he is responsible
for the factual accuracy of what is stated therein. On the other hand, when a reporting auditor
gives a report, he is responsible for ensuring that the report is based on factual data, that his
opinion is in due accordance with facts, and that it is arrived at by the application of due care and
skill. The ‗report‘ involves expression of opinion which may differ from one professional to
another. There is no question of exactitude in case of a report since the information contained
therein is based on estimates and involves judgment element.
Question No. 5
Distinguish between the following: (5 Marks each June 2006)
a) Qualificatory Notes vs. Explanatory Notes

Answer:
Qualificatory notes (QN) refer to the matters stated in the statements of accounts and usually
are included under "NOTES TO ACCOUNT" along with the explanatory notes. QN are such
notes on which the auditor has taken an adverse view. In view of their impact on the financial
statements and on the result of audit, the auditor refers to QN in the audit report itself in a
specific manner by identifying the notes on which they have taken adverse view and draw
attention of the shareholders of the company. Since the responsibility of preparation of the
financial statements lies with the management, QA are prepared and presented in Notes to
Accounts and the auditor refers the same in his report.
Explanatory Notes (EN) is meant to explain or supplement a matter contained in or related to

financial statements. The matter on which an EN is given is one on which the auditor has not
taken adverse view. EN are given by the management of the company and are usually shown
under "NOTES TO ACCOUNT". Such notes may also appear elsewhere in the financial
statements. EN helps in understanding the accounting policies adopted by the management in
preparation of financial statements.
b) Certificates for special purpose vs. Audit report

Answer:
A certificate is a written confirmation of the accuracy of the facts stated therein and does not
involve any estimate or opinion. Certificate on specific matters may be required from an

auditor by an enterprise for its own special purposes or by the government in support of the
statements made by the enterprise. These certificates or reports are unlike a general purposes
report. These are formal statements usually made after an enquiry, examination or review of
specified matters under report and include the reporting auditor's opinion thereon. Thus, when
a reporting auditor issues a certificate, he is responsible for the factual accuracy of what is
stated therein, e.g. certification of export turnover, etc. On the other hand, when the reporting
auditor gives the report, he is responsible for ensuring that the report is based on factual data,
that his opinion is in due accordance with the facts, and that it is arrived at by the application
of due care and skill.
On the other hand, an audit report is an opinion expressed by an auditor about the true and
fairness of the financial statements prepared following identified financial reporting
framework. It provides reasonable assurance and not the absolute assurance as has been done
by the certificates.
c) Qualified Audit Opinion vs. Disclaimer

Answer:
As per NSA 700: Forming an Opinion and Reporting on Financial Statements The Auditor's
Report on Financial Statements, the opinion paragraph of the auditor's report should clearly
the financial reporting framework or relevant practices used to prepare the financial
statements and state the auditor's opinion as to whether the financial statements give a true and
fair view (or are presented fairly, in all material respects), in accordance with that financial
reporting framework and, where appropriate, whether the financial statements comply with
statutory requirements:
An unqualified opinion should be expressed when the auditor concludes that the financial
statements give a true and fair view (or are presented fairly, in all material respects) in
accordance with the identified financial reporting framework or relevant practices. An auditor
may not be able to express an unqualified opinion when either of the following circumstances
exists and, in the auditor's judgment, the effect of the matter is or may be material to the
financial statements:
i. There is a limitation on the scope of the auditor's work; or
ii. There is a disagreement with management regarding the acceptability of the accounting
policies selected, the method of their application or the adequacy of financial statement
disclosures.
A qualified opinion should be expressed when the auditor concludes that an unqualified
opinion cannot be expressed but that the effect of any disagreement with management, or
limitation on scope is not so material and pervasive as to require an adverse opinion or a
disclaimer of opinion. A qualified opinion should be expressed as being 'except for' the effects
of the matter to which the qualification relates.
A disclaimer of opinion should be expressed when the possible effect of a limitation on scope
is so material and pervasive that the auditor has not been able to obtain sufficient appropriate
audit evidence and accordingly is unable to express an opinion on the financial statements.

As can be seen from above, qualified opinion is an expression of an opinion on financial

statements with some reservations, whereas disclaimer of opinion is a statement, which
provides that the auditor is not in a position to form any opinion at all.
Question No. 6
Distinguish between the following:
a) Certificate and Report (5 Marks December 2006)
b) Qualified Opinion and Adverse Opinion (5 Marks December 2006)
c) Reporting responsibilities of Joint Auditor (4 Marks December 2007)
Answer
a) An auditor can issue a certificate on a factual statement which is capable of direct

verification and in respect of which measurement yardsticks are definite. For example, he
can issue a certificate on actual cash on hand on any day be actually counting the cash. He
can also issue a certificate about the fixed assets of various descriptions in any organization
by physically verifying them in the premises of organization. But even in these cases it
would be extremely difficult for him to certify about the ownership of such assets. Certain
other matters, which are based on documentary evidence, also can be certified by the auditor
provided he makes clear that the certificate is issued based on the examination of the
documents produced. In case of certificate of imports or exports or circulation of a journal,
he goes on the basis of documentary proof. Matters requiring computations or arithmetic
accuracy checks can also be certified for example, computation of royalty etc.
On the other hand, where quantitative statements are prepared partly based on documentary
or other proof and partly on the basis of subjectivity in the situation and estimates based
thereon, subject to certain accepted rules and principles, it is not possible for the auditor to
issue any certificate. In such a situation he can express an informed opinion about the
position shown by the statement as to its truth and fairness which is called report. There are
varying accounting rules for recognition of income, estimating the value of stocks,
determination of the quantum of depreciation, etc. Therefore, the absoluteness that is
essential to enable one to issue a certificate is absent in a situation like this. Similarly, the
balance sheet also does not profess to show an undisputable and absolute picture about the
assets and liabilities; judgement and estimate do enter in a significant way in valuing assets
and liabilities while drawing up a balance sheet. Therefore, in these cases, the auditor cannot
take any more responsibility than to state in his report his opinion about these statements
based on the examination carried out by him, having regard to the accepted accounting rules,
convention and principles. This opinion is generally known as the auditor's report.
b) A qualified opinion is issued when the auditor concludes that he cannot issue an unqualified
opinion but that the effect of any disagreement, uncertainty or limitations on scope is not so
material as to require an adverse or a disclaimer of an opinion. It is given in respect of a part
of the information reflected in the financial statements and that the auditor is not in
agreement with that part. Moreover, the part with reference to which he is not in agreement
does not materially affect the view portrayed by the financial statements. Thus, the need for
a qualified opinion arises where the auditor is satisfied with the truth and fairness of the
financial statements; yet because of certain transactions he is not fully satisfied so as to issue
a clean or unqualified report.

An adverse opinion is issued by the auditor when the financial statements do not show a true
and fair view of the state of affairs or of the operating results. At times when the effect of
disagreement is so material and pervasive on financial statements that the auditor concludes
that the qualification in the audit report is not adequate to disclose the misleading picture of
the financial statements. An adverse opinion is given when there is flagrant violation of
accounting principles or evidence is not available for material transactions or where these
exists misstatement or concealment about financial affairs.
c) Normally, the joint auditors are able to arrive at an agreed report. However, 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 view of the majority of the joint auditors regarding matters to be covered in the
report and should express his opinion in a separate report in case of disagreement.
Question No. 7
Distinguish between Audit Note and Qualifications. (5 Marks December 2007)
Answer
All qualifications should be contained in the auditor‘s report itself and should appear at one place
in order to give the reader a clear view thereof. Notes to account normally represent explanatory
statements given by the directors elucidating or clarifying various items of accounts. A large
number of notes, including those giving specific information required under various
directives/rules, usually appear on the accounts. Examples of matters which are disclosed as
notes are: arrears of dividend on preference shares, capital commitments, computation of
managerial remuneration, etc. If the qualifications made by the auditor are also included in the
numerous notes, or if the auditor qualifies his report by making his reference to the notes, the
readers may be unable to appreciate the significance of such qualification.
It is, therefore, required that the notes to account should not contain the opinion of auditor.
Further, the auditors should reproduce the notes of a qualificatory nature in their report to enable
the reader to know the importance of these qualifications. Where notes of qualificatory nature
appear in the accounts, the auditor should state all qualifications independently in his report in an
adequate manner so as to enable a reader to assess the significance of these qualifications. For this
purpose, where a note has already been given in detail by the management, it is not necessary to
reproduce it verbatim in the audit report and brief self-explanatory statements may be sufficient.
Question No. 8
AB Garment Limited is not operating properly due to cancellation of export orders from
various parts of the World as a result of global recession. In order to sustain the company, the
company initiated a restructuring exercise and announced VRS (Voluntary Retirement
Scheme) to its staff as a measure to reduce cost. During the FY 2064/65, the company paid
NRs. 1 crore as compensation to those who availed the VRS scheme. The Chief Accountant has
reflected the above payment as regular salaries and wages paid by the company. Give your
view. (5 Marks June 2009)
Answer
The payment paid to staff of AB Garment Limited on account of Voluntary Disclosure Scheme
(VRS) as a measure to reduce cost to sustain the company in a financially difficult situation is the
ordinary activities of the company. It is a restructuring exercise carried out by the company.

Though this is not extraordinary items, the nature and amount of such items may be relevant to
the users of financial statements in understanding the financial position and performance of the
company and in making projections about financial position and performance. When items of
income and expense are material, their nature and amount shall be disclosed separately.
Disclosure of such information is sometimes made in the notes to the financial statements.
In view of the above, the compensation of NRs. 1 Crore paid by AB Garment limited towards
VRS availed by staff should be shown separately in the profit and loss account of the company so
that the effect of it on the operating results of the company during the year can be perceived.
Therefore, payment of VRS shown in the regular salaries and wages is not appropriate and hence
separate disclosure is required.
Question No. 9
d) A company is engaged in the manufacture of process control instruments like valves, level-
gauges etc. Its substantial sales are to two fertilizer / power projects. The Company receives
purchase order from the project. The purchase order stipulates that spares required for one
year‟s functioning of the instrument should be supplied together with the order.
The company regarded such sales as normal sales and not as sale of raw material because
sale of such spare parts are part of sales in execution of the order regarded as essential
spares to ensure continuous operation of instruments and quantity is stipulated by the
customer to avoid delay in replacement and consequent loss due to suspension of operation.
It is normal feature with equipment manufacturer to supply such set of spares along with
equipment.
But the internal auditor insisted that such dispatch should be treated as sale of raw material
requiring separate quantification.
Express your opinion on:
i) Whether the supply of spares along with sales order should be shown as a part of sales
(turnover) and consequently the quantitative details thereof to be given. If the
equipment is quantified, is it necessary to separately indicate quantity and spare
accompanying them?
ii) Whether it is tantamount to sale of raw materials requiring computation of profit on
sale of raw material and whether it is to be disclosed as such. (5 Marks December
2009)
e) M/s XYZ Co. Ltd. obtained an actuarial valuation for gratuity liability at the year end. The
actuary changed certain basic assumptions for working out liability at the yearend as
compared to previous year. What should be the auditor‟s responsibility in this regard?
Answer
a) The spares supplied together with the instruments are in accordance with one composite
sales contract in the ordinary course of business and the prices of such spares are not
separately indicated in the order. In such a case, such supplies should be treated as a part
of turnover of the company and in respect of quantitative details, only number of
equipment sold need to be quantified and it is not necessary to separately indicate quantity
of spares accompanying such equipment.
b) In the given case the company has taken the services of an actuary as an expert for the
actuarial valuation of its gratuity liability. Though the auditor should assess the
appropriateness of the expert‘s work as audit evidence regarding the financial statement

being considered, the appropriateness and reasonableness of assumptions are the

responsibility of the expert.
The responsibility of the auditor should be to establish and assure himself whether the
changes in assumptions are required as per the changes in prevailing conditions. This can
be done with his understanding of the assumptions and methods used in the valuation. He
has to satisfy himself with the source data used.
If the auditor is satisfied and it has no material impact on his reporting, then he need not
disclose that basic assumption has been changed by the expert for actuarial valuation of
gratuity liability.
Question No. 10
Write a short note on- Current Period Consolidation Adjustments.
Answer
Current Period Consolidation Adjustments are those adjustments that are made in the accounting
period for which the consolidation of the financial statements is done. Current period
consolidation adjustments primarily relate to elimination of intra-group transactions and account
balances including:
a) intra-group interest paid and received, or management fees etc.;
b) unrealized intra-group profits on assets acquired from other subsidiaries;
c) intra-group indebtness;
d) adjustments related to harmonizing the different accounting policies being followed by the
parent enterprise and its subsidiaries;
e) adjustments made for the effects of significant transactions or other events that occur
between the date of the financial statements of the parent and one or more of the
components, if the financial statements to be used for consolidation are not drawn up to the
reporting date; and
f) determination of movement in equity attributable to the minorities since the date of
acquisition of the subsidiary
Question No. 11
What are the basic elements that should be included in the Auditor‟s Report on examination of
prospective financial information? (5 Marks December 2009)
Answer
As per NSAE 3400, The Examination of Prospective Financial Information, the report by an
auditor on an examination of prospective financial Information should include the following:
a. Title;
b. Addressee;
c. Identification of the prospective financial information;
d. A reference to the NSAE or relevant national standards or practices applicable to the
examination of prospective financial information;
e. A statement that management is responsible for the prospective financial information
including the assumptions on which it is based;
f. When applicable, a reference to the purpose and/or restricted distribution of the
prospective financial information;
g. A statement of negative assurance as to whether the assumptions provide a reasonable
basis for the prospective financial information;

h. An opinion as to whether the prospective financial information is properly prepared on

the basis of the assumptions and is presented in accordance with the relevant financial
reporting framework;
i. Appropriate caveats concerning the achievability of the results indicated by the
prospective financial information;
j. Date of the report which should be the date procedures have been completed;
k. Auditor‘s address; and
l. Signature.
Such a report would:
 State whether, based on the examination of the evidence supporting the
assumptions, anything has come to the auditor‘s attention which causes the auditor
to believe that the assumptions do not provide a reasonable basis for the
prospective financial information.
 Express an opinion as to whether the prospective financial information is properly
prepared on the basis of the assumptions and is presented in accordance with the
relevant financial reporting framework.
 State that:
 Actual results are likely to be different from the prospective financial
information since anticipated events frequently do not occur as expected
and the variation could be material.
Likewise, when the prospective financial information is expressed as a
range, it would be stated that there can be no assurance that actual results
will fall within the range; and
 In the case of a projection, the prospective financial information has been
prepared for (state purpose), using a set of assumptions that include
hypothetical assumptions about future events and management‘s actions
that are not necessarily expected to occur. Consequently, readers are
cautioned that the prospective financial information is not used for
purposes other than that described.
Question No. 12
What are the features of a qualified Audit Report? (7 Marks June 2010)
a) The features of a qualified report are
1. Clarity: The auditor must express the nature of qualification, in a clear and unambiguous
manner.
2. Explanation: Where the auditor answers any of the statutory affirmations in the negative
or with a qualification his report shall state the reasons for such answer.
3. Placement: All qualifications should be contained in the Auditor‘s Report. When there
are notes which are subject matter of a qualification, the same should preferably be
annexed to the Auditors‘ Report. However, a reference to the notes to Accounts in the
Auditors‘ Report does not automatically become a qualification.

4. Subject to/ Except: The words‘" subject" or "except" to are essential to state any
qualification. The qualification should be preceded by words such as ‗subject to‘ or
except that‘ to make it clear that he is making an exception.
5. Quantification: It is also necessary that the auditor should quantify, wherever possible,
the effect of individual as well as the total effect of all qualifications on profit or loss
and/or state of affairs these qualifications on the financial statements in a clear and
unambiguous manner. In circumstances where it is not possible to quantify the effect of
the qualifications accurately the auditor may do so on the estimates made by the
management after carrying out such audit tests as are possible and clearly indicate that
the figures given are based on the estimates of the management.
6. Nature of qualification: Vague statements the effect of which on accounts cannot be

ascertained like ‗the debtors balances are subject to confirmation‘, ‗no provision for
taxation has been made in view of the loss during the year‘ etc., should be avoided.
7. Violation of law: Where the company has committed an irregularity resulting in a breach
of law, the auditor should bring the same to the notice of the shareholders by properly
qualifying his report.
8. Notes – Report Relationship – Where notes of a qualificatory nature appear in the

accounts the auditors should state all qualifications independently in their report so that
the user can assess the significance of these qualifications.
9. Draft Report: The auditor may discuss matters of qualification with the management of
the company to acquire their views. It is not necessary that the auditor should accept the
managements view and modify his opinion. But it would enable the auditor to accurately
draft the qualifications in his final report.
Question No. 13
Apple & Oranges Limited is engaged in manufacturing and sale of office equipment. It has
appointed you in place of ABC & Co. for the audit of financial statements for the year ended
Ashad 32, 2067.
During the audit you noted the following:
 An employee of the company, responsible for after-sales-services, misappropriated cash
which he recovered from the customers without raising proper invoices. The amount
was small and much below the materiality level.
 During the last year (ended on Ashad 31, 2066), the middle management in connivance
with lower staff booked a sale of material amount which actually pertained to the
current year. The higher management has issued warning letters to the concerned
employees but is reluctant to take any further action as the company has not suffered
any losses. ABC & Co. has given an unmodified report on the financial statements of
the previous year.
You are required to:
i) Describe how each of the above situations will impact the following:
A) Assessment of risk and audit procedures; (2 Marks December 2010)
B) Communication with management and with those charged with governance.

ii) As a result of material misstatement in sales of previous year, the management has agreed on
restatement of the corresponding figures in the financial statements of current year. How
would you treat this in your auditors‟ report? (5 Marks December 2010)
Answer
i) A) In the case of misappropriations of cash recovered by person responsible for after-sales-
service – it shows lack of proper authority delegation and control and hence chances of mis-
statement of debtors balance high and hence auditors shall opt for external confirmations and
increase substantive checking with respect to debtors account.
In the case of booking of sales for the following year in the current year – This is a kind of fraud
committed by middle management and weak control over raising of sales invoice and booking
of sales. Thus, substantive checking with respect to sales booked during the end of the period
shall be checked and ledgers for subsequent year shall also be checked for any reversal of sales
booked last year.
B) Misappropriations of cash collected shall be reported and discussed with the management for
enhancing the control over cash realization and the same may not be reported to those charged
with governance as the current impact of such acts is not material.
Misstatement of sales – This needs to be discussed with the management to tight control over
booking of sales and shall also be reported to those charged with governance as this is a kind of
fraud committed by persons with responsibilities and has impact on the financial results of the
organization.
ii) Adjustment for previous year mistakes shall be made in accordance with the provisions of
NAS 8 by re-stating the corresponding figures of previous year and a note to this extent shall be
given in the financial statements showing the impact of such re-statement and reasons for re-
statements.
The audit report for the year can however be issued without qualification if the auditor is
satisfied with the current year‘s sales accounting.
Question No. 14
Distinguish between the following:
a) Audit Certificate and Audit Report (5 Marks December 2010)
b) Clean Audit Report and Qualified Audit Report (5 Marks December 2010)
Answer
a) A certificate is a written confirmation of the accuracy of the facts stated therein and does not
involve any estimate or opinion. The term ‗certificate‘ is, therefore, used where the auditor
verifies the accuracy of facts. An auditor may thus, certify the circulation figures of a
newspaper or the value of imports or exports of a company. An auditor‘s certificate
represents that he has verified certain figures and is in a position to vouchsafe their accuracy
as per his examination of documents and books of account. A report, on the other hand, is a
formal statement usually made after an enquiry, examination or review of specified matters
under report and includes the reporting auditor‘s opinion thereon. Thus, when a reporting
auditor issues a certificate, he is responsible for the factual accuracy of what is stated therein.
On the other hand, when a reporting auditor gives a report, he is responsible for ensuring that
the report is based on factual data, that his opinion is in due accordance with facts, and that it
is arrived at by the application of due care and skill. The ‗report‘ involves expression of
opinion which may differ from one professional to another. There is no question of

exactitude in case of a report since the information contained therein is based on estimates
and involves judgement element.
b) Clean Audit Report and Qualified Audit Report: A clean report which is otherwise known as
unconditional opinion is issued by the auditor when he does not have any reservation with
regard to the matters contained in the financial statements. In such a case, the audit report
may state that the financial statements give a true and fair view of the state of affairs and
profit and loss account for the period. Under the following circumstances an auditor is
justified in issuing a clean report:
i. the financial information has been prepared using acceptable accounting policies,
which have been consistently applied;
ii. the financial information complies with relevant regulations and statutory
requirements; and
iii. there is adequate disclosure of all material matters relevant to the proper
presentation of the financial information, subject to statutory requirements, where
applicable.
Qualified audit report, on the other hand, is one which does not give a clear-cut assurance
about the truth and fairness of the financial statements and makes certain reservations on the
truth and fairness of the financial statements.
The gravity of such reservations will vary depending upon the circumstances. In majority of
cases, items which are the subject matter of qualification are not so material as to affect the
truth and fairness of the whole accounts but merely creates uncertainty about a particular
item. In such cases, it is possible for the auditors to report that in their opinion but subject to
specific qualifications mentioned, the accounts present a true and fair view.
Thus, an auditor may give his particular objection or reservation in the audit report and state
"subject to the above, we report that balance sheet shows a true and fair view……..". The
auditor must clearly express the nature of qualification in the report. The auditor should also
give reasons for qualification and all qualifications should be contained in the auditor's
report.
The words "subject to" are essential to state any qualification. It is also necessary that the
auditors should quantify, wherever possible the effect of these qualifications on the financial
statements in clear and unambiguous manner if the same is material and state aggregate
impact of qualifications.
Thus, it is clear from the above that in case of a clean report, the auditor has no reservation in
respect of various matters contained in the financial statements, but a qualified report may
involve certain matters involving difference of opinion between the auditor and the
management.
Question No. 15
What are the basic elements of auditor‟s report? (4 Marks December 2010)
Answer
The auditor‘s report includes the following basic elements, ordinarily in the following layout:
Title  The auditor‘s report shall have a title that clearly indicates that it is the
report of an independent auditor.
(“INDEPENDENT AUDTORS REPORT")
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 in that particular jurisdiction.

 The auditor‘s report is normally addressed to those for whom the report is
prepared, often either to the shareholders or to TCWG of the entity whose
financial statements are being audited.
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.
 The auditor‘s opinion Modified opinion or Unmodified opinion, as the case
may be, shall be expressed in this paragraph
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 NSAs
b. Refers to the section of the auditor‘s report that describes the
auditor‘s responsibilities under the NSAs;
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.
Going Concern  Where applicable, the auditor shall report in accordance with NSA 570
(Revised)- Going Concern.
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 NSA 701 (Key Audit Matters).
 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 NSA 701.
Other Information  Where applicable, the auditor shall report in accordance with NSA 720
(Revised).
Responsibilities for the  The auditor‘s report shall include a section with a heading
Financial Statements ―Responsibilities of Management for the Financial Statements.‖
 This section of the auditor‘s report shall describe management‘s
responsibility for:
a. Preparing the financial statements in accordance with the applicable
FRF 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; and
b. Assessing the entity‘s ability to continue as a going concern15 and

whether the use of the going concern basis of accounting is
appropriate.
Auditor‟s Responsibilities  The auditor‘s report shall include a section with the heading ―Auditor‘s
for the Audit of the Responsibilities for the Audit of the Financial Statements.‖
Financial Statements  This section of the auditor‘s report shall:
a. State that the objectives of the auditor are to:
1. Obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement,
whether due to fraud or error; and
2. 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 NSAs will

always detect a material misstatement when it exists; and

c. State that misstatements can arise from fraud or error and explain
under what circumstances they are considered material
In this section the auditor also states his responsibilities for:
a. Assessing the risk of material misstatements
b. Understanding the internal control system
c. Evaluating the appropriateness of accounting policies
d. Concluding the appropriateness of the managements use of going
concern basis
e. Communication with TCWG etc.
Other Reporting  For other matters to be reported as per the requirements of other laws and
Responsibilities regulations the 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
Name of Engagement  The name of the engagement partner shall be included in the auditor‘s
Partner report on financial statements of listed entities unless, in rare
circumstances, such disclosure is reasonably expected to lead to a
significant personal security threat.
 Naming the engagement partner in the auditor‘s report is intended to
provide further transparency to the users of the auditor‘s report on financial
statements of a listed entity.
Signature of the Auditor  The auditor‘s report shall be signed. The auditor‘s signature is either in the
name of the audit firm, the personal name of the auditor or both, as
appropriate for the particular jurisdiction.
Auditor‟s Address  The auditor‘s report shall name the location in the jurisdiction where the
auditor practices.
Date of the Auditor‟s  The auditor‘s report shall be dated no earlier than the date on which the
Report auditor has obtained sufficient appropriate audit evidence on which to base
the auditor‘s opinion on the financial statements
Question No. 16
Is it mandatory for a company to have its Cash Flow Statement, Statement of changes in
Equity and Notes to the accounts signed by its directors? Where the footnote of the balance
sheet and profit and loss states that “the annexed notes form an integral part of these
accounts”. (5 Marks December 2010)
Answer
Sectio109(1) of Companies Act 2063 states that ―Company shall prepare following financial
statement, in specified form, before 30 days of annual general meeting in case of public company
and within six months from the date of closing of financial year in case of private company.
 Balance Sheet as at the closing day of financial year
 Profit & Loss account for the financial year
 Cash Flow Statement for the financial year
In view of the above it can be inferred that both cash flow statement and statement of changes in
equity should be treated as part of balance sheet or profit and loss account and are not to be
disclosed as notes to the accounts. Therefore, being merely a continuation / part of balance sheet
or profit and loss, these are required to be signed by chairman of the Board of director and at least
one director as per section 109(7) of Companies Act 2063. As such strictly speaking, there is no
specific legal requirement of signing notes to the accounts by directors.
Question No. 17
State the effect on your audit report of the following alternative situations:
i) Depreciation had not been provided on any non-current asset for a number of years, the
effect of which if corrected would be to turn an accumulated profit into a significant
accumulated loss. (3 Marks December 2010)

ii) Doshi& Co were appointed auditors after the end of the financial year 2009-10 of Balaju
& Co. Consequently, the auditors could not attend the year-end inventory count. Inventory
is material to the financial statements. (Note: you are not required to draft any audit
reports). (3 Marks December 2010)
Answer
(i) Depreciation had not been provided
 The auditor would still disagree with the lack of depreciation on non-current assets so a
modified opinion on the grounds of disagreement would be required.
 As the financial statements need significant amendment (profit becoming a large loss) then
the auditor may conclude that the financial statements do not show a true and fair view
and issue an adverse report (rather than an ‗except for‘ report).
(ii) auditors appointed after the end of the financial year
 The auditors normally attend the inventory count to confirm the existence of inventory. As
the count was not attended, the existence of inventory cannot be confirmed.
 The auditor will be uncertain regarding existence and consequently valuation of inventory.
An ‗except for‘ audit report will be issued noting that adjustments may be necessary to the
inventory value.
Question No. 18
Explain in brief the types of modified audit report? (5 Marks June 2011)
Answer
a) An auditor‘s report is considered to be modified when it includes:
i) Matters that do not affect the auditor‘s opinion,

 Emphasis of matter
ii) Matters that do affect the auditor‘s opinion
 Qualified opinion
 Disclaimer of opinion
 Adverse opinion
Matters that do not affect the auditor‟s opinion (NSA 706)
In certain circumstances, an auditor‘s report may be modified by adding and emphasis of

matter paragraph to highlight a matter affecting the financial statements which is included in a
note to the financial statements that more extensively discussed the matter. The addition of
such an emphasis of matter paragraph does not affect the auditor‘s opinion.
Matters that do affect the auditor‟s opinion (NSA 705)
An auditor may not be able to express an unqualified opinion when either of the following
circumstances exists and, in the auditor‘s judgment, the effect of the matter is or may be
material to the financial statements:
 there is limitation of scope of the auditor‘s work; or

 there is disagreement with management regarding the acceptability of the accounting

policies selected, the method of their application or the adequacy of financial
statement disclosures
The circumstance described as first could lead to qualified opinion or disclaimer of opinion
whereas in the circumstance described as in the second could lead to a qualified opinion or
adverse opinion.
Question No. 19
Assume that you are the auditor of M/S LMN Ltd. for FY 2066/67. While conducting the audit,
you observed that the company has not charged depreciation for the period in the financial
statement provided to you. The carrying amount of pool “Building” is Rs.50 lakhs and
“Equipment” is Rs. 120 lakhs. The management of the company is of the opinion that since the
Company has suffered a loss of Rs. 235 lakhs during the period, it would not increase the loss
by charging depreciation in the financial statements and it will be disclosed in its notes.
What type of audit report of M/S LMN Ltd. will you issue? Please draft the additional content,
if any, of the report which will be different from an unqualified report?
(4 Marks June 2011)
Answer
As discussed in Note XX to the financial statements, no depreciation has been provided in the
financial statements. This, in our opinion, is not in accordance with Nepal Accounting Standards.
The depreciation for the year ended Asadh 2067 should be 27 lakhs based on the straight-line
method of depreciation using annual rates of 5% for the building and 20% for the equipment.
Accordingly, the fixed assets should be reduced by the depreciation of 27 lakhs and loss for the
year should also be increased by the 27 lakhs.
In our opinion, except for the effect on the financial statements of the matter referred to Basis for
Qualified Opinion Paragraph, the financial statements of M/S LMN Ltd. for the financial year
ending Asadh 32, 2067 give a true and fair view of the financial position of M/S LMN Ltd. as of
Asadh 32 2067 and of its financial performance and its cash flows for the year then ended in
accordance with Nepal Accounting Standards.
(Other paragraphs containing Management‘s responsibility, Auditors responsibility Legal

requirements are the same as of the example of unqualified opinion)
Question No. 20
A has been appointed internal auditor by a co-operative society. This co-operative society is
involved in the business of procuring vegetables through the members of co-operative societies
from the farmers and sells the same in the open market as well as to the members of societies.
The internal auditor accordingly audited the accounts of the co-operatives and signed the
financial statement. The report on above is yet to be given.
The Board of co-operative society proposes certain adjustment/changes in the profit & Loss
account and balance sheet for the year. The proposed adjustment is to transfer ¼ of profit
(subject to final audit) on trading of vegetables to development fund. The society has offered to
give an indemnity in writing that the said signed financial statement have not been circulated
yet and submitted at any authority. Suggest whether internal auditor can sign the financial
statement after incorporating such adjustments. (5 Marks June 2011)

Answer
The cooperative is within its power to amend its financial statements before they are released for
use by a third party or adopted in general body meeting. It is to be ensured that amended financial
statements are in substitution of the financial statements signed by the internal auditor. Unless all
copies of the original signed financial statements are returned to the internal auditor, such
substitution is not possible.
The internal auditor can sign the amended financial statements after satisfying themselves that all
copies of the original signed financial statements have been obtained by them from the
cooperative and not copied and circulated to others. In such situation no disclosure is necessary of
the fact of earlier certification in their report or in the notes to accounts.
However, in case the internal auditor is not satisfied in this regard, he/ she may insist on
including the facts of the said amendment by way of a note to the accounts. If the cooperative
does not agree to include the appropriate note to the accounts, the internal auditor should refuse to
sign the amended accounts.
Question No. 21
Explain the circumstances that are considered as disagreement with management and that may
result in other than an unqualified audit report. (4 Marks June 2011)
Answer
Limitation on scope and disagreement with management:
The auditor may disagree with management about matters such as the acceptability of accounting
policies selected, the method of their application, or the adequacy of disclosures in the financial
statements. If such disagreements are material to the financial statements, the auditor should
express a qualified or an adverse opinion.
Question No. 22
Distinguish between Audit Report and Certificates.
(4 Marks June 2011, 4 Marks, December 2011)
Answer hint
The term audit report is used where an expression of opinion is involved. The term certificate is
preferable where the auditor comments on or verifies facts such as a verification of investment by
inspection or the checking of ballot papers on a poll in a company meeting. Statutorily, there are
number of situations where an auditor is required to issue a certificate rather than a report.
Question No. 23
Distinguish between Accounting policies and notes to Accounts (4 Marks June 2011)
Answer
An accounting policy are the measurement basis (or bases) used in preparing the financial
statements; and the other policy used that are relevant to an understanding of the financial
statements. It is important for users to be aware of the measurement basis (bases) used (historical
cost, current cost, realizable value, fair value or present value) because they form the basis on
which the whole of the financial statements is prepared. When more than one measurement basis
is used in the financial statements, for example when certain non – current assets are revalued, it

is sufficient to provide an indication of the categories of assets and liabilities to which each
measurement basis is applied.
The summary of significant accounting policies should be disclosed to help users to understand
the basis of preparation of financial statements. In deciding whether a particular accounting policy
shall be disclosed, management considers whether disclosure would assist users in understanding
the way in which transactions and events are reflected in the reported financial performance and
financial position.
The notes to the financial statements of an entity shall:
The notes to account of the financial statements (i) present information about the basis of
preparation of the financial statements and the specific accounting policies selected and applied
for significant transactions and events; (ii) disclose the information required by Nepal
Accounting Standards that is not presented elsewhere in the financial statements; and (iii) provide
additional information which is not presented on the face of the financial statements but that is
necessary for a fair presentation.
Notes to the financial statements shall, as far as practicable, be presented in a systematic manner.
Each item on the face of the balance sheet, income statement, statement of changes in equity and
cash flow statement shall be cross – referenced to any related information in the notes. Notes to
the financial statements include narrative descriptions or more detailed analyses of amounts
shown on the face of the balance sheet, income statement, cash flow statement and statement of
changes in equity, as well as additional information such as contingent liabilities and
commitments. They include information required and encouraged to be disclosed by Nepal
Accounting Standards, and other disclosures necessary to achieve a fair presentation
Question No. 24
Enumerate the „Basic Elements of Audit Reports‟. (5 Marks December 2011)
Or
What are the elements of the Auditor's Report in an audit conducted in accordance with NSA?
Answer
Basic Elements of Auditor‟s Report:
The auditor‘s report includes the following basic elements:
Title  The auditor‘s report shall have a title that clearly indicates that it is the
report of an independent auditor.
(“INDEPENDENT AUDTORS REPORT")
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 in that particular jurisdiction.
 The auditor‘s report is normally addressed to those for whom the report is
prepared, often either to the shareholders or to TCWG of the entity whose
financial statements are being audited.
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.
 The auditor‘s opinion Modified opinion or Unmodified opinion, as the case
may be, shall be expressed in this paragraph
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 NSAs
b. Refers to the section of the auditor‘s report that describes the
auditor‘s responsibilities under the NSAs;
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.
Going Concern  Where applicable, the auditor shall report in accordance with NSA 570
(Revised)- Going Concern.
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 NSA 701 (Key Audit Matters).
 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 NSA 701.
Other Information  Where applicable, the auditor shall report in accordance with NSA 720
(Revised).
Responsibilities for the  The auditor‘s report shall include a section with a heading
Financial Statements ―Responsibilities of Management for the Financial Statements.‖
 This section of the auditor‘s report shall describe management‘s
responsibility for:
a. Preparing the financial statements in accordance with the applicable
FRF 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; and
b. Assessing the entity‘s ability to continue as a going concern15 and

whether the use of the going concern basis of accounting is
appropriate.
Auditor‟s Responsibilities  The auditor‘s report shall include a section with the heading ―Auditor‘s
for the Audit of the Responsibilities for the Audit of the Financial Statements.‖
Financial Statements  This section of the auditor‘s report shall:
a. State that the objectives of the auditor are to:
1. Obtain reasonable assurance about whether the financial
statements as a whole are free from material misstatement,
whether due to fraud or error; and
2. Issue an auditor‘s report that includes the auditor‘s opinion.
A) State that reasonable assurance is a high level of assurance, but
is not a guarantee that an audit conducted in accordance with
NSAs will always detect a material misstatement when it exists;
and
B) State that misstatements can arise from fraud or error and
explain under what circumstances they are considered material
In this section the auditor also states his responsibilities for:
b. Assessing the risk of material misstatements
c. Understanding the internal control system
d. Evaluating the appropriateness of accounting policies

e. Concluding the appropriateness of the managements use of going

concern basis
f. Communication with TCWG etc.
Other Reporting  For other matters to be reported as per the requirements of other laws and
Responsibilities regulations the 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
Name of Engagement  The name of the engagement partner shall be included in the auditor‘s
Partner report on financial statements of listed entities unless, in rare
circumstances, such disclosure is reasonably expected to lead to a
significant personal security threat.
 Naming the engagement partner in the auditor‘s report is intended to
provide further transparency to the users of the auditor‘s report on financial
statements of a listed entity.
Signature of the Auditor  The auditor‘s report shall be signed. The auditor‘s signature is either in the
name of the audit firm, the personal name of the auditor or both, as
appropriate for the particular jurisdiction.
Auditor‟s Address  The auditor‘s report shall name the location in the jurisdiction where the
auditor practices.
Date of the Auditor‟s  The auditor‘s report shall be dated no earlier than the date on which the
Report auditor has obtained sufficient appropriate audit evidence on which to base
the auditor‘s opinion on the financial statements
Question No. 25
Distinguish between Disclaimer of opinion and adverse opinion (4 Marks June 2012)
Answer
A disclaimer of opinion is expressed when the possible effect of a limitation on scope is so
material and pervasive that the auditor has not been able to obtain sufficient appropriate audit
evidence and accordingly is unable to express an opinion on the financial statements.
When there is limitation on the scope of the auditor‘s work that requires expression of a
disclaimer of opinion, the auditor‘s report should describe the limitation and indicate the possible
adjustments to the financial statements that might have been determined to be necessarily had the
limitation not existed.
An adverse opinion is expressed when the effect of a disagreement is so material and pervasive to
the financial statement that the auditor concludes that a qualification of the report is not adequate
to disclose the misleading or incomplete nature of the financial statements.
Question No. 26
In respect of sales in the seed‟s division of Ramu & Co., prepare a report to be sent to the audit
committee of Ramu & Co. which: (5 Marks each December 2012)
a) Identifies and explain four weaknesses in the sales system.
b) Explain the possible effect of each weakness; and
c) Provide a recommendation to alleviate each weakness.
Answer:
Report to audit committee - Inventory control and Sales System Seed division
The internal audit of the inventory and sales system identified the following weaknesses:
Weakness Potential effect of Recommendation
weakness
Recording of orders

Weakness Potential effect of Recommendation

weakness
Orders placed on the Internet site Customers will be sent The computer systems are
are transferred manually into the incorrect goods resulting amended so that order details
inventory and sales system. in increased customer are transferred directly
Manual transfer of order details complaints between the two computer
may result in information being systems. This will remove
transferred incompletely or manual transfer of details
incorrectly, for example, order limiting the possibility of
quantities may be incorrect, or human error
the wrong product code recorded
Control over orders and
packing lists
Each order/packing list is given Packing lists can be lost Orders/packing lists are
a random alphabetical code. resulting either in goods controlled with a numeric
While this is useful, using this not being despatcher to sequence. At the end of each
type of code makes it difficult to the customer (if the list is day, gaps in the sequence of
check completeness of orders at lost prior to goods being packing lists returned to
any stage in the dispatch and dispatched) or the accounts are investigated
invoicing process customer‘s credit card not
being charged (if lost
after goods dispatched
but prior to the list being
received in the accounts
department).
Obtaining payment
The customer‘s credit card is Ramesh & Co. will not be Authorization to charge the
charged after dispatch of goods paid for the goods customer‘s credit card is
to the customer, meaning that dispatched where the obtained prior to dispatch of
goods are already sent to the credit company rejects goods to ensure Ramu & Co.
customer before payment is the payment request. is paid for all goods
authorized Given that customers are dispatched
unlikely to return seeds,
Ramu & Co. will
automatically incur a bad
debt
Completeness of orders
The computer system correctly Entire orders may be The computer is
ensures that order details are overlooked and programmed to review the
available for all charges to consequently sales and order file and orders where
customer credit cards. However, profit understated there is no corresponding
there is no overall check that all invoice for an order, these
orders recorded on the inventory should be flagged for
and sales system have actually subsequent investigation
been invoiced
.
Summary
We look forward to arranging a meeting to discuss these weaknesses with you in more detail Note
to candidates: the marking scheme shows other valid points.

Question No. 27
The auditor report of Kathmandu Ltd. for the fiscal year 2068/69 contains a qualification
regarding non-provision of doubtful debts. As a statutory auditor of the company for the fiscal
year 2069/70, how would you report if:
i) The company does not make provision for doubtful debts in 2068/69.
ii)The company makes adequate provision for doubtful debts in 2068/69.
Answer:
Auditor‘s responsibility in cases where audit report for the earlier year is qualified is given in
NSA 710 ‗Comparative Information‘. As per NSA 710, when the auditor‘s report on the prior
period, as previously issued, included a qualified opinion, a disclaimer of opinion or an adverse
opinion and the matter which gave rise to the modified opinion is resolved and properly dealt with
in the financial statements in accordance with the applicable financial reporting framework, the
auditor‘s opinion on the current period need not refer to the previous modification.
NSA 710 further states that if the auditor‘s report on the prior period, as previously issued,
included a qualified opinion and the matter which gave rise to the modification in unresolved, the
auditor shall modify the auditor‘s opinion on the current period‘s financial statements. In the basis
for modification paragraph in the auditor‘s report, the auditor shall either:
i) Refer to both the current period‘s figures and the corresponding figures in the
description of the matter given rise to the modification when the effects or possible
effects of the matter on the current period‘s figures are material; or
ii) In other cases, explain that the audit opinion has been modified because of the effects
or possible effects of the unresolved matter on the comparability of the current
period‘s figure and the corresponding figures.
In the instant case, if Kathmandu Ltd. does not make the provision for doubtful debts the
auditor will have to modify his report for both current and previous year‘s figures as
mentioned above. If, however, the provision is made, the auditor need not refer to the earlier
year‘s modification.
Question No. 28
You are the auditor of M/S Dragon Tea Limited for the financial year 2069/70. During the
course of audit of the Company, you observed that the accumulated net loss of the Company is
Rs. 50 Million and current liabilities amounts to Rs. 400 Million. The total assets of the
Company amount to Rs. 350 Million only. However, adequate disclosure of the same has been
made in the financial statements of the Company. You want to express unqualified opinion but
still doubt the company‟s ability to continue as going concern and hence would like to draw
attention to the possibility that the Company may be unable to continue realizing its assets and
discharging its liabilities in the normal course of business. You are requested to draft only the
paragraph showing the emphasis of matter in the audit report that shall be issued by you.
(5 Marks June 2014)
Answer
―Without qualifying our opinion, we draw attention to Annexure X of the financial statements of
the Co. which indicated that the Company has incurred the accumulated loss up to financial year
2069/70 of Rs. 50 Million and the Company‘s current liabilities exceed its total assets by Rs. 50
Million. These conditions, along with other matters as set forth in Annexure X, indicate the
existence of a material uncertainty which may cast significant doubt about the Company‘s ability
to continue as a going concern.‖

Question No. 29
Briefly outline the types of audit report/opinion with an example/scenario for each type of
opinion.
(8 Marks June 2014)
Answer
a) Audit opinion/reports are classified as follows:
1. Unqualified or clean report (opinion)
When the Auditor concludes that the Financial Statements give a true and fair view in
accordance with the financial reporting framework used for the preparation and
presentation of the Financial Statements. In this case auditor does not have any
significant reservation in respect of matters contained in the Financial Statements.
2. Modified Reports
An auditor's report is considered to be modified in the following situations:
a. Matters That Do Not Affect the Auditor's Opinion
Emphasis of matter: - The effect of this is given by adding an emphasis of matter paragraph to
highlight a matter affecting the financial statement which is included in notes to
accounts. Example: applied for going concern problem and other uncertainty.
b. Matters That Do Affect the Auditor's Opinion
When:
(a) There is a limitation on the scope of the auditor's work; (Can be qualified or disclaimer of
opinion)
(b) There is a disagreement with management regarding the acceptability of the accounting
policies selected, the method of their application or the adequacy of financial statement
disclosures. (can be qualified or adverse)
And, in the auditor's judgment, the effect of the matter is or may be material to the financial
statements, below opinions may be issued.
(a) Qualified opinion,

Expressed when the auditor concludes that an unqualified opinion cannot be expressed but
that the effect of any disagreement with management, or limitation on scope is not as material
and pervasive as to require an adverse opinion or a disclaimer of opinion. A qualified opinion
should be expressed as being 'except for' the effects of the matter to which the qualification
relates. Example: limitation of scope by client or single deviation from standards.
(b) Disclaimer of opinion,

Expressed when the possible effect of a limitation on scope is so material and pervasive that
the auditor has not been able to obtain sufficient appropriate audit evidence and accordingly is
unable to express an opinion on the financial statements. Example: limitation of scope is
imposed by client or auditor is not independent.
(c) Adverse opinion.

An adverse opinion should be expressed when the effect of a disagreement is so material and
pervasive to the financial statements that the auditor concludes that a qualification of the
report is not adequate to disclose the misleading or incomplete nature of the financial
statements. Example: Failure of company to consolidate a material subsidiary company.

Question No. 30
Distinguish between Audit Certificate and Audit Report. (4 Marks December 2014)
Answer
A certificate is a written confirmation of the accuracy of the facts stated therein and does not
involve any estimate or opinion. The term ‗certificate‘ is, therefore, used where the auditor
verifies the accuracy of facts. An auditor may thus, certify the circulation figures of a newspaper
or the value of imports or exports of a company. An auditor‘s certificate represents that he has
verified certain figures and is in a position to vouchsafe their accuracy as per his examination of
documents and books of accounts. A report, on the other hand, is a formal statement usually made
after an enquiry, examination or review of specified matters under report and includes the
reporting auditor‘s opinion thereon. Thus, when a reporting auditor issues a certificate, he is
responsible for the factual accuracy of what is stated therein. On the other hand, when a reporting
auditor gives a report, he is responsible for ensuring that the report is based on factual data, that
his opinion is in due accordance with facts, and that it is arrived at by the application of due care
and skill. The ‗report‘ involves expression of opinion which may differ from one professional to
another. There is no question of exactitude in case of a report since the information contained
therein is based on estimates and involves judgment element.
Question No. 31
Under the applicable standard on auditing, in what circumstances does the report of the
statutory auditor require modification? What are the types of modifications possible to the said
report?
(8 Marks June 2015)
Answer
As per NSA 705, "Modification to the opinion in the independent auditor's report" the auditor
may modify the opinion in the auditor's report in the following circumstances
a. If the auditor concludes that, based on the audit evidence obtained, the financial statements as
a whole are not free from material misstatement, or
b. If the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the
financial statements as a whole are free from material misstatement.
If financial statements prepared in accordance with the requirements of a fair presentation

framework do not achieve fair presentation, the auditor shall discuss the matter with management
and, depending on the requirements of the applicable financial reporting framework and how the
matter is resolved, shall determine whether it is necessary to modify the opinion in the auditor's
report in accordance with NSA 705.
Types of modification to the auditor's Opinion:
As per NSA 705, modified opinion may be defined as a qualified opinion, an adverse opinion or a
disclaimer of opinion.
Types of modifications possible to the said report are below-mentioned-

i. Qualified Opinion : the auditor shall express a qualified opinion when the auditor, having
obtained sufficient appropriate audit evidence, concludes that misstatements, individually or
in the aggregate, are material, but not pervasive, to the financial statements, or the auditor is
unable to obtain sufficient appropriate audit evidence on which to base the opinion, but the
auditor concludes that the possible effects on the financial statements of undetected
misstatements, if any, could be material but not pervasive.

ii. Adverse Opinion: The auditor shall express an adverse opinion when the auditor having
obtained sufficient appropriate audit evidence concludes that misstatements, individually or
in the aggregate, are both material and pervasive to the financial statements.
iii. Disclaimer of opinion: the auditor shall disclaim an opinion when the auditor is unable to
obtain sufficient appropriate audit evidence on which to base the opinion, and the auditor
concludes that the possible effects on the financial statements of undetected misstatements,
if any, could be both material and pervasive.
Question No 32
Write the short note on;
Reporting of Review Engagement (5 Marks December 2016)
The review report should contain a clear written expression of negative assurance. The auditor
should review and assess the conclusions drawn from the evidence obtained as the basis for the
expression of negative assurance. Based on the work performed, the auditor should assess whether
any information obtained during the review indicates that the financial statements do not give a
true and fair view (or are not presented fairly, in all material respects) in accordance with the
identified financial reporting framework. The report on a review of financial statements describes
the scope of engagement to enable the reader to understand the nature of the work performed and
make it clear that an audit was not performed and, therefore, that an audit opinion not expressed.
Reporting should be made in accordance with the provisions of NSRE 2400.
Question No. 33
ABC and Associates is the Auditor of Omega Limited who has prepared its financial statements
for 2072/73 in accordance with NFRS. During the course of audit, the audit team noted that
the inventory of Omega as on 31stAshad 2073 is stated as Rs. 13 crores at cost although net
realizable value of the inventory is Rs. 7 crores only. The misstatement of value of inventory is
considered as material but not pervasive by the audit team. Audit manager is not quite clear
about audit opinion and wording of the opinion in such circumstance. As an engagement
partner for this audit what will be your guidance to audit manager.
(8 Marks June 2017)
Answer
Modification to the opinion in independent auditor‟s report: NSA 705: ―Modification to the
opinion in independent auditor‘s report‖ provides guidance to the auditor for dealing with similar
cases.
Since the audit team concludes that inventory is misstated and the misstatement is material
although not pervasive, qualified opinion will be appropriate in such case. When the auditor
modifies the opinion on the financial statements, the auditor shall, in addition to the specific
elements required by NSA 700, include a paragraph in the auditor‘s report that provides a
description of the matter giving rise to the modification. The auditor shall place this paragraph
immediately before the opinion paragraph in the auditor‘s report and use the heading ―Basis for
Qualified Opinion,‖ ―Basis for Adverse Opinion,‖ or ―Basis for Disclaimer of Opinion,‖ as
appropriate. the auditor shall include in the basis for modification paragraph a description and
quantification of the financial effects of the misstatement, unless impracticable. If it is not
practicable to quantify the financial effects, the auditor shall so state in the basis for modification
paragraph. 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 paragraph. When the auditor expresses a qualified opinion due to a material misstatement
in the financial statements, the auditor shall state in the opinion paragraph that, in the auditor‘s
opinion, except for the effects of the matter(s) described in the Basis for Qualified Opinion
paragraph:
 The financial statements present fairly, in all material respects (or give a true and fair view)
in accordance with the applicable financial reporting framework when reporting in
accordance with a fair presentation framework; or
 The financial statements have been prepared, in all material respects, in accordance with
the applicable financial reporting framework when reporting in accordance with a
compliance framework.
Hence based on above guidance Extract from Independent Auditor‟s Report can be provided as
below for the given case
Qualified Opinion
……………….In our opinion, except for the effects of the matter described in the Basis for
Qualified Opinion paragraph, the financial statements present fairly, in all material respects, (or
give a true and fair view of) the financial position of Omega as at 31 Ashad 2073, and (of) its
financial performance and its cash flows for the year then ended in accordance with Nepal
Financial Reporting Standards
Basis for Qualified Opinion

The company‘s inventories are carried in the statement of financial position at Rs 13 crore.
Management has not stated the inventories at the lower of cost and net realizable value but has
stated them solely at cost, which constitutes a departure from Nepal Financial Reporting
Standards. The company‘s records indicate that had management stated the inventories at the
lower of cost and net realizable value, an amount of Rs 6 crore would have been required to write
the inventories down to their net realizable value. Accordingly, cost of sales would have been
increased by Rs. 6 crores and provision for current income tax, net income and shareholders‘
equity would have been reduced by Rs. 1.5 core, 4.5 crores and 4.5 crores respectively.
Question No. 34
You are appointed as an auditor of a life insurance company for year 2070/71. Your audit team
raised the following major concerns in this audit.
Item Total NPR Value Remarks

value in the selected in
financial the sample
statement
Insurance 10 Arab 10 crores Premium of 1 crore could be verified and
premium (100 files) other files were not made available. The
verified files indicate overstatement of
premium by 25 lakhs
Insurance 3 Arab 1 Arab (50 Claim of 20 crores could be verified and
claim files) other files were not made available. The
verified file revealed understatement of
claim by Rs 2 cores.
Investment 50 Arab 5 Arab Evidence of only 1 Arab were produced
indicating no discrepancies.

Premium and claim represents 80% and 30% of total income and expenses respectively.
Similarly, investment accounts for 80% of total assets of the company. The team is under
dilemma on how to frame audit opinion. Please guide your team as the engagement partner
with extract from audit report. (10 Marks June 2018)
Answer:
Audit Opinion on financial statements of life insurance company:
Premium income and claim expenses of life insurance company are major items of income and
expenditures as mentioned in the given case also (premium represents 80% of total income and
claim represents 30% of total expenses). Further investment is the major asset item of a life
insurance company. It seems from the case that auditor could not obtain sufficient evidence for
audit of these major items as summarized below:
 Premium: out of sample selected, only 10% could be verified and in verified items
misstatement by 25% was noted.
 Claims: out of sample selected, only 20% could be verified and in verified sample
misstatement by 10% was noted.
 Investment: out of sample selected, only 20% could be verified and no misstatements
were found in verified cases.
So, major portion of income, expenditures and assets of the financial statements could not be
verified by the auditor in the absence of evidence. Further the verified evidences indicate
misstatements in income and expenditure whereas no misstatements were noted in investment (i.e.
assets) based on verification. Hence the possible effect on the financial statements of
misstatements that are undetected due to inability to obtain sufficient evidence could be material
and pervasive. So, it appears that the auditor should disclaim his opinion in this situation.
Extract from audit report applicable in this situation is:
Disclaimer of Opinion
Because of the significance of the matter described in the Basis for Disclaimer of Opinion
paragraph, we have not been able to obtain sufficient appropriate audit evidence to provide a basis
for an audit opinion. Accordingly, we do not express an opinion on the financial statements.
Basis for Disclaimer of Opinion

Premium income and claim expenses are stated as NPR 10 Arab and 3 Arab respectively. We
have selected sample representing 1% and 33.33% of these for verification but the company could
not provide any evidence for verification of 90% and 80% of selected samples for premium and
claims respectively. Further in the limited verification of premium and claims we noted
understatement of premium income by 25 lakh and overstatement of claim expenses by 2 crores.
So, the possible effect in the financial statements of misstatements on premium and claims that
was not verified could be material and pervasive.
Further, investment is stated at NPR 50 Arab. We selected samples to verify 10% of investment
but could not verify 80% of selected samples in want of evidences. There could be misstatements
in unverified investments and the possible effect could be material and pervasive.
As a result, we were unable to determine whether any adjustments were necessary in respect of
premium, claim, investment and other items of financial statements.

Question No. 35
Comment and give your views with reasons on the following case, giving consideration to
The position of ABC Company Private Limited as on Ashadh 32, 2075 is as below:
The paid capital of the company is Rs. 25 crores. The company has fixed assets costing Rs. 2
crores on which depreciation provision was Rs. 1.95 crore, which was equal to the full cost of
depreciable assets. The balance of Rs. 5 lakhs represented the cost of land. It has discontinued
its operations for past many years. The company has made investment in various companies to
the tune of Rs. 30 crores.
Unfortunately, all these investee companies have turned out to be bankrupt and nothing is
expected to be realized on such investments. The company has dues from customers amounting
to Rs. 4.95 crore of which Rs. 4.90 crore is due from businesses which have become defunct.
The balance Rs. 5 lakhs are due for over 3 years. The accumulated loss is Rs. 10 crores. The
amounts due to suppliers are Rs. 3 crore and they are overdue for long time. The balancing
figure in the balance sheet refers to loan from financial institutions.
Workers who had put in long years of service have lodged claims for termination benefits of Rs.
10 crores, which have been decreed in their favor. No accounting entries have been passed
since the decree on Jestha 29, 2073. Also, the company continues to prepare its accounts
undergoing Concern assumption.
In the light of NSA 570 (Revised) relating to Going Concern you are required to
i) Analyze the facts of the case and state the reasons supporting your audit
opinion. (5 Marks December 2018)
ii) Draft appropriate paragraph for your audit report:
Basis for Opinion (3.5 Marks December 2018)
Opinion (1.5 Marks December 2018)
Answer:
NSA 570 (Revised) ―Going Concern‖ requires the auditor to consider the appropriateness of
the going concern assumption underlying the preparation of the financial statements which
may no longer be appropriate. The following indications inter alia have to be taken into
consideration in determining the appropriateness of going concern assumption:
 Financial indications such as negative net worth, adverse key financial ratios,
substantial operation loss, inability to pay creditors on due date etc.
 Operating indications such as labor difficulties, loss of major markets etc.
 Other indicators include non-realizability of investment etc.
Having regard to aforesaid indicators and as per the facts of the case, the company is not
going concern as on Ashad 32, 2075 on account of the following reasons
 The company has discontinued its operations for last many years. Its productive fixed
assets are fully depreciated. The only productive asset left is land worth of Rs. 5 lakhs.
 The claim of worker for termination benefits amounting to Rs. 10 crores though
decreed on Jestha 29, 2073 has not been provided for in the books of accounts.
 The amounts recoverable from customer totaling Rs. 4.95 crore of which Rs. 4.90 crore
are due from business which are totally defunct are doubtful of recovery in its entirety.
Even the balance amount is due for more than three years. Hence the amount is
doubtful of recovery.
 The company has not been able to pay to its suppliers amounting to Rs. 3 crore which
are long overdue.

 The company‘s investment to the tune of Rs. 30 crores are not realizable and are
worthless in view the investee companies are bankrupt and nothing is realizable from
them.
 The balance figure for loan from financial institutions works out to Rs. 17 crores as per
the records which company is unable to pay.
 Thus, in view of the aforesaid financial, operation and other indicators, the assumption
of going concern is not appropriate.
Since, the company continues to prepare its account on going concern basis though going
concern is inappropriate, the auditor should give adverse opinion in accordance to NSA 705:
Modifications to the Opinion in the Independent Auditors Report.
(Extract)
Adverse Opinion
In our opinion, because of the significance of the matter discussed in the Basis for Adverse
Opinion paragraph, the financial statements do not give true and fair view in conformity with
the accounting principles generally accepted in Nepal
a. In the case of the Balance Sheet of the state of the affairs of the company as at Ashad 32,
2075.
b. In the case of the Profit and Loss account, of the profit/loss of the year ended on that date.
c. In the case of the Cash Flow Statement, of the cash flows for the year ended on that date.
Basis for Adverse Opinion

The Company as at Ashad 32, 2075 has an accumulated loss of Rs. 10 cores, has irrevocable
debts of Rs. 4.95 crore as at that date, the diminution in value of its investment is Rs. 30 crores
as at that date and a non-provision of decree obligation in favor of employees of Rs. 10 crores.
The company has discontinued its operation for last many years and has not been able to
honor its obligation to creditors and financial institutions for quite some time. Thus, the total
accumulated losses are Rs. 54.95 crore (and not 10 crores as reported).
After taking into account the above factors we are of the opinion that the company is not
going concern as on at Ashad 32, 2075 and thus, the usage of going concern assumption in the
preparation of financial statements is inappropriate.

Chapter 8 Audit of specialized enterprises
Question No. 1
a. With regard to the General Insurance Companies, list the procedures that you think
important for the purpose of establishing internal control procedures for underwriting
. (6 Marks December 2004)
b. During the Financial Year 2075/76 ABC Bank Ltd. (a commercial bank) managed a
capital fund at 10% of its total Risk Weighted Assets? How do you advise the bank
management to deal with Nepal Rastra Bank on such matter if NRB issues a notice to the
bank for non-compliance of directives issued by NRB to Commercial Banks? What are the
consequences if the bank management does not agree with your advice?
c. How do you classify the loans and advances of a bank and on what basis?
a. Answer
Underwriting is assuming/accepting a specified work for a value return (Money). The
underwriting function, which comprises of examination and evaluation of applications for
insurance, the rating of risks and the establishment of premiums, is fundamental to the
operations of a general insurance company. The prime objective of an internal control system
for underwriting is adherence to guidelines for acceptance of insurance, proper recording of
insurance risk and its evaluation.
The following may be the internal control procedure with regard to underwriting:
i. Appropriate and clear underwriting guidelines are framed and communicated to the
underwriting department and the intermediaries where such guidelines are executed with a
reasonable certainty without providing substantial flexibility to the underwriters. An
appropriate official of the company should monitor the adherence to these guidelines.
ii. There is an effective communication between claims and underwriting department.
iii. The relevant information is processed on a timely basis to avoid processing backlogs.
iv. Suspense/unreconciled account balances are reviewed and analyzed on a timely basis by
responsible officials.
v. Guidelines for reinsurance are established and monitored by a responsible officer.
vi. Adequate systems are developed to identify existence of premium deficiency, if any, and the
calculation is respect thereof is regularly performed and approved by an appropriate official.
vii. Ensure that the policy is not issued before payment is received.
b. Answer
As per Directives No. 1 (unified directives 2075 issued by Nepal Rastra Bank, a commercial
bank has to manage a capital fund based on Capital Adequacy Framework 2015.
There is a transitional arrangement issued by NRB in order to ensure smooth migration of Basel
III from Basel II.
The phase-in arrangements for banks are indicated in the following Table

BASEL III in Nepal

Transition Period
Mid July
2015 2016 2017 2018 2019
Minimum Common Equity Capital Ratio 4.00% 4.50% 4.50% 4.50% 4.50%
Capital Conservation Buffer 1.00% 1.25% 1.50% 2.00% 2.50%
Minimum common equity plus capital conservation buffer 5.00% 5.75% 6.00% 6.50% 7.00%
Minimum Tier 1 Capital (Excluding conservation buffer) 6.00% 6.00% 6.00% 6.00% 6.00%
Minimum Total Capital (Excluding conservation buffer) 10.00% 9.75% 9.50% 9.00% 8.50%
Minimum Total Capital (including conservation buffer) 11.00% 11.00% 11.00% 11.00% 11.00%
According to the directives the bank has to manage the minimum total capital fund (including
conservation reserve) at 11% on its risk weighted assets.
i. Issue of share capital
ii. Reallocation of Assets
Consequences:
 Restriction on declaration and distribution of dividends;
 Restriction on extension of new branch offices;
 Restriction on NRB refinancing facility;
 Restriction on new credit investment and lending activities;
 Restriction of accepting new deposits; and
 Other action as deemed necessary by NRB as per the NRB Act.
c. Answer
As per the Directives No.2 issued by the Nepal Rastra Bank, Loans and advances of a
commercial bank are to be classified in the following groups from finance year 2075/76:
Classification of Loans and Basis of Classification

Advances
Pass (Performing Loan) Principle amount of Loans and
advances paid within due date and
overdue not exceeding 1 month.
Watchlists Principle amount of Loans and
advance due for 1 months and not
exceeding 3 months
Substandard (Non-Performing Principle amount of Loans and
Loan) advance due for 3 months and not
exceeding 6 months.
Doubtful (Non-Performing Loan) Principle amount of Loans and
advances due for 6 months and not
exceeding 12 months /1 year
Loss (Non-Performing Loan) Principle amount of Loans and
advances due for 12 months/1 year
or more, doubtful for recovered in
future.

Question No. 2
What is energy audit? List out the functions of an energy auditor. (6 Marks December 2004)
Answer
Energy audit is defined as an activity that serves the purposes of assessing energy pattern of
factory or energy consuming equipment and identifying energy saving opportunities. It is the first
step of any energy management programmes. Energy auditor is normally expected to give
recommendations on efficiency improvements leading to monetary benefits and also advises on
energy management issues.
Some of the functions of energy auditor:

 Quantify energy costs and quantities;
 Correlate trends of production or activity to energy costs;
 Devise energy database formats to ensure they depict the correct picture – by product,
department, consumer, etc.;
 Advise and check the compliance of the organization for policy and regulation aspects;
 Highlights areas that need attention for detailed investigation; and
 Conduct preliminary and detailed energy audits.
Question No. 3
You are the Auditor of ABC Bank Ltd., a commercial bank, for the finance year ending 20X9.
In meeting with the credit officer of the bank, the credit officer got up and quipped "I do not
see any requirement on part of the bank to provide for loan losses in our portfolio since at
present there is not a single case of default from borrowers. Besides, all our loans are backed
by adequate collateral. Why should I reduce my bonus by providing loan loss provision in
accounts when it is not absolutely necessary?" How would you present your views in the
general meeting as a statutory auditor? (8 Marks December 2004)
Answer
 Provisions for loan losses are not provided only for current possible losses but also the loss
that may arise in future. Though all borrowers are good at present some of them may default
the payment on different grounds including bad performance of business or overall economic
performance. Thus, the bank must provide for loan losses.
 Concept of prudency/conservation requires that any loss that is likely to arise in future though
may not be foreseen today should be provided.
 Good collateral does not negate the principles behind making provisions.
 Existing central bank directives require that one percent provision for all good loans should be
provided in accounts. Thus, not providing for loan losses shall contravene the central bank
directives and may cause for disciplinary action on the part of central bank.
 A non-provision for loan losses may cause for qualified audit report.
 A regular payment today is not the guarantee for tomorrow, thus providing provision now
shall ensure the existence of the bank's operation. (Going concern)
 Not providing for loan losses shall amount to not taking permissible tax deductions and
causing the bank to pay heavy amount of taxes.
Question No. 4
a. Explain briefly the steps that are required to be taken in a situation where "going
concern assumption" on which preparation of financial statements of the public enterprise
is based, is subject to question, while carrying out the audit of such organization under the
directives issued by the Office of the Auditor General of Nepal. (6 Marks June 2005)

Answer:
The auditor should be alert to the possibility that the going concern assumption on which the
preparation of the financial statements is based may be subject to question. When such a question
arises, he should gather sufficient appropriate evidence to confirm to dispel the doubt regarding
the entity‘s ability to continue in operation further foreseeable future, generally for a period not to
exceed one year after the balance sheet date.
Indications that continuance as a going concern should be questioned may come from the
financial statements or from other sources. Examples of such indications are listed below:
a. Net liability or Net current liability position
b. Fixed term borrowing approaching maturity without realistic prospects of renewal
c. Adverse key financial ratios
d. Substantial operating losses
e. Any ability to obtain financing for necessary investment
f. Noncompliance with capital or other statutory requirements
g. Pending legal proceedings against the entity that may, if successful, result in judgements
that could not be met.
If the going concerns questions are not resolved ensure there is adequate disclosure in the
financial statements of the principle conditions that raise doubt about the entity‘s ability to
continue in operation in foreseeable future.
If the disclosure considered necessary by the auditor not made quality audit opinion or express an
adverse opinion for lack of such disclosure.
Question No. 5
a. Propriety audit. (4 Marks December 2004)
Property audit stand for verification of transactions on the test of public interest, company
accepted customs and standards of conduct. Propriety audit requires the transactions and more
particularly expenditure to confirm to certain general principles. These principles are:
i. that the expenditure is not prima facie more than the occasion demands and that every
official exercise the same degree of vigilance in respect of expenditure as a person of
ordinary prudence would exercise in respect of his own money.
ii. that funds are not utilized for the benefit of a particular person or group of persons and
iii. that apart from the agreed remuneration or reward, no other avenue is kept open to
indirectly benefit the management personnel, employees and others.
b. Objectives of audit as outlined in directives issued by OAG for an audit of Public Sector
Enterprises.
Answer:
The objectives of the regularity audit as per the directive to the auditors for the audit of public
sector enterprises are:
a. Expression of an opinion whether the financial statements of the audited organization as
a whole present fairly, in all material respects the financial position of the organization
at year end, the result of its operations for the year then ended, etc., in conformity with
applicable accounting principles;

b. Audit of financial systems and transactions including an evaluation of compliance with

applicable statutes and regulations;
c. Generally, management is responsible for establishing an effective system of internal
controls to ensure compliance with laws and regulations. Auditor should examine the
appropriateness, the relevance through the control and evaluation of the:
 Internal Organization (structures, functions, tasks, authority, responsibilities,
methods, procedures, etc.)
 Existence, respect and application of laws, regulations and instructions,
 Protection of resources and assets.
 Prevention of errors and fraud
 Quality and viability of the information system and the reporting.
d. Competent, relevant and reasonable evidence should be obtained to support the auditor‘s
judgements and conclusions regarding the organization, program, activity or function
under audit.
e. Analyze the financial statements to establish whether acceptable accounting standards
for financial reporting and disclosures are complied with.
f. Examination of the consideration of remarks stemming from previous audit reports.
The auditor in order to assist the AG in fulfilling his/her constitutional responsibility should
address one or all aspects of economy, efficiency and effectiveness (performance audit).
Similarly, the auditor should evaluate the propriety of any financial transactions in his audit as
and when situation demands.
Reporting of any other mattes arising from or relating to the audit that OAG considers should be
disclosed.
Question No. 6
Write shorts notes on the concept Environmental Audit. . (8 Marks June 2005)
Answer:
Environmental reporting is the term now commonly used to describe the disclosure by an
entity of environmentally related data, verified (audited) or not, regarding environmental risks,
environmental impacts, policies, strategies, targets costs liabilities or environmental
performance to those who have an interest in such information as an aid to enabling/ enriching
their relationship with the reporting entity via either:
(a) the annual report and accounts package;
(b) a stand-alone corporate environmental performance report (CER)
(c) a site-centered environmental statement; or
(d) some other medium (e.g. staff newsletter, video, CD ROM, Internet site)
Different methodological approaches to environmental reporting have evolved, mainly
because of local cultural/ regulatory differences are as under;
Compliance based reporting:
Reporting the level of compliance with external regulations and consent limits is a common
feature of the environmental reports of heavily regulated utilities (water, electricity)
Impact based performance reporting;
Most private sector companies that are not subject to specific consent requirements identify
key environment impacts and base their reporting around target setting and performance (over
time) in achieving those targets.
The eco-balance approach:

Some companies (including many from Germany) construct a formal ―eco-balance (=resource
inputs vs. product and non-product output) from which they then derive performance
indicators.
The environmental burden approach (ICIO: ICI) (the UK chemicals manufacturer) has
developed an externally focused reporting approach which quantifies the company‘s impact
on 6 to 8 environment quality measures.
Environmental audits are becoming increasingly common in certain industries. The term
―environmental audit‖ has a wide variety of meanings. They can be pe5rformed by external or
internal experts (sometimes including internal auditors), at the discretion of the entity‘s
management. In practice, persons from various disciplines can qualify to perform
‗environmental audits. Often the work is performed by multi-disciplinary team. Normally,
environmental audits are performed at the request of management and are internal use. They
may address various subjects matters, including site contamination, or compliance with
environmental laws and regulations. However, ‗an environmental audit‘ is not necessarily an
equivalent to an audit of an environmental performance report.
Question No. 7
Loan and advance outstanding as at the year ended on 31 Ashad 2062 included Rupees 1 crore
against the blacklisted customers whose loans are fully provide for. No further disclosure is
made in the financial statements about the blacklisted customers as at the year ended on 31
Ashad 2062. Provide your opinion on the stand taken by the bank.
Answer:
Loan Loss Provisioning against Blacklisted Customer and its disclosure
Basis for opinion
Nepal Rastra Bank introduced revised system of loan classification and provisioning effective FY
2056/2059. Unlike previous system, the loans reclassified into 4 categories only and provisioning
is made entirely based on the overdue period.
The required classification based on directive No. 2 of Unified Directives 2075 of loan and
advances, including bills purchased, is as follows
PASS Not past due and past due for a period up to 1 (one)
months. These are classified and defined as Performing
Loans.
WATCHLISTS Principle amount of Loans and advance due for 1

months and not exceeding 3 months
SUBSTANDARD Past due for a period of 3 months to 6 months.
DOUBTFUL Past due for a period of 6 months to 1 (one) year.
LOSS Past due for period of more than 1(one) year as well as
advances, which have least possibility or recovery or
considered unrecoverable and those having thin
possibility of even partial recovery in future shall be
included in this category.
Loan and Advances falling in the category of Sub-Standard, Doubtful and Loss are classified and
defined as Non- Performing Loan. If it is appropriate in the views of the bank management, there
is no restriction in classifying the loan and advances from low risk category to high-risk category.

For instance, loans falling under sub-standard may be classified into Doubtful or Loss, and loans
falling under Doubtful may be classified into loss category.
Even if the loan is not past due, loans having any or all of the following discrepancies shall be
classified as ―Loss‖
 No security at all or security that is not in accordance with the borrower‘s agreement
with the bank,
 The borrower has been declared bankrupt,
 The borrower is absconding or cannot be found,
 Purchase or discounted bills are not realized within 90 days from the due date.
 The credit has not been used for the purpose originally intended (even partial
diversification is not allowed)
 Owing to non-recovery, initiation as to auctioning of the collateral has passed six months
and if the recovery process is under litigation.
 Loans provided to the borrowers included in the blacklist and where the Credit
Information Bureau blacklists the borrower.
A cent percent loan loss provisioning shall be provided for the amount due form black-listed
person, firm, company or organized institutions.
Where any bank and financial institution extends loan/facility to any black-listed person, firm,
company or organized institution, such bank and financial institution shall be penalized under
Section 99 (1) of Nepal Rastra Bank Act, 2058 with the amount equivalent to such loan/ facility.
Opinion
There are no further requirements as to financial reporting and disclosures in respect of loans
provided to blacklisted customers in Nepal Rastra Bank Regulations.
Further, as per NSA, disclosure of the material items should be made if it helps in assessing the
financial information presented in the financial statements. Since 100% provision has been made
against, he loans granted to blacklisted customers as per NRB regulations and additional
information would have no financial impact, the practice followed by the bank seems reasonable
and auditors should not require the bank to make additional disclosure with respect to loan
against.
Question No. 8
Describe different methodological approaches to environmental reporting? (6 Marks December
2005)
Answer:
Different methodological approaches to environmental reporting have evolved, mainly because of
local cultural/regulatory differences are as under:
Compliance base reporting:
Reporting the level of compliance with external regulations and consent limits is a common
feature of the environmental reports of heavily regulated utilities (water, electricity).
Impact base performance reporting:
Most private sector companies that are not subject to specific consent requirements identity their
key environment impacts and base their reporting around target setting and performance (over
time) in achieving those targets.
The Eco-balance approach:
Some companies (including many from Germany) construct a formal ―eco-balance‖ (resource
inputs vs. product and non-product output) from which they then derive performance indicators.

The environmental burden approach (ICIO):

ICI (the UK chemicals manufacturer) has developed an externally focused reporting approach,
which quantifies the company‘s impact on 6 or 8 environmental quality measures.
Question No. 9
You are appointed as an auditor of an insurance company. Draw up an audit programme and
state four special points that you would take into consideration while drawing up programme?
(8 Marks December 2005, 8 Marks June 2006)
Answer:
Audit programme for the audit of an insurance company:
General:
1) Verify the system of internal control in operation
2) Different categories of insurance business carried on by the company should be ascertained
and it should be seen whether separate accounts in respect of each category is maintained.
3) It should be confirmed that Registers of policies, claims and licensed agents are properly
maintained.
Specific:
4) Premium Collection:
This should be vouched with copies of insurance policies and cover notes of premium
receipts. Premium is payable in advance except where the insured maintains an appropriate
deposit with the insurance company. There cannot be any outstanding premium except for
those policies, which are covered by bank guarantee.
5) Claims:
Payments on account of claims should be verified by reference to payee‘s receipt, discharge of
liabilities signed by the claimants and other supporting evidence like survey report, repairer‘s
bill etc. See that the value of salvaged materials has been deducted. The admission and
payment of the claim should be in terms of policy.
6) Commissions:
It should be vouched with the acknowledgement of the agent and authorized vouchers. The
commission should be seen to have been paid in cheque except when it is for a very small
sum. The amount of the commission should not exceed the amount calculated at the rate
approved for different types of business and the category of agent. Adequate provision should
be made for commission accrued but not paid. Any commission received against re-insurance
should be checked with credit note and other similar evidence. Care should be taken to see
that commission is paid against policies executed through the concerned agent.
7) Re-insurance:
Verify that premium and commission payable or receivable against re-insurance, ceded or
accepted, have been properly accounted for and settled by payment of receipt or adjustment.
See that claim receivable on reinsured policy has been collected from the re-insurer, similarly,
claim payable on re-insurance accepted is paid or provided for. Further see that commission
on re-insurance ceded or accepted has been shown separately in the Revenue Account.
8) Investments:
Should be physically verified at the close of the year. Certificate of bank should be obtained
for investments lodged with it. It should be seen that restriction on investments imposed by
the Insurance Act, 1938 have not been violated.
Question No. 10
Explain 'Loan loss provisioning' and its implication to a commercial bank.

Answer:
Provisions for loan losses are provided for current possible losses and the loss that may arise in
future. Though all borrowers are good at present some of them may default the payment on
different grounds including bad performance of business or overall economic performance. Thus,
the banks are required to provide for loan losses depending upon their classification.
Existing NRB directives provide different categories for provision for all good and bad loans and
the bank should provide such provisions on loans against their loss in accounts. No providing for
loans losses shall contravene the NRB directives and may cause for disciplinary action on the part
of NRB.
Not providing for loan losses shall amount to not taking permissible tax deductions and causing
the bank to pay heavy amount of taxes.
Question No. 11
A commercial bank submitted its audited financial statements for the year 2061/62 to Nepal
Rastra Bank (NRB) for approval for publication and holding annual general meeting. The
financial statements were duly approved by the board and signed by the auditor. However, NRB
asked for additional provision of Rs. 40 lacs towards a loan, which was under scrutiny by them
and adjust the staff bonus accordingly. You are appointed as an auditor for 2062/63 and the
bank seeks your advice on its treatment in the books and financial statements for 2062/63.
(5 Marks June 2006)
Answer:
Criteria used to form an opinion
As per current practice, each financial institution established under the Banking and Financial
Institution Ordinance is regulated by the NRB and it is the duty of the financial institution to
follow instruction given by the NRB. Accordingly, the commercial bank in question should
follow instruction from the NRB. However, it is to be ensured that the bank complies with NAS
02 with respect to treatment of additional provision and its impact on audited financial statement.
As per NAS 02, the amount of the correction of a fundamental error or that relates to prior periods
should be reported by adjusting the opening balance of retained earnings. Comparative
information should be restated, unless it is impracticable to do so.
The financial statements, including the comparative information for prior periods, are presented as
if the fundamental error had been corrected in the period in which it was made. Therefore, the
amount of the correction that relates to each period presented is included within the net profit or
loss for that period. The amount of the correction relating to periods prior to those included in the
comparative information in the financial statements is adjusted against the opening balance of
retained earnings in the earliest period presented. Any other information reported with respective
to prior periods, such as historical summaries of financial data, is also restated.
Opinion
As per above analysis, I will advise the bank to give effect of the additional provision and change
in bonus provision in the opening retained earnings as if these were rectified before approval of
the financial statements for the year 2061/62 and make a note for disclosure of such rectification
in the financial statements for 2062/63.
Question No. 12
Mr. Nepal was an auditor of Nepali Bank Ltd. for finance year 2001-02 to 2003-04. During the
finance year 2004-05 Nepali Bank Ltd. and Goodwill Development Ltd. merged and became
Excellent Bank Ltd. The directors of Nepali Bank Ltd. hold 60 percent share of Excellent Bank
Ltd. Similarly, the board of directors of new bank, Excellent Bank Ltd., appointed Mr. Nepal as

an auditor of the bank for finance year 2004-05. Can he become an auditor for the finance
year 2004-05? (5 Marks June 2006)
Answer:
No, he cannot be appointed as an auditor. As per the section 63 (3), of Bank and Financial
Institution Act 2073, a person cannot be re-appointed as an auditor of the same bank and financial
institution if he has already served as an auditor for continuous three preceding year to the year of
appointment. In this case the same bank holds 60 percent share of the new bank, it is therefore the
new appointment is not valid one.
Question No. 13
Define Energy Auditing. What are the key functions of an Energy Auditor?
(7 Marks June 2006)
Answer:
Energy auditing is defined as an activity that serves the purpose of assessing energy use pattern of
a factory or energy consuming equipment and identifying energy saving opportunities. In that
context, energy management involves the basic approaches reducing avoidable losses, improving
the effectiveness of energy use, and increasing energy use efficiency.
The functions of an energy auditor could be compared with that of a financial auditor. The energy
auditor is normally expected to give recommendations on efficiency improvements leading to
monetary benefits and also advise on energy management issues. Generally, energy auditor for the
industry is an external party. The following are some of the key functions of the energy auditor:
i. Quantification of energy costs and quantities,
ii. To correlate trends of production or activity to energy cost,
iii. To devise energy database formats to depict to correct picture-by product, department
or consumer,
iv. To advise and check the compliance of the organization for policy and regulation
aspects
While performing the aforesaid key functions, the energy auditor is required to carry out the
following activities:
i. To analyze the historical energy consumption and cost data,
ii. To conduct preliminary energy audit with the objective to identify:
a. Major energy consuming equipment and process,

b. Obvious inefficiencies and energy wastes, and
c. Priority areas for further detailed investigation.
iii. To conduct detailed technical and economic analysis of energy efficiency measures
involving large efficiency measures involving large capital investment or long payback
periods.

Question No. 14
Strong Bank Ltd. provides you the following information during the finance year 2004-05:
- Total accumulated losses up to FY 2003-04 Rs. 400 Million

- Net profit before adjusting above losses in F/Y 2004- Rs. 300 Million
05
- Proposed dividend during FY 2004-05 Rs. 100 Million
Can strong Bank Ltd. distribute dividend without adjusting above losses? Comment.
(4 Marks June 2006)
Answer:
Re-Ammonia Soda Co. Ltd. V Chamberlain (1918)
A company could pay dividends out of current trading profits without making goods past revenue
losses.
Section 47 (2) Banking and Financial Institution Act 2073
No bank or financial institution shall be allowed to declare or distribute dividends to its

shareholders until it recovers all of its preliminary expenses and the losses sustained by it until the
previous year, capital, capital fund and possible loan loss provisioning as prescribed by the
Rastra bank and for general reserve fund pursuant to Section 44 and until complete sale of
shares to be allotted to general public.
Conclusion: unless the bank has recovered above accumulated losses, it cannot distribute such
dividend.
Question No. 15
How do you verify "Claims Paid" in the course of audit of a General Insurance Company?
(5 Marks June 2006)
Answer:
The following specific areas need to be given attention while examining claims paid by the
general insurance company:
i.Obtain information from branches/ divisions regarding each class of business categorizing
the claims value wise,
ii. Ascertaining the status of claims outstanding at the year-end on the basis of
information available, with the company, claims for which company is liable, etc.
iii. To verify in the case of claims paid on the basis of advices from other insurance
companies whether share of premium was also received by the company,
iv. To ensure that claims communicated to other insurance companies after the year-end
for losses which occurred prior to the year must be accounted for in the years of audit,

v. Claim payments have been duly sanctioned by authority concerned and

acknowledgements obtained from the recipients,
vi. Salvage recovered has been duly accounted for and letter of subrogation has been
obtained in accordance with the laid down procedures.
vii. Amounts deposited with the Courts where litigation is not completed are treated as
advance/ deposit and held as assets till disposal of such claims,
viii. Part/ Past payment made against claims are duly vouched,
ix. Ensure that the claimant has given unqualified discharge not in the case of final
payment of claims,
x. In the case of co-insurance arrangements, claims to be booked in respect of company's

share and the balance have to be debited to other insurance companies.
Question No. 16
What the "Objectives of the Audit" are as outlined in directives issued by the Office of the
Auditor General of Nepal? (6 Marks December 2006)
Answer
a) The objectives of the regularity audit as per the directives to the auditors for the audit of
public sector enterprise are:
i. Expression of an opinion whether the financial statements of the audited organization

as a whole present fairly, in all material respects the financial position of the
organization at year end, the results of its operations for the year then ended, etc., in
conformity with applicable accounting principles.
ii. Audit of financial systems and transactions including an evaluation of compliance with
applicable statutes and regulations;
iii. Generally, management is responsible for establishing an effective system of internal

controls to ensure compliance with laws and regulations. Auditor should examine the
appropriateness, the relevance through the control and evaluation of the:
 internal organization;
 existence, respect and application of laws, regulations and instructions
 protection of resources and address;
 prevention of errors and fraud,
 quality and viability of the information system and the reporting,
iv. Competent, relevant and reasonable evidence should be obtained to support the
auditor's judgments and conclusions regarding the organization, programme, activity
or function under audit.
v. Analyze the financial statements to establish whether acceptable accounting standards

for financial reporting and disclosures are complied with.
vi. Examination of the consideration of remarks from previous audit reports.

The auditor in order to assist the Auditor General in fulfilling his/her constitutional
responsibility should address one or all aspects of economy, efficiency and
effectiveness i.e. performance audit. Similarly, the auditor should evaluate the
propriety of any financial transactions in his audit as and when situation demands.
Reporting of any other matters arising from or relating to the audit that Office of the
Auditor General considers should be disclosed.
Question No. 17
Explain "Loan Loss Provisioning" and its implication to a commercial bank.
Answer
Loan loss provision is provided for current possible losses and the loss that may arise in future.
Though all borrowers are good at present some of them may default the payment on different
grounds including bad performance of business or overall economic performance. Thus, the banks
are required to provide for loan losses depending upon their classification.
Existing Central Bank directives provide different categories for provision for all good and bad
loans and the bank should provide such provisions on loans against their loss in accounts. Not
providing for loan losses shall contravene the Central Bank directives and may cause for
disciplinary action on the part of Central Bank.
Not providing for loan losses shall amount to not taking permissible tax deductions and causing
the bank to pay heavy amount of taxes.
Question No. 18
Define Environmental Auditing. Describe the main aspects to be considered in respect of
Environmental Audit of various industrial units. (7 Marks December 2006)
Answer
Environment Audit is the management tool comprising a systematic, documented, periodic
and objective evaluation of how well environmental organization, management and equipment are
performing with the aim of helping to safeguard the environment by:
(a) facilitating management control of environment process.
(b) assessing compliance with company policies, which would include meeting regulatory
requirements.
i. Layout and Design:
The layout to be sketched in the style which will allow adequate provisions for
installing pollution control devices, as well as provision for up-gradation of
pollution control measures and the meeting of the requirements of the regulations
framed by the Government.

ii. Management of Resources:
Management resources include air, water, land, energy, raw materials and human
resources besides others. The uses of all resources are interlinked and the best uses
in a synchronized manner results the best output and minimum waste.
iii. Pollution Control System:
An effective system of pollution control should be in existence. Proper attention

should be given whether all required pollution control measures are exercised or
not and the same is effective or not. Further, pollution control measure should be
according to the nature and complexity of the Industry.
iv. Emergent Safety Arrangement:
Chemical and gas industries which are prone to sudden requirement of safety
arrangements must be alert all the time. The emergency plans are to be reviewed
periodically. The staff, remained so engaged, must possess the required awareness and
alertness to meet the contingency. The degree of awareness, however, can be upgraded
with proper training provisions.
v. Medical & Healthcare Facilities:
The medical services should be maintained. The health of the workers should be a big
consideration for the management.
vi. Industrial Hygiene:
Proper system should be in use to eliminate industrial unhygienic state.
vii. Occupational Health:
The requirement for safeguarding against occupational health hazards should be

available for all the workers. The concerned industry must pay proper weightage to
those diseases which are prone to that particular type of industry.
viii. Information Assimilation and Reporting System:
The information should be strengthened to generate, and its reporting system should be
proper, keeping in view, the authorities, responsibilities and subsequent delegations. A
report of compliance of all statutory environmental laws along with other preventive
and precautionary measures should be put to Board at regular intervals.
ix. EIA Methodology:
The Environmental Impact Assessment (EIA) is usually pre-requisite to start an

industry. This is done considering the known spheres of activities on the existing
environmental conditions. To accommodate the deviation in the system is also to be
incorporated in the EIA report, if it is noticed that the degradation to the environment

caused on the establishment and running of the industry is much higher than what was
predicted, the mitigating measures suggested must also be furthered.
x. Compliance to the Regulatory Mechanism:
As the persons who are directly working with the system, may be unaware of the latest
developments and requirements for the compliance of stipulations and standards
prescribed by the various regulatory authorities, they should be trained and instructed
on a regular basis.
xi. Concern for the Society:
The industries very often transform the agrarian environment into an industrial
environment. The people so displaced by industrialization feel alienated and develop a
feeling of facing the gaseous, dustful, clumsy state of surroundings. The audit should
look into this aspect how the industry is making a balance between its own
development and the society's concern.
Question No. 19
What is the "Scope of the Audit" of the public sector enterprises (state owned enterprises) as
outlined in guidelines issued by the Auditor General Office of Nepal?
(8 Marks June 2007)
Answer
The scope of the audit of the public sector enterprises should cover adequately all aspects of
the enterprise to express audit opinion on the financial statements being audited. The auditor
should be reasonably satisfied that:
(i) The information contained in the underlying accounting records and other source
data is reliable and sufficient; and
(ii) Whether the relevant information is properly disclosed in the financial statements
subject to statutory requirements, where applicable.
The auditor should assess the reliability and sufficiency of the information by:
(i) Studying and evaluating accounting systems and internal controls to determine the
nature, extent and timing of other auditing procedures; and
(ii) Carrying out such other tests, enquiries and other verification procedures of
accounting transactions and account balances as considered appropriate in the
circumstances.
The auditor should determine whether the relevant information is properly disclosed in the
financial statements by: (i) Comparing the financial statements with the underlying accounting
records and other source data; and (ii) Considering the judgment that management has taken
in preparing the financial statements and accordingly, assess the selection and consistent
application of accounting policies, the manner in which the information has been classified,
and the adequacy of disclosure.
As there is an unavoidable risk that some material misstatement may remain undiscovered due
to nature of test conducted, other inherent limitations of an audit and the inherent limitations
of internal control system. The auditor should design audit steps and procedures to provide
reasonable assurance of detecting errors, irregularities and illegal acts that could have a direct

and material effect on the financial statement amounts. Where the auditor has found during the
audit any indication that some fraud or error may have occurred, which result into material
misstatement, the scope of audit should be extended to confirm occurrence of fraud and error.
The auditor should consider items which either individually or as a group are material:
(i) In general terms, a matter may be judged material if knowledge of it would be likely
to influence the user of the financial statements or the audit report.
(ii) Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements. Materiality depends
on the size of the item or error judged in the particular circumstances of its omission
or misstatement.
The scope of audit should also include the following:

 verification of expenditures with approved budget,
 verification of purchase procedures and also that goods purchased are utilized
within the foreseen objectives and are still available or have been ceded/sold in
conformity with the methods defined in audited entity‘s rules and regulations,
 verification of the transactions under the following aspects:
(i) Conformity of expenditure authorizations and validity of the supporting
documents;
(ii) Arithmetic accuracy of accounts, supporting documents and financial
statements;
(iii) Accuracy of the bookkeeping entries;
(iv) Allocation of expenditures in conformity with budgets;
(v) Verification that contracts are in conformity with prevailing laws and
regulation;
(vi) Verification that receipts are exhaustively and regularly accounted for; and
(vii) Control of advances accrued or in abeyance, justification for amounts overdue
or outstanding for long.
 Verification of the accounting systems and cost analysis system to confirm
that it fulfils the needs of managements, and
 Verification that all corrections required from previous audit have been
carried out.
Question No. 20
a. Restricted funds and unrestricted funds in the books of account of not-for profit
organizations. (4 Marks June 2007)
Answer
In a not-for organization, revenue funds are received to meet operating expenses, but the use
of revenue funds may be restricted or unrestricted. Restricted funds account for resources
whose use, by the net – for profit organization, is restricted by the donor. For example, a
grant may be received by a university from the Government for the specific purpose. This
grant will constitute a restricted fund. The unrestricted fund accounts for resources that may
be expended to carry out the primary purposes of the institution e.g. instructions, research,
maintenance etc. and are not restricted to specific purposes. However, the not-for profit
organization may convert part of the unrestricted fund into a restricted fund by earmarking a
certain sum for a specified purpose

b. Objectives of Peer Reviews and establishing a Post Audit Quality Review System (PAQRS)
under the Office of Auditor General. (4 Marks June 2007)
Answer
 Evaluate quality of performance on engagements
 Provide reasonable assurance that the work performed confirm to the generally accepted
government auditing and accounting standards and the OAG's laid down policies and
procedures.
 Provide reasonable assurance that adequate work has been performed to support the
reports
 issued and that the underlying working papers provide sufficient evidence of this.
 Evaluate the performance of individual audit team of staff in relation to understanding and
implementation of the OAG's policies and guidelines and to facilitate the process of
educating the value of complying with such policies and guidelines.
 Corroborate the implementation and effectiveness of action plans for correcting
deficiencies.
 Identify significant deficiencies in operations and quality assurance procedures.
 Provide constructive recommendation for improving the efficiency and effectiveness of
the Office of the Auditors ‗General PAQRS and enhancing service and satisfaction to the
audited entity.
c. Performance Audit (4 Marks June 2007)

Answer
A performance audit involves obtaining and evaluating evidence about the efficiency,
economy and effectiveness of an entity's operating activities in relation to specified
objectives. The term performance audit is usually applied in the public sector, with some
application in the private sector. Thus, a performance audit includes one or a combination of
two aspects of economy, efficiency and effectiveness. Economy means the acquisition of the
appropriate quality and quantity of human, financial, physical and information resources at
the lowest reasonable cost. Efficiency means maximum output from the minimum use of
human, financial, physical and information resources. Effectiveness means the achievement
of the objectives or an intended outcome.
Performance audit provides the stakeholders with an assessment whether the audited entities
are achieving real value for money. It intends to arrive at a verifiable condition for
comparing what is being done and how well it is being done with the plans, policies and
standards.
Performance audit goes beyond the consideration of regularity audit. It aims to determine to
what extent the auditee has discharged its financial or other responsibilities which imply
assessment of the auditee's operation in terms of the economy in acquiring resources,
efficiency in using resources and effectiveness in achieving objectives.
The broad objectives of performance audits are economy, efficiency and effectiveness of
auditee, evaluation of accountability and due care of probability in use of resources.
Performance examines and evaluates the systems, procedures, operation and result related to
the following:
 Planning, budgeting, accounting and reporting systems;
 Development, appraisal and utilization of resources;

 Acquisition and utilization of property, equipment, plant, inventory and other assets;
and
 Development, production and use of information.
d. Directives issued by the office of the Auditor General for an audit of Public Sector Entity.
(5 Marks June 2008)
Answer
Directives are issued by the Office of the Auditor General for the audit of fully owned
Government Enterprises, statutory bodies and other autonomous entities. It is also applicable
to the audit of substantially owned Government Enterprises on the recommendation by
Auditor General (AG). The auditor appointed by AG should always keep in mind that he
should work as AG's subordinate. The auditor should perform his work with full knowledge of
the rights, duties and responsibilities of the AG. The auditors appointed for the audit of
corporate bodies are supposed to address one or all aspects of economy, efficiency and
effectiveness (performance) audit. Similarly, the auditor should use propriety in his audit as
and when situation demands.
These directives cover the following matters:
(i) Fundamental principles of Auditing,
(ii) Objectives of the Audit,
(iii)Scope of the Audit,
(iv) Responsibility for Financial Statements,
(v) Field Work:
 Planning,
 Supervision and Review,
 Audit Evidence,
 Analysis of Financial Statements,
(vi) Reporting Standards,
(vii) Going Concern,
(viii) Events after the Balance Date,
(ix) Commencement and Audit Closures,
(x) Preservation of working paper documents,
(xi) Quality Assurance Programme,
(xii) Relationship and Responsibilities of Auditor, and
(xiii) Template for the types of Auditors' Report.
Question No. 21
List out the special points in audit of public sector companies. Also explain the scope of such
audit as outlined in guidelines issued by the Auditor General Office of Nepal.
Answer
In view of special characteristics of the public sector enterprises, their audit has some distinctive
features. The auditor of public sector enterprises has to adopt certain techniques of government
audit on the one hand and the practices of commercial audit on the other. The government audit is
generally an audit of regularity, economy, efficiency, effectiveness and propriety. It seeks to
verify whether the expenditure conforms to various provisions of the law and the rules, and
whether it is covered by definite sanction of a competent authority. It further examines whether
every official has exercised the same vigilance in respect of the expenditure incurred for the
public money as a person of ordinary prudence would exercise in respect of expenditure of his

own money, whether the expenditure was necessary, and whether the individual items of
expenditure give best results.
As per the ‗Directives to the auditors for the audit of Public Sector Enterprises‘ issued by
Office of Auditor General, the scope of audit covers the following matters:
i) The audit should be organized to cover adequately all aspects of the enterprise as far
as these are relevant to the financial statements being audited and should be
reasonably satisfied that:
(a) the information contained in the underlying accounting records and other source
data is reliable and sufficient; and
(b) Whether the relevant information is properly disclosed in the financial statements
ii) Assess the reliability and sufficiency of the information by:
(a) Studying and evaluating accounting systems and internal controls to determine the
(b) Carrying out such other tests, enquiries and other verification procedures of
accounting transactions and account balances as considered appropriate in the
circumstances.
iii) Determine 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; and
(b) Considering the judgment that management has made in preparing the financial
statements, accordingly, assess the selection and consistent application of
accounting policies, the manner in which the information has been classified, and
the adequacy of disclosure.
iv) The auditor should design audit steps and procedures to provide reasonable assurance
of detecting errors, irregularities and illegal acts that could have a direct and material
effect on the financial statement amounts or the results of regularity audits.
v) The auditor should consider items which either individually or as a group are
material.
vi) Verification that expenditures correspond to the budgets as approved by the
authorities. Briefly analyze the deviations between budgeted and effective expenses.
vii) Verification of the respect of purchasing procedures and also that goods purchased are
utilized within the foreseen objectives and are still available or have been ceded/sold
in conformity with the methods defined in audited entity‘s rules and regulations.
viii) Verification of the transactions under the following aspects:
(a) Conformity of expenditure authorizations and validity of the supporting
documents;
(b) Arithmetic accuracy of accounts, supporting documents and financial statements;
(c) Accuracy of the bookkeeping entries;
(d) Allocation of expenditures in conformity with budgets;
(e) Verification that contracts are in conformity with prevailing laws and regulation;
(f) Verification that receipts are exhaustively and regularly accounted for;
(g) Control of advances accrued or in abeyance, justification for amounts overdue or
outstanding for long.
ix) Verification that the accounting system in use responds to the needs of managements,
particularly as concerns cost analysis.
x) Verification that all corrections required from previous audit have been carried out.

Question No. 22
Explain following terms used in the audit of the financial statements of banks.
(5 Marks June 2008)
i) Hidden reserves
ii) Stress testing
iii) Vostro Accounts
Answer
i) Hidden Reserves:
Some financial reporting frameworks allow banks to manipulate their reported income by
transferring amounts to non-disclosed reserves in years when they make large profits and
transferring amounts from those reserves when they make losses or small profits. The reported
income is the amount after such transfers. The practice served to make the bank appear more
stable by reducing the volatility of its earnings and would help to prevent a loss of confidence
in the bank by reducing the occasions on which it would report low earnings.
ii) Stress testing:
Testing a valuation model by busing assumptions and initial data outside normal market
circumstances and assessing whether the model‘s predictions are still reliable is known as
stress testing.
iii) Vostro Accounts:
Accounts held by the bank in the name of a corresponding bank, e.g. accounts of Citi Bank
maintained by any Banks in Nepal is Vostro account in the books of that Nepali bank.
Question No. 23
Explain the provisions relating to loan loss provision for financial institution as outlined in
Unified Directives issued by Nepal Rastra Bank. (5 Marks June 2008)
Answer
a) Nepal Rastra Bank introduced revised system of loan classification and provisioning
effective FY 2058/2059. Unlike previous system, the loans re classified into 4 categories
only and provisioning is made entirely based on the overdue period.
The required classification of loan and advances, including bills purchased, is as follows:
Pass No past dues and past due for a period up to 1 (one) months.
These are classified and defined as Performing Loans.
Watchlists Principle amount of Loans and advance due for 1 months and not
exceeding 3 months. These are also classified and defined as
performing Loans.
Substandard Past due for a period of 3 months to 6 months.
Doubtful Past due for a period of 6 months to 1 (one) year.
Loss Past due for period of more than 1(one) year as well as advances,
which have least possibility or recovery or considered
unrecoverable and those having thin possibility of even partial
recovery in future shall be included in this category.

Loan and advances falling in the category of Sub-Standard, Doubtful and Loss are classified and
defined as Non-Performing Loan. If it is appropriate in the views of the bank management, there
is no restriction in classifying the loan and advances from low risk category to high-risk category.
For instance, loans falling under Sub-Standard may be classified into Doubtful or Loss, and loans
falling under Doubtful may be classified into Loss category.
Even if the loan is not past due, loans having any or all of the following discrepancies shall be
classified as "Loss."
 No security at all or security that is not in accordance with the borrower's agreement
with the bank,
 The borrower has been declared bankrupt,
 The borrower is absconding or cannot be found,
 Purchased or discounted bills are not realized within 90 days from the due date.
 The credit has not been used for the purpose originally intended (even partial
diversification is not allowed)
 Owing to non-recovery, initiation as to auctioning of the collateral has passed six
months and if the recovery process is under litigation.
 Loans provided to the borrowers included in the blacklist and where the Credit
Information Bureau blacklists the borrower.
A cent percent loan loss provisioning shall be provided for the amount due from black-listed
person, firm, company or organized institutions.
Where any bank and financial institution extends loan/facility to any black-listed person, firm,
company or organized institution, such bank and financial institution shall be penalized under
Section 99 (1) of Nepal Rastra Bank Act, 2058 with the amount equivalent to such loan/facility.
Question No. 24
Quality Assurance program under the audit of Public Sector Enterprises as per the directives
issued by Office of Auditor General. (5 Marks December 2008)
Answer
Because of the importance of ensuring a high standard of work by the auditors, it should pay
particular attention to quality assurance programs in order to improve audit performance and
result.
Office of Auditor General (OAG) may require an auditor to establish systems and procedures to
confirm that integral quality assurance processes have been established and operated
satisfactorily. OAG may establish its own quality assurance arrangements and perform
independent appraisal of auditor‘s work.
The auditor should plan the audit in a manner which ensures that an audit of high quality is
carried out in an economic, efficient and effective way and in a timely manner.
The work of the audit staff at each level and audit phase should be properly supervised during the
audit and documented to ensure quality of the audit. A senior member of the audit staff should
review work. Supervision should be directed both to the substance and to the method of auditing.

Question No. 25
Distinguish between Functions of an Energy auditor (5 Marks December 2008)
Answer
Functions of an Energy auditor
Energy auditing is defined as an activity that serves the purposes of assessing energy use pattern
of a factory or energy consuming equipment and identifying energy saving opportunities. In that
context, energy management involves the basis approaches reducing avoidable losses, improving
the effectiveness of energy use, and increasing energy use efficiency. The function of an energy
auditor could be compared with that of a financial auditor. The energy auditor is normally
expected to give recommendations on efficiency improvements leading to monetary benefits and
also advise on energy management issues. Generally, energy auditor for the industry is an external
party. The following are some of the key functions of the energy auditor:
 Quantification of energy costs and quantities
 To correlate trends of production or activity to energy costs
 To devise energy database formats to depicts to correct picture – by product, department
or consumer
Question 26
Mr. Raj Bahadur, a partner in RB & Co., Chartered Accountants has completed the audit of
financial statements of Sun Rise Finance Company Ltd for the Fiscal year 2063/64 and issued
a clean report. There was a net profit of Rs. 50,00,000/- as per audited financial statements. On
the basis of such audited financial statements, the finance company distributed bonus to the
staff as per the Bonus Act and also declared dividend for the distribution to its shareholders.
The audited financial statements have been sent to Nepal Rastra Bank for permission to hold
annual general meeting. However, Nepal Rastra Bank instructed the finance company to make
additional loan loss provision of Rs. 2,00,00,000 on the basis of their offsite inspection.
Comment. (5 Marks December 2008)
Answer:
In the given case M/s Sun Rise Finance Company is required to make an additional loan loss
provision of Rs. 2,00,00,000/- on the basis of offsite inspection letter issued by Nepal Rastra
Bank. As a result, there has been significant deviation in the financial position of the finance
company from financial position as reflected in the audited financial statement. There has been
significant amount of loss. From the given statement, it appears that the auditor of the finance
company could not find out and report such significant deficit of loan loss provision that are
required to be made as reflected from the NRB off site inspection report. Therefore, there has
been a lapse in the part of the auditor Mr. Raj Bahadur, a partner, RB & Co., chartered
accountants to report on deficiency in loan loss provision and hence may be treated as gross
negligence.
In case of finance company, prior approval of the Nepal Rastra Bank, the regulating authority,
should be obtained before publishing the financial statements. The financial statements sent for
approval of the Nepal Rastra Bank are not final and the financial statements should be revised if
any instructions are given for revision. The Board can only propose the amount of bonus to be
paid to staff and dividend to be paid to the shareholders but cannot distribute bonus to staff and
declare dividend before approval of the financial statements by the annual general meeting. Bonus
and dividend will be paid only after approval of the financial statements by the annual general
meeting. As per Para 12 of the NSA 560 Subsequent Events, the auditor should consider the
instruction given by the Nepal Rastra Bank and discuss the matter with management for
amendment and issue new report on the amended financial statements.

Question 27
Explain the Verification of Re-insurance outward by a General Insurance Company
(5 Marks June 2009)
Answer
The Re-Insurance Outward by a General Company may be verified by following the below
mentioned activities:
i) Verify that re-insurance underwriting returns received from the operating units regarding
premium, claims, paid, outstanding claims, tally with the audited figures of premium claims
paid and outstanding claims.
ii) Check whether the pattern of re-insurance underwriting for outward cessions fits within the
parameters and guidelines applicable to the relevant year.
iii) Check whether cessions have been made as per the stipulation applicable to various categories
of risk.
iv) Verify whether the cessions have been made as per the agreements entered into with the
various companies.
v) See whether the outward remittances to foreign re-insurance have been done as per the foreign
exchange regulations.
vi) Ascertain whether the commission has been calculated as per the terms of the agreement with
the re-insurance.
vii) Verify the computation of profit commission by various treaty arrangements in the figure of
the periodical accounts rendered and in relation to outstanding less pertaining to the treaty.
viii)Examine whether the cash loss recoveries have been claimed and accounted on a regular
basis.
ix) Verify whether the claims paid items appearing outstanding claims list by ever. This can be
verified at least in respect of major claims.
x) See whether provisioning for outstanding losses recoverable on cessions have been confirmed
by the re-insurers and in the case of major claims, documentary support was insisted and
verified.
xi) Accounting aspects of the re-insurance cession premium commission recoverable, paid claims
recovered and outstanding losses recoverable on cessions have to be checked.
xii) Check percentage pattern of gross to net premium, claim paid and outstanding claim to ensure
comparative justifications.
Question No. 28
Briefly describe the following:
Reporting requirement by the Auditor in the audit of public sector enterprise
Answer
The auditor should present his detail findings and recommendation in a management letter to the
governing body of the public sector enterprise under audit with a copy to OAG/N. The governing
body is expected to make written representation to the auditor within 35 days of the submission of
report. The auditor should consider the management response and its effect on the financial
statement. The auditor should finalize the report in consultation with OAG/N, if necessary.
The OAG/N will issue the final audit report to the concerned audit entity. In addition, a separate
report should be made to the Auditor General where the weaknesses exist in system of accounting
or financial control.
The auditor should also report on significant irregularities, whether perceived or potential.

In reporting on irregularities or instances of non-compliance with laws or regulations, the auditors

should be careful to place their findings in the proper perspective. The extent of non-compliance
can be related to the number of cases examined or quantified monetarily
Reports on irregularities may be prepared irrespective of a qualification in the auditor‘s opinion.
The auditor is not normally expected to provide an overall opinion on the achievement of
economy, efficiency and effectiveness of the entity in the same way as the opinion on the
financial statements. Where the nature of the audit allows this to be done in relation to specific
areas of an entity‘s activities the auditor should provide a report which describes circumstances.
In formulating the audit opinion or report, the auditor should consider the materiality of the matter
in the context of financial statements.
Question No. 29
Briefly describe Long form audit report (5 Marks December 2009)
Answer
Long Form Audit Report (LFAR) is the additional or elaborated information which are not
covered in the main report generally required by the regulating authorities e.g. Central Banks,
Insurance Boards.
The auditor expresses his opinions and gives comments on various issues in LFAR. But it is not
the substitute of main report. The format and contents are generally provided by
monitoring/regulating body itself. The information required to be provided by the auditor also
includes matters requiring attention of the management.
The auditor should consider wherever practicable significance various comments in LFAR in the
main report. Where any comments in LFAR stipulates the qualification in the report depending on
facts and circumstances, the auditor should qualify the report.
The comments/opinions to be provided by the auditor of a bank in the LFAR generally includes:
 Comments/Opinion on Risk Management System (Credit, Market and Operational)

 Comments /Opinion on Internal Control System
 Comments /Opinion on compliance with applicable rules and regulations
 Conclusion – Type of audit opinion (Unqualified, Qualified, Disclaimer, Adverse)
Question No. 30
M/s True Saving and Credit Co-operative Ltd. is a co-operative entity registered and operated
under the Co-operative Act 2048 (1990). The paid-up capital of the entity is Rs.300 Lakhs as at
end of F.Y.2008/09. During the F.Y.2008/09, the entity made net profit of Rs.100 Lakhs. Out of
Rs.100 Lakhs, it transferred Rs.20 Lakhs to General Reserve Fund. It has not appropriated any
amount to other reserves as no other reserve fund has been established.
Out of remaining balance, the Board of Directors have proposed distribution of 20% dividend
to the shareholders. Express your opinion as an auditor. (5 Marks December 2009)
Answer
As per section 68 (1) of the Co-operative Act 2074 (2017), a minimum of one-fourth of net saving
amount should be transferred to a reserve fund (statutory reserve) before the distribution of
dividend. Further as per Co-operative Rules 2075 (2018), the board of directors of a co-operative
entity may decide to maintain other reserve funds such as Share Dividend Fund, Employees

Bonus Fund, Co-operative Education Fund, Co-operative Development Fund, Loss equalization
Fund, Share Refund Fund, etc.
Appropriation to such reserves can be made only after the maintenance of statutory reserve as per
section 68. Further the co-operative under section 71(2) of the act is not allowed to distribute
more than 18% dividend on shares. In the given case, the entity has transferred only 20% of its net
profit to the General Reserve Fund in spite of legal requirement of 25%. Further, the board
directors have proposed 20% dividend on share capital which is higher than that is statutorily
allowed.
As in the case of maintenance of other reserves, there are no statutory requirements.
Question No. 31
What are the areas to be considered in an Environmental Audit? (8 Marks June 2010)
Answer
b) Environmental auditor should deal with the following areas in respect of industrial units:
(i) Layout and Design: To examine whether pollution control devices are installed, and
pollution control measures are taken to meet the requirement of regulations framed by
the Government.
(ii) Management of Resources: To examine whether all the resources such as Air, Water,
land, Energy, Raw Material and Human Resources are best used with minimum wastage.
(iii) Pollution Control System: To examine that an effective system of pollution control
exists, and all possible measures of control are taken.
(iv) Emergent Safety Arrangement: To examine whether the safety arrangement against
sudden possible accidents due to chemical, gas or other explosives have been taken and
also required safety amenities have been kept ready and staff awareness created.
(v) Medical and health Care Facilities: To ensure proper medical services have been
maintained and regular health checkup of workers have been done.
(vi) Industrial Hygiene: To ensure proper system is maintained to eliminate unhygienic

State.
(vii) Occupational health: To ensure proper measures are taken for safeguarding health of
workers against occupational health hazards.
(viii) Information Assimilation and reporting: To ensure proper information is generated

and reported by proper distribution of authority, responsibility and delegation and
compliance of statutory environmental laws.
(ix) Environment Impact Assessment: To ensure EIA has been conducted to start industry,
proper system and up gradation whenever necessary.

(x) Compliance of Regulatory Measure: To ensure there is regular training and imparting
of knowledge of latest development for persons working on system for acquaintance
with latest developments.
Question No. 32
You are appointed as an auditor of an insurance company. What are the internal control
procedures with regard to underwriting of the insurance company that you should check for in
the company? (4 Marks June 2010)
Answer
The auditor should examine to check following internal control procedures with regard to
underwriting of the insurance company:
i) Appropriate and clear underwriting guidelines are framed and communicated to the
underwriting department and the intermediaries where such guidelines are executed with a
reasonable certainty without providing substantial flexibility to the underwriters. The
adherence to these guidelines should be monitored by an appropriate official of the
company.
ii) Firm procedures are instituted to ensure adequate investigation of the risks assumed (e.g.,
medical or other investigative reports are duly obtained from the insured).
iii) There is an effective communication between claims and underwriting department.
iv) The relevant information is processed on a timely basis to avoid processing backlogs.
v) Suspense/un-reconciled account balances are reviewed and analysed on a timely basis by
responsible officials.
vi) Guidelines for reinsurance are established and monitored by a responsible officer.
vii) Adequate systems are developed to identify existence of premium deficiency, if any, and the
calculation in respect thereof is regularly performed and approved by an appropriate official.
Question No. 33
What are the key functions of an Energy Auditor? (5 Marks December 2010)
Answer
Energy auditing is defined as an activity that serves the purposes of assessing energy use pattern
context, energy management involves the basis approaches reducing avoidable losses, improving
the effectiveness of energy use, and increasing energy use efficiency. The function of an energy
auditor could be compared with that of a financial auditor. The energy auditor is normally
expected to give recommendations on efficiency improvements leading to monetary benefits and
also advise on energy management issues.
Generally, energy auditor for the industry is an external party. The following are some of the key
functions of the energy auditor:
i) Quantification of energy costs and quantities
ii) To correlate trends of production or activity to energy cost.
iii) To devise energy database formats to depict to correct picture – By product,
department or consumer.
Question No. 34
Explain the scope of audit of the public sector undertaking as outlined in the guidelines issued
by the Auditor General Office of Nepal. (8 Marks December 2010)

Answer
The audit of the public sector undertaking has some distinctive features in view of special
characteristics of the public sector undertakings. The auditor has to adopt certain techniques of
government audit on the one side and the practices of commercial audit on the other. The
government audit is generally an audit of regularity, efficiency, economy, effectiveness and
propriety. It seeks to verify whether the expenditures confirm to various provisions of the
prevailing laws and rules and whether it is covered by proper approval of the appropriate
authority. It also seeks to examine whether every official has exercised the same vigilance in
respect of the expenditures incurred for the public money as a person of ordinary prudence would
exercise in respect of expenditure of his own money.
The guidelines issued by the Auditor General Office of Nepal have outlined the following scope
of audit of the public sector undertaking:
a) The scope of the audit of the public sector undertaking should cover adequately all aspects
of the undertaking to express audit opinion on the financial statements being audited. The
auditors should be reasonably satisfied that:
i) The information contained in the underlying accounting records and other source data is
reliable and sufficient; and
ii) Whether the relevant information is properly disclosed in the financial statements subject
to statutory requirements, where applicable.
b) The auditor should assess the reliability and sufficiency of the information by:
i) studying and evaluating accounting systems and internal controls to determine the nature,
extent and timing of other auditing procedures; and
ii) Carrying out such other tests, enquiries and other verification procedures of accounting
transactions and account balances as considered appropriate in the circumstances.
c) The auditor should determine whether the relevant information is properly disclosed in the
financial statements by:
i) Comparing the financial statements with the underlying accounting records and other
source data; and
ii) Considering the judgment that management has taken in preparing the financial statements
and accordingly, assess the selection and consistent application of accounting policies, the
manner in which the information ha bee classified and the adequacy of disclosure.
d) As there is an unavoidable risk that some material misstatements may remain undetected
due to the nature of tests conducted, other inherent limitations of an audit and the inherent
limitations of internal control system, the auditor should design audit steps and procedures
to provide reasonable assurance of detecting errors, irregularities and illegal acts that could
have a direct and material impact on the financial statements amounts or the results of
regularity audits. Where the auditor has found any indication during the audit that some
fraud or error may have occurred which result into material misstatement, the scope of
audit should be extended to confirm occurrence of fraud and error.
e) The auditor should consider items which either individually or as a group are material:
i) In general term, a matter may be judged material if knowledge of it would be likely to
influence the users of the financial statements or the audit report.
ii) Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements.
f) The scope of audit should also include the following:
i) Verification of expenditures with approved budget.
ii) Verification of purchase procedures and also that goods purchased are utilized within the
foreseen objectives and are still available or have been ceded / sold in conformity with the
methods defined in audited entity‘s rules and regulations.
iii) verification of the transactions under the following aspects:

a. conformity of expenditures authorizations and validity of the supporting documents;

b. arithmetic accuracy of accounts, supporting documents and financial statements,
c. Accuracy of bookkeeping entries.
d. Allocation of expenditures in conformity with budgets.
e. Verification that contracts are in conformity with prevailing laws and regulations.
f. Verification that receipts are exhaustively and regularly accounted for, and
g. Control of advances accrued or in abeyance, justification for amounts overdue.
iv)Verification of the accounting systems and cost analysis system to confirm that it fulfills
the needs of management and
v) Verification that all corrections required from previous audit have been carried out.
Question No. 35
What do you mean by concurrent audit? Is there any provision in Nepal to perform concurrent
audit of banks and FIs? (4 Marks December 2010)
Answer
Concurrent audit is an audit or verification of transactions or activities of an organization
concurrently as the transaction/activity takes place. It is not a pre-audit. The concept in this audit
is to verify the authenticity of the transaction/activity within the shortest possible time after the
same takes place. In view of the complexities of economic activities it is now well recognized that
there must be a system of someone, other than the person involved in the operations, verifying the
authenticity of the transaction/activity on a regular basis so that any deviation from the laid down
procedures can be noticed in the shortest possible time and remedial action can be taken.
The concept of concurrent audit in the public as well as the private sector banks has gained
acceptance in recent years. However, in Nepal the concept of concurrent audit is yet to be
introduced in banks. As such there is no provision in Nepalese banks and Financial Institutions to
perform concurrent audit.
Question No. 36
Explain the scope of audit of the public sector undertaking as outlined in the guidelines for the
Audit of Public Sector Undertaking issued by the Auditor General Office of Nepal.
(5 Marks June 2011)
Answer
The audit of the public sector undertaking has some distinctive features in view of special
characteristics of the public sector undertakings. The auditor has to adopt certain techniques of
government audit on the one side and the practices of commercial audit on the other. The
government audit is generally an audit of regularity, efficiency, economy, effectiveness and
propriety. It seeks to verify whether the expenditures confirm to various provisions of the
prevailing laws and rules and whether it is covered by proper approval of the appropriate
authority. It also seeks to examine whether every official has exercised the same vigilance in
respect of the expenditures incurred for the public money as a person of ordinary prudence would
exercise in respect of expenditure of his own money. The guidelines issued by the Auditor
General Office of Nepal have outlined the following scope of audit of the public sector
undertaking:
a) The scope of the audit of the public sector undertaking should cover adequately all aspects
of the undertaking to express audit opinion on the financial statements
b) being audited. The auditors should be reasonably satisfied that:

i) The information contained in the underlying accounting records and other source data
is reliable and sufficient; and
ii) Whether the relevant information is properly disclosed in the financial statements
c) The auditor should assess the reliability and sufficiency of the information by:
i. studying and evaluating accounting systems and internal controls to determine the
ii. Carrying out such other tests, enquiries and other verification procedures of accounting
transactions and account balances as considered appropriate in the circumstances.
d) The auditor should determine whether the relevant information is properly disclosed in
the financial statements by:
i. Comparing the financial statements with the underlying accounting records and other
source data; and
ii. Considering the judgment that management has taken in preparing the financial
statements and accordingly, assess the selection and consistent application of
accounting policies, the manner in which the information ha bee classified and the
adequacy of disclosure.
e) As there is an unavoidable risk that some material misstatements may remain undetected
due to the nature of tests conducted, other inherent limitations of an audit and the inherent
limitations of internal control system, the auditor should design audit steps and procedures
to provide reasonable assurance of detecting errors, irregularities and illegal acts that could
have a direct and material impact on the financial statements amounts or the results of
regularity audits. Where the auditor has found any indication during the audit that some
fraud or error may have occurred which result into material misstatement, the scope of
audit should be extended to confirm occurrence of fraud and error.
f) The auditor should consider items which either individually or as a group are material:
i) In general term, a matter may be judged material if knowledge of it would be likely to
influence the users of the financial statements or the audit report.
ii) Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements.
g) The scope of audit should also include the following:
i. Verification of expenditures with approved budget.
ii. Verification of purchase procedures and also that goods purchased are utilized within
the foreseen objectives and are still available or have been ceded / sold in conformity
with the methods defined in audited entity‘s rules and regulations.
h) verification of the transactions under the following aspects:
i. conformity of expenditures authorizations and validity of the supporting documents;
ii. arithmetic accuracy of accounts, supporting documents and financial statements,
iii. Accuracy of bookkeeping entries.
iv. Allocation of expenditures in conformity with budgets.
i) Verification that contracts are in conformity with prevailing laws and regulations.
j) Verification that receipts are exhaustively and regularly accounted for, and
k) Control of advances accrued or in abeyance, justification for amounts overdue.
i. Verification of the accounting systems and cost analysis system to confirm that it
fulfills the needs of management and
ii. Verification that all corrections required from previous audit have been carried out.

Question No. 37
Auditor General of Nepal appointed Mr. Control as an auditor of RTL ltd. a 100% public sector
undertaking (PSE), for the Fiscal Year 2066/67. In his appointment the audit objective and the
scope of the audit were not mentioned. However, in the appointment letter it was mentioned
that all auditors of PSEs shall follow the directives issued by the Office of the Auditor General
(OAG) and applicable auditing standards. Due to unavailability of OAG's directives Mr.
Control had followed the Nepal Standards on Auditing only. How OAG can consider his audit
report?
(4 Marks June 2011)
Answer
As per the directives issued by OAG, auditor appointed by Auditor General (AG) should work as
AG's subordinate. The auditor should perform his work with full knowledge of the rights, duties
and responsibilities of the AG. These directives are issued for the audit of public sector
enterprises (PSEs).
Audit of PSEs includes not only to give true and fair view on financial statements but also to
address all aspects of economy, efficiency, effectiveness and propriety as well and to judge the
organization, management, programme, function or activity under an audit.
Therefore, unless auditor of PSEs follows the directives of OAG, OAG cannot consider the
auditors job as complied with the AG's requirement.
Question No. 38
Distinguish between Reinsurance and coinsurance. (5 Marks December 2011)
Answer
Reinsurance is a mode of distributing the risks of an insurance company. It is a mode through
which an insurance company passes a portion of the risk undertaken by it to other insurance
companies. Hence, a reinsurance transaction may be defined as an agreement between the ceding
company and a reinsurer whereby the former agrees to cede and the later agrees to accept a certain
specified share of risk or liability upon terms set out in the agreement. A ceding company is the
company which has accepted risk and has agreed to cede or pass on that risk to another insurance
company or another reinsurance company. In the event of loss, the insured claims for the full
amount against the original insurer only and the original insurer in turn, lodges the claim with the
reinsurer company.
On the other hand, a co-insurance transaction comes into existence where the party wishing to
take insurance may choose to have more than one insurer for the same risk, particularly in the
case of larger risk exposure. Thus, in a co-insurance transaction, based on an understanding
between the parties concerned, the leader of the co-insurance transaction receives the premium
which is shared by the insurers to co-insurance, issues the policy with a co-insurance clause
therein, and settles any claim under the policy.
Question No. 39
A Donor has appointed you as an auditor for ensuring financial management capacity of the
NGO before funding made to the NGO to rely on the fund operating capability of the NGO.
What would be your special focus area for such assignment? (5 Marks December 2011)

Answer
For ensuring financial management capacity of the NGO my special focus areas would be:
i. To ensure whether adequate internal control system for accounting administration has
been existed within the organization.
ii. To ensure the required experiences & academic qualification of accounting staff.
iii. To ensure the volume of donor‘s fund previously operated by the NGO.
iv. To ensure the adequacy of policies etc. (like accounting manual, chart of account,
financial & administrative regulation, software is in place & adequate).
v. To see the annual audit report, internal audit report & other types of audit report for
ensuring serious and risky areas if any to pay due attention.
vi. To ensure the basic accounting concept of non-accounting staff for handling the
advances.
vii. To see overall account of the NGO, whether there is any diversion of project fund to
institutional fund through any unfair means.
viii. To see the composition of program cost & office running cost for ensuring whether
office running cost mainly salary is excessively high than program cost.
ix. To the composition of common cost (cost shared by different donors) in past period to
ensure that whether same cost has been borne by different donors in books of
accounts.
x. To ensure whether periodical reconciliation (bank/cash/fund etc.) system are in place.
xi. To ensure whether budgetary control system is in place.
xii. To ensure whether there is excessive turnover of the accounting staff.
xiii. To ensure whether proper & adequate delegation of authority has been made and
properly exercised in practice.
Question No. 40
Enumerate the main areas to be covered by the auditor in the case of environment audit of an
Industrial unit. (5 Marks June 2012)
Answer
Environmental auditor should deal with the following aspects in respect of various industrial
units:
i. Layout and Design: To see pollution control devices are installed. Pollution control
measures to meet requirement of regulations framed by the Government.
ii. Management of Resources: Ensure that air, Water, land, Energy, Raw Material and
Human Resources are best used with minimum wastage.
iii. Pollution Control System: See that an effective system of pollution control exists. All
possible measures of control are taken.
iv. Emergent Safety Arrangement: Ensure Safety arrangement against sudden possible
accidents due to chemical, gas or other explosives are in place. Required safety amenities
are kept ready and staff awareness created.
v. Medical and health Care Facilities: See that Proper medical services are maintained.
Regular health checkup of workers is done.
vi. Industrial Hygiene Proper system is maintained to eliminate unhygienic conditions.

vii. Occupational health: Safeguarding health of workers against occupational health

hazards.
viii. Information Assimilation and reporting: Proper information generated and reported by
proper distribution of authority, responsibility and delegation and compliance of statutory
environmental laws.
ix. Environment Impact Assessment: EIA to start industry, proper system and up gradation
whenever necessary.
x. Compliance of Regulatory Measure: Regular training, and knowledge of latest

development for persons working on system for acquaintance with latest developments.
Question No. 41
M/s Rely More Cooperative Limited with a paid-up share capital of Rs. 20,00,000 has earned
surplus after tax in the financial year 2074/75 to the tune of Rs.7,50,000. The management of
the Cooperative Limited wants to distribute the profit to various funds as follows:
i) General Reserve Rs. 1,00,000

ii) Dividend to members Rs. 5,00,000
iii) Appropriation in various funds Rs. 1,50,000
The above appropriation of surplus to various funds has also been approved by the Board of
Directors of the Cooperative. You are required to verify, as an auditor, the validity of above
appropriations in the light of the Cooperatives Act, 2074. (5 Marks June 2012)
Answer
As per Section 68 (1) of the Cooperatives Act, 2074, from the surplus made by a Cooperative in
any financial year, the funds as prescribed may be apportioned after allocating into the reserve
fund at least one fourth of the net saving. Sub Section 2 of the same Act mentions that a dividend
to the extent mentioned in the By-law may be distributed from the funds, other than the reserve
fund in consonance with the purpose of such funds. Provided that, the amount of share dividend
for a year, shall not exceed eighteen percent of the share capital.
In the given case, M/S Rely More Cooperative Limited which has a share capital of Rs.
20,00,000, apportioned Rs. 100,000 to the reserve fund. As per Section 68 (1), the minimum
appropriation to general reserve required is one fourth i.e., Rs. 187,500. So, the proposed
appropriation is inadequate and hence the Cooperative is required to make appropriation of at
least one fourth of the net surplus.
Similarly, approved dividend of Rs. 500,000 is 25% of the share capital of Rely More
Cooperative Limited. Section 71 (2) of the Act specifies that the Cooperative can distribute
dividend to the maximum 18% of its share capital i.e., Rs. 360,000. Hence, the board has to
rectify earlier decision and make appropriation of net surplus as per provision of Cooperatives Act
and Bylaws of the Rely More Cooperative Limited.
Remaining surplus after the above apportionment may be apportioned in various other funds as
specified in its By-law of the Cooperative.

Question No. 42
What are the principals involved in “Propriety Audit”? (8 Marks December 2012)
Answer
Prudence: the expenditure should not be prima facie more than the occasion demand. The
Government Official should exercise the same vigilance in respect of expenditure incurred from
public moneys as a person of ordinary prudence would exercise when spending his own money.
 Proper Sanction: the expenditure should be properly sanctioned by the competent authority.
No authority should exercise its powers of sanctioning expenditure to pass an order, which will
be directly or indirectly to its own advantage.
 General benefit: the expenditure should be incurred for the general benefit of the society as a
whole. Public moneys should not be utilized for the benefit of a particular person or section of
the community unless:
a. The amount of expenditure involved is insignificant, or
b. A claim for the amount could be enforced in a court of law, or
c. The expenditure is in pursuance of a recognized policy or custom, and
d. The amount of allowances, such as travelling allowances, granted to meet expenditure of a
particular type should be so regulated that the allowances are not, on the whole, source of profit to
the recipients.
 No social incentives: apart from the agreed remuneration or reward (i.e. salary, etc.) no
other revenue should be kept open to indirectly benefit the management personnel, employees and
others. The amount of allowances, e.g. travelling allowance, granted to meet expenditure of a
particular type should be so regulated that the allowances are not, on the whole, source of profit to
the recipients
Question No. 43
Describe the procedure for verification of “Documentary Bills Purchased Account” reflected in
the balance sheet of a bank. (7 Marks December 2012)
Answer:
Examine the sanction advice and verify whether all the conditions contained therein are being
followed properly.
 Physically verify all the bills in the possession of the Bank and ensure that all documents of
title are in order and are also in the custody of the Bank.
 Review the covering letters under which the bills have been sent for collection to ensure that
the proper documents of title were with the Bank as n the date of the account.
 Verify as to whether the advance is re-classified as unsecured, as soon as the bills are accepted
by the drawee as on acceptance of these bills, the documents of title should be delivered to the
drawee.
 In respect of bills remaining uncollected after the due dates, verify that the advances are re
classified as unsecured.
 Verify as to whether any party is misusing the facility by submitting bills that are
subsequently returned unpaid.
 Check the computation of discount of the bills.
Enumerate the main areas to be covered by the auditor in the case of environment audit of an
Industrial unit.
Question No. 44

Mr. Talent is a renowned practicing-chartered accountant in the field of audit and taxation.
The Auditor General of Nepal got aware of this fact and wishes to take his professional service
in the Public Sector undertaking (wholly owned by Government) as well? How can do so?
Answer
The Auditor General of Nepal can take the professional service of a chartered accountant in
practice in the two ways:
i. As per Section 10(1) of the Audit Act 2075, the Auditor General of Nepal has the power to
appoint professional auditors as his assistants to conduct the audit of Public Sector
Undertakings wholly owned by the Government of Nepal.
ii. Also, as per Section 11(1) of the Audit Act 2075, the Auditor General shall be consulted while
appointing an auditor for auditing of the Public Sector Undertaking substantially owned by the
Government of Nepal.
Hence, in the case of Mr. Talent, the Auditor General of Nepal may appoint him as his assistant
for fully Government owned PSU or recommend him as an auditor in substantially Government
owned PSU if he wishes to do so.
Question No. 45
As an auditor what audit procedures would you follow to verify “Premium Income” in an
insurance company. (4 Marks December 2012)
Answer
a) The Procedures to be followed are:
i) Scrutinize and review control account of premium, its debit balance and their nature should be
enquired into.
ii) Examine inoperative old dues and treatment given to them with reference to company rules.
iii) Ensure that recognition of premium income is as per the accounting standards and instruction
of the regulatory body of the country.
iv) Enquire into the reasons for relating the old balance dues.
v) Verify old debit balances which may require provision or adjustment. Notes of explanation
may be obtained from the management in this regard.
vi) Check age-wise, sector-wise analysis of outstanding premium.
vii) Verify whether outstanding premiums have since been collected.
viii) Check the availability of adequate bank guarantee or premium deposit for outstanding
premium.
Question No. 46
As an auditor, what audit procedures would you perform on the following:
(3+2 Marks June 2012)
i) “Loans and Advances” in a bank
ii) “Stock & Inventory” in a trading company
Answer
a) Ensure that the loans and advances have been sanctioned properly (after due scrutiny
based on product paper at appropriate level) and complied with Directives of Nepal
Rastra bank
b) Verify whether the sanctions are in accordance with delegated authority and ensure
that securities and documents have been received and properly charged/registered.

c) Ensure that post disbursement supervision and follow-up is proper, such as receipt of
stock statements, installments, renewal of limits etc.
d) Verify the record that the loans were used for intended purpose and whether there are
no events or conditions indicative of diversion of funds.
e) Verify whether the classification and provisioning of loans and advances have been
done as per NRB Directives.
f) Verify that applicable interest rate is correctly imputed in the system.
ii)
a) Verify that the inventory cut-off procedure duly complied with during the inventory
taking. The auditor will examine the procedures for receiving in and shipment from
main store of inventory items at the time of the physical inventory count to avoid
possibility of double counting of inventory items.
b) Observe the inventory count to ensure that the details of the stock register tally with
the physical counting and other details.
c) Verify that the value shown in the books of accounts is as per the Nepal Accounting
Standard 02, which is consistently applied with.
d) Perform audit procedures to ensure that the costs of inventory are appropriate, trace
unit costs of inventory items to supplier invoice or from standard cost sheet.
e) Check the slow-moving, obsolete, damaged and scrapped inventories items and
discuss with the management, realizable value of such inventory if any recorded in the
books.
f) Verify that there is no abnormal value of stock item appearing in the books. If yes,
verify the reason and rectify the same
Question No. 47
Explain the loan loss provision criteria for Banks as prescribed by Nepal Rastra Bank.
(5 Marks June 2012)
Answer
The banks make loan loss provision on the basis of aging of the principal, interest and other
criterions prescribed by Directive of Nepal Rastra Bank. The basis of provision for loans and
advances are:
1. Aging of principal
- Pass: Loans/advances which have not overdue or overdue by a period up to one month.
Provision @ 1%
- Watch Lists: Loans/advances which are overdue by a period from one month to a
maximum period of three months. Provision @ 5%
- Sub-standard: Loans/advances which are overdue by a period from three months to a
maximum period of six months. Provision @ 25%

- Doubtful: Loans/advances which are overdue by a period from six-months to a Maximum

period of one year. Provision @ 50%
- Loss: Loans/advances which are overdue by a period of more than one year. Provision @
100%
Term/EMI loan should be classified based on the aging of installment
2. Aging of interest
In case of working capital loan, if interest is not received on due dates such working capital loans
should be classified on the basis of the duration of interest overdue.
3. Other criterion on provisioning
i. The loans/advances extended against the collateral of gold and silver, fixed deposit
receipts, Government of Nepal securities and Nepal Rastra Bank bonds should be
classified as good loans. However, these collaterals are used as additional collateral then
such loans/advances shall be classified based on the aging of the principal.
ii. In the following events or discrepancy, whether loans/advances are overdue or not such
loans/advances should be categorized as the loss loans:
 The market price of the collateral cannot secure the loans
 The debtor is bankrupt or has been declared to be bankrupt
 The debtor disappears or is not identified
 In case non-fund-based facilities such as purchased or discounted bills and L/C and
guarantee which have been converted into fund-based loan, are not recovered within
ninety days from the date of their conversion into loan
 Bills purchased or discounted is not recovered within 90 days from the maturity date
 Loan is misused
 Expiry of six months of the date of auction process after the loan could not be
recovered or a case is pending at a count under the recovery process
 Providing loan to a debtor who has been enlisted in the blacklist of Credit Information
Bureau Ltd;
 The Project/business is not in a condition to be operated or project or business is not
in operation
 The credit card loan is not written off within 90 days from the date of expiry of the
deadline
 In case of expiry of the deadline of a trust-receipt loan.
iii. Rescheduling and/or Restructuring of good loans require provision @12.50%, and if the
non-performing loans are rescheduled, or restructured provision should be maintained as it
is.
iv. Loans/advances are insured or guaranteed by Credit Guarantee Corporation, 75%
provision requirement on such loans/advances are exempted.
v. Loans against personal guarantee requires additional provision at 20%
Question No. 48
Distinguish between Vostro and Nostro Accounts (5 Marks December 2012)
Answer
Bank‘s maintain stocks of foreign currencies in the form of Bank Accounts with their overseas
branches/correspondents. Such foreign currency accounts maintained by Nepalese banks at other
overseas centers is designated by it as ―Nostro Account‖. ―Vostro Account‖ is the opposite of
Nostro accounts. Here a foreign bank in another country maintains stocks of Nepalese rupees with

their Nepalese branch/correspondent/local bank. Such Accounts are designated as a Vostro

Account While examining the transaction in foreign exchange, the auditor should also pay
attention to reconciliation of Nostro Accounts with the respective minor account. The amount in
the Nostro account is stock of foreign currency in the form of bank accounts with the overseas
branches and correspondents. Unreconciled Nostro Accounts, on an examination, may reveal
unauthorized payments from the foreign currency account, unauthorized withdrawals, and
unauthorized debit to minor account. The auditor should also evaluate the internal control with
regard to inward/ outward messages. The inward/ outward messages should be properly
authenticated, and discrepancies noticed, should be properly dealt with, in the books of accounts.
The auditor should also verify whether prescribed procedure in relation to interbank confirmation
in the Vostro account is followed or not. In case balance confirmation certificate have been
received but the same have not been reconciled, or where confirmation has not been received the
same should be reported, in respect of each Vostro Account.
Question No. 49
What are the internal control measures that are to be taken into consideration in the following
activities? (4 Marks each June 2014)
i) “Credit Card Operations” in a bank.
ii) “Reinsurance” in an insurance company.
Answer
(i)
 There is a system of effective screening of applications with reasonably good credit
records of the applicants.
 There is strict control over storage and issue of cards.
 There should be a system of prompt reporting by the merchants of all settlements
accepted by them through credit cards.
 There should be a system that reimbursement to merchants should be made only after
verification of the validity of the merchant‘s acceptance of cards.
 All the reimbursement (gross of commission) should be immediately charged to the
customer‘s account.
 There should be a system to ensure that statements are sent regularly and promptly to
the customer.
 There exists system to monitor and follow-up customers‘ payments closely.
(ii)
 Adequate guidelines and procedures are established with respect to obtaining
reinsurance and selecting reinsurers after considering the relevant regulations.
 The ceded insurance programs and agreements are approved by appropriate officials.
 Compliance with the terms of the reinsurance contracts entered into by the company is
monitored by a responsible official.
 Adequate procedures are designed to notify reinsurers in time in respect of the losses,
where the contract so requires.

 The calculation of ceded transactions and balances, including period-end calculations

are reviewed by an appropriate official.
 There are regular reconciliations between the premium ceded register, ceded
commission register and the general ledger by appropriate officials.
 The financial stability of the reinsurers is duly monitored by the insurance company.
 Any foreign currency exposure is duly monitored by the insurance company.
 Compliance with the relevant regulations is ensured by a responsible official on a
continuous basis.
Question No. 50
How will you verify “Machinery acquired under Hire-purchase system”, while auditing a
company? (4 Marks June 2014)
Answer
a. Examine the Board‘s Minute Book approving the purchase on hire-purchase terms.
b. Examine the hire-purchase agreement carefully and note the description of the machinery, cost
of the machinery, hire purchase charges, terms of payment and rate of purchase.
c. Ascertain that the machinery has been included in the related assets account at its cash value.
Also, installments due have been paid and the hire-purchase charges applicable to the period
from the commencement of the agreement to the end of the financial year have been charged
against current profits.
d. Ensure that machinery acquired on hire purchase basis has been included at its cash value in
the balance sheet and depreciation has been calculated on the cash value from the date of the
purchase. The amount due to the hire purchase company in respect of the capital outstanding
has either been shown as a deduction from the machinery account or as a separate amount
under current liabilities.
Question No. 51
As an auditor what audit procedures would you follow to verify the following account heads:
i) “Foreign Exchange Transactions” in a bank
ii) “Inventory” in a trading company
Answer: i)
(i) Check foreign bills negotiated under letters of credit
(ii) Check Foreign Currency Non-Resident and other non- resident accounts whether
the debits and credits are permissible under rules.
(iii) Check whether inward/outward remittance has been properly accounted for.
(iv) Examine extension and cancellation of forward contracts for purchase and sale of
foreign currency. Ensure that they are duly authorized and necessary charges have
been recovered.
(v) Ensure that balances in Nostro Accounts in different foreign currencies are within
the limit as prescribed by the bank.
(vi) Ensure the overbought/oversold position maintained in different currencies is
reasonable taking into account the foreign exchange operations.
(vii) Ensure adherence to the guidelines issued by NRB/HO of the bank about dealing
room operations.

(viii) Ensure verification/reconciliation of Nostro and Vostro account

transactions/balances.
(ix) Verify and check the foreign currency transactions through exchange counters and
also ensure that commission income and exchange gain/loss (trading and
revaluation) are properly accounted for.
(x) Ensure that all the reporting requirements of NRB with respect to foreign currency
transactions are reported on a timely basis.
(xi) Check whether NRB requirement with respect to transfer to Exchange Fluctuation
Fund (25% of exchange gain) is made properly.
Answer ii)
(i) Ensure that the details of the stock register tally with the physical counting and
other details.
(ii) Verify that the value shown in the books of accounts is as per the Nepal Accounting
Standard 04.
(iii) Ensure that there is an adequate system of physical verification of stock on periodic
basis.
(iv) Check if there is any non-moving and slow-moving item in the stock. Verify the
reason.
(v) Verify if there is obsolete item and disposal thereof to update the store and books of
accounts.
(vi) If obsolete and non-moving items are disposed of, ensure that appropriate
procedures are followed, and proper accounting treatment is made.
(vii) Verify that there is no abnormal value of stock item appearing in the books. If yes,
verify the reason and get the management‘s view on the same.
(viii) Verify if the obsolete and non-moving items in the inventory list would have
significant impact on the financial statements and see whether any provision for the
same is required.
Question No. 52
Briefly describe comprehensive audit of public enterprises. Discuss some of the broad areas
to be examined therein. (5 Marks June 2015)
Answer
The scope and extent of audit of public enterprises is determined by the comptroller and auditor
general of Nepal. Audit of PE is not restricted to financial and compliance audit, it extends also to
efficiency, economy and effectiveness with which these operate and fulfill their objectives and
goals. Another aspect of such audit relates to questions of propriety; this audit is directed towards
an examination of management decisions in sales, purchases, contract, etc. To see whether these
have been taken in the best interests of the undertaking and conform to accepted principles of
financial propriety. Comprehensive audit involves assessing efficiency and effectiveness of public
enterprises in its entirety to be conducted on the basis of certain standards and criterion. Public
enterprises have been set-up with socio-objectives. An objective assessment with reference to
such objectives' fulfillment would require comprehensive audit.
Areas to be covered: the areas covered in comprehensive audit will naturally vary from
enterprise to enterprise depending on the nature of the enterprise, its objectives and operations.
Some of the broad areas are listed below-
(i) Comparison of overall capital cost of the project with the approved planned costs.

(ii) Production or operational outputs vis-à-vis under-utilization of the installed capacity

(iii) Systems of project formation and implementation.
(iv) Planned rate of return.
(v) Cost control measures.
(vi) Research and development programs.
(vii) System of repairs and maintenance.
(viii) Adequate purchase policies.
(ix) Effective and economical procedures.
(x) Project planning.
(xi)Undue waste, unproductive time for men and machines, wasteful utilization or even non-
utilization of resources.
Question No. 53
How would you vouch/verify assets acquired on hire purchase? (4 Marks December 2015)
Answer
(i) Examine the Board‘s minutes book approving the purchase on Hire Purchase terms
(ii) Examine the Hire Purchase Agreement carefully & note the description of the
machinery and cost of machinery, Hire Purchase charges, terms of payment and rate of
purchase
(iii) Assets acquired under Hire Purchase system should be recorded at full cash value with
corresponding liability of the same amount. In case cash value is not readily available,
it should be calculated presuming an appropriate rate of interest
(iv) Hire Purchased assets are shown in Balance Sheet with appropriate narration to
indicate that the enterprise does not have full ownership thereof. The interest payable
along with each installment, whether separately or included therein, should be debited
to the interest account, and not to the asset account
Question No. 54
Oswal & Associates, a Chartered Accountant firm issued audit report of a Bank without any A
qualification where, the Bank while accepting the nonbanking assets,
i) Did not charge the difference amount to the Income Statement as loss even though
the market value of the collateral was found lower than the principal amount, and
ii) Charged the difference amount to the Income Statement as income where the
market value of the collateral was found higher than the total of loan and interest
amount, though the assets were not actually sold.
Answer
The Auditor of the Bank is required to ensure whether his/her client has accounted for and
presented financial statements as required by the regulators. In the given case the bank (auditee) is
required to comply with Directives issued by the Nepal Rastra Bank regarding Non-Banking
Asset. As per NRB Directives on major accounting policies, it prescribes accounting policies for
Non-banking Assets which requires to account for non-banking assets at lower of all dues
(Principal, interest and others) or prevailing market price of collateral as valued by approved
Valuator as per latest NRB Circular. While booking NBA, in case where prevailing market
price/value of the collateral is lower than the amount due from borrower, the difference should be
charges as loss in the Income Statement of the same year with corresponding effect with loan
account & AIR. Accordingly, loan loss provision made earlier should be written back and 100%

provision in NBA should be made. Further if in case where prevailing market price/value of the
collateral is higher than the amount due from borrower, the difference would be represented by
AIR & should be transferred to NBA provision until the NBA is actually sold instead of booking
as income.
In the given first case the bank has not followed the NRB guidelines in accounting of Non-
banking assets. In the second case the booking of AIR as income is not allowed until sale of NBA
will not been made. The AIR amount should be transferred to the provision of NBA instead of
booking as income. In the both cases the bank has not complied with NRB Directives. The
Auditor has a responsibility to ensure whether client has complied with all applicable laws,
regulation and guidelines. However, the auditor has not qualified this non-compliance in his audit
report and accordingly report should issue.
The auditor was found compromising the provisions of Section 34(9) of the Nepal Chartered
Accountants Act 2053 which requires that members holding Certificate of Practice to discharge
their duties with due care in the course of their profession and shall draw attention of all
concerned to all material facts which are or have taken place contrary to the prevailing law and do
not comply with generally accepted principles of auditing.
The auditor was also found compromising the provisions of Section 110 of the Code of Ethics
which requires members to act diligently in accordance with applicable technical and professional
standards.
Question No. 55
a. Excess of Loss (XL) Treaties (4 Marks December 2008)
Answer
Excess of Loss Treaties denotes a special arrangement under the reinsurance contract where
the reinsures liability arises only when a claim exceeds a predetermined figure relating to a
specific branch of the ceding company‘s business or its entire business. The Treaty would
provide for maximum liability as well as the amount up to which the ceding company would
bear the loss itself, which is called the ―underlying Limit‖. The XL cover can also be
arranged for an unlimited amount in excess of the underlying limit.
Excess of loss cover on prevent basis: In this type of cover, in case as a result of one event
several risks are affected, the loss under each risk is arrived at separately and the underlying
limit is applied to each risk to determine the liability of the insurer. This is also known as
―Working Excess of Loss Cover‖.
Excess of loss cover on non-prevent basis: In this type of cover, losses resulting from one
event are considered together and aggregate amount of loss is determined and one loss
underlying limit is deducted from the aggregate amount of the loss to determine the liability of
the excess of loss reinsurer. This type of cover provides protection to an insurer against the
numerous losses caused by one or the same event such as cyclone, earthquake, etc. This type
of cover is also, therefore, known as ―Catastrophic Covers‖.
b. The steps required to be followed while conducting audit of incomplete records.


Steps that are required to be followed during audit of incomplete records are explained as
below:
i) Ascertain the exact status of accounting records available including memoranda records.
ii) Ensure that the management compiles / reconstructs accounting records to the extent
practicable.
iii) Perform compliance procedure to assess whether any control system is in operation.
iv) Vouch transactions recorded in books of account with reference to appropriate audit
evidence. Check posting, casting etc.
v) Examine the system in operation in respect of custody managed cash memos, receipts,
check books etc.
vi) Verify fixed assets by observing physical verification.
vii) Conduct surprise checks to verify cash in hand, inventory etc.
viii) Apply analytical review procedures in depth and notice deviations to investigate in detail.
ix) Formulate an appropriate audit opinion based on above findings.
c. Long Form Audit Report (4 Marks December 2014)
As required by Nepal Rastra Bank directives no 4 on Accounting policy and format of

financial statements, Statutory Auditor of Banks (A category) and Financial Institutions (B
and C Category) is required to submit long form audit report within 15 days of the
completion of the audit to Nepal Rastra Bank, Bank and Financial Institutions Supervision
Department.
The contents that are to be included and reported in the Long Form Audit Report is
prescribed by the NRB which includes the following:
 Audit Approach
 Risk Management Systems (Credit risk, Market risk, operational risk)
 Internal Control Systems
 Compliance with Applicable rules and regulations
 Others- contingent liability exposures, related party transactions, purchase of fixed
assets, etc.
 Conclusion – type of report, any major problems in Banks/FIs.
Similarly, Insurance Board (Beema Samiti), which is the insurance regulatory authority of
Nepal has also issued its directives with regards to the submission of Long Form Audit
Report by the auditors.
d. Energy Audit (4 Marks June 2016)

Energy Auditing is defined as an activity that serves the purposes of assessing energy use
pattern of a factory or energy consuming equipment and identifying energy saving
opportunities. In that context, energy management involves the basic approaches reducing
avoidable losses, improving the effectiveness of energy use, and increasing energy use
efficiency. The energy auditor is normally expected to give recommendations on efficiency
improvements leading to monetary benefits and also advise on energy management issues.

e. Environmental Audit (3 Marks June 2018)

Environmental audits are reviews of a company‘s operations and processing for the purpose
of assessing compliance with environmental rules and regulations. It is the critical analysis of
the following aspects that relates to the environment.
 Policies
 Principles
 System and procedures
 Practices
Question No. 56
You are the audit manager of Poor & Rich Bank Limited, class “A” commercial bank with
more than 100 branches spread across Nepal. Branch Manager Mr. Champak and his
second in charge Mr. Gurju are very old and loyal staffs of the bank located at
Sandhikhara. During the course of the branch audit, you noted the following:
 Vault Key Management: There is no practice of maintaining key movement register.
While reviewing the CCTV footage it was noted that both the vault keys (combination
keys) were handled by single staff during holiday counter.
 Customer Service Department: The new staffs who are deputed for managing cheques
requisition and cheques handover to customer has full access to the core banking
system. Owing to urgency, the system access was provided by head IT under verbal
request of Mr. Champak.
 Mr. Champak and Mr. Gurju are of the view that the surprise physical verification of
cash and cash equivalent apart from daily reconciliations by departmental staff are
mere waste of time and are to be done by the auditors on need basis.
 Trade Operations: The letter of guarantee is handled by Mr. Champak himself, this
being a sensitive issue. Mr. Champak receives the application for opening letter of
guarantee from customer having permanent guarantee limit and verifies the request of
the customer and after ensuring that it is within the guarantee limit issues the letter
guarantee on his sole signature.
 Human Resource Management: The job roles of Mr. Champak and Mr. Gurju have not
been changed for the last five years and the block leave was not availed by Mr.
Champak during the fiscal year 2074/75.
Required:
(3+3+4=10, June 2019)
i) Briefly describe the internal control weaknesses.
ii) Consider the possible consequences of each weakness.
iii) Describe the controls you would recommend remedying each weakness.
Answer
The internal control weakness, consequences of each weakness and recommendation
of the auditor is tabulated below:

Weakness Consequences Recommendation

Key movement register Possibility of financial Ensure that all movements of
documenting the fraud. Even trusted key are recorded in a key
possession of the key is employees can become movement register, signed by
not maintained. untrustworthy. new & old custodians with
date and time entry in the
The cash vault is under Opportunity and motive register.
the control of single staff can combine to cause
during holiday counter. out-of-character actions The vault key handling
arrangement shall be made in
such a way that dual control
over vault is ensured at all
times.
System access to new System access not Provide access to core

staff was provided without
commensurate with job banking system on need basis
accessing which module role and responsibilities. only after proper verification
of the system access are and written approval from the
required in line with Possibility of fraud as authorized personal only.
his/her job responsibility.
the staff has access to
customer specimen
System access provided signature, account
on verbal request of details and account
Branch manager. history.
Surprise checking element Possibility of fraud/error Surprise physical verification

from branch staff by departmental staff of cash and cash equivalent at
independent of cash and collusion. vault/tellers should be done.
cash equivalent related This surprise/spot check
work is missing. maintains check and balance
on departmental work.
One individual has authority Possibility of Financial Greater segregation of duties

for receiving applications, loss/fraud. (E.g.: while is required in the Trade
verification of limits and verifying the expiry date operation department (e.g.
other documents and issues of guarantee, he may There should be maker and
the letter of guarantee erroneously/intentionally checker concept and
under his sole signature. provide the guarantee guarantee should be issued
for longer period than under dual signature.
requested for)
Job rotation of the staff No job rotation of Human Resources

after certain time interval sensitive personal and Department should ensure the
and block leave once in a non-availing of block job rotation of the staff and
year not made leave by key personal block leave policy is
mandatory/availed by the exposes bank to mandatorily followed.
branch staff operational risk.
Someone else should assume

Over reliance on certain the duties of staff during the

staffs might impact on block leave as a
work life balance. fraud/prevention and
detection toll.
Question No. 57 (3 Marks, June 2019)

Energy audit
Answer
Energy Auditing is defined as an activity that serves the purposes of assessing energy use pattern
context, energy management involves the basic approaches reducing avoidable losses, improving
the effectiveness of energy use, and increasing energy use efficiency. The energy auditor is
normally expected to give recommendations on efficiency improvements leading to monetary
benefits and also advise on energy management issues.

Chapter 9 Assurance and related services
Question No. 1
"Since statutory audit is compulsory, internal audit in a medium scale industry is only
extravaganza." Do you agree with this statement? Justify your views. (10 Marks June 2004)
Answer
The answer should deal with following points:
a. Scope of internal audit and statutory audit in brief.

b. On the basis of scope emphasize on managerial functions of internal audit and
contribution to the management regarding accounting and control aspects. This part
should specifically point out aspects, which do not general fall in the scope of statutory
audit.
c. Relate certain aspects, which overlap in both the audit with contribution to perform
statutory audit in short time.
(d) Conclude on the basis of above points that the statement is not correct.
Question No. 2
List the factors to be considered while assessing internal control for following areas:
Answer
Factors to be considered while assuring internal control for following areas are as below:
a. Fax Transfers and Demand Drafts
i. The bank should have a reliable private code known only to responsible officers
of its branches, coding and decoding of faxes and DDS should be done only by
such officers.
ii. Signature on DDS should be visited with specimen signatures.
iii. Confirmation through advises to the branches concerned.
iv. Whether reasons are ascertained for non-confirmation of issuing branches.
b. Clearings in a bank
i. Cheques received by the bank in cleaning should be checked with the list
accompanying them. Independent list should be prepared for cheques debited to
different customers‘ accounts and those returned unpaid and these should be
checked my officers. The total numbers and amount of cheques included in these
lists should be agreed with the list first mentioned by a person unconnected with
both the customers, ledgers and the cleaning department.
ii. The total number and amount of cheques sent out by the bank for cleaning should
be agreed with the total of the cleaning pay-in-slips by and independent person.

iii. The unpaid cheques received back in return cleaning should be checked in the
same manner as the cheques received.
c. Preparation of payroll
i. What records are to be used as bases for complication of the payroll and how
they are to be authorized.
ii. Responsibility of preparation, checking and approval. Preferable these activities

should be done by separate persons.
iii. Means of indication of responsibility at each stage.
iv. Procedures for notifying and dealing with non-routine circumstances such as
absence, termination etc.
d. Cash payments
i. Nomination of responsible person to authorize, means of indication of

authorization and documentation for evidence.
ii. Arrangements to ensure that the vouchers supporting payment cannot be for
double payment.
iii. Limits regarding disbursements.
iv. Rules for cash advances to employees, IOUs and encashment of cheques.
Question No. 3
There is no difference between Performance Audit Report and Due Diligence Report". Do you
agree? State reasons in support of your opinion. (10 Marks June 2006)
Answer
Answer for this question should focus on following points:
i. Objectives of performance audit and due diligence report.
ii. Users of the reports.
iii. Differences in contents of reports.
On the basis of above deliberations conclude that you do not agree with the statements.
Question No. 4
Discuss on relationship between internal auditing and external auditor. (4 Marks June 2006)

Answer:
As per NSA 610, the role of internal auditing is determined by management, and its objectives
differ from those of the external auditor who is appointed to report independently on the financial
statements. The internal audit function‘s objectives vary accordingly to management‘s
requirements. The external auditor‘s primary concern is whether the financial statements are free
of material misstatements.
Nevertheless, some of the means of achieving their respective objectives are often similar and
thus certain aspects of internal auditing may be useful in determining the nature, timing and extent
of external audit procedures.
Internal auditing is a part of the entity. Irrespective of the degree of autonomy and objectivity of
internal auditing, it cannot achieve the same degree of independence as required of the external
auditor when expressing an opinion on the financial statements. The external auditor has sole
responsibility for the audit opinion expressed, and that responsibility is not reduced by any use
made of internal auditing. All judgments relating to the audit of the financial statements are those
of the external auditor.
Question No. 5
Answer:
The following are examples of factors, which might cast doubt on the going-concern status of a
company: (These are the indicators as mentioned in NSA 570)
 Internal matters such as loss of key management, labour difficulties or excessive
dependence upon a few product lines where the market is depressed.
 External matters such as loss of key suppliers or customers or technical developments,
which render a key product obsolete.
 An excess of liabilities over assets.
 Default on terms of loan agreements.
 Significant liquidity or cash flow problems.
 Major litigation in which an adverse judgement would imperil the company‘s
continued existence.
 Denial of normal terms of credit by suppliers.
 Major debt repayment falling due where refinancing is necessary to the company‘s
Question No. 6
Even an auditing has its own inherent limitations, an audit provides reasonable assurance that
financial statements are presented fairly in all material respects. Justify.
Answer:
Reasonable Assurance and Audit Limitations
An audit in accordance with NSA is designed to provide reasonable assurance that the financial
statements taken as a whole are free from material misstatement. Reasonable assurance is a
concept relating to the accumulation of the audit evidence necessary for the auditor to conclude
that there are no material misstatements in the financial statements taken as a whole. Reasonable
assurance relates to the whole audit process. However, there are inherent limitations in an audit
that affect the auditor‘s ability to detect material misstatements. These limitations result form
factors such as:

a) The use of testing

b) The inherent limitations of any accounting and internal control system (e.g. the
possibility of collusion)
c) The fact that most audit evidence is persuasive rather than conclusive
The work undertaken by the auditor to form an opinion is permeated by judgement, in

particular regarding:
a) The gathering of audit evidence, e.g. in deciding the nature, timing and extent of audit
procedures; and
b) The drawing of conclusion based on audit evidence gathered, e.g. assessing the
reasonableness of the estimates made by management in preparing the financial
statements.
Other limitations may affect the persuasiveness of evidence available to draw conclusions
on particular financial statement assertions (e.g. transactions between related parties). In
these cases, certain NSA (s) identify specified procedures, which will, because of the
nature of the particular assertions provide sufficient appropriate audit evidence in the
absence of:
a) Unusual circumstances, which increase the risk of material misstatement beyond that
which would ordinarily be expected; or
b) Any indication that a material misstatement has occurred.
statements, the responsibility for preparing and presenting the financial statements is that
of the management of the entity. The audit of the financial statements does not relieve
management of its responsibility.
Besides having above mentioned limitations, an audit conducted in accordance with NSAs
provides reasonable assurance to the user of the financial statements.
Question No. 7
Discuss auditors' responsibility for detecting and reporting internal control weaknesses.
(5 Marks June 2006)
Answer:
The auditors are not primarily responsible for evaluating the effectiveness of all internal controls
and reporting all weaknesses. In the letter of weakness and in the engagement letter the auditor
should make it clear that the assessment of control effectiveness is restricted to those controls on
which reliance is intended to be placed for audit purposes. If auditors intend to place reliance for
particular financial statement assertions wholly on substantive procedures, they have no
responsibility for controls over those assertions.
Where the auditors do become aware of internal control weaknesses, however, there is an
expectation that they will warn management where the risk of loss or misstatement is considered
material. Awareness of control weaknesses may come about from procedures other than those
directed specifically at testing controls. For example, in obtaining an understanding of the system
the auditor may become aware of major control weaknesses. Also, in performing substantive
procedures, investigation of errors may alert the auditor to the presence of control weaknesses.

The auditors' duty to report on the effectiveness of internal controls, under auditing standards, is
confined to the management of the entity. They have no responsibility to report to other parties.
The letter of weaknesses normally carries a disclaimer of responsibility to any other persons to
whom the letter might be shown.
Auditors may accept engagements to report on control weaknesses, either to managers, to

regulators or to third parties. In such case auditors will be under obligation to report internal
control weaknesses. However, such engagements are not part of the audit of the financial
statements.
The Students should also mention the requirements of NSA 265 regarding communication of
deficiencies in the internal control system to TCWG.
Question No. 8
EFG Logistic Pvt. Ltd. get registered to Inland Revenue Department in order to obtain Value
Added Tax Registration Number-TPIN. During the finance year 2004-05 its turnover was Rs. 5
Million. This turnover includes Rs. 2 Million from a contract agreement with FAO South Asia
Region, Bangkok and payment against such contract services was received in convertible
currency, i.e. Japanese Yen. Can the company issue no-VAT bill in a plain paper? If not, give
your suggestion. (5 Marks June 2006)
Answer:
In this case, the company is a registered TPIN holder and it cannot issue two types of bill. So,
issuance of bill in a plain paper is not a legal act. However, as per VAT Act, the company can
issue Zero VAT bill to the FAO, Bangkok office in the same order of its approved billed from the
Inland Revenue Office. The company has to issue VAT bill and the amount of Tax will be zero
instead of 13 percent in the respective column of the bill.
Question No. 9
A systematic planning is a necessity for proper execution of a cost audit. Indicate the matters to
be included in a Cost Audit Programme. (10 Marks December 2006)
Answer
The cost audit programme should include all the usual broad steps that a financial auditor includes
in his audit programme. It is a true that like any other audit a systematic planning for cost audit is
also necessary This would require that the various aspects like what to be done, when to be done,
by whom to be done are adequately takes care of. Cost audit, in order to be effective, should be
completed at one time as far as practicable. Based on above factors a set of procedures and
instructions are evolved which may be termed the cost audit programme. Matters to be included in
the Cost Audit Programme may be divided into following two stages:
i. Review of Cost accounting record includes the followings:

 Method of costing in use
 Method of accounting for raw material, stores and spares, wastage
 System of recording wages, salary, etc.

 Basic of allocation of overheads to cost centers and absorption by product and

services.
 Treatment of expenses like research & development, royalty etc.
 Method of depreciation accounting.
 Method of stocktaking and valuation.
 System of budgetary control.
ii. Verification of cost statement and other data covers the following aspects.
 Licensed, installed and utilized capacity.
 Operating and financial ratio.
 Production data.
 Consumption of material and actual expenses.
 Sales realization.
 Abnormal non-recurring and special cost.
 Reconciliation with financial books.
Question No. 10
Distinguish between Control Risk and Detection Risk (5 Marks December 2006)
Answer
Control Risk means risk that the client's system of internal control will not prevent or correct such
errors whereas Detection Risk means risk that any remaining material errors will not be detected
by the auditor. Control Risk is the risk that misstatement that could occur in an account balance
or class of transactions and that could be material, individually or when aggregated with
misstatement in other balances or classes, will not be prevented or detected on a timely basis by
the system of internal control.
Detection Risk is the risk that an auditor's procedures will not detect a misstatement that exists in
an account balance or class of transactions that could be material, individually or when aggregated
with misstatements in other balances or classes. There will always be some control risk because of
intrinsic limitation of any system of internal control whereas the level of detection risk relates
directly to the auditor's procedures.
Control risk exists independently of an audit of financial information. Control risk is function of
the entity's business and its environment and the nature of the account balances or classes of
transactions, regardless of whether an audit is conducted. Detection risk is dependent on
appropriateness of audit procedures, application of the audit procedures and appropriate
interpretation of the audit results.
Question No. 11
What are the differences between Limited Assurance Engagements and Reasonable Assurance
Engagements as per International Standards on Assurance Engagements?

Answer
Following are the differences between a reasonable assurance engagement and a limited assurance
engagement as discussed in the International Framework for Assurance Engagement:
Type of Objective Evidence-gathering procedures Theassurance
Engagement report
Reasonable A reduction in A reduction in assurance engagement Description of
Assurance assurance risk to an acceptably low level in the the
Engagement engagement risk to circumstances of the engagement, as the engagement
an acceptably low basis for a positive form of expression of circumstances,
level in the the practitioner‘s conclusion. Sufficient and a positive
circumstances of appropriate evidence is obtained as part form of
the engagement, as of a systematic engagement process that expression of
the basis for a includes: the
positive form of  Obtaining an understanding of the conclusion.
expression of the engagement circumstances;
practitioner‘s  Assessing risks;
conclusion.  Responding to assessed risks;
 Performing further procedures using
a combination of inspection,
observation, confirmation,
recalculation, re-performance,
analytical procedures and inquiry.
Such further procedures involve
substantive procedures, including,
where applicable, obtaining
corroborating information, and
depending on the nature of the
subject matter, tests of the operating
effectiveness of controls; and
 Evaluating the evidence obtained
Limited A reduction in Sufficient appropriate evidence is Description of
assurance assurance obtained as part of a systematic the
engagement engagement risk to engagement process engagement
a level that is that includes obtaining an understanding circumstances,
acceptable in the of the subject matter and other and a negative
circumstances of engagement form of
the engagement circumstances, but in which procedures expression of
but where that risk are the
is greater than for deliberately limited relative to a conclusion.
a reasonable reasonable
assurance assurance engagement.
engagement, as the
basis for a
negative form of
expression of the
practitioner‘s
conclusion.

Question No. 12
The promoters of M/s ABC Bank Ltd. are not in a position to increase share capital as per
Nepal Rastra Bank requirements. Therefore, its promoters wish to sell out its all the shares
held by them. Shree Global Group Pvt. Ltd. is interested to acquire all the shares held by its
promoters. Shree Global Group Pvt. Ltd. requests you to conduct a “Due Diligence” of the
ABC Bank Ltd. and submit your report. What are the key areas you will cover in your review as
a due diligence auditor?
(10 Marks December 2007,9 Marks December 2008)
Answer
It is quite important for the acquirer to assess the proposal from different angles and specifically
whether proposed acquisition of promoters‘ shareholding would be beneficial. On the other hand,
financial due diligence review would be performed after the commercial valuation. Accordingly,
while preliminary review might be performed during initial stages of the restructuring exercise
and may, in fact, be performed simultaneously with the commercial evaluation at a later stage,
financial due diligence may be performed on the books of account and other information directly
pertaining to the financial matters of the entity. In addition, a legal due diligence may be required
where legal aspects of functioning of the entities are reviewed; for example, the legal aspects of
property owned by the entity or compliance with various statutory requirements under various
laws including regulatory body‘s regulations. Like other due diligence exercises, personnel due
diligence is also carried out in order to establish whether various propositions with regard to
personnel of the enterprise under review are appropriate. In any case, it is quite important to look
behind the veil of initial information provided by the company and to assess the benefits and costs
of the proposed acquisition by inquiring into all relevant aspects of the past, present and future of
the business to be acquired. Some of the significant key areas which shall be covered under the
review are as follows;
a) Historical background:
As a due diligence auditor, he should begin the financial due diligence review by looking into the
history of the company and the background of the promoters. The detail of how the company was
set up and who were original promoters has to be obtained, before verification of financial data in
detail. An eye into the history of the company may reveal its turning points, survival strategies
adopted from time to time, the market share enjoyed by and changes therein and adequacy of
resources. It could also help him in determining whether, in the past, any regulatory requirements
have had an impact on the business of the said company. This could, inter alia, include the nature
of businesses, location of service facilities, offices and markets.
b) Significant Accounting Policies:
The accounting Policies being followed by the company and appropriateness thereof is another
key area. The impact of the recent changes in the accounting policies in the recent past in view its
intention of offering itself for sale.

He has to look at the main effect of accounting policies on the overall profitability and their
correctness. It is also quite important to ascertain significant accounting policies used by the
company, the changes made to the accounting policies in the recent past, the area in which
accounting policies being followed by the company are different from those adopted by the
acquiring enterprise and the effect of such difference. Finally examine whether the financial
statements of the company have been prepared in accordance with the governing statutory
requirements.
c) Review of Financial Statements:
An evaluation of the profit reported by the company would be largely based upon its operating
results. Any extraordinary item of income or expense that might have affected the operating
results would require close examination. It is advisable to compare the actual figures with the
budgeted figures for the period under review and those of the previous accounting period. It is
important that the trading results for the past four to five years are compared and the trend of
normal operating profit arrived at. The normal operating profits should further be benchmarked
against other similar financial institutions. Besides, the above, and based on the trend of operating
results, the auditor has to advise the acquiring enterprise, through due diligence report, on the
indicative valuation of the business. The exercise to evaluate the balance sheet of the company
has to take into consideration the basis upon which assets have been valued and liabilities have
been recognized. The net worth of the business has to be arrived at by taking into account the
impact of over/ under valuation of assets and liabilities.
d) Cash Flow:
A review of historical cash flows and their pattern would reflect the cash generating abilities of
the company and should highlight the major trends. It is important to know if the company is able
to meet its cash requirements through internal accruals or does it have to seek external help from
time to time. It is necessary to check;
i) Whether the company is to honor its commitments to its creditors, other financial
institutions, to government and other stakeholders;
ii) How well the company is able to turn its receivables.
iii) How well does it deploy its funds; and
iv) Whether any fund is lying idle or is the company able to reap maximum benefits out of
the available funds.
e) Financial Projects:
The projections for the next five years with detailed assumptions and workings and the
appropriateness of assumption used in the preparation and presentation of financial projects. If the
auditor is of the opinion that as assumption used by the company are unrealistic, he should
consider its impact on the overall valuation of the company.

f) Human Resources:
The status of work force, staff and employees is a complex problem. It is important to work out
how much of the human resource has to be retained. It is important to judge profile of the
administrative and managerial staff to gauge which of these matches the requirements of the new
incumbents. The aspects whether all employee benefits like PF Gratuity/ superannuation have
been properly paid / funded. Any other staff liabilities have been properly settled or set aside. The
pay package of the key employees will be thoroughly reviewed since this can be a crucial factor in
future employee costs.
g) Statutory Compliance:
This is one area that has to be examined in detail. It is important to make a list of laws that are
applicable to the entity as well as to make a checklist of compliance required from the company
under those laws. If the company has not been regular in its legal compliance, it could lead to
punitive charges under the law. The impact on such violations be quantified and assessed in
respect of entity; financial status and even on its governing concern status.
Question No. 13
Distinguish between Management and operational audit (5 Marks December 2007)
Answer
Management Audit deals with various aspects of the management process. It attempts to evaluate
the performance of various management processes and functions. It is an audit to examine, review
and appraise the various policies and actions of the management on the basis of certain standards.
It goes beyond the conventional audit which involves a scrutiny of financial transactions and
books of account. It is a comprehensive and critical review of all aspects of management
performance.
Management audit is a complex task closely linked with the process of management. It usually
involves the following steps.
i) Identification of the objectives of the organization.

ii) The overall objective of the organization is to be broken down into detailed targets and
plans for various segments.
iii) The organization structure is to be reviewed to assess whether or not it can effectively
achieve the overall objectives and the detailed targets. If possible, specific
responsibility center may be identified in the organization.
iv) The performance of each functional area or responsibility center is to be examined and
should be compared with the objectives and targets.
v) On the basis of above examination, a realistic course of actions may be suggested.
Whereas, operational audit refers to a systematic independent appraisal activity within an

organization for a review of the entire departmental operations as a service to management. The
overall objective of operational auditing is to assist all levels of management in the effective
discharge of their responsibilities by furnishing them with objective analyses, appraisals,
recommendations and pertinent comments concerning the activities reviewed.

Operational audit is confined to various activities and operations in the functional areas, whereas
management audit deals with various aspects of the management process. Management audit, as
name signifies, attempts to evaluate the performance of various management processes and
functions. It is an audit to examine, review and appraise the various policies and actions of the
management on the basis of certain standards.
Question No. 14
a.Evaluation of Internal Audit Function (5 Marks June 2006)
Answer:
The external auditor should as a part of his audit, carry out general evaluation of the internal audit
function to determine the extent to which he can place reliance upon the work of the internal
auditor. NSA 610: Using the work of internal auditors stipulates important aspects to be
considered by external auditor in this connection. These are:
a. Organizational Status: specific status of internal auditing in the entity and the effect this
has on its ability to be objective. In the ideal situation, internal auditing will report to
the highest level of management and be free of any other operating responsibility. Any
constraints or restrictions placed on internal auditing by management would need to be
carefully considered. In particular, the internal auditors will need to be free to
communicate fully with the external auditor.
b. Scope of Function: the nature and extent of internal auditing assignments performed.
The external auditor would also need to consider whether management acts on internal
audit recommendations and how this is evidenced.
c. Technical Competence: whether internal auditing is performed by persons having

adequate technical training and proficiency as internal auditors. The external auditor
may, for example, review the policies for hiring and training the internal auditing staff
and their experience and professional qualifications.
d. Due Professionals Care: whether internal auditing is properly planned, supervised,

reviewed and documented. The existence of adequate audit manuals, work programs
and working papers would be considered.
b. Inherent limitations of internal control (4 Marks December 2006)

Answer
Accounting and internal control systems cannot provide management with conclusive evidence
that objectives are reached because of inherent limitations. Such limitations include:
 management's usual requirement that the cost of an internal control does not exceed the
expected benefits to be derived,
 most internal controls tend to be directed at routine transactions rather than non-routine
transactions,

 the potential for human error due to carelessness, distraction, mistakes of judgement and the
misunderstanding of instructions,
 the possibility of circumvention of internal controls through the collusion of a member of

management or an employee with parties outside or inside the entry,
 the possibility that procedures may become inadequate due to changes in conditions, and
compliance with procedures may deteriorate.
c. Due Diligence (4 Marks December 2006 ,3 Marks June 2011,5 Marks June 2011)
Answer
Due Diligence is a term that is often heard in the corporate world these days in relation to
corporate restructuring. The term 'corporate restructuring' normally includes internal
reconstruction, amalgamations, divestiture, mergers, joint ventures, split-off etc. Certain
corporate restructuring exercises are not within the group (also known as external corporate
restructuring exercise), for example, a joint venture between two parties where one party hives
off an existing unit or division into another company into which the joint venture partner then
acquires an interest or has acquired an interest. These are all corporate restructuring exercises
that involve more than one party. For such a corporate restructuring exercise to succeed, it must
be planned properly. A key element in such an exercise, where it involves the acquisition of
another entity, unit or assets of an entity, is the performance of 'due diligence' review. Due
diligence may also be required to be performed in cases of venture capital financing, lending,
public offerings, disinvestments, etc. Sometimes, in a restructuring exercise, while the unit may
remain within a group, it may pass from under the charge of one management team to another
team. This situation also gives rise to the need for due diligence review.
d.Decision Tree (4 Marks June 2009)

Answer
A decision tree is a graphic display of the relationship between the present position and future
events; future events and their consequences. The sequence of events is mapped out over time
in a format similar to the branches of a tree. The decision tree approach gets its name because
of the resemblance with a tree having number of branches. A decision tree represents a
decision problem as a series of decisions to be taken under conditions of uncertainty. A present
decision depends upon the past decision and their outcomes. The decision trees are the
diagrams that permit the various decision alternatives, their outcomes and probabilities of their
occurrences to be mapped in a clear fashion.
In a typical decision tree, therefore, the project is broken down into clearly defined stages, and
the possible outcomes at each stage are listed along with the probabilities and cash flows effect
of each outcome. Important steps while constructing a decision tree in respect of an investment
proposal are: definition of the investment proposal, identification of decision alternatives,
identification of decision points, chance of events and other data, location on the decisions tree
branches of the relevant data such as projected cash flow, expected present value, and selection
of the best alternatives. This approach is extremely useful in handling sequential investments
and working backwards, eliminating unprofitable branches and determination of optimum
decision at various decision points. The major advantage of a decision tree is that it brings out
the implicit assumptions and calculations for all to see, raise questions and revise. It also

allows a decision maker to visualize assumptions and alternatives in the graphic form which
are easy to understand. The disadvantages, however, are that the diagram becomes complicated
and cumbersome as more and more variables are added. The addition of interdependent
alternatives and variables does not only present a queer picture but also makes calculation time
consuming.
e. Types of Operational Audits. (4 Marks June 2009)

Answer
There are three board categories of operational auditors: functional, organizational, and special
assignments. In case, part of the audit is likely to concern evaluating internal controls for
efficiency and effectiveness.
Functional Audits: Functions are a means of categorizing the activities of a business, such as
the billing function or production function. There are many different ways to categorize and
subdivide functions. For example, there is an accounting function, but there is also cash
disbursement, cash receipts, and payroll disbursement functions. There is a payroll function,
but there are also hiring, timekeeping, and payroll disbursement functions. As the name
implies, functional audit deals with one or more functions in an organization. It could concern,
for example, the payroll function for a division or for the company as a whole.
A functional audit has the advantage of permitting specialization by auditors. Certain auditors
within an internal audit staff can develop considerable expertise in an area, such as production
engineering. They can more efficiently spend all their time auditing in that area. A
disadvantage of functional auditing is the failure to evaluate interrelated functions. The
production engineering function interacts with manufacturing and other functions in an
organization.
Organizational Audits: An operational audit of an organization deals with an entire

organizational unit, such as a department, branch or subsidiary. An organizational audit
emphasizes how efficiently functions interact. The plan of organization and the methods to
coordinate activities are especially important in this type of audit.
Special Assignments: In operational auditing, special assignments arise at the request of

management. There are a wide variety of such audits. Examples include determining the cause
of an ineffective IT system, investigating the possibility of fraud in a division, and making
recommendations for reducing the cost of a manufactured product.
f. Overall control environment (4 Marks June 2009)

Overall control environment represents the attitude and actions of the board and management
regarding the significance of control within the organization. The control environment provides
the discipline and structure for the achievement of the primary objectives of the system of
internal control. The control environment includes the following elements:
 Integrity and ethical values.
 Management's philosophy and operating style.
 Organizational structure.
 Assignment of authority and responsibility.
 Human resource policies and practices.
 Competence of personnel.

Question No. 15
Explain the concept of reasonable assurance in the context of an external audit.
(5 Marks June 2008)
Answer
An audit in accordance with NSA is designed to provide reasonable assurance that the financial
statements taken as a whole are free from material misstatement. Reasonable assurance is a
concept relating to the accumulation of the audit evidence necessary for the auditor to conclude
that there are no material misstatements in the financial statements taken as a whole. Reasonable
assurance relates to the whole audit process.
However, there are inherent limitations in an audit that affect the auditor's ability to detect
material misstatements. These limitations result from factors such as:
(i) The use of testing
(ii) The inherent limitations of any accounting and internal control system (e.g. the possibility
of collusion)
(iii) The fact that most audit evidence is persuasive rather than conclusive
The work undertaken by the auditor to form an opinion is permeated by judgment, in particular
regarding:
(i) The gathering of audit evidence, e.g. in deciding the nature, timing and extent of audit
procedures; and
(ii) The drawing of conclusion based on audit evidence gathered, e.g. assessing the
reasonableness of the estimates made by management in preparing the financial
statements.
Other limitations may affect the persuasiveness of evidence available to draw conclusions on
particular financial statement assertions (e.g. transactions between related parties). In these cases,
certain NSA(s) identify specified procedures which will, because of the nature of the particular
assertions provide sufficient appropriate audit evidence in the absence of:
(i) Unusual circumstances which increase the risk of material misstatement beyond that
which would ordinarily be expected; or
(ii) Any indication that a material misstatement has occurred.
statements, the responsibility for preparing and presenting the financial statements is that of the
management of the entity. The audit of the financial statements does not relieve management of
its responsibility.
Besides having above mentioned limitations, an audit conducted in accordance with NSAs
provides reasonable assurance to the users of the financial statements.
Question No. 16
Distinguish between Co-insurance and Re-insurance (5 Marks December 2008)

Answer
When the insured chooses to have more than one insurer for the same transaction of risk, it would
amount to co-insurance. The concept of co-insurance emerges when there is a predetermined set
of understanding, leader of the business receives the premium and issues policy with the co-
insurance clause in the policy and the referred leader also settle the claims to the insured in the
case of occurrence of claims. Balances pertaining to other companies relating to premiums and
claims are accounted under co-insurance as ―Amounts due to/ due from‖ other insurance
companies.
Whereas a re-insurance transaction may be defined as an agreement between the ceding company
and a reinsurer whereby the former agrees to cede and later agrees to accept a certain specified
share of risk or liability upon terms set out in the agreement. A ceding company is the original
company which has accepted the risk and has agreed to cede or pass on that risk to another
insurance company or reinsurance company. In the event of loss, the insured claims for the full
amount against the original insurer only. The original insurer in turn, lodges the claim with the
reinsurer.
Question No. 17
Explain the following term:
Advantages of Cost Audit to the Government (5 Marks June 2009)
Answer
Cost auditor‘s approach is to ensure that the cost accounting plan is in consonance with the
objectives set by the organization and the system of accounting is geared towards the attainment
of the objectives. A cost accounting system designed to exercise control over cost may be
different from the one if the objective is to fix price. Accordingly, over a period of time
particularly in view of administered pricing system the cost accounting becomes quite important.
Some of the specific advantages which can be reaped by the Government are:
 It helps in the fixation of selling prices of essential commodities and thereby avoiding
undue profiteering.
 In the case of cost-plus contracts of Government, it helps to fix the price at reasonable
level.
 It enables the Government to focus the attention on inefficient units.
 It enables the Government to lay down policies in favor of protecting certain industries.
 It facilitates the settlement of disputes brought to the Government.
 It creates healthy competition in the industry.
Question No. 18
Briefly describe the components of Internal Control. (10 Marks December 2009)
Answer
a) Internal Control
Internal control is broadly defined as a process, effected by an entity's board of directors,

management and other personnel, designed to provide reasonable assurance regarding the
achievement of objectives in the following categories:
 Effectiveness and efficiency of operations

 Reliability of financial reporting

 Compliance with applicable laws and regulations
Internal control consists of five interrelated components. These are derived from the way
management runs a business and are integrated with the management process. Although the
components apply to all entities, small and mid-size companies may implement them
differently than large ones. Its controls may be less formal and less structured, yet a small
company can still have effective internal control. The components are:
 Control Environment - The control environment sets the tone of an organization,

influencing the control consciousness of its people. It is the foundation for all other
components of internal control, providing discipline and structure. Control environment
factors include the integrity, ethical values and competence of the entity's people;
management's philosophy and operating style; the way management assigns authority and
responsibility and organizes and develops its people; and the attention and direction
provided by the board of directors.
 Risk Assessment - Every entity faces a variety of risks from external and internal sources
that must be assessed. A precondition to risk assessment is establishment of objectives,
linked at different levels and internally consistent. Risk assessment is the identification
and analysis of relevant risks to achievement of the objectives, forming a basis for
determining how the risks should be managed. Because economic, industry, regulatory
and operating conditions will continue to change, mechanisms are needed to identify and
deal with the special risks associated with change.
 Control Activities - Control activities are the policies and procedures that help ensure
management directives are carried out. They help ensure that necessary actions are taken
to address risks to achievement of the entity's objectives. Control activities occur
throughout the organization, at all levels and in all functions. They include a range of
activities as diverse as approvals, authorizations, verifications, reconciliations, reviews of
operating performance, security of assets and segregation of duties.
 Information and Communication - Pertinent information must be identified, captured and
communicated in a form and timeframe that enable people to carry out their
responsibilities. Information systems produce reports, containing operational, financial and
compliance-related information, that make it possible to run and control the business.
They deal not only with internally generated data, but also information about external
events, activities and conditions necessary to informed business decision-making and
external reporting. Effective communication also must occur in a broader sense, flowing
down, across and up the organization. All personnel must receive a clear message from top
management that control responsibilities must be taken seriously. They must understand
their own role in the internal control system, as well as how individual activities relate to
the work of others. They must have a means of communicating significant information
upstream. There also needs to be effective communication with external parties, such as
customers, suppliers, regulators and shareholders.
 Monitoring - Internal control systems need to be monitored a process that assesses the
quality of the system's performance over time. This is accomplished through ongoing
monitoring activities, separate evaluations or a combination of the two. Ongoing
monitoring occurs in the course of operations. It includes regular management and
supervisory activities, and other actions personnel take in performing their duties. The
scope and frequency of separate evaluations will depend primarily on an assessment of
risks and the effectiveness of ongoing monitoring procedures. Internal control deficiencies

should be reported upstream, with serious matters reported to top management and the
board.
There is synergy and linkage among these components, forming an integrated system that
reacts dynamically to changing conditions. The internal control system is intertwined with
the entity's operating activities and exists for fundamental business reasons. Internal
control is most effective when controls are built into the entity's infrastructure and are a
part of the essence of the enterprise. "Built in" controls support quality and empowerment
initiatives, avoid unnecessary costs and enable quick response to changing conditions.
There is a direct relationship between the three categories of objectives, which are what an
entity strives to achieve, and components, which represent what is needed to achieve the
objectives. All components are relevant to each objective‘s category. When looking at any
one category--the effectiveness and efficiency of operations, for instance - all five
components must be present and functioning effectively to conclude that internal control
over operations is effective.
Question No. 19
Internal Audit is said to be “an independent appraisal activity within an organization for the
review of accounting, financial and other operations as a basis of service to the organization. It
is a managerial control which functions by measuring and evaluating the effectiveness of other
controls”. Explain. (10 Marks December 2009)
Answer
Concept of internal audit has changed, and the scope of audit has been widened in light of the
requirement of the management. Internal Audit is the tool of management control whereby not
only an independent review of accounting and financial functions is undertaken but review of
resource utilization and operations are undertaken as well.
Though the efficiency of accounting and finance is a major concern for an internal auditor,
effectiveness of other functional control also forms part of the audit.
The internal audit functions supplement the other management functions thereby making vital
contribution for management to take business decisions. The management is always concerned
with optimum utilization of resources to get the best result and the role of internal auditor is to
report on management weaknesses and make suggestions to achieve the goals and objectives of
the organization.
The internal audit functions are part of the entity and it may be difficult to maintain the degree of
autonomy as desired, yet independence of internal auditor is crucial for the effective discharge of
his duties. Only an independent appraisal can achieve goals and objective of internal auditing.
Internal Audit functions may include the following:
 Review of internal control and procedures

 Review of custodianship and safeguarding of assets
 Review of compliances with policies, plan, procedures and regulations
 Review of relevance and reliability of information
 Review of organization structure

 Review of utilization of resources

 Review of accomplishment of goals and objectives
Question No. 20
“Operational auditing is not different from internal auditing”. Discuss.
Answer:
Internal auditing is an activity carried out by the internal staff of the organization to meet the
management requirements of information. The definition of internal auditing as given by the
Institute of Internal Auditors of New York, in fact, is so wide in its scope that it covers both
operational and management auditing.
According to the Institute of Internal Auditors, ―the overall objective of internal auditing is to
assist all members of management in the objective discharge of their responsibilities, by
furnishing them with objective analysis, appraisals, recommendations and pertinent comments
concerning the activities reviewed. The internal auditor, therefore, should be concerned with any
phase of business activity wherein he can be of service to organization‖. According to the
definition, the overall objective of internal auditing is to assist all members of management in the
objective discharge of their responsibilities, by furnishing them with objective analysis,
appraisals, recommendations and relevant comments concerning the activities reviewed. The
internal auditor, therefore, should be concerned with any phase of business activity wherein he
can be of service to the organization. Naturally, when an auditor is concerned with the appraisal
of operations, he would be performing the role of an operational auditor. Another important point
that this definition throws up is that operational auditing is essentially a function of internal
auditing staff. Traditionally, the internal auditing was concerned with the financial transactions
only. It was during early 1940‘s, the concept of operational auditing came into existence.
According to Cadmus ―operational auditing is not different from internal auditing; it is merely an
extension of internal auditing into operational areas. It is characterized in both financial and
operational areas – by the auditor‘s approach and state of mind‖. The main objective of
operational auditing is to verify the fulfilment of plans and sound business requirements as also to
focus on objectives and their achievement as against the performance yardsticks evident from in
the management objectives, goals and plans, budgets records of past performance, policies and
procedures.
Industry standards can be obtained from the statistics provided by industry, associations and
government sources. It should be appreciated that the standards may be relative depending upon
the situation and circumstances; the operational auditor may have to apply them with suitable
adjustments. It might appear from the above that an internal auditor is not concerned with
operational aspects and operational auditor is, not concerned with financial aspects which is not
so. Because traditionally, internal auditors had been engaged in a sort of protective function,
deriving their authority from the management. They examined internal controls in the financial
and accounting areas to ensure that possibilities of loss, wastage and fraud are not there; they
checked the accounting books and records to see, whether the internal checks are properly
working, and the resulting accounting data are reliable. They also looked into the aspect of safety
of the assets and properties of the company. Some element of operational auditing could be found
even in these traditional functions of internal auditors, especially in the context of fraud, wastage
and loss. Internal auditors emboldened by their ability to appraise financial and accounting control
gradually started extending their field to cover non-accounting control as well. On the other hand,
it should not be assumed, that, since an operational auditor is concerned with the audit of

operations and review of operating conditions, he is not concerned with the financial aspects of
transaction and controls. A point has already been made that the special expertise acquired by the
operational auditor, that enables him to view the controls and operations from the management
point of view, can be carried back to his review of the financial areas. In the matter of cash
transactions, the operational auditor will look into such aspects as the quantum of cash in hand (by
relating it to the requirement of cash to be held) carried generally or the use of cash not
immediately required. Also, he will review the operational control on cash to determine whether
maximum possible protection has been given to cash. Similarly, in the audit of stocks, he would
have management policy. In pure administrative areas on stock, he will see whether adequate
security and insurance arrangements exist for protection of stocks.
Thus, over a period of time, the scope of internal auditing was widened to cover not only
accounting and financial operations but other operations such as marketing, personnel,
production, etc. As per the modern definition of internal auditing, there is no difference between
the two. However, still some auditors believe that there might exist difference between the two on
account of perception as far as scope of the two is concerned which in fact is not true as evident
from the foregoing analysis.
Question No. 21
Distinguish between Internal Audit and External Audit (5 Marks June 2010)
Answer
External auditors are the persons who practice the profession of accountancy having qualified in
the professional examination and are external vis-a-vis the organization of which they audit the
accounts. The internal auditors, on the other hand, may also be professionally qualified and are
internal vis-a-vis the organization in which they are appointed to perform specific work. They are
considered internal because their appointment is done by the management and the scope of work
is also specified by it. They may be appointed either on a contract basis or as employees to
undertake auditing of the books and records as a part of management control and appraisal
system.
The external auditors, on the other hand, are appointed by the owners of the organization, say,
shareholders of the company and thus they are treated external to the organization in which they
have been appointed. When an external auditor is appointed under a particular statute, such
auditor may be known as the statutory auditor. Their scope of work is determined by the statute
under which they have been appointed. Another significant distinction between the internal and
external auditor is that the former is not considered independent vis-a-vis the management of the
organization while the latter is independent of the management of the organization which is
responsible for the preparation of the books of account. Finally, the scope of work of an internal
auditor may extend even beyond the financial accounting and may include cost investigation,
inquiries relating to losses and wastages, production audit, performance audit, etc. It must be
remembered that the basic foundation of any type of auditing, whether internal or external,
envisages that the auditor must be independent of the activity for which he is going to conduct an
audit. Even though the internal auditor is an employee, yet he must be independent to the extent
practicable.

Question No. 22
What are the special issues in Investigation? Briefly explain. (6 Marks June 2010)
Answer
Investigation may be carried out in a situation where the accounts, documents, records and other
information are available or in the situation where little information is available. Investigation
may cover the whole accounting or may relate to only a part of accounting.
Some issues which often arises and very important for an investigator are:
 Where the investigator is required to undertake 100% verification approach, or he can
adopt selective verification.
This is the question, answer of which depends on the circumstances of each case under
investigation. For example, investigation for cash defalcation may require 100%
examination of documents.
 Whether the investigator can put reliance on the already audited statement of account.
If the investigation has been undertaken due to some doubt in the audited accounts,
then no question on the reliance on audited accounts arise. However, if the investigator
has been requested to establish value of a business or amount of goodwill then
investigator may rely on the audited accounts to some extent.
 The investigator may require the view of other experts during the course of
investigations. The involvement of other experts and related cost should be identified
before the investigation assignment is undertaken.
When the investigation has arisen out of disputes and conflicting claims, the
investigator should be alert to the possibilities of the information and documents made
available to him to be prejudiced.
 The investigator should refrain from issuing speculative opinion. He should confine
his opinion to the established facts and nothing more.
 The investigator should not be futuristic. He may assume that the established trend of
business will continue the near future in the absence of any contrary evidence in
arriving at the present value of business. He, however, should not project the trend into
any future years to establish a value.
 The investigating accountant should retain all notes, schedules and other working
papers in his files.
Question No. 23
Discuss briefly advantages of joint audit. (4 Marks June 2010)
Answers: The advantages of a joint audit are discussed below:
Advantages: Joint audit basically implies pooling together the resources and expertise of more
than one firm of auditors to render an expert job in a given time period which may be difficult to
accomplish acting individually. It essentially involves sharing of total work. This by itself is a
great advantage. The specific advantages that follow are as under:
i. Sharing of expertise and advantage of mutual consultations.
ii. Lower workload.

iii. Better quality performance.

iv. Lower cost to carry out the work, and
v. A sense of healthy competition towards a better performance.
Question No. 24
Distinguish between Management audit and Performance Audit (4 Marks June 2010)
Answer
Management audit and Performance Audit
Management audit is a vital exercise and embraces conducting the audit for the management as
also the auditing of the management. Management has to evolve objectives and policies to run the
organisation, within the framework of governing law and regulations; and for carrying out the
activities it has to plan, direct and control. All this is done through layers of delegated authorities.
Management audit is directed towards evaluating the performance of all the management
processes and functions. In management audit, the auditor has to make appraisal up to the level of
top management, its formulation of objectives, plans and policies and its decision making. The
management audit covers much broader field as compared to performance audit.
Performance audit seeks to evaluate whether the resources of an enterprise have been utilized
efficiently to achieve the objectives by deploying them in an optimum manner. Performance audit
has come as a natural sequel to the performance budgeting in the government sector to ensure the
performance in monetary as well as physical terms. The need for performance audit was felt as the
financial audit including propriety audit could not portray in full details the pictures of
performance of an entity.
Since public sector undertakings involve lot of public money and are, therefore, responsible for
their efficient functioning to other higher levels of authority, an appraisal of their performance by
an outside agency becomes imperative. In such a situation, the need for performance audit to
assess whether the activities of the organisation are resulting in the achievement of objectives is
apparent.
Question No. 25
You are a member of the audit team engaged in the audit of a listed company. At the planning
stage, the audit in-charge paid little attention to the internal auditing activity on the pretext that
internal auditor generally lacks independence in performing its duties.
The department is headed by a professional and experienced individual who is a close friend of
the Chief Executive Officer and the General Manager of the company. He utilizes such
relations very effectively and applies surprise physical checks, unplanned investigations and
takes on-the-spot corrective measures on detection of errors or flaws in controls. This approach
has reduced the lengthy paperwork that is normally seen in internal auditing departments of
other companies.
You are required to assess the internal audit function of the company and its relevance for the
external auditors. (5 Marks December 2010)
Answer
Internal audit is also an activity which ensures proper functioning of the systems and operations as
envisaged by the management to safeguards assets and implementation of management decisions.
If the internal audit is also carried out complying with the professional ethics, it helps the external

auditor to design and plan his work very efficiently and effectively and audit risks can be reduced
to acceptably low level. However, it is the duty of the external auditor to ensure that:
 The internal audit department is independent and adequate recognition has been given in
the organization
 The internal audit department has adequate and trained staff to perform assigned tasks
 There is internal audit charter and plan approved by higher management
 Internal audit chief has been part of the Audit Committee and his report has been
considered by AC.
 Internal audit department maintains proper record of its jobs.
 Management takes appropriate action on the recommendations made by the internal
auditor.
 Internal audit staff has been given training the relevant issues and development in the
related fields.
 Internal staffs are not involved in operations
Thus, when an internal audit function has been considered appropriate, it helps reducing external
auditor's work significantly.
Question No. 26
M/s Standard Bank Limited is operating profitably since last five years and has started
distributing dividend since last year. However, its promoters are not in a position to increase
share capital as per Nepal Rastra Bank requirements. Therefore, its promoters are trying to sell
out all of its shares held by them. In the process M/s Global Investment Company Limited
showed its interest to acquire all the shares in association with other investor groups. M/S
Global Investment Company Limited requests you to conduct a “Due Diligence” of the
Standard Bank Limited. What are the key areas you will cover in your review as a due diligence
auditor? (10 Marks December 2010)
Answer
It is natural from the side of M/s Global Investment Company Limited to assess the proposal from
different angles and specifically whether the proposed acquisition of promoters‘ shares would be
profitable. Accordingly, financial due diligence study needs to be performed on the books of
accounts and other information directly pertaining to the financial matters of M/s Standard Bank
Limited. Similarly, a legal due diligence might also be necessary where legal aspects of the
operation of the Standard Bank Limited are reviewed. Like other due diligence exercises,
personnel due diligence may also be carried out in order to establish whether various proposals
with regard to the personnel of the bank are appropriate or not. Hence, it is very important to look
behind the veil of initial information provided by the bank and to assess the benefits and costs of
the proposed acquisition by reviewing all the relevant aspects of the past, present and future of the
bank to be acquired. In this process, as a due diligence auditor, I will cover the following
significant key areas during my due diligence study:
a) Historical Background.
I should start my financial due diligence review by going through the history of the bank and the
background of the promoters. The details of how the bank was established and who were the
original promoters have to be obtained. This process may reveal its turning points, survival
strategies it followed from time to time, the market share enjoyed by and changes therein and

adequacy of resources. It may also help in determining whether any regulatory requirement have
had an impact on its business in the past.
b) Significant accounting policies.

Another significant area is the accounting policies being followed by the bank and
appropriateness thereof. As a due diligence auditor, I will have to look at the main effect of
accounting policies on the overall profitability and their correctness. I will also have to observe
the changes made to the accounting policies in the recent past, and its impact and appropriate
disclosure in the financial statements. I will also have to examine whether the financial statements
of the bank have been prepared in accordance with the governing statutory requirements.
c) Review of financial Statements.

Review of the financial statements is also very important. An evaluation of the profit reported by
the bank would be largely based upon its operating results. Any extra ordinary item of income or
expense that might have affected the operating results would require close security. Comparison
of the actual and budgeted figures for the period under review and the previous year may also be
advisable. It is important that the operating results for the past 4 to 5 years are compared and the
trends reviewed. The industrial operating results comparison may also be advisable. In the
process, valuation of the business is also necessary. The net worth of the bank has to be arrived at
by taking into account the impact of over/ under valuation of assets and liabilities.
d) Cash Flow.
I will also have to review the cash flow position of the bank. A review of historical cash flows and
their pattern would reflect the cash generating capabilities of the bank and should highlight the
major trends. It is also necessary to review if the bank is able to meet its liquidity requirements
through internal sources or does it have to seek external help from time to time.
e) Financial Projections:
Another key area is to review the projections for the next five years with detailed assumptions and
workings and the appropriateness of assumptions used in the preparation and presentation of
financial statements. If the assumptions used by the bank are found to be unrealistic, its impact on
the overall valuation of the bank also needs to be considered.
f) Human Resources:
It is important to review the status of the work force, staff and employees. It is important to work
out how much of the human resources can be retained. So, the profile of the administrative and
managerial staff needs to be judged. The aspects whether all employees‘ benefits and liabilities
like PF, gratuity, and superannuation have been properly paid / funded. The pay package of the
key employees needs to be thoroughly reviewed.
g) Statutory and Regulatory Compliances:

This area needs to be reviewed in depth. It is important to make a list of laws and regulations that
are applicable to the bank as well as to make a checklist of compliances required from the bank
under those statutory and regulatory provisions. The impact of serious violations if any should be
quantified and assessed in respect of the bank‘s financial status and even it‘s going concern status.
Question No. 27
Auditors are required to provide assurance for a range of non-audit engagements regularly.
List and explain the elements of an assurance engagement. (8 Marks December 2010)

Answer
An assurance report is an opinion that is issued by the professional accountant to the intended user
and the responsible party under a specific term of reference and agreed terms of engagement.
Generally, there will be three different parties involved in an assurance engagement;

 The professional accountant who will review the subject matter and provide the assurance.
 The responsible party, which is the organization responsible for preparing the subject
matter to be reviewed.
 The intended user (who requires the assurance report).
In addition, a suitable subject matter i.e. the data that the responsible party has prepared, and
which requires verification by the professional accountant is very important factor.
Further, suitable criteria are must in an assurance engagement against which the subject matter
will be compared in order to be assessed and an opinion issued.
Moreover, the professional accountant must obtain sufficient appropriate evidence in order to give
the required level of assurance to the contracted parties.
Question No. 28
Discuss the advantages and disadvantages of outsourcing an internal audit department.
Answer
Advantages of outsourcing internal audit
 Staff recruitment - There will be no need to recruit staff for the internal audit department; the
outsourcing company will provide all staff and ensure staff are of the appropriate quality.
 Skills - The outsourcing company will have a large pool of staff available to provide the
internal audit service. This will provide access to specialist skills that the company may not be
able to afford if the internal audit department was run internally.
 Set up time - The department can be set-up in a few weeks rather than taking months to
advertise and recruit appropriate staff.
 Costs - Costs for the service will be agreed in advance. This makes budgeting easier for the
recipient company as the cost and standard of service expected are fixed.
 Flexibility (staffing arrangements) - Staff can be hired to suit the workloads and
requirements of the recipient company rather than full-time staff being idle for some parts of
the year.
Disadvantages of outsourcing internal audit

 Staff turnover - The internal audit staff allocated to one company may change frequently; this
means that company systems may not always be fully understood, decreasing the quality of
the service provided.
 External auditors - Where external auditors provide the internal audit service there may be a
conflict of interest (self-review threat), where internal audit work is then relied upon by
external auditors.
 Cost - The cost of the outsourced service may be too high for the company, which means that
an internal audit department is not established at all. There may be an assumption that internal
provision would be even more expensive.
 Confidentiality - Knowledge of company systems and confidential data will be available to a
third party. Although the service agreement should provide confidentiality clauses, this may
not stop breaches of confidentiality e.g. individuals selling data fraudulently.

 Control - Where internal audit is provided in-house, the company will have more control over
the activities of the department; there is less need to discuss work patterns or suggest areas of
work to the internal audit department.
Question No. 29
a. Inherent limitations of internal control: (4 Marks June 2010)
Accounting and internal control systems cannot provide management with conclusive
evidence that objectives are reached because of inherent limitations. Such limitations
include:
 management‘s usual requirement that the cost of an internal control does not exceed the
expected benefits to be derived,
 most internal controls tend to be directed at routine transactions rather than non-routine
transactions,
 the potential for human error due to carelessness, distraction, mistakes of judgement and
the misunderstanding of instructions,
 the possibility of circumvention of internal controls through the collusion of a member
of management or an employee with parties outside or inside the entry,
 the possibility that a person responsible for exercising an internal control could abuse
that responsibility, for example, a member of management overriding an internal control
and the possibility that procedures may become inadequate due to changes in conditions,
and compliance with procedures may deteriorate
b. Concept of reasonable assurance in the context of an external audit (5 Marks December

2010)
Reasonable assurance provides a high level of assurance that financial statements are free from
material misstatement. It is not a guarantee that financial statements are free from material
misstatement. Absolute assurance cannot be provided because of the inherent limitations of an
audit and the use of judgement in financial reporting and auditing. The inherent limitations of an
audit result from the:
i) use of testing;
ii) possibility of deliberate misrepresentation by management;
iii) fact that audit evidence is persuasive rather than conclusive; and
iv) inherent limitations of internal control (e.gs management override, collusion, human error)
v) Judgement is involved in:
vi) deciding the nature, timing and extent of audit procedures;
vii) assessing the reasonableness of estimates made by management in preparing financial
statements;
viii) assessing the appropriateness of accounting policies selected by management; and drawing
conclusions
ix) The concept of reasonable assurance acknowledges that there is a risk that the audit
opinion is inappropriate. It is obtained when audit risk is reduced to an acceptably low
level enabling the auditor to express the conclusion in a positive form.
c. Continuous Audit (5 Marks December 2012, 5 Marks June 2017)
A continuous audit is one in which the auditor‘s staff is engaged continuously in checking the
accounts of the client the whole year round or when for this purpose the staff attends at

intervals, fixed or otherwise, during the currency of the financial period. This is when an audit
conducted up to a particular date within the accounting period. The auditor may attend the
audit the figures for a month for a quarter, as the work may require. It would differ distinctly
from the final audit in the extent of the work carried out; verification of assets; for example,
would be left until the final audit.
In continuous audit, the work is conducted throughout the course of the financial year but is
not taken to a specific accounting period, as in an interim audit. It might be that during the
course of the continuous work interim figures are being audited, but the significant factor here
is that the auditor will be engaged continuously on the audit throughout the financial period.
Staff may be in residence throughout the period or may come and go at irregular intervals, but
most of the time, the audit staff is present at the location.
Thus, in case of continuous audit, the audit staff is present at the client‘s premises almost
during the entire accounting period. Some of the advantages of continuous audit are pointed as
follows:
1) Errors are discovered earlier facilitate in timely rectification.
2) Due to frequent presence of auditor opportunities of committing frauds are reduced.
3) The attendance of audit staff acts as a moral check to the client‘s staff.
4) Accounts are always kept up to date.
d. Qualities of a Management Auditor (4 Marks December 2012)

Answer:
Qualities of a management auditor.
As the management auditor is expected to evaluate operational performance and non-
monetary operational controls, he should possess basic knowledge of the technology &
commercial practices of the enterprises, an enquiring, analytical, pragmatic and imaginative
approach and a thorough understanding of the control system is required. Further, he should
possess
 Ability to understand the nature and objectives and problems faced by the organization.
 Should understand the decision-making process, planning process in the organization.
 Should have knowledge of the accounting policies being followed and the organization‘s
financial management.
 Should have general understanding of different laws and regulations like Tax Laws,
Company Laws etc.
 Should have basic knowledge of commerce including quantitative methods, EDP system.
 Should have knowledge of management principles such as delegation of authority,
management by exception, budgetary control, flow charts, etc.
 Should understand the reports required at different levels and actual reports being
received.
e. Internal check system (4 Marks December 2015)

Internal check system implies organization of the overall system of bookkeeping and
arrangement of staff duties in such a way that no one person can carry through a
transaction and record every aspect thereof. It is a part of overall control system and
operates basically as a built-in-device as far as organization and job allocation aspects of
the controls are concerned. The system provides existence of checks on the day to day
transactions which operates continuously as part of the routine system whereby the work

of each person is either proved independently or is made complimentary to the work of

another.
f. Forensic audit (5 Marks December 2016)

Forensic Auditing covers a broad spectrum of activities, with terminology not strictly
defined in regulatory guidance. Generally, the term ―forensic accounting "is used to
describe the wide range of investigative work which accountants in practice could be
asked to perform. The work would normally involve an investigation into the financial
affairs of an entity and is often associated with investigations into alleged fraudulent
activity. Forensic accounting refers to the whole process of investigating a financial
matter, including potentially acting as an expert witness if the fraud comes to trial.
Although normally the focus is on investigation into alleged frauds, it is important to be
aware that forensic accountants could be asked to look into non-fraud situations, such as
the settling of monetary disputes in relation to a business closure or matrimonial disputes
under insurance claims.
g. Purpose of cost audit (5 Marks December 2016)

The undernoted circumstances may warrant the introduction of cost audit in an entity:
i. Price fixation: The need for fixation of retention prices in the case of materials of
national importance, like steel, cement etc. may be useful in knowing the true cost of
production.
ii. Cost variation within the industry: Where the cost of production varies significantly
from unit to unit in the same industry, cost audit may be necessary to find the reasons
for such differences.
iii.Inefficient management: Where a factory is run inefficiently and uneconomically,
institution of cost audit may be necessary. It may be particularly useful for the
government before it takes over any unit.
iv. Tax-assessment: Where a duty or tax is levied on products based on cost of production,
the levying authorities may ask for cost audit to determine the correct cost of
production.
v. Trade disputes: Cost audit may be useful in settling trade disputes about claim for
higher wages, bonus, etc.
Question No. 30
M/s Kanchanjunga Bank Limited had been operating profitably since last five years and has
started distributing dividend since last year. But however, its promoters are not in a position to
increase share capital as per Nepal Rastra Bank requirements. Therefore, its promoters are
trying to sell out all shares held by them. In the process M/s Global Investment Company
Limited showed its interest to acquire all the shares in association with other investor groups.
M/S Global Investment Company Limited requests you to conduct a “Due Diligence” of the
Kanchanjunga Bank Limited. What are the key areas you will cover in your review as a due
diligence auditor?

Answer
It is natural from the side of M/s Global Investment Company Limited to assess the proposal
from different angles and specifically whether the proposed acquisition of promoters‘ shares
would be profitable. Accordingly, financial due diligence study needs to be performed on the
books of accounts and other information directly pertaining to the financial matters of M/s
Kanchanjunga Bank Limited. Similarly, a legal due diligence might also be necessary where
legal aspects of the operation of the Kanchanjunga Bank Limited are reviewed. Like other due
diligence exercises, personnel due diligence may also be carried out in order to establish whether
various proposals with regard to the personnel of the bank are appropriate or not. Hence, it very
important to look behind the veil of initial information provided by the bank and to assess the
benefits and costs of the proposed acquisition by reviewing all the relevant aspects of the past,
present and future of the bank to be acquired. In this process, as a due diligence auditor, I will
cover the following significant key areas during my due diligence study:
A) Historical Background.
I should start my financial due diligence review by going through the history of the bank and
the background of the promoters. The details of how the bank was established and who were
the original promoters have to be obtained. This process may reveal its turning points,
survival strategies it followed from time to time, the market share enjoyed by and changes
therein and adequacy of resources. It may also help in determining whether any regulatory
requirement have had an impact on its business in the past.
B) Significant accounting policies.

Another significant area is the accounting policies being followed by the bank and
appropriateness thereof. As a due diligence auditor, I will have to look at the main effect of
accounting policies on the overall profitability and their correctness. I will also have to
observe the changes made to the accounting policies in the recent past, and its impact and
appropriate disclosure in the financial statements. I will also have to examine whether the
financial statements of the bank have been prepared in accordance with the governing
statutory requirements.
C) Review of financial Statements.

Review of the financial statements is also very important. An evaluation of the profit
reported by the bank would be largely based upon its operating results. Any extra ordinary
item of income or expense that might have affected the operating results would require close
security. Comparison of the actual and budgeted figures for the period under review and the
previous year may also be advisable. It is important that the operating results for the past 4
to 5 years are compared and the trends reviewed. The industrial operating results
comparison may also be advisable. In the process, valuation of the business is also
necessary. The net worth of the bank has to be arrived at by taking into account the impact
of over/ under valuation of assets and liabilities.
D) Cash Flow.
I will also have to review the cash flow position of the bank. A review of historical cash
flows and their pattern would reflect the cash generating capabilities of the bank and should
highlight the major trends. It is also necessary to review if the bank is able to meet its
liquidity requirements through internal sources or does it have to seek external help from
time to time.

E) Financial Projects:
Another key area is to review the projections for the next five years with detailed
assumptions and workings and the appropriateness of assumptions used in the preparation
and presentation of financial statements. If the assumptions used by the bank are found to be
unrealistic, its impact on the overall valuation of the bank also needs to be considered.
F) Human Resources:
It is important to review the status of the work force, staff and employees. It is important to
work out how much of the human resources can be retained. So, the profile of the
administrative and managerial staff needs to be judged. The aspects whether all employees‘
benefits and liabilities like PF, gratuity, and superannuation have been properly paid /
funded. The pay package of the key employees needs to be thoroughly reviewed.
G) Statutory and Regulatory Compliances:

This area needs to be reviewed in depth. It is important to make a list of laws and
regulations that are applicable to the bank as well as to make a checklist of compliances
required from the bank under those statutory and regulatory provisions. The impact of
serious violations if any should be quantified and assessed in respect of the bank‘s financial
status and even it‘s going concern status.
Question No. 31
Distinguish between Management audit and performance Audit (4 Marks June 2011)
Answer
Management audit is a vital exercise and embraces conducting the audit for the management as
also the auditing of the management. Management has to evolve objectives and policies to run the
organisation, within the framework of governing law and regulations; and for carrying out the
activities it has to plan, direct and control. All this is done through layers of delegated authorities.
Management audit is directed towards evaluating the performance of all the management
processes and functions.
In management audit, the auditor has to make appraisal up to the level of top management, its
formulation of objectives, plans and policies and its decision making. The management audit
covers much broader field as compared to performance audit.
Performance audit seeks to evaluate whether the resources of an enterprise have been utilized
efficiently to achieve the objectives by deploying them in an optimum manner. Performance audit
has come as a natural sequel to the performance budgeting in the government sector to ensure the
performance in monetary as well as physical terms. The need for performance audit was felt as the
financial audit including propriety audit could not portray in full details the pictures of
performance of an entity. Since public sector undertakings involve lot of public money and are,
therefore, responsible for their efficient functioning to other higher levels of authority, an
appraisal of their performance by an outside agency becomes imperative. In such a situation, the
need for performance audit to assess whether the activities of the organisation are resulting in the
achievement of objectives is apparent.
Question No. 32
On being appointed the auditor of XYZ Company Ltd. for the first time you find that the
cashier also handles the books of account and the cash receipt are not being banked intact but

parts of these are being utilized for cash payments. What would be your reaction? What
recommendations would you make to the company in this connection?
Answer
Cash and cash equivalents are very sensitive items as the liquidity of the company is very
important aspect of the business. So, there should be intact internal control system regarding these
sensitive items. Most of the business organization prepares separate fund management and
operation guidelines to control and handle cash and cash equivalents. The main aspect of fund
management is to use the fund in required area for maximum return. The internal control system
and internal check system should be in such a manner that single person shouldn‘t have both
authority of handling cash and keeping books of account. The chances of cash embezzlement will
be high if we give both functions to the single person.
With reference to above, we can observe that the internal control system of the XYZ Company
Ltd. is found very weak regarding fund management and there are the chances of cash being
misappropriated. So, the current practice should be corrected immediately for which company
should follow following recommendations for the enhancement of the internal control system of
the company:
a) A fund management and operation guidelines should be prepared to handle cash and cash
equivalents.
b) The cashier should not have access to the books of accounts. The books of account
should be handled by the accountants who should not be directly involved with the cash
transaction.
c) All the cash collections should be deposited to the bank and cash payments should be
made through the Bank only.
d) Bank reconciliation statement should be prepared in a regular interval for proper checking
and verification of the balance.
e) Petty expenses should be managed through the Petty cash book, for which purpose the
petty cash, imprest should be provided to the petty cashier through the bank.
Question No. 33
a) Discuss the advantages and disadvantages of outsourcing an internal audit department.
10 Marks December 2011)
b) Contrast the role of internal and external auditors. (5 Marks December 2011)
Answer
a. Advantages of outsourcing internal audit
Staff recruitment
There will be no need to recruit staff for the internal audit department; the outsourcing
company will provide all staff and ensure staff are of the appropriate quality.

Skills
The outsourcing company will have a large pool of staff available to provide the internal audit
service. This will provide access to specialist skills that the company may not be able to afford
if the internal audit department was run internally.
Set up time
The department can be set-up in few weeks saving time for advertising and recruiting
appropriate staff.
Costs
Costs for the service will be agreed in advance. This makes budgeting easier for the recipient
company as the cost and standard of service expected are fixed.
Flexibility
Staff can be hired to suit the workload and requirements of the recipient company. It prevents
from keeping full-time staff idle for some part of the year.
Disadvantages of outsourcing internal audit

Staff turnover
The internal audit staff allocated to one company may change frequently; this means that
company systems may not always be fully understood, decreasing the quality of the service
provided.
Cost
The cost of the outsourced service may be too high for the company, which means that an
internal audit department is not established at all. There may be an assumption that internal
provision would be even more expensive.
Confidentiality
Knowledge of company systems and confidential data will be available to a third party.
Although the service agreement should provide confidentiality clauses, this may not stop
breaches of confidentiality e.g. individuals selling data fraudulently.
Control
Where internal audit is provided in-house, the company will have more control over the
activities of the department; there is less need to discuss work patterns or suggest areas of
work to the Internal Audit Department.
b. Role of internal and external auditors – differences
Objectives
The main objective of internal audit is to improve a company‘s operations, primarily in terms
of validating the efficiency and effectiveness of the internal control systems of a company.
The main objective of the external auditor is to express an opinion on the truth and fairness of
the financial statements and fulfilling specific requirements of other jurisdictions such as
confirming that the financial statements comply with the reporting requirements included in
legislation.
Reporting
Internal Audit reports are normally addressed to the Board of Directors, or other people
charged with the governance such as the Audit Committee. Those reports are not publicly
available, being confidential between the Internal Auditor and the recipient.

External Audit reports are provided to the shareholders of a company. The report is attached
to the annual financial statements of the company and is therefore publicly available to the
shareholders and any reader of the financial statements.
Scope of work
The work of the internal auditor normally relates to the operations of the organization,
including the transaction processing systems and the systems to produce the annual financial
statements. The internal auditor may also provide other reports to management, such as value
for money audit which external auditors rarely become involved with.
The work of the external auditor relates only to the financial statements of the organization.
However, the internal control systems of the organization will be tested as these provide
evidence on the completeness and accuracy of the financial statements.
Relationship with company

In most organizations, the internal auditor is an employee of the organization, which may have
an impact on the auditor‘s independence. However, in some organizations the internal audit
function is outsourced.
The external auditor is appointed by the shareholders of an organization and are independent
from the company and management.
Question No. 34
Define the concept of internal control and explain its inherent limitations.
Answer
The concept of internal control may be defined as the plan of organization and all the methods and
procedures adopted by the management of an entity to assist in achieving management‘s
objectives of ensuring the orderly and efficient conduct of its business, including adherence to
management policies, the safeguarding of assets, prevention and detection of fraud and error, the
accuracy and completeness of the accounting records, and the timely preparation of reliable
financial information. The system of internal control extends beyond those matters which relate
directly to the functions of the accounting system and comprises control environment and control
procedures. Internal control is an essential prerequisite for efficient and effective management of
any organization. It is thus, a primary responsibility of every management to establish and
maintain an adequate system of internal control appropriate to the size and nature of the business
of the entity.
An internal control system can provide only reasonable, not absolute, assurance that the
management‘s objectives in establishing the system are achieved. This is because there are some
inherent limitations of internal control. These limitations are mentioned hereunder:
a) Controls have to be cost effective. Hence, some control mechanisms may not have been
implemented merely because they are not cost-effective.
b) Most control tools are directed at transactions of a usual nature. Therefore, transactions of
unusual nature might have been escaped from such controls.
c) The human error potentiality prevails everywhere, even in the control systems.
d) Any system of control has its limitations in preventing frauds through collusion between
two or more persons.

e) Controls may not change with the pace of changes in conditions.

f) Management itself may manipulate transactions or accounting estimates.
g) A member of management may himself override the control system
Question No. 35
Distinguish between Financial Auditing and Operational Auditing (4 Marks December2011)
Answer
The major differences between financial and operational auditing can be described as follows:
1) Purpose: The financial auditing basically concerned with the opinion that whether the
historical information recorded is correct or not, whereas the operational auditing
emphasizes on effectiveness and efficiency of operations for the future performances.
2) Area: Financial audits are restricted to the matters directly affecting the
appropriateness of the presented financial statements, but the operational auditing
covers all the activities that are related to efficiency and effectiveness of operations
directly towards accomplishments of objectives of organization.
3) Reporting: The financial audit report is sent to all stockholders, bankers and other
persons having stake in the organization. However, the operational audit report is
primarily for the management.
4) End Task: The financial audit has reporting the findings to the persons getting the
report as its end objective; however, the operational auditing is not limited to reporting
only but includes suggestions for improvement also.
Question No. 36
Distinguish between Audit and Investigation. (4 Marks December 2011)
Answer
The major differences between audit and investigation can be described as follows:
i. Objective: The main objective of an audit is to verify whether the financial statements
display a true and fair view of the state of affairs and working results of an entity. An
investigation aims at establishing a fact or a happening or at assessing a particular
situation.
ii. Scope: The scope of audit is wide and in case of statutory audit the scope of work is
determined by the provision of relevant law. The scope of investigation may be
governed by statute or it may be non-statutory.
iii. Periodicity: The audit is carried on quarterly, half-yearly or yearly. The investigation
work is not limited to rigid time frame. IT may cover several years, as the outcome of
the same is not certain.
iv. Nature: Audit involves test checking or sample technique to draw evidences for
forming a judgment and expression of opinion. Investigation requires a detailed study
and examination of facts and figures.
v. Inherent Limitation: Audit suffers from inherent limitations. No inherent limitation
owing to its nature of engagement in case of investigation.
vi. Evidences: Audit is mainly concerned with prima-facie evidence. Investigation seeks
conclusive evidences.
vii. Reporting: In audit, the outcome is reported to the owners of the business entity. In
investigation, the outcome is reported to the person on whose behalf investigation is
carried out.

Question No. 37
Distinguish between Inspection and Observation (5 Marks June 2012)
Answer
Inspection: Inspection consists of examining records, documents or tangible assets. Inspection of
records and documents provide evidence of varying degrees of reliability depending on their
nature and the effectiveness of internal control over their processing. Four major categories of
documentary evidence which provide different degrees of reliability to the auditor are:
i. documentary evidence originating from and held by third parties;
ii. documentary evidence originating from third parties and held by the entity;
iii. documentary evidence originating from the entity and held by third parties; and
iv. documentary evidence originating from and held by the entity.
Inspection of tangible assets is one of the methods to obtain reliable evidence with respect to their
existence but not necessary as to their ownership or value.
Observation: Observation consists of looking at a process of procedure being performed by the

others. For example, the auditor may observe the counting of inventories by client personnel or
the performance of internal control procedures that leave no audit trail.
Question No. 38
Distinguish between Reasonable assurance engagements and limited assurance engagements
(4 Marks June 2012)
Answer
The major differences between a reasonable assurance engagement and a limited assurance
engagement can be outlined as follows:
i. Objective: A reduction in assurance engagement risk to an acceptably low level in the
circumstances of the engagement as the basis for a positive form of expression of the
practitioner‘s conclusion, whereas objective of a limited assurance engagement
includes a reduction in assurance engagement risk to a level that is acceptable in the
circumstances of the engagement but where that risk is greater than for a reasonable
assurance engagement, as the basis for a negative form of expression of the
practitioner‘s conclusion .
ii. Evidence gathering procedure: Sufficient appropriate evidence is obtained as part of
a systematic engagement process that includes obtaining an understanding of the
engagement circumstances, assessing risks, performing further procedures using a
combination of inspection, observation, confirmation, recalculation, reperformance,
analytical procedures and enquiry. In a limited assurance engagement, sufficient
appropriate evidence is obtained as a part of a systematic engagement process that
includes obtaining an understanding of the subject matter and other engagement
circumstances, but procedures are deliberately limited relative to a reasonable
assurance engagement.
iii. Reporting: Description of the engagement circumstances and a positive form of
expression of the conclusion in reasonable assurance engagement whereas in a limited
assurance engagement, description of the engagement circumstances and a negative
form of expression of the conclusion.

Question No. 39
Distinguish between Audit and Investigation (5 Marks December 2012)
Answer:
Etymologically, auditing and investigation are largely overlapping concepts because auditing is
nothing, but an investigation used in a broad sense. Both auditing and investigation are fact
finding techniques, but their basic nature and objectives differ as regards scope, frequency, basis,
thrust, depth and conclusiveness. Audit and investigation differ in objectives and in their nature.
Auditing is general while investigation is specific. The object of auditing is to ensure that the
financial statements are free and fair and not misleading or unreliable. The merit of auditing lies
in its ability to pronounce in general terms whether the accounts are basically reliable or not and
in accordance with the legal requirements and regulations applicable to the particular audit. Audit
is not based on suspicion unless circumstances exist to arouse suspicion of the auditor.
Investigation implies systematic, critical and special examination of the records of a business for a
specific purpose. The examination conducted under investigation is intensive as well as
exhaustive so far as the activities or areas of accounting is concerned. Investigation requires a
concentrated focus on the subject matter of inquiry and related matters. Often, investigations may
spread over a period longer than one year and its scope may extend to inquiry beyond the books
of accounts if the circumstances so require.
Question No. 40
A manufacturing company whose products are sold both in home market as well as in foreign
market finds a substantial fall in the domestic market during the immediately preceding year
and the demand so far during the current year is also found to be not encouraging. The
production department is of the view that this is due to failure of the sales department.
You have been appointed as investigator to investigate the affairs of the sales department. State
relevant points on which you would carry out your work. (10 Marks December 2012)
Answer:
As an investigator of the sales department of the manufacturing company, I would pay my due
attention to the following relevant points so as to establish the basic reasons for decline in the
demand for the company's product in the domestic market:
 Details of the products, technical specifications, scale of production and the method of sales.
 Extent of awareness of the sales department about economic trends, customer spending
patterns and competitors‘ activities.
 Market share of various products, trend of domestic sales and the extent of loss of domestic
market for products.
 Details of efforts made to maintain customer patronage to the products of company by
advertisement campaign, participation in trade fairs etc.
 Re-organization of the sales department staff in the recent past.
 Any change in the method of sales or price of the product.
 Whether the sales representatives were sufficiently knowledgeable and motivated.
 Whether there was negligence in attending to and executing customers‘ orders.
 Whether adequate market research, sales analysis and forecasting were done to trace
changing trends and whether steps have been taken by incorporating the changes in product
features.

 Whether the company had any bulk customers who had stopped purchasing.
 Whether the performance in the sales front is interrelated to the production department? Are
there failure in production in quantity range and products or otherwise that give rise to
problems in executing sales orders?
Question No. 41
Draft an internal control policy for bank in respect of loans and advances. What factors do you
consider important while drafting such a policy? (4 Marks December 2012)
Answer
The following are the important factors to be considered while drafting internal control policy in
respect of loans and advances of a bank:
i. The bank should make advances only after satisfying itself as to the creditworthiness of
the borrowers and after obtaining sanction from the proper authorities of the bank.
ii. All the necessary documents (e.g. agreements, demand promissory notes, letters of
hypothecation, etc.) should be executed by the parties before advances are made.
iii. Sufficient margin should be kept against securities taken so as to cover any decline in the
value thereof and also to comply with NRB directives. Such margins should be determined
by the proper authorities of the bank as a general policy or for particular accounts.
iv. All the securities should be received and returned by responsible officer. They should be
kept in the joint custody of two officers.
v. All securities requiring registration should be registered in the name of the bank or
otherwise accompanied by the documents sufficient to give title of the bank
vi. In the case of goods in the possession of the bank, contents of the packages should be test
checked at the time of receipts. The godowns should be regularly inspected by a
responsible officer of the branch concerned, in addition by the inspectors of the bank.
vii. Surprise checks should be made in respect of hypothecated goods not in the possession of
the bank.
viii. Market value of goods should be checked by officers of the bank by personal enquiry in
addition to the invoice value given by the borrowers.
ix. As soon as any increase or decrease takes place in the value of securities proper entries
should be made in the drawing power book and daily balance book. These entries should
be checked by the officer.
x. All accounts should be kept within both the drawing power and the sanctioned limit at all
the times.
xi. All 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 regularly.
xii. Post disbursement supervision and follow-up should be proper, such as receipt of stock
statements, installments, renewal of limits, etc.
xiii. The operation in each advance should be reviewed at least once every year.
xiv. There should not be any misutilization of the loans and instances indicative of diversion of
funds should be checked.
xv. Bank guarantees issued should be properly worded and recorded in the register of the
bank. They should be promptly renewed on the due dates.
xvi. Classification of advances should be done as per NRB guidelines.
Question No. 42
What is the purpose of cost audit? (4 Marks June 2013)

Answer
According to the Institute of Cost and Management Accountants of England, cost audit represents
the verification of cost accounts and a check on the adherence to cost accounting plan. Cost audit,
therefore, comprises:
i) Verification of the cost accounting records such as the accuracy of the cost accounts,
cost reports, cost statements, cost data and costing techniques, and
ii) Examination of those records to ensure that they adhere to the cost accounting
principles, plans, procedures and objectives.
The undernoted circumstances may warrant the introduction of cost audit:
 Price Fixation: The need for fixation of retention price in the case of materials and
services of national importance, like hydropower, cement etc. may be useful in knowing
the true cost of production.
 Cost variation within the Industry: where the cost of production varies significantly
from unit to unit in the same industry, cost audit may be necessary to find the reasons for
such difference.
 Inefficient Management: Where a factory is run inefficiently and uneconomically,
institution of cost audit may be necessary. It may be partially useful for the government
before it takes over any unit.
 Tax Assessment: Where a duty or tax is levied on products based on cost of production,
the levying authorities may ask for cost audit to determine the correct cost of production
 Trade Dispute: Cost audit may be useful in settling trade disputes about claim for higher
wages, bonus etc.
The purpose of cost audit is:
 To see that the cost accounting principles have been followed properly in the
maintenance of cost accounts records.
 To institute cost consciousness.
 To examine earning, efficiency or inefficiency of the organization and to optimize
the use of resources: national, financial, physical, and human.
 To facilitate inter-firm comparison of costs, selling price fixation, tariff rate
determination.
 To ensure whether return on capital employed could be improved by adopting
alternative plan of action.
Question No. 43
What do you mean by due diligence? Distinguish between financial due diligence and
operational due diligence. (10 Marks December 2013)
Answer
The terminology ―Due Diligence‖ is often heard in the corporate and banking sector these days in
relation to corporate restructuring. Corporate restructuring includes merger, acquisition,
amalgamation, joint ventures, purchase and split offs; both internal and external. A key element in
such an exercise, where it involves the acquisition of another entity, unit or assets of an entity, is

the performance of a ―due diligence review.‖ The purpose of due diligence is to assist the
purchaser or the investor in finding out all the relevant information about the business he is
acquiring or investing in prior to completion of the transaction including its critical success
factors as well as its strength and weaknesses.
Operational Due Diligence generally involves an evaluation from a commercial, strategic or
operational perspective. For example, whether proposed merger would create operational
synergies? On the other hand, Financial Due Diligence review would be performed after the
commercial valuation. Accordingly, while a preliminary review might be performed during initial
stages of the restructuring exercise, simultaneously or at a later stage; financial due diligence may
be performed on the books of account and other information directly pertaining to the financial
matters of the entity.
Question No. 44
"Timely reporting is the essence of the concurrent audit". Explain. (5 Marks December 2013)
Answer
Concurrent audit, as the name suggests, is an audit or verification of transactions or activities of
the organization concurrently as the transaction/activity takes place. The concept in this audit is to
verify the authenticity of the transaction/activity within the shortest possible time after the same
takes place. Hence, the objective of performing concurrent audit will not be fulfilled unless the
reporting is done on timely manner. For example, depending upon the size of the operations of the
units of the bank, it is conducted on a daily basis, monthly basis or quarterly basis. In case of daily
or monthly audit, the audit report of the work done for a particular work is required to be
submitted by the auditor by the 10th of the next month. In case of quarterly audit, the report is to
be given by the 10th of the month after the end of the quarter. In case of any serious irregularities
noticed by the auditor while conducting the audit, he has to give flash report immediately so that
the bank can take remedial action without any delay. Hence, the auditor has to adhere to this
discipline of timely reporting.
Question No. 45
What are the general considerations in framing a system of internal check?
Answer
Internal check has been defined by the institute of chartered accountants of England and wales as
the " checks on day to day transactions which operates continuously as part of the routine system
where by the work of one person is proved independently or is complementary to the work of
another, the object being the prevention or early detection of errors or fraud"
The general considerations in framing a system of internal check are as follows:

1. No single person should have independent control over any important aspect of the
business. All dealings and acts of every employee should, in the ordinary course, come
under the review of another.
2. The duties of members of the staff should be changed from time to time without any
previous notice so that the same officer or subordinate does not, without a break, perform
the same function for a considerable length of time.
3. Every member of the staff should be encouraged to go on leave at least once in a year.
Experience has shown that frauds successfully concealed by employees are often
unearthed when they are on leave.

4. Person having physical custody of assets must not be permitted to have access to the
books of account.
5. There should exist an accounting control in respect of each important class of assets. In
addition, these should be periodically inspected so as to establish their physical condition.
6. To prevent loss or misappropriation of cash, mechanical devices such as the automatic
cash register should be employed.
7. Business concerns now- a- days work according to some kind of budgetary control. It
enables them to review from time to time the progress of their trading activities. Such
business houses should have a separate staff for the collection of statistical figures which
later on should be checked with the corresponding figures from the financial books. If
wide discrepancies are observed these should be reconciled.
8. For stock-taking at the close of the year, trading activities should, if possible, be
suspended. The task of stock taking, and evaluation should be done by staff belonging to
several sections of the organization. It may prove dangerous to depend exclusively on the
stock section staff for these tasks since they may be tempted to under or overstate the
stock.
9. The financial and administrative powers should be distributed very judiciously among
different officers and the manner in which these are actually exercised should be
reviewed periodically.
10. Procedures should be laid down for periodical verification and testing of different
sections of accounting records to ensure that they are accurate.
11. accounting procedures should be reviewed periodically, for, even well-designed and
carefully installed procedures, in course of time, cease to be effective.
12. The system of budgetary control should be introduced. It would enable business concerns
to review from time to time the progress of their trading activities.
Question No. 46
A trader is worried that in spite of substantial increase in sales compared to earlier year, there
is considerable fall in gross profit. After satisfying himself that the sales and expenses are
correctly recorded and that the valuation of inventories is on consistent basis, he wants to
ensure that purchases have been truthfully recorded. How will you proceed with this
assignment? (10 Marks June 2014)
Answer
a) There are three steps involved in such an assignment
 Study and evaluation of internal control system
 Vouching of purchase transactions
 Analytical procedures
A. Study and evaluation of internal control system

This involves the following steps:
i) internal check: it should consist of the segregation of duties at the following points:
a. Requisitioning the goods: specified employees from the stores department or
from the production department‘s store unit should prepare and approve a
purchase requisition for raw materials or goods used in production. The purchase
requisition is sent to the purchase department.
b. Ordering the goods requisitioned: the purchase department is responsible for
negotiating the best prices, fixing delivery dates with suppliers and ensuring that
appropriate quality goods are obtained. It should prepare a serially numbered
purchase order.

c. Receiving the goods ordered: Goods ordered should be inspected and counted
by the receiving department. If satisfied, it prepares serially numbered receiving
report or goods received note and forwards its notification copies to the stores,
purchase department and finance department.
d. Preparing the payment voucher: the accounts payable department or accounts
payable unit of finance department will receive the invoices and process for its
payment and accounting.
ii) Physical controls
a. Physical controls over inventory include locked warehouses and storerooms and
limiting access to them to authorized personnel and
b. Printed and prenumbered forms should be used for purchase requisitions,
purchase orders, receiving reports and vouchers.
iii) Authorization procedures
a. Re-order points should be established for various inventory items that may
trigger a manual request.
b. Authorization procedures should be designed for all the four control points viz
requesting the goods, ordering the goods requisitioned, receiving the goods
ordered and preparing the payment voucher.
iv) Internal review
a. It should ensure that there is adequate separation of duties and proper
authorization procedures with regard to processing and recording of purchase
transactions.
b. Paid invoices should be reviewed to ascertain the accuracy of the recording of
these invoices and if possible, these invoices should be traced back to purchase
requisition through receiving reports or goods received notes and purchase
orders.
B. Vouching of Purchases transactions
The auditor should vouch purchases in the following manner:
i) Examine purchase book: The auditor should examine the transactions recorded in the
purchase book with reference to related purchase invoice.
ii) Examine purchase invoices: the auditor should select a small sample of vendors‘
invoices at random and should conduct in-depth audit on them i.e. trace the transaction
from placing the order to the entries in inventory goods for actual receipt and payment
made to the suppliers. In respect of imports, documents such as bill of lading, customs
clearance, etc. should be examined. The auditor should ensure that subsidies, rebates,
duty drawbacks or other similar items have been properly accounted for.
iii) Examine the numerical sequence of source documents: the auditor should ensure
the numerical sequence of source documents such as purchase requisitions, purchase
orders, receiving reports and vouchers have been maintained and missing numbers
have been duly accounted for.
iv) Examine cut off points: in order to ensure that purchases were recorded at that point
of time when title was passed to the client, the auditor should examine cut-off points
on pre-numbered purchase requisitions, purchase orders and goods received notes. The
auditor should, then, trace the goods received notes pertaining to a few days before the
end of the period under audit to the related purchase invoices. Such a comparison

would ensure that purchases represented by such invoices have been recorded as the
purchases of the period under audit.
v) Examine transaction with related parties carefully.
C. Analytical procedures
The auditor should compare item-wise and location-wise both quantity and value of
purchases for the current period with the corresponding figures for the previous period
and ensure that major variations are explained and justified. Various analytical ratios
should also be calculated and compared.
Question No. 47
What are the important steps involved while conducting investigation on behalf of an incoming
partner? (8 Marks December 2014)
Answer
The general approach of the investigating accountant in this type of investigation would be more
or less similar, irrespective of the nature of business of the firm-manufacturing, trading or
rendering a service. Primarily, an incoming partner would be interested to know whether the
terms offered to him are reasonable having regard to the nature of the business, profit records,
capital distribution, personal capability of existing partners, socio-economic setting, etc. and
whether he would be capable for services to be rendered, which can be justified by the overall
economic conditions prevailing and other considerations considering his own personality and
achievements. In addition, he would be interested to ascertain whether the capital to be
contributed by him would be safe and applied usefully. Broadly, the steps involved are as under:
1. Ascertaining the history of the firm since inception and growth of the firm.
2. Studies of the provisions of the Deed of Partnership, particularly for composition of
partners, their capital contribution, drawing rights, retirement benefits, job allocation,
etc.
3. Scrutiny of the record of profitability of the firm‘s business over a suitable number of
years, with usual adjustments that are necessary in ascertaining the true record of
business profits. Particular attention should, however, be paid to the nature and
profitability of the business, qualification and expertise of the partners and such
others as may be relevant.
4. Examination of the asset and liability position to determine the tangible asset,
partners, investment, appraisal of the value of intangibles like goodwill, know-how,
patents, etc. impending liabilities including contingent liabilities and those for
pending tax assessment.
5. Assess position of order at hand and the range and quality of clientele should be
thoroughly examined under which the firm is presently operating.
6. Scrutinize terms of loan finance to assess its usefulness and the implication for the
overall financial position.
7. Important contractual and legal obligations should be ascertained, and their nature
studied. It may be the case that the firm has standing agreement with the employees as
regards to salary and wages, bonus, gratuity and other incidental benefits. Such
standing agreements should be evaluated before a final decision is reached.
8. Study the composition and quality of key personnel employed by the firm and any
likelihood of their leaning the organization.

9. Ascertain reasons for the offer of admission to a new partner and it should be
determined whether the same synchronizes with the retirement of any senior partner
whose association may have had considerable impact on the firm‘s successes.
10. Appraisal of the record of capital employed and the rate of returns. It is necessary to
have a comparison with alternative business avenues for investments and evaluation
of possible results on a changed capital and organization structure.
11. Ascertain manner of computation of goodwill on admission as also on retirement, if
any.
12. Examine whether any special clause exists in the Deed of Partnership to allow
admission in future a new partner. (Coverage of steps: 6, Overall: 2)
Question No. 48
Explain in brief the behavioral aspects encountered in the management audit and state the
ways to solve them. (8 Marks December 2015)
Answer
Financial auditors deal mainly with figures. Management auditors deal mainly with people. There
are many causes for behavioral problems arising in the review function of management audit.
Particularly, when management auditor performs comprehensive audit of operations, they cannot
be as well informed about such operations as a financial auditor in a financial department.
Operating process may be unfamiliar and complex. The operating people may be speaking a
language and using terms that are foreign to the auditor's experience. The nature and causes of
behavioral problems that the management auditor is likely to face in the discharge of the review
function that is expected of him and possible solutions to overcome these problems are discussed
below: -
i. Staff/line conflict: management auditors are staff people while the members of other
departments are line people. Management auditors tend to discount the difficulties the line
staff may face. If called on to act on the ideas of management auditors. Management
auditors are specialists in their field, and they may think their approach and solutions are
the only answers.
ii. Control: the management auditor is expected to evaluate the effectiveness of controls.
There is an instinctive reaction from the auditee that the report of the auditor may affect
them. There is fear that the action taken based on the management audit report will affect
the line people. It breeds antagonism. the causes are as under:
a. Fear of criticism stemming from adverse audit findings.
b. Fear of change in day to day working habit because of changes resulting from audit
recommendations.
c. Punitive action by superior prompted by reported deficiencies.
d. Insensitive audit style
e. Hostile audit style.
Solution to behavioral problems: the following steps may be taken to overcome the aforesaid
problems-
a. To demonstrate that audit is part of an overall program of review for protective and
constructive benefit.
b. To demonstrate the objective of review is to provide maximum service in all feasible
managerial dimensions.

c. To demonstrate the review will be with minimum interference with regular operation.
d. The responsible officers will be involved in the process of review of the findings and
recommendations before the audit report is formally released. It is essential to create an
atmosphere of trust and friendliness so that audit reports will be understood in their proper
perspective.
Finally, it needs hardly any emphasis that there should be right management culture, enlightened
auditees and auditors of the right caliber. May be to expect a combination at all times of all the
three is asking for the impossible. But, a concerted effort by the management, auditors and
auditees to achieve a more acceptable climate would go a long way to achieve the goal.
Question No. 49
What are the purposes of cost audit? (4 Marks December 2015)
Answer
The undernoted circumstances may warrant the introduction of cost audit in an entity:
i. Price fixation: The need for fixation of retention prices in the case of materials of national
importance, like steel, cement etc. may be useful in knowing the true cost of production.
ii. Cost variation within the industry: Where the cost of production varies significantly
from unit to unit in the same industry, cost audit may be necessary to find the reasons for
such differences.
iii. Inefficient management: Where a factory is run inefficiently and uneconomically,
institution of cost audit may be necessary. It may be particularly useful for the government
before it takes over any unit.
iv. Tax-assessment: Where a duty or tax is levied on products based on cost of production,
the levying authorities may ask for cost audit to determine the correct cost of production.
v. Trade disputes: Cost audit may be useful in settling trade disputes about claim for higher
wages, bonus, etc.
Question No. 50
What do you mean by management letter? What are the contents of management letter?
(4 Marks June 2016)
Answer
Management Letter identifies the issues not required to be disclosed in the Annual Financial
Report but represents the auditors concerns and suggestions noted during the audit. Upon the
completion of a financial audit, the auditor may have a need to express written concerns to the
entity outlining deficiencies/issues pertaining to the conduct of affairs of the entity. These
concerns, with noted recommendation would come in the form of management letter. It serves to
identify for the organization areas in which the auditor has determined certain issues that the
Corporations may want to improve operations.
The summary of audit findings is categorized and indicator of the significance of each is assessed.
Each observation may be dealt with creating the following fields.
i. Condition

ii. Criteria
iii. Cause
iv. Effect
v. Recommendation
vi. Significance
vii. Management Response
viii. Auditors Comment
Status of prior period audit recommendations can also be given considering the audit findings,
audit recommendation, Management comments in prior year and current status.
Question No. 51
Z Ltd is intending to acquire A Ltd. It hires B & Co., a firm of Chartered Accountants to
conduct a due diligence. B & Co. wants to reduce the risk of over valuation of assets in its due
diligence exercise. Guide B & Co. (8 Marks December 2016)
Answer:
Due diligence is an all-pervasive exercise to review all important aspects like financial, legal,
commercial, etc. before taking any final decision in the matter. As far as any overvalued assets are
concerned, this shall form part of such a review. Normally, overvalued assets are not apparent
from books of accounts and financial statements. Review of financial statements does involve
examination from the viewpoint of extraordinary items, analysis of significant deviations, etc.
However, in order to reduce the risk of over valuation of assets, the auditor should pay his
attention to the following areas:
Overvalued assets: The auditor shall have to specifically examine the following areas:
1. Uncollected/uncollectable receivables
2. Obsolete, slow non-moving inventories or inventories; huge inventories of packing
materials etc. with the name of company.
3. Underused or obsolete Plant and Machinery and their spares; asset values which
have been impaired due to sudden fall in market value etc.
4. Assets carried at much more than current market value due to capitalization of
expenditure/foreign exchange fluctuation, or capitalization of expenditure mainly in
the nature of revenue
5. Litigated assets and property
6. Investments carried at cost though realizable value is much lower
7. Investments carrying a very low rate of income / return
8. Infructuous project expenditure/deferred revenue expenditure etc.
9. Group Company balances under reconciliation etc.
10. Intangibles of no value
Question No. 52
Om food products Ltd., a company engaged in manufacturing of different food products is
consistently recording higher sales turnover, but declining net profits for the last 5 years. As an
investigator appointed to find out the reasons for the same, what are the points you would look
into? (7 Marks December 2016)

Answer
Investigation for higher sales turnover but declining net profits: as per the facts that there has been
consistently high turnover, but declining net profits is an anomalous situation. It may be attributed
to one or more following reasons requiring further investigation-
i. Unfavorable sales mix: where the company sells different food products with
different product margins, the product with the maximum PV ratio/margin should
have higher share in the total sales. If due to revision of sales mix, more quantities of
unprofitability products are sold, profits will be reduced in spite of an increase in
sales.
ii. Negative impact of financial leverage- where the company does not have sufficient
own funds (equity) but has a higher debt-equity ratio, the interest commitments will
be higher. As the volume of its operation increases, higher debt and interest charges
would result in lower profits.
iii. Other items included in sales- The figure of sales as per P&L A/c may include
incidental revenues, e.g., freight, excise duty etc. where the amount of excise duty
goes up considerably the total sales may show an increase which is not represented
by a real increase sales quantity/value.
iv. High administrative and selling expenses- administrative and selling costs are
generally period costs which are fixed in nature. Their increase is generally not
proportional to sale increase. However, a reduction in profit could also be due to
increase in administrative overheads and sales overheads at a rate higher than the
rate of increase in sales.
v. Cost price relationship- if the increase in cost of raw materials and labor has not been
compensated by a corresponding increase in the sale price this would also result in
higher sales and declining profits. In spite of same sales quantity, for the increase
cost of raw materials and other services, per unit value of the product has been
increased which is however unmatched by the increase in cost.
vi. Competitive price- where sales have been made at cut-throat prices in order to
eliminate competition from the market, the profit would be in the declining trend in
the short run.
vii. Additions to the fixed assets- where there are heavy additions to the fixed assets and
consequent depreciation charges in the initial years of addition, there may be
reduction in profits in spite of increased sales.

Question No. 53
a) What is the objective of review engagement of financial statements? How does review
engagement differ from audit engagement? (8 Marks June 2017)
b) While compiling the financial statements of a concern, you observed that the input
information supplied by the concern is incomplete, incorrect and few of the Accounting
Standards have not been followed. Describe, in brief, the procedures you will follow in the
above case. (7 Marks June 2017)
Answer
a) Objective of Review Engagements: The objective of a review of financial statements is to
enable a practitioner to state whether, on the basis of procedures which do not provide all
the evidence that would be required in an audit, anything has come to the practitioner‘s
attention that causes the practitioner to believe that the financial statements are not prepared,
in all material respects, in accordance with the applicable financial reporting framework
(negative assurance).
Difference between review and audit engagements: The level of assurance provided by
review engagement (limited assurance) is less than that of audit engagement (reasonable
assurance). The opinion is provided in the form of negative assurance in review
engagements whereas in the form of positive assurance in audit engagements. In the review
engagement the practitioner obtains sufficient and appropriate evidence primarily through
inquiry and analytical procedures whereas in audit other procedures like inspection,
observations, confirmation, self-computation etc. are also often used.
b) According to NSRS 4410 Compilation Engagements, the practitioner would normally have
to rely upon the management for information to complete the financial statements in a
compilation engagement. If in the course of compilation of financial statements, it is
observed that the information supplied by the entity is incorrect, incomplete or otherwise
unsatisfactory, the practitioner should perform following procedures:
i) Make any enquiries of management to access the reliability and completeness of
the information provided;
ii) Assess internal controls prevailing in the entity; and
iii) Verify any matters or explanations.
The practitioner may also request the management to provide additional information. This
may be asked in the form of management representation letter. If the management refuses
to provide additional information, the practitioner should withdraw from the engagement,
informing the entity of the reasons for such withdrawal.
If one or more Accounting Standards are not complied with, the same should be brought to the
notice of the management and if the same is not rectified by the management, the practitioner
should include the same in notes to the accounts and the compilation report.
Question No. 54
M Limited is going to acquire S Limited. The purchase consideration has been decided at Rs.
4000 million. M Limited is worried about hidden liabilities or overvalued assets of S Limited
and approached you to examine the same. List out important account balances or transactions
items which you would like to investigate in the Due Diligence exercise.

Answer:
Due diligence is an all-pervasive exercise to review all important aspects like financial, legal,
commercial, etc. before taking any final decision in the matter. As far as any hidden liabilities or
overvalued assets are concerned, this shall form part of such a review of Financial Statements.
Normally, cases of hidden liabilities and overvalued assets are not apparent from books of
accounts and financial statements. Review of financial statements does not involve examination
from the viewpoint of extraordinary items, analysis of significant deviations, etc. However, in
order to investigate hidden liabilities or over-valued assets the auditor should pay his attention to
the following areas:
Important transactions/ items which need to be investigated in the due diligence exercise are
Items of Hidden Liabilities:
The company may not show any show cause notices which have not matured into demands, as
contingent liabilities. These may be material and important.
The company may have given Letters of Comfort to banks and Financial Institutions. Since these
are not guarantees, these may not be disclosed in the Balance sheet of the target company.
The Company may have sold some subsidiaries/businesses and may have agreed to take over and
indemnify all liabilities and contingent liabilities of the same prior to the date of transfer. These
may not be reflected in the books of accounts of the company. Product and other liability claims;
warranty liabilities; product returns/discounts; liquidated damages for late deliveries etc. and all
litigation. Tax liabilities under direct and indirect taxes. Pending assessments by tax authorities of
income tax/or customs duty where such assessment may impose more tax liabilities. Agreement to
buy back shares sold at a stated price and Future lease.
Liabilities.
Environmental problems/claims/third party claims.
Unfunded gratuity/superannuation/leave salary liabilities; incorrect gratuity valuations. Huge
labour claims under negotiation when the labour wage agreement has already expired.
Items of Over-Valued Assets:

Uncollected/uncollectable receivables.
Obsolete, slow non-moving inventories or inventories valued above NRV; huge inventories of
packing materials etc. with name of company. Underused or obsolete Plant and Machinery and
their spares; asset values which have been impaired due to sudden fall in market value etc. Assets
carried at much more than current market value due to capitalization of expenditure/foreign
exchange fluctuation, or capitalization of expenditure mainly in the nature of revenue.
Litigated assets and property.

Investments carried at cost though realizable value is much lower. Investments carrying a very
low rate of income / return. Infructuous project expenditure/deferred revenue expenditure etc.
Group Company balances under reconciliation etc. Intangibles of no value.
Question No. 55
Answer the following: (2.5 Marks each June 2018)
Everest Construction Ltd. carries out construction activities in Nepal. At the beginning of the
year 2072, the internal audit plan was agreed by the board of directors of the company.
Purchasing of construction materials is an area specified in the internal auditor‟s plan, for

internal control testing. The internal auditor has carried out his testing and submitted a draft
report to the board of directors of the company.
Required:
i) Identify two risks the company may have over its process of purchasing
construction material.
ii) Explain the role of internal controls within an entity in reducing the risks of its
purchasing process.
iii) Identify the responsibilities of the internal auditor for the internal controls of the
company.
iv) Identify the responsibilities of the board of directors of the company for the internal
controls of the company.
Answer
a)
i. The internal control of an organization reduces the risks at the level of business processes
and operations. The purchasing process has many risks. Some of them are;
a. Selection of wrong supplier
b. Placing orders for items not required
c. Making payments for materials which are not in good condition.
d. Making purchases at higher prices
ii. If sound internal controls are established around the purchasing process of the company,
these will help to reduce the risks, and will provide reasonable assurance regarding the
achievement of the objectives in areas such as:
a. Effectiveness and efficiency of purchasing-the purchases can be made at the right time at
the right price
b. Reliability of financial information-the financial statements may be accurate and free of
errors
c. Compliance with rules and regulations related to purchases
iii.The internal auditor provides management with information and recommendations about
internal controls. He does not have a direct responsibility for internal controls.
The internal auditor‘s responsibility is to investigate control system of Everest
Construction Ltd as per the annual internal audit plan given and report the findings to the
board/audit committee, with the recommendations.
iv. The board of directors has the final responsibility for the effectiveness of the internal
control system of the company.
The board is responsible for ensuring that the company has an effective control system.
The board should review the design and effectiveness of the system of internal controls.
For this the board can get the help of internal auditors. The board is ultimately responsible
to the shareholders.
Question No. 56
What do you mean by forecast and prospective financial information? Explain the statement
that “An auditor generally provides negative assurance while reporting on forecast”. Whether
an auditor can provide reasonable assurance on forecast? (2+4+2 Marks June 2018)

Answer
Forecast: A ―forecast‖ means prospective financial information prepared on the basis of
assumptions as to future events which management expects to take place and the actions
management expects to take as of the date the information is prepared (best-estimate
assumptions).
Prospective financial information‖ means financial information based on assumptions about

events that may occur in the future and possible actions by an entity. It is highly subjective in
nature and its preparation requires the exercise of considerable judgment. Prospective financial
information can be in the form of a forecast, a projection or a combination of both, for example, a
one year forecast plus a five-year projection.
Assurance on Forecast: Forecast relates to events and actions that have not yet occurred and may
not occur. While evidence may be available to support the assumptions on which the forecast is
based, such evidence is itself generally future oriented and, therefore, speculative in nature, as
distinct from the evidence ordinarily available in the audit of historical financial information. The
auditor is, therefore, not in a position to express an opinion as to whether the results shown in the
forecast will be achieved.
Further, given the types of evidence available in assessing the assumptions on which the forecast
is based, it may be difficult for the auditor to obtain a level of satisfaction sufficient to provide a
positive expression of opinion that the assumptions are free of material misstatement.
Consequently, when reporting on the reasonableness of management‘s assumptions the auditor
provides only a moderate level of assurance; i.e. negative form of assurance.
However, when in the auditor‘s judgment an appropriate level of satisfaction has been obtained,
the auditor is not precluded by the standard from expressing positive assurance regarding the
assumptions. That is, an auditor can provide reasonable assurance (in the form of positive
assurance) based on his level of satisfaction.
Question No. 57
The internal audit was carried out recently at Black Stone Inc. (P) Ltd. as a special assignment
by an audit practitioner. The draft report issued by the internal auditor to the management
includes a number of internal control weaknesses identified during the audit. The following
have been identified as critical issues:
- Generating of sales invoices, recording of sales and receipt are performed by the
same person. Therefore, there is no segregation of duties.
- There are large numbers of small items with large value and there are inadequate
physical controls to prevent threat of theft.
- Differences have been noted between the sales ledger and the general ledger and the
reason for such differences are not explained.
You are required to:
i) Explain the importance of internal controls to an organization. (3 Marks December 2018)
ii) Discuss two importance of segregation of duties to the company. (3 Marks December
2018)
iii) State measures that management can take to ensure the physical safeguard of inventories.
iv) State the objective of arithmetical and accounting controls. (2 Marks December 2018)

i) Answer
Internal controls are important:
 All the business organizations have risks (e.g. risk of fraud, risk of omissions etc.,
operational risks). When controls are implemented it reduces risks at the level of
business processes and operations.
 Controls ensure compliance with laws, regulations applicable to the entity.
 Controls reduce the risks of loss of efficiency or effectiveness in business operations;
ensure operations are conducted in accordance with organizations policies and
objectives.
 Controls ensure reliability and accuracy of financial information processed through the
entity‘s system
 Ensure assets are safeguard including information
 Fraud is prevented or detected if it occurs.
ii) Answer
 It reduces the risks of fraud and will be able to detect errors or omissions made by
person who initiating the transactions if those are checked by another person in the
organization.
 It makes difficult for an individual to commit fraud.
iii) Answer
 High value small items that are movable easily can be kept in lockable cabins.
 The management can have CCTV cameras to monitor stores.
 Assign a reasonable person to monitor the movement of toe items and make him
responsible for any shortage of items.
 Implement necessary requirement to obtain insurance cover.
 Frequent stock verification.
iv) Answer
The objective of controls on arithmetical and accounting records to check the correct and
accurate recording and processing of transactions. For example, reconciling sales ledger
with the general ledger is an arithmetical and accounting control and it will ensure
accuracy and completeness of sales recorded in the ledger.
Question No. 58
While verifying the employees‟ records in a company, it was found that a major portion of the
labour employed was child labour. On questioning the management, the statutory auditor was
told that it was outside his scope of the financial audit to look into the compliance with other
laws. Comment.
Answer:
Compliance with other laws and regulations: As per NSA 250 ―Consideration of Laws and
Regulation in an Audit of financial statements, the auditor is required to obtain sufficient
appropriate audit evidence regarding the compliance with the provisions of those laws and
regulations generally recognized to have a direct impact on the determination of material amounts

and disclosures in the financial statements including tax and labour law. For the other laws, the
auditor ‗s responsibility is limited to undertake specified audit procedures to help identify non-
compliance with those laws and regulations that may have a material effect on the financial
statements. Non-compliance with other laws and regulations may result in fines, litigation or other
consequences for the entity, the cost of which may need to be provided for.
In the given case, major portion of the labour employed was child labour. Auditor should ensure
the disclosure of above fact and provision of the cost of fines, litigation or other consequences. In
case auditor concludes that non-compliance may have a material effect on financial statements, he
should modify his opinion accordingly.
Question No. 59
When is forensic audit necessary? Elaborate. (8 Marks December 2018)
Answer:
Necessity of forensic audit: Forensic in laymen terms means relating to court of law or something
which can be held as an evidence in a court of law. Accordingly, forensic audit is necessary when
any fraud is alleged, and such allegation is to be proved/disproved in court of law. Mainly, Frauds
are divided into following categories which require a Forensic Audit:
 Financial Statement Fraud
 Asset Misappropriation regarding:
 Cash Receipts
 Fraudulent Disbursements
 Inventory and Other Assets
 Bribery and Corruption
 Theft of data and intellectual property
 Financial Institution Fraud
 Payment Fraud
 Insurance Fraud
 Health Care Fraud
 Consumer Fraud
 Computer & Internet Fraud
 Contract & Procurement Fraud
 Insolvency Fraud
 Securities Fraud
 Money Laundering Fraud
 Tax Fraud
Now, a Forensic Auditor in any of the above mentioned cases have to gather evidence and give
conclusion on that whether any fraud has happened or not and the same can be challenged in a
court of law so that the auditor may also have to act as an expert witness in some of the cases.
Forensic Auditors could be acting on behalf of either the management or Government Authorities.
Question No. 60
a. Investigation (5 Marks December 2016)
Investigation implies systematic, critical, and specific examination of the records of a
business for a specific purpose. The examination conducted under investigation is intensive as

well as exhaustive so far as the activities or area of accounting is concerned. Investigation

requires a concentrated focus on the subject matter of inquiry and related matter. Often,
investigations may spread over a period longer than one year and its scope may extend to
inquiry beyond the books of accounts if the circumstances so require.
b. Performance Audit (3 Marks December 2018)

Performance Audit: A performance audit is an objective and systematic examination of
evidence for the purpose of providing an independent assessment of the performance of a
government organization, program, activity or function in order to provide information to
improve public accountability and facilitate decision making by parties with responsibilities to
oversee or initiate corrective action. Performance audit include economy and efficiency and
program audits. OAGN has issued the performance audit guide with technical assistance of
World Bank with a view to enhance performance auditing capability of OAGN. This guide
follows the 3Es (Economy, Efficiency and Effectiveness) principle.
c. Management Audit (3 Marks December 2018)

Management Audit: Management Audit refers to the analysis and assessment of competencies
and capabilities of a company‘s management in order to evaluate their effectiveness,
especially with regard to the strategic objectives and policies of the business. The objective of
a management audit is not to appraise individual executive‘s performance, but to evaluate the
management team in relation to their competition.
It is a systematic assessment of methods and policies of the organization‘s management in the
administration and the use of resources, tactical and strategic planning and employee and
organizational improvement.
The objectives of management audit are

 Establish the current level of effectiveness,
 Suggest improvements and
 Lay down standards for future performance.
d. Financial Mediation (3 Marks December 2018)

Financial Mediation: Financial mediation is extrajudicial methods of resolving a dispute
between clients in which they agree to make their cases before an impartial person or panel.
The two sides employ a third party who attempts to find a common ground that will resolve
the dispute. Mediation is a less lengthy and less expensive alternative to arbitration. Each side
must agree to mediation and either side may walk away from the process at any time.
Mediation is an informal, voluntary method of resolving disputes in which the parties in
conflict meet with a trained, independent third party to come up with a solution that is
satisfactory to everyone involved. Unlike, arbitration, mediation is non-binding, which means
that if you are not happy with the outcome, you can stop the process, and either drop the issue
or move to more formal proceedings.

Chapter 10-Audit Under Computerized environment
Question No. 1
A large company has a computerized accounting system. The software was purchased from
market and customized by the vendor to the needs of the company. Since printing of books and
registers is very tedious, the company requests you to conduct audit in computer. Management
assures you that it will provide prints of query-based reports generated by computer. You are
requested to advise your assistants about the audit techniques to be used in this case.
(7 Marks June 2004)
Answer
The answer should focus on change in audit trail in an IT environment. Special attention should
be given to:
a) Arrangement for special print-out of additional information for the auditor's use.
Activation of additional part of program at the auditor's request.
b) Use of query-based reports. It should be done on selective banks.
c) Clerical recreation. Verify totals by cross checking. For example, adding of invoices
and comparing with sales ledger balances.
d) Testing on a total bar and ignoring individual items comparing analysis which can be
verified in total, but to which individual items cannot be fraud, with previous periods
and budgets.
e) Alterative tests such as testing the stock taking procedures and examining the
procedures for dealing with discrepancies.
f) Special Audit techniques:
 Audit Software
 Test Data
Question No. 2
Outline the specific characteristics of an effective computerized audit programme system.
Answer
The following are some characteristics of an effective computerized audit programme system.
i. Simplicity: The system should be simple to use and eliminate the need for
remembering countless details normally required in writing or revising computer
programmes.
ii. Understandability: The system should be readily understandable by members of
the audit staff, even those with little computer expertise. The capabilities of the
system should be known, and it should be cast to use.
iii. Adaptability: The programme should be useful for the various types of computers
used in the company.
iv. Vendor technical support: The vendor of the programme should assist in the initial
installation and providing adequate documentations, training for the audit staff,
revision and changes in the programme and continuous maintenance services.
v. Statistical sampling capability: The programme should be able to perform the
various statistical routines, such as: random sampling and stratified sampling.

vi. Acceptability: The system should be acceptable to both the auditors and to
computer centers.
vii. Processing capabilities: The programme should be able to process many different
types of applications.
viii. Report Writing: The package should have strong report writing function to prepare
multi reports in a single programme run and to generate flexible output report
formats.
Question No. 3
Discuss on the Auditor's involvement at the time of setting up computer system.
(8 Marks June 2005)
Answer:
The success of computerizations largely depends on the active participation of top management
and existence of high-quality Information System (IS) Management. Each of the management
functions must be evaluated by the auditor to assess the overall involvement of management in
computerization. Careful planning by the management is essential for computerization to succeed.
The major planning functions are as follows:
 If computerization is attempted for the first time, a feasibility study must be conducted to
examine the cost and benefits of using computers in the long – run.
 The necessary hardware/software specifications must be drawn up and a suitable computer
system selected.
 Physical planning and site preparation must be done. Subsequently, procurement and
installment of the computer system must be done in a planned matter.
 An organization structure must be properly designed for computer installation.
A cooperate computerization plan must be prepared, say for the next two or five years. This must
fit well with the organization‘s overall strategic plan. A project plan must be prepared for every
application system and a close monitoring done. A comprehensive disaster recovery and
contingency plan must be prepared to cope with unforeseen disasters. Once proper plans are laid
out, the issues of concern during the execution stage are as follows:
 If standard packages are to be used their limitations and the scope for customization must
be clearly understood.
 Staff at all levels must be appropriately trained and the entire organization slowly molded
into the computer culture. Properly designed training programs for top management and
users are very essentials.
 Reliability of hardware and software is of utmost importance since users would lose
confidence otherwise.
 The organization must be service oriented and not view itself as being in an ivory tower,
which tends to happen at times.
 User requirements are bound to change over a period of time, primarily due to the
experience gained. The systems must be flexible enough to accommodate such changes.
Question No. 4
Discuss problems that will be encountered in an EDP system in implementing internal control.

Answer
Problems in implementation of Internal Control in EDP System: The internal controls over
computer processing, which help to achieve the overall objectives of internal control, include both
manual procedures and procedures designed into computer programs. Such manual and computer
control procedures comprise the overall controls affecting the EDP environment, general EDP
controls, and the specific controls over the accounting applications, EDP application controls. The
following problems normally arise in implementation of internal control in an EDP system:
i. Separation of duties: In a manual system, separate individuals are responsible for

initiating transaction of duties helps in preventing or detecting errors and other
irregularities. In the EDP environment, this traditional segregation of duties may not
always apply. For example, a program may reconcile a vendor invoice against a receiving
document and print a cheque for the amount owned to a creditor. Thus, the program is
performing functions that in a manual system would be considered incompatible.
ii. Delegation of authority and responsibility: Normally a clear line of authority and
responsibility is essential aspect of control in any system. In a computer system, however,
delegating authority and responsibility may prove difficult because some resources are
shares among multiple users. When multiple users have access to the same data, it is not
always easy to trace or find out who is responsible for any corruption of the data ad for
identifying and correcting errors. Some organizations have attempted to overcome these
problems by designating a single user as the owner of data. This user assumes ultimate
responsibility for the integrity of the data.
iii. Component and trustworthy personnel: Highly skilled personnel are needed to develop,
modify, maintain and operate the computer systems. Getting competent and trustworthy
personnel for working in the EDP environment is, however, difficult as well-trained and
experienced people in this field are normally in short supply.
iv. System of authorizations: The auditor should see the general system and specific system
of authorization at various levels. General authorizations establish policies for the
organization to follow and specific authorizations apply to individual transactions. In a
manual system, auditors can evaluate the adequacy of procedures of authorization by
examining the work of employees. In a computer system, however, the procedures are
often embedded within a computer program. In such a case when evaluating the adequacy
of authorization procedures, auditors will not only have to examine the work of the
employees but also find out the veracity of program processing.
v. Adequacy of documents and records: In a manual system, adequate documents and

records are necessary to provide an audit trail of the various activities within the system.
In a computer system, documents may not be used to support the initiation, execution and
recording of some transactions. There would be no visible audit trail to trace a
transaction. This absence of a visible audit trail will not hinder the auditor's work if
systems are designed to maintain a record of all events and there is a means of accessing
these records.
vi. Physical control over assets and records: Physical control over access to their assets and
records is critical in both manual systems as well as computer systems. In computer
system, however, there is concentration of the data processing assets and records of an
organization. This means that in such an environment, if any fraud is to be perpetrated,

the person does not have to go to long distance but only have access to the computer
system. Hence, it is important that a good EDP environment restricts access to the data
processing assets the records.
vii. Adequate management supervision: In a manual system, the management supervision of

employee activities is relatively simple because the managers and employees are often at
the same physical location. In computer systems, however, the employees handling the
data processing may be remotely located. Supervisory controls must therefore be built
into the computer system to compensate for the controls that usually can be exercised
through observation and inquiry.
viii. Comparing recorded accountability with assets: In any system, the data and their assets
that the data purports to represent should be compared to determine the completeness and
accuracy of the data. In a manual system, there is normally an independent staff to
prepare the basic data for such comparison. In a computer system, however, programmes
are used to prepare this data. Therefore, care must be taken that there are no unauthorized
modifications to this program or to any of the data files database programs use otherwise
the irregularity may not be discovered.
Question No. 5
Distinguish between Application Controls and General Controls. (5 Marks December 2006)
Answer
Application controls relate to the transactions and data belonging to each computer-based
accounting system and are, therefore, specific to each application. These are basic controls over
the thoroughness, accuracy and validity of accounting information.
Application controls codify the operating routine to be followed in EDP and the user departments
in relation with each other. Application controls over input, processing, output and master file
controls.
Application controls performed by companies are not controls themselves but part of computer
programs which allow control to be exercised. They said the provision of controls over
completeness and accuracy of input and processing and validity of accounting entries in the same
way as normal controls. In addition, they provide control over calculation, summarization and
categorization carried out by the computer. General controls relate to the accounting environment
which computer-based accounting systems are developed, maintained and operated and which,
therefore apply to all individual applications. These controls determine the environment in which
the application control operates General controls cover administrative and system development
controls.
Question No. 6
Distinguish between Batch processing system and Real-time processing system.
(5 Marks June 2007)
Answer
In batch processing system, transactions are collected over a period of time and processed at a
time at periodical interval. Transactions like sales orders for the day, invoices to be recorded and
daily cash receipts treating them as a "batch" of transactions are accumulated, entered in a batch

and processed as a group. Control totals, consisting of adding machine tapes summing the rupee
amount of transactions in a group, are usually developed and compared with output in order to
assure complete and accurate processing. Batch processing systems are distinguished by their
relative simplicity and reliability. They do not process transactions as quickly as the more
advanced systems, nor do they possess the potential for providing timely information concerning
the files updated by transactions processing.
In an on-line real-time processing system, transactions are entered as they occur and processed
as they are entered. These systems form the heart of the management information systems and
helps management to take timely decision by providing up to date information. Given the
continuous updating of the database as transactions are entered, the status of such files as accounts
receivables, accounts payable, and inventory may be determined at any time. Although powerful
in terms of information capability, these systems are more complex in comparison to batch
processing systems. Moreover, they ordinarily do not provide the extent of audit trail
documentation produced by batch system; reason for this they are more difficult to audit in terms
of obtaining satisfaction concerning the existence of necessary controls, and of designing
substantive testing procedures.
Question No. 7
Explain the Audit trails in financial software. (5 Marks June 2008)
Answer
The audit trail is an essential element in ensuring the reliability of financial software. The auditor
needs to be aware of the following issues.
 An audit trail should provide a means of tracing transaction from its origin to the financial
statements, and vice versa. Establishing a source document field (which accepts the identity
of any source documents, enabling an authorized user to look up the transaction by referring
to that identity) is an additional useful feature. A look up screen is also helpful for auditors.
 While most accounting software provides a listing of ledgers, some modules still do not
have ledgers, preventing the accounting package from transferring to the general ledger all
the transactions in accounts receivable, accounts payable and inventory. A continuing audit
trail deficiency is the inability to trace entries easily from the ledger accounts to their
original journal source.
 An audit trail which shows the flow of data among the various modules in an accounting
package enables either summary data or subsidiary modules to be examined. This is
dependent on the availability of ledger modules and proper referencing or identification.
Question No. 8
a. Access Control (4 Marks June 2007)
Answer
Access control refers to procedures designed to restrict access to online terminal devices,
programs and data. Access control consists of ―user authentication‖ and ―user authorization‖.
―User authentication‖ typically attempts to identify a user through unique logon identifications,
passwords, access cards or biometric data. ―User authorization‖ consists of access rules to
determine the computer resources each user may access. Specifically, such procedures are
designed to prevent or detect:

i) Unauthorized access to online terminal devices, programs and data

ii) Entry of unauthorized transactions
iii) Unauthorized changes to data files
iv) Use of computer programs by unauthorized personnel
v) Use of computer programs that have not been authorized.
b. Utility routines (5 Marks June 2008)

Answer
Utility routines are generally supplied by the computer manufacturer and are available for call up
by the operating system. Theses routines play a key role in an electronic data processing. These
are generalized programs that perform necessary but routine jobs in a computer installation. These
routines are sufficiently flexible to handle needs of all users. They are controlled by parameters to
indicate the characteristics of the data or the requirements. Generally, three types of utility
routines are made available by computer vendors.
Data set utilities are used to manipulate files of stored data. One data set utility program might
merge or combine data from more than one file of stored data. Another might copy a field of data
to another file. A third might instruct the computer to print selected portions of the set data. A
fourth might sort file records into a desire sequence.
System utilities are used to simplify the task of knowing where data are stored in a computer file.
One utility routine might add data to a file name the set of data and catalogue the data set to
distinguish it from other data sets. Another utility routine might list the catalogue of data sets,
showing where particular data is stored in a file. A third might label magnetic tapes. A fourth
might accumulate and report errors incurred during the processing of magnetic disc and tape.
Independent utilities perform such housekeeping functions as preparing a backup copy of the
contents stored on a magnetic disc file or analyzing a magnetic disc for defective tracks. This
type of utility routine performs the needed diagnostic tests.
c. Internal Control System in EDP environment (4 Marks June 2010)

The Internal control over EDP system which help to achieve the overall objectives of internal
control, include both manual procedures and procedures designed into computer programs. Such
manual and computer control procedures comprise the overall controls affecting the IT
environment (general IT controls) and the specific controls over the accounting applications (IT
application controls).
General IT controls: The purpose of general It controls is to establish a framework of overall
control over the IT activities and to provide a reasonable level of assurance that the overall
objectives of internal control are achieved.
IT application controls: The purpose of the IT application control is to establish specific control
procedures over the accounting applications in order to provide reasonable assurance that all
transactions are authorized and recoded, and are processed completely, accurately and on a timely
basis.

d. Audit trail in a computerized accounting environment (3 Marks June 2011,5 Marks

December 2012)
EDP audit approach is applied for auditing in the computerized accounting environment. While
the new environment has not changed the fundamental nature of auditing, it has definitely caused
substantial changes in the methods of evidence collection and evaluation. Also, it calls for
auditors to keep pace with the rapidly changing information technology, even to the extent of
using sophisticated audit software. The prime objectives of EDP audit are to determine whether
the computer systems safeguard assets, maintain data integrity, achieve organizational goals
effectively and consume resources efficiently. A proper internal control is necessary to ensure that
these objectives are met. It may be recalled that the overall objectives and scope of an audit does
not change in an EDP environment. Although the procedures followed by the auditor in his study
and evaluation of the accounting system and related internal controls and the nature, timing and
extent of his other audit procedures may be affected, still the significance of audit trials cannot be
negated.
The audit trial is the facility to trace individual transactions through a system from source to
completion or vice versa and will normally is required by management in order to run its business
properly.
Audit trial is a chronological sequence of audit records, each of which contains evidence directly
pertaining to and resulting from the execution of a business process or system function. In simple
words, it refers to documentation of detailed transactions supporting summary ledger entries. This
documentation may be on paper or electronic records. The work of an auditor would be hardly
affected if audit trial is maintained properly, a simplified representation of the documentation in a
manually created audit trial. On the basis of audit trials, the auditor can check all detailed
calculations, casts and postings in the accounting records, at any time.
In the first and early second-generation computer system, a complete trial was generally available;
no doubt, to managements‘ own healthy skepticism of what the new machine could be relied upon
to achieve- an attitude obviously shared by the auditor. In such a system, the output itself is a
complete and as detailed as in any manual system and the trial, from beginning to end is complete
so that all documents may be identified, be located for purposes of vouching, totaling and cross
referencing. Any form of audit checking is possible, including depth testing in either direction.
However, loses of, and changes in traditional audit trials are encountered increasingly in the more
advanced computer applications. Frequently computer-generated totals, analyses and balances are
not printed out in detail. A commonsense attitude should be adopted to assess losses of audit trial
of this nature. Under such circumstances, following techniques can be used:
a) Arranging for special printouts of additional information for the auditors use.
b) Program interrogation facilities were by records held on magnetic or card files or other
form of hidden files are printed out on a selective basis.
c) Clerical recreation (e.g., the copy of invoices of sales might be add-listed and total dare of
compared with the computer total),
d) Testing on a total basis and ignoring individual items with previous periods and budgets,
e) Using other form of special audit techniques like Computer Assisted Audit Techniques
(CAATs) to ensure the validity of accounting data.
e. Risk assessment under Computerized Information System (CIS) (4 Marks June 2013)
The auditor in identifying and assessing the risks of material misstatement through understanding
the entity and its environment should make an assessment of inherent and control risk for material
financial statement assertions. The inherent risk and control risk in a CIS environment may have

both a pervasive effect and an account-specific effect on the likelihood of material misstatements,
as follows:
i) Risk may result from deficiencies in pervasive CIS activities such as:
(a) Program development and maintenance,
(b) System software support;
(c) Operations
(d) Physical CIS security;
(e) Control over access to specialized utility programs;
These deficiencies would tend to have a negative impact on all application system that are
processed through the computer, and
ii) Risk may also increase the potential for errors or fraudulent activities in;
(a) Specific applications.
(b) Specific data base or master files, or
(c) Specific processing activities.
As new CIS technologies are emerging for data processing and Clients are adopting the
same for building complex computer systems, these may increase risk which needs further
consideration.
f. Use of test packs (4 Marks December 2014)

Answer:
"Test Packs" contain simulated transactions of all sorts of error conditions which can be used to
test all the program controls. It consists of test data which will be processed in the same way as
actual or live data. The data may either be fictitious as invented by the auditor or genuine data
selected prior to processing. The essence of a test pack is that data will be chosen to test the
workings of each control upon which reliance is to be placed. Data will include both that which
falls outside the control parameters (and therefore should be printed out as an error or exception),
and that which falls within the parameters (and therefore should be processed normally). For
example, assume that stock numbers range from 0 to 8,000, and that any stock movements with a
number outside this range should be printed out as an error. So, test data with numbers of 7,999
and 8,001 might be chosen. The latter should be printed out as an error, the former should be
processed normally. Assume further that all debts over 60 days old should be printed out as
exceptions on account of their being overdue. So, a debt at 59 days, and one at 61 days might be
chosen as the test data. The latter should be printed out as an exception, whereas the former
should not appear on the exception report. The results of the test data can be predetermined, and
these anticipated results can then be compared with the error or exception reports produced by
the computer. If this compliance testing reveals that the program controls can be relied upon,
then it means that the resulting error and exception reports can be regarded as reliable. The
auditor will then have to satisfy himself that the appropriate action is taken on all error and
exception reports. This would be determined by appropriate compliance testing, such as the
review of a sample of error reports, to ensure that all errors have been removed, and, if necessary,
reprocessed. If the results of this compliance testing are satisfactory, the auditor may then be
satisfied that the chances of material error existing in the system are small and may accordingly
reduce the quantity of substantive testing for error, on the basis of reliable internal control.

Question 9
What are the important characteristics of an effective system of Computer Audit Program?
(7 Marks June 2008)
Answer
The important characteristics of an effective System of Computer Audit Program are as
follows:
(i) The system has to be simple to use and eliminate the need to remember countless
details normally required in writing or revising computer programs.
(ii) It has to be easily understandable even by those with little computer experience and
easy to use.
(iii) It has to be capable of being used with different configuration of computers.
(iv) The package has to include adequate support at the time of installation, provide
adequate training to staff and to provide documentation. There should be a provision
for future revision of the program.
(v) The package should have statistical sampling capability.
(vi) The system has to be acceptable to all users in terms of easy execution and
compatible with existing system.
(vii) The program has to be capable of processing different types of applications.
(viii) The program should have strong report writing function including the ability to
prepare multiple reports in a single program run and to generate flexible output report
formats.
Question No. 10
In the process of development of an overall audit plan for the audit of the Financial Statements
of a bank, the auditor should give particular attention to IT and other system used by bank.
Discuss.
Answer
In developing an overall plan for the audit of the financial statements of a bank, the auditor should
give particular attention to the extent of IT and other system used by the bank.
The high volume of transactions and the short times in which they must be processed typically
result in most banks making extensive use of IT, EFT and other telecommunications systems.
The control concerns arising from the use of IT by a bank are similar to those arising when IT is
used by other organizations. However, the matters that are of particular concern to the auditor of
a bank include the following:
 The use of IT to calculate and record substantially all of the interest income and interest
expense, which are ordinarily two of the most important elements in the determination of a
bank‘s earnings.
 The use of IT and telecommunications systems to determine the foreign exchange security
and derivative trading position‘s and to calculate and record the gains and losses arising
from them.
 The extensive, and in some cases almost total, dependence on the records produced by IT
because they represent the only readily accessible source of detailed up-to-date
information on the bank‘s assets and liability positions, such as customer loan and deposit
balances.

 The use of complex valuation models incorporated in the IT systems.

 The models used to value assets and the data used by those models are often kept in
spreadsheets prepared by individuals on personal computers not linked to the bank‘s main
IT systems and not subject to the same controls as applications on those systems. ―IT
environments- Stand-alone Personal Computers‖ provides guidance to auditors in respect
of these applications.
 The use of different IT systems resulting in the risk of loss of audit trail and
incompatibility of different systems. EFT systems are used by banks both internally (for
example, for transfers between branches and between automated banking machines and
the computerized files that record account activity) and externally between the bank and
other financial institutions (for example, through the SWIFT network) and also between
the bank and its customers through the internet or other electronic commerce media.
The auditor obtains an understanding to the core IT, EFT and telecommunication application
and the links between those applications. The auditor relates this understanding to the major
business processes or balance sheet positions in order to identify the risk factors for the
organization and therefore for the audit.
When auditing in the distributed IT environment, the auditor obtains an understanding of where
the core IT applications are located. If the banks‘ wide area network (WAN) is dispersed over
several countries, specific legislative rules might apply to cross- border data processing.
Electronic commerce presents new aspect of risk and other considerations that the auditor
addresses. For instance- business risks the bank‘s e-commerce strategy presents, risks inherent
in the technology, compliance with legal and regularity requirements in respect of cross-border
transactions, security and privacy of transactions across the Internet, completion, accuracy and
timeliness and authorization of Internet transactions as they are recorded in the bank accounting
system.
An organization may outsource IT or EFT related activities to an external service provider. The
auditor gains, an understanding of the outsourced services and the system of internal controls
within the outsourcing bank and the vendor of the services, in order to determine the nature,
extent and timing of substantive procedures.
Question No. 11
"The method of collecting audit evidence and evaluating the same, changes drastically under
the EDP auditing". Discuss the correctness of the said statement. (5 Marks June 2010)
Answer
The overall objective and scope of an audit does not change in an EDP environment. However,
the use of a computer changes the processing and storage of financial information and may affect
the organisation and procedures employed by the entity to achieve adequate internal control.
Accordingly, the procedures followed by the auditor in his study and evaluation of the accounting
system and related internal controls and the nature, timing and extent of his other audit procedures
may be affected by an EDP environment.
Many computerised accounting systems perform tasks for which no visible evidence is available,
and, in these circumstances, it may be impracticable for the auditor to perform tests manually.
The lack of visible evidence may occur at different stages in the accounting process for example:

(a) Input documents may be non-existent and data may be generated by computer
programs with no visible authorisation of individual transactions.
(b) The system may not produce a visible audit trail of transaction processed through the
computer.
(c) Output reports may produce by the system retaining supporting details in computer
files.
Due to aforesaid limitations, review of internal control acquires special significance in EDP
environment. The extent of reliance on internal control would determine nature, extent and
timing of substantive procedures. Following this, the auditor would have to examine accuracy
and validity of data produced by the data processing system. In case, the auditor is able to
construct the audit trail by taking special printout, etc. and trace selected transactions at depth
which then would not involve much use of computer and as such, there would be no significant
differences in collecting and evaluating audit evidence even under EDP auditing. However, in
case it is not possible to trace transaction to source documents, the auditor has to perform "audit
through the computer". Under such cases, the efficiency of audit and its effectiveness can be
improved through the use of computer assisted techniques in obtaining and evaluating audit
evidence. Thus, the methods of collecting audit evidence and evaluating the same changes
drastically under the EDP auditing.
Question No. 12
What specific problems may arise in the implementation of internal control system in an
Electronic Data Processing environment? Please explain. (5 Marks December 2010)
Answer
Information technology is rapidly changing, and the pace is so fast that even expert in that field
are finding it difficult to cope with. This resulted in hardware and software products becoming
obsolete in ridiculously short period of time. In this scenario, it is very important for auditors to
know what the current IT trends are and how they would influence auditing. The rapid
advancements in IT would no doubt have a dramatic impact on auditing. Auditors must adapt
themselves to the changing environment and acquire the necessary additional skills. The skill
requirement in the scenario of manual accounting system and auditing in the EDP environment
has evolved with significant change. Significant data security risk has emerged in the context of
EDP environment. For this purpose, the internal control mechanism should be much strengthened
to prevent PC users from initiating unauthorized or erroneous file changes and data
manipulations.
But however, the following specific problems may arise in the implementation of internal control
system in an EDP environment:
a) Segregation of duty: In a manual system, separate persons are responsible for initiating
transactions, recording them, and custody of assets. As a basic control, segregation of
duties prevents or detects errors and irregularities. But in an EDP environment, the
traditional notion of segregation of duties does not apply. The program is performing
functions that in a manual system would be considered incompatible. In an EDP
environment, separation of incompatible functions will be more difficult to achieve. Some

minicomputers and PCs allow users to change programs and data easily. They do not
provide any record of these changes. If the PCs do not have an inbuilt capability to provide
a secure record of changes, it may be difficult to trace whether incompatible functions have
been performed by the system users.
b) Delegation of duties and responsibilities: In an EDP environment, delegation of authority

and responsibilities may be difficult because some resources are shared among multiple
users. When multiple users have access to the same data and integrity of the data is
somehow violated, it is not normally easy to trace who is responsible for corrupting the
data and who is responsible for identifying and correcting the error.
c) Competent and trustworthy personnel: The technology of data processing has now
become significantly complex as compared to that in the days of manual systems. Highly
skilled and competent personnel are required to develop, modify, maintain, and operate in
the EDP environment. However, it has been very hard nut to any organization to assure that
it has enough competent and trustworthy data processing personnel. Moreover, it is not
always easy for any institution to assess the competency and integrity of its EDP staff.
d) System of authorizations: In a manual system, auditors evaluate the adequacy of
procedures for authorization by examining the work of employees. But in an EDP
environment, authorization procedures are often embedded within a computer system.
Thus, when evaluating the adequacy of authorization procedures, auditors have to examine
not only the work of employees but also different processing programs in the computer.
e) Adequate documents and records: In a manual system, adequate records and documents
are necessary to provide an audit trial of activities within the system. But in an EDP
environment, documents may not be used to support the initiation, execution and recording
of transactions. Some activities may be automatically activated by the system itself. In such
cases, no visible audit or management trial may be available to trace the transaction. Some
minicomputer and PC software packages provide inadequate access controls and logging
facilities to ensure preservation of an accurate audit trial. When this situation is coupled
with a decreased ability to separate incompatible functions, serious control problems can
arise.
f) Adequate management supervision: in a manual system management and supervision of
employees‘ activities are relatively straight forward since managers and employees are
often at the same physical location. But in an EDP environment, data communication
maybe used to enable employees to be closer to the customers they serve. Hence,
supervision of employees has to be performed remotely. Supervisory controls must be built
into the computer system to compensate for the controls that usually can be exercised
through observation and inquiry.
g) Comparing recorded accountability with assets: Periodically data and assets need to be
and should be compared to determine whether incompleteness or inaccuracies in the data
exist or not or whether the shortages in the assets have occurred or not. In a manual system,
independent employee prepares the basic data used for comparison purpose but in an EDP
environment programs are used to prepare this data. If unauthorized modifications occur to
the programs or data files that the programs use, an irregularity may not be detected.
Question No. 13
Distinguish between On-line real time processing system and batch processing system.

Answer
On-line computer systems are computer systems that enable users to access data and programs
directly through terminal devices. Such systems may comprise mainframe computers,
minicomputers or a network of connected PCs. When the entity uses an on-line computer system,
the technology is likely to be complex and linked with the entity‘s strategic business plans. Online
computer systems may be classified according to how information is entered into the system, how
it is processed and when the results are available to the user. In an on-line real-time processing
system, individual transactions are entered at terminal devices, validated and used to update
related computer files immediately. An example is the application of cash receipts directly to
customers‘ accounts. The results of such processing are then available immediately for inquiries
or reports. In an on-line real-time (OLRT) processing system, transactions are entered as they
occur, and are processed as they are entered. These systems form the heart of management
information systems. Given the continuous updating of the database as transactions are entered,
the status of such files as accounts receivable, accounts payable, and inventory may be determined
at any time. In a system with on-line batch processing, individual transactions are entered at a
terminal device, subjected to certain validation checks and added to a transaction file that contains
other transactions entered during the period. Later, during a subsequent processing cycle, the
transaction file may be validated further and then used to update the relevant master-file. For
example, journal entries may be entered and validated on-line and kept on a transaction file, with
the general ledger master-file being updated on a monthly basis. Inquiries of, or reports generated
from, the master-file will not include transactions entered after the last master-file update. In a
batch processing system which is not on-line, transactions are accumulated and processed in
group sales orders for the day, invoices to be recorded, and daily cash receipts might each be
viewed as a ―batch‖ of transactions, to be processed as a group. Batch processing systems are
distinguished by their relative simplicity and reliability. They do not process transactions as
quickly as the more advanced systems, nor do they possess the potential for providing timely
information concerning the files updated by transactions processing. Given these limitations, the
use of networked PCs terminals has become widespread, even among small entities. Batch
processing systems are rarely found in today‘s systems environment. Although powerful in terms
of information capability, OLRT systems are more complex than batch processing systems.
Moreover, they ordinarily do not provide the extent of audit trail documentation produced by
batch system and for this they are more difficult to audit in terms of obtaining satisfaction
concerning the existence of necessary controls, and of designing substantive testing procedures.
Conversely, in a batch processing system, the transaction is accumulated and processed in batches
or groups. Control totals, both monetary and documentary, are also available for review to ensure
completeness and accuracy of data being processed. The system is simple and reliable. However,
its deficiency lies in the MIS is not updated on a concurrent basis and, therefore, information is
not available on a timely basis. Accordingly, it is a question of cost-benefit analysis as to which
system will be more preferable to an entity.
Question No. 14
Define “Access Controls” in Computerized Environment and explain the methods of access
control.
(4 Marks June 2014)

Answer:
Access controls are usually aimed at for preventing unauthorized access. The controls may seek to
prevent persons who are authorized for access from accessing restricted data and program, as well
as preventing unauthorized persons from gaining access to the system as a whole.
a. Segregation Controls: Access to program documentation, data files, programs and
computer hardware should be limited to authorized individuals only.
b. Limited Physical Access to the computer Facility: The physical facilities that hold
the computer equipment, files and documentation should have controls to limit access
only to authorized individuals.
c. Visitor entry Logs - Entry logs should be used to determine and document those who
have had access to the area.
d. Hardware and Software access controls - Access control software like ‗user
identification‘ may be used with a combination of a unique identification code and a
confidential password.
e. Call back - It is a specialized form of user identification in which the user dials the
system, identifies him and is disconnected from the system. Then, either an individual
manually finds the authorized telephone number or the system automatically finds the
authorized telephone number of the individual and finally the user is called back.
f. Encryption - In encryption, data is encoded when stored in computer files / and or
before transmission to or from remote locations. This coding protects data because to
use the data unauthorized users must not only obtain access, but must also decrypt the
data i.e., decode it from encoded form.
g. Computer Application Controls - Programmed application controls apply to
specific application rather than multiple applications.
Question No. 15
Doing an audit in an EDP environment is simpler since the trial balance always tallies analyze
critically? (5 Marks June 2015)
Answer
Though it is true that in EDP environment the trial balance always tallies, the same cannot
imply that the job of an auditor becomes simpler. There can still be some accounting errors
like omission of certain entries, compensating errors, duplication of entries, error of
commission in the form of wrong A/C head is posted, possibility of window dressing and/or
creation of secret reserves where the trial balance tallied. At present, due to complex business
environment the importance of trail balance cannot be judged only up to arithmetical
accuracy, but the nature of transactions recorded in the books and appears in trial balance
should be focused.
The emergence of new forms of financial instruments like futures and options, derivatives,
off balance sheet financing etc. have given rise to further complexities in recording and
disclosure of transactions. In an audit, besides the tallying of a trial balance, there are also
other issue like estimation of provision for depreciation, valuation of inventories, obtaining
audit evidence, ensuring compliance procedure and carrying out substantive procedure,
verification of assets and liabilities their valuation etc. which still requires judgment to be
exercised by the auditor .
Responsibility of expressing an audit opinion and objectives of an audit are not changed in
the audit in EDP Environment. Therefore, it can be said that simply because of EDP
environment and the trial balance has tallied it does not mean that the audit would become
simpler.

Question No. 16
a. Tagging and Tracing (4 Marks June 2016)
Tagging and Tracing is a technique better than Integrated Test Data Facility. It involves
tagging the client‘s input data in such a way that relevant information is displayed at key
points. It uses the actual data, and so the question of elimination of ‗special entries‘ test data
designed under Integrated Test Data Facility does not arise. The hard copy, so produced is
available only to the auditor and may describe such inputs as hours worked in a pay period in
excess of 50; or sales orders processed in excess of Rs. 100,000. This enables the auditor to
examine transactions at the intermediate steps in processing. The advantage of the tagging
and tracing approach lies in the use of actual data and elimination of the need for reversing
journal entries. The disadvantage is that the erroneous data will not necessary be tagged. An
effective combination approach may be to use the Integrated Test Facility approach for a few
hypothetical transactions and the tagging and tracing approach to follow line data through a
complex system.
b. Audit Input Controls (CIS environment) (4 Marks June 2015)

Input into the CIS system should be properly authorized and approved. The system should
verify all significant data fields used to record information i.e., Should perform editing of the
data. Conversion of data into machine readable form should be controlled and verified for
accuracy.
For validation of input controls, the following procedure can be applied:
Pre-printed form - All constant information is printed on a source document to verify the
inputs. For example, if only limited number of responses to a question is considered
appropriate then preprint the responses and have the user tick or circle the correct responses
deleting those that are inappropriate.
Check Digit - Control used to guard against errors made in transcribing and keying data is a
‗Check Digit‘. A Check Digit is a redundant digit (s) added to a code that enables the
accuracy of other characters in the code to be checked. The check digit can act as a prefix or
suffix character or it can be placed somewhere in the middle of the code. When the code is
entered, a program recalculates the check digit to determine whether the entered check digit
and the calculated check digit are the same. If they are the same, the code is most likely to be
correct.
Completeness Totals - Inputting data erroneously is one type of error. It could be leaving out
or losing data completely against which controls are to be provided.
Completeness totals may be:
i) Batch Control Totals
ii)Batch Hash Total
iii)Batch Record Totals
iv)Sequence Checks

Question No. 17
The methods of collecting audit evidence and evaluating the same changes drastically under
the EDP auditing. Explain. (8 Marks June 2016)
Answer:
The overall objective and scope of audit does not change in an EDP environment. However,
the use of a computer changes the processing and storage of financial information and may
affect the organization and procedures employed by the entity to achieve adequate internal
control. Accordingly, the procedure employed by the auditor in his study and evaluation of
the accounting system and related internal controls and the nature, an EDP environment may
affect timing and extent of his other audit procedures.
Many computerized accounting systems perform tasks for which no visible evidence is
available, and, in these circumstances, it may be impracticable for the auditors to perform
tests manually. Thus, lack of visible evidence may occur at different stages in the accounting
process, for example:
a. Input documents may be non-existent where sales orders are entered on-line. In
addition, computer programs with no visible authorization of individual transactions
may generate accounting transactions, such as discounts and interest calculations.
b. The system may not produce a visible audit trail of transactions processed through the
computer. Delivery notes and suppliers‘ invoices may be matched by a computer
program. In addition, programed control procedures, such as checking customer credit
limits, may provide visible evidence only on an exemption basis. In such cases there
may be non-visible evidence that all transactions have been processed.
c. Output reports may not be produced by the system. In addition, a printed report may
only contain summary totals while supporting details are retained in computer files.
The timing of audit procedures may be affected because data may not be retained in computer
files for a sufficient length of time for audit use, and the auditor may have to make specific
arrangements to have it retained or copied.
Due to aforesaid limitations, review of internal control acquires special significance in EDP
environment.
The extent of reliance on internal control would determine nature, extent and timing of
substantive procedures. Following this, the auditor would have to examine accuracy and
validity of data produced by the data processing system. In case the auditor is able to
construct the audit trail by taking special printout, etc. and trace selected transactions at
depth which then would not involve much use of computer and as such, there would be no
significant difference in collecting and evaluating audit evidence even under EDP auditing.
However, in case it is not possible to trace transactions to source documents, the auditor has
to perform ―audit through the computer‖. Under such cases the efficiency of audit and its
effectiveness can be improved through the use of computer assisted audit techniques in
obtaining and evaluating audit evidence. Hence EDP set up changes drastically the method of
colleting the audit evidence and its evaluation.
Question No. 18
Khiladi Ltd. transformed its accounting processes from manual to customized accounting
software. Therein, all the transactions are recorded processed and the final accounts
generated from the system. The management tells you that in view of the voluminous nature of

transactions, there is no need to take printouts and that audit can be conducted on the
computer itself. The management further assures you that any 'query-based reports' as
required can be generated and printed.
As a statutory auditor of the company, enumerate the procedures you would adopt to conduct
the audit in such environment. (7 Marks December 2017)
Answer
A key feature of the accounting software package used by the company definitely involves
the absence of a clear physical audit trail. In other words, transactions cannot be easily traced
or co-related from the individual supporting documents of those transactions. Moreover, the
management does not wish to print the transactions in view of the voluminous nature since
it may involve extensive costs. This has naturally led to extensive dependence by
management upon the "exception reporting" principle.
From the auditor's point of view, it must also be conceded that the exception reports in the
form of 'query-based reports' which isolate the above data will provide the very material
information that the auditor requires for most of the verification work. The only problem
which it raises, and it is a serious one, is that the auditor cannot simply assume that the
programmes which produce the exception reports are reliable in respect of the following
factors:
 operating accurately;
 printing out all the exceptions which exist; and
 bound by programmed control parameters which meet the company's genuine internal
control requirements.
In view of the above, the auditor is required to test the processes which purport to embody
the controls and produce the output such as it is. These tests, which invariably involve the use
by the auditor of the computer itself, are known as tests through the computer. In that
approach, the auditor starts by proving the accuracy of the input data, and then thoroughly
examines (by applying tests) the processing procedures with a view to establishing the
following that:
i) all input is actually entered into the computer.
ii) neither the computer nor the operators can cause undetected irregularities in the final
reports.
iii) the programmes appear, on the evidence of rejection and exception routines, to be
functioning correctly.
iv) all operator intervention during processing is logged and scrutinized by the
supervisors.
The auditor in such circumstances will have to first evaluate the existing controls. For the same,
he has to do the following:
i. Evaluate the internal control system especially the controls and checks existing for
recording the transactions, i.e., he has to verify at what level transactions can be
entered into the system and what checks are available to prevent any unauthorized data
entry and for rectifying errors/omissions in the transactions entered.
ii. Evaluate at what level there is authority given for modification of transactions already
entered. Is there any authority given only to a senior employee to carry out
modifications? Or is it that once transactions are entered and validated no further
modifications are possible there to.

iii. Whether there is a provision in the software for carrying out an online audit of
transactions, i.e. whether there a separate module in the package, where a separate
password given to the auditor and once he has seen and approved a particular
transaction/set of transactions, the same would be locked and no modifications would
be possible by anyone (including the senior most employee) in the company.
iv. Whether there are proper procedures for backup of data on a regular basis and whether
the said procedures are being strictly followed.
v. In case of any loss of data whether there is a clearly defined recovery procedure to
minimize the loss of data due to power failures or any human errors.
vi. The auditor may introduce some dummy data into the system and see the results
obtained.
After the auditor has evaluated the above procedures, he has to prepare an audit plan depending
on the results obtained from his earlier evaluation. Since the transactions are not being printed,
the plan can contain procedures wherein data is verified directly on the computer from the
vouchers/invoices, etc. The audit plan will also require a lot of analytical procedures to be
performed. Depending on the importance of various expense heads and other important account
heads, the auditor will also obtain various reports from the system depending on various queries
that he would have to identify. Some illustrative reports can be:
i) To check whether proper classification is done for revenue/capital - a report can be

obtained of all purchases (not being raw materials or other routine purchases) exceeding
specified amount.
ii) To check whether all outward bills are accounted for a report containing a month wise co-
relation between goods dispatched and freight amount paid. The same can be further co-
related with the freight rates obtained from the bills.
Once the auditor has performed the above procedures, he would be able to form an opinion
whether reliance can be placed on the accounting systems and the data recorded. If the auditor
finds that reliance cannot be placed on the systems, he can inform the management about the fact
and also that the transactions will need to print to allow him to conduct the audit. The finalization
procedures to be followed even under this system would remain more or less similar to other
accounting systems.
Question No. 19
Application controls in information technology (3 Marks June 2018)
Manual or automated procedures that typically operate at a business process level. Application
controls can be preventative or detective in nature and are designed to ensure the integrity of the
accounting records. Accordingly, application controls relate to procedures used to initiate, record,
process and report transactions or other financial data.
Question No. 20
State the important characteristics of an effective system of Computer Audit Programme.
Answer:
Important characteristics of an effective system of computer audit program:
i. The system has to be simple to use and eliminate the need to remember countless
details normally required in writing or revising computer programs.

ii. It has to be easily understandable even by those with little computer expertise and easy
to use.
iii. It has to be capable of being used with different configuration of computers.
iv. The package has to include adequate support at the time of installation, provide
adequate training to the staff and to provide documentation. There should be a
provision for future revision of the program.
v. The package should have statistical sampling capability.
vi. The system has to be acceptable to all users in terms of easy execution and compatible
with the existing system.
vii. The program has to be capable of processing different types of applications.
viii. The program should have strong report writing function including the ability to prepare
multiple reports in a single program run and to generate flexible output report formats.

Chapter 11-CAAT
Question No. 1
You are an audit manager of an audit firm whose partner has been in practice since last 20
years and is not familiar with computer assisted audit technique in an audit under the EDP
environment. Upon appointment as an auditor of a company fully computerized, your partner
requested you to discuss the control procedures, which should be adopted in applying CAAT in
the audit. Provide a memo to your partner on this subject.
Answer:
Background
The common types of CAAT‘s are audit software and test data. Audit software consists of
computer programmes used by the auditor to process data of audit significance from entity‘s
accounting systems. It may consist of package programmes, purpose-written programs and utility
programmes. Regardless of the source of programme, the auditor should substantiate their validity
for audit purposes prior to use. Test data techniques on the other hand are used in conducting
audit procedures by entering data (a sample transactions) into an entity‘s computer systems and
comparing the results obtained with the predetermined results. Test data is used to test specific
controls in computer programmes., such as, online password and data access.
Controlling the CAAT Application:
The use of a CAAT should be controlled by the auditor to provide reasonable detailed
specifications of the CAAT have been met and that the CAAT is not improperly manipulated by
the entity‘s staff. The specific procedures necessary to control the use of a CAAT will depend on
the particular application in establishing audit control, which require the auditor should consider
the need to:
i.Approve the technical specifications and carry out a technical review of the work
involving the use of the CAAT,
ii. Review the entity‘s general IT controls, which may contribute to the integrity of the
CAAT, e.g. control over programme changes and access to computer files. When such
controls cannot be relied upon to ensure the integrity of the CAAT, the auditor may
consider processing the CAAT applications at another suitable computer facility.
iii. Ensure appropriate integration on the output by the auditor into the audit process.
Procedures carried out by the Auditor to control Audit Software Application:
a. Participating in the design and testing of the computer programmes.
b. Checking the coding of the programme to ensure that it conforms with detailed
programme specifications.
c. Requesting the entity‘s computer staff to review the operating system instructions to
ensure that the software will run in the entity‘s computer installation.
d. Running the audit software on small test files before running on the main data files.
e. Ensuring that the correct file was used, e.g. by checking with external evidence, such
as controls totals maintained by the user.
f. Obtaining evidence that the audit software functioned as planned, for example,
returning output and control information.

g. Establishing appropriate security measure to safeguard against manipulation of the

entity‘s data files.
The presence of the auditor is not necessarily required at the computer facility during the running
of a CAAT to ensure appropriate control procedure. However, it may provide practical
advantages, such as being able to control distribution of the output and ensuring the timely
corrections of errors.
Procedures carried out by the auditor to control test data applications:

i. Controlling the sequent of submissions of test data where it spans several processing
cycles.
ii. Performing test runs containing small amounts of test data before submitting the main
audit test data.
iii. Predicting the results of the test data and comparing it with the actual test data output,
for the individual transactions and in total.
iv. Confirming that the answered version of the programme was used to process the test
data were used by the entity throughout the applicable audit period.
When using CAAT, the auditor may require the co-operation of the entity‘s staff who have
extensive knowledge of the computer installation. In such circumstances, the auditor should have
reasonable assurance that the entity‘s staff did not improperly influence the results of the CAAT.
Finally, the standard of working papers and retention procedures for a CAAT should be consistent
with that on the audit as a whole. It may be convenient to keep technical papers relating to the use
of the CAAT separate from the other audit working papers. The working paper should contain
sufficient documentation to describe the CAAT application.
Question No. 2
What are the factors to be considered while determining the use of Computer Assisted
Auditing Techniques (CAAT)? (5 Marks June 2006)
Answer:
In determining whether to use CAAT, the auditor should consider the following factors:
i. Availability of sufficient IT knowledge and expertise:
It is essential that members of the audit team possess sufficient knowledge and experience
to plan, execute and use the results of CAAT. The audit team should have sufficient
knowledge to plan, execute and use the results of the particular CAAT adopted.
ii. Availability of CAAT and suitable computer facilities and data in suitable format:
The auditor may plan to use other computer facilities when the use of CAAT on an entity's
computer is uneconomical or impractical, for example, because of an incompatibility
between the auditor's package program and entity's computer.
iii. Impracticability of manual tests due to lack of evidence:
Some audit procedures may not be possible manually because they rely on complex
processing or involve amounts of data that would overwhelm any manual procedure.

iv. Impact on effectiveness and efficiency in extracting a data:

It includes selection of samples, applying analytical procedures, time involved in
application of CAAT, etc.
v. Time constraints in certain data:
It is often kept for a short time and may not be available in machine-readable form by the
time auditor wants them. Thus, the auditor will need to make arrangements for the retention
of data required or may need to alter the timing of the work that requires such data.
Question No. 3
If you are recruited as an internal auditor of M/s ABC Bank Ltd., what kind of cyber-crime do
you see that are commonly perpetrated against such bank? (8 Marks December 2007)
Answer
The terms computer crime generally known as e-crime and cyber-crime can be used
interchangeably with electronic crime. Such crimes are essentially crimes where the computer is
used either as tool to commit the crime, as a storage device, or as a target of the crime. As a
storage device, computers can either store information that will assist in the execution of the
crime or information that is illegal for the owners to possess, such as stolen intellectual property.
Computers are classified as a target if the information that they contain is altered or retrieved in an
unlawful way, such crimes can range from amateur hacking to terrorism.
Perpetrators against banks can use several kinds of cyber-crimes. The most common are as
follows;
i) Phishing:
Phishing involves the use of seemingly legitimate communications i.e. spoofed to deceive
bank customers into disclosing sensitive information, such as bank account number, credit
card data, passwords or financial personal identification numbers (PIN). The purpose of
phishing is to gain sufficient information to perpetrate a fraud.
ii) Identity Theft:
ID theft involves manipulating or improperly accessing another person‘s identifying
information, such as social security number, or PIN rather than account number, in order to
fraudulently establish credit or take over deposit, credit or other financial account for benefit.
iii) Worms and Trojan horses:
They are a significant threat to banks in terms of resources lost. A worm is a program or
algorithm that replicates itself over a computer network and usually performs a malicious
action, such as using up the computer‘s resources and possibly shutting the system down. It is
similar to virus. Unlike worms and viruses, Trojan horses do not replicate themselves but that
can be just as destructive. The perpetrator with the help of worms and Trojan horses can steal
passwords and IDS, especially for online banking.
iv) Spyware:
A spyware is any software that gathers user information through the user‘s Internet
connection without his knowledge, usually for advertising purposes. Spyware ranges from
harmless pop-up ads top the ability to record anything that happens on a computer and then
transmit that data to a remote site.

v) Search engines:
One key cyber-tool used by criminals is the Internet search engine, such as Google. For
instance, credit card numbers are easily pulled. Bank account numbers can be found if placed
improperly on the web. In addition to sensitive information, sensitive resources can be
obtained, such as secure login pages not published to the general public. This misuse of
Google is referred to as ―Google Hacking.‖
vi) Denial-of service (DOS) attack:
There is the risk of denial of service. DOS attack against online banking. DOS is intended to
harm victims by bringing computer systems to a screeching halt, specifically server, such as
online banking servers that provide internet access to bank transactions and data. When
financial institutions‘ online banking services are down, not only the business operations
disrupted but also the cyber enabled perpetrator might gain publicity from his/her act. This is
a common goal of such attacks. DOS or distributed DOS attacks have less of an impact on
financial institutions and are less devastating to the overall entity than the other forms of
attack.
Question No. 4
Discuss the control procedures, which the auditor should adopt in applying CAAT in an
audit under EDP environment. (10 Marks December 2007)
Answer
The common types of CAATs are audit software and test data. Audit software consists of
computer programs used by the auditor to process data of audit significance from the entity‘s
accounting systems. It may consist of package programs purpose –written programs, and utility
programs. Regardless of the source program, the auditor should substantiate their validity for
audit purposes prior to use. Test Data techniques on the other hand are used in conducting audit
procedures by entering data (a sample transactions) into an entity‘s computer systems and
comparing the results obtained with the predetermined results. Test data is used to test specific
controls in computer programs, such as, online password and data access.
Controlling the CAAT Application:

The use of a CAAT should be controlled by the auditor to provide reasonable detailed
specifications of the CAAT have been met and that the CAAT is not improperly manipulated by
the entity‘s staff. The specific procedures necessary to control the use of a CAAT will depend on
the particular application in establishing audit control which requires the auditor should consider
the need to:
i) Approve the technical specifications and carry out a technical review of the work
involving the use of the CAAT.
ii) Review the entity‘s general IT controls which may contribute to the integrity of the
CAAT, e.g. control over program changes and access to computer files. When such
controls cannot be relied upon to ensure the integrity of the CAAT, the auditor may
consider processing the CAAT applications at another suitable computer facility.
iii) Ensure appropriate integration of the output by the auditor into the audit process.

Procedures carried out by the Auditor to control Audit Software Application:

i) Participating in the design and testing of the computer programs.
ii) Checking the coding of the program to ensure that it conforms to detailed program
specifications.
iii) Requesting the entity‘s computer staff to review the operating system instructions to
ensure that the software will run in the entity‘s computer installation.
iv) Running the audit software on small test files before running on the main data files.
v) Ensuring that the correct files were used, e.g. by checking with external evidence, such
as control totals maintained by the user.
vi) Obtaining evidence that the audit software functioned as planned, for example,
returning output and control information.
vii) Establishing appropriate security measures to safeguard against manipulations of the
entity‘s data files.
The presence of the auditor is not necessarily required at the computer facility during the running
of a CAAT to ensure appropriate control procedures. However, it may provide practical
advantages, as being able to control distribution of the output and ensuring the timely corrections
of error.
Procedures carried out by the Auditor to control Test Data Applications:

i) Controlling the sequence of submissions of test data where it spans several processing
cycles.
ii) Performing test runs containing small amounts of test data before submitting the main
audit test data.
iii) Predicting the results of the test data and comparing it with actual test data output, for
the individual transactions and in total.
iv) Confirming that the answered version of the programs was used to process the test data.
v) Obtaining reasonable assurance that the programs used to process the test data were
used by the entity throughout the applicable audit period.
When using a CAAT, the auditor may require the cooperation of the entity‘s staff who have
extensive knowledge of the computer installation. In such circumstances, the auditor should have
reasonable assurance that the entity‘s staff did not improperly influence the result of the CAAT.
Finally, the standard of working papers and retention procedures for a CAAT should be consistent
with that on the audit as a whole. It may be convenient to keep the technical papers relating to the
use of the CAAT separate from the other audit working papers. The working papers should
contain sufficient documentation to describe the CAAT application.
Question No. 5
Audit Software facilitates detection of fraud. Explain (6 Marks June 2009)
Answer
Computer Assisted Auditing Technique (CAAT) allow the auditor to give access to data without
dependence on the client, test the reliability of client software and perform audit tests more
efficiently. CAATs are used to perform various audit procedures like;

i) Tests of details of transactions and balances e.g. use of audits software to test all or a
few transactions in a computer file.
ii) Analytical review procedures e.g. use of audit software to identify unusual fluctuations
or items.
iii) Compliance tests of IT application controls e.g. use of test data to test the functioning
of a programmed procedure.
However, the methods of applying audit procedures to gather evidence may be influenced by the
methods of computer processing. Sometimes, in some accounting systems that use computer for
processing significant applications, it may be difficult or impossible for an auditor to obtain
certain data for inspection, inquiry or confirmation without computer assistance.
CAAT in fraud Detection: In an EDP environment, the Auditor is required to plan his work by
exercising reasonable care and skill in such a manner that there is reasonable expectation of
detecting material misstatements in the financial information resulting from fraud or error. Use of
the CAAT/ audit software systems will help the auditor to identify errors and frauds in the
accounting and internal control system.
Conclusion: Frauds are intentional. Auditing through the computer with adequate knowledge of
computer systems may highlight some frauds, but there is no empirical evidence to prove the
assertion that the use of audit software systems has unearthed well concealed frauds.
Thus, it cannot be conclusively said that use of audit software systems increases the probability of
detection of fraud.
Question No. 6
Describe the role of Computer-Assisted Audit Techniques in EDP environment.
Answer
In an EDP environment, the auditor cannot rely on manual techniques only. These days, IT-based
auditing is commonly used to increase audit efficiency. In fact, without the use of today‘s
standard audit programs, full audits of large volumes of data can now be considered prohibitively
inefficient. Such tools can be applied in many audits to improve the speed and accuracy with
which audit findings are generated.
Computer Assisted Audit Techniques (CAATs) play a significant role here. This generic term
covers a range of tools that auditors can use to audit data, programs and more.
There are two of the most common accepted audit techniques namely Audit Software and Test
Data. Audit software consists of computer programs used by the auditor as part of his auditing
procedures, to process data of audit significance from the entity‘s accounting system. Audit
software may consist of package programme, purpose written programs and utility programs. Test
data are used in conducting audit procedures by entering data into the computer system and
comparing the result obtained with pre-determined results.
In EDP environment, CAAT can be used for performing various auditing procedures which
includes:
 Tests of details of transactions and balances
 Analytical review procedures
 Compliance tests of general IT controls
 Compliance test of IT application controls

The auditor may consider the following factors before he uses the CAAT
 Computer knowledge, expertise and experience
 Availability of CAAT and suitable computer facilities
 Impracticability of manual tests
 Effectiveness and efficiency
Question No. 7
Distinguish between Black Box Approach and White Box Approach of Auditing
(4 Marks June 2011)
Answer
In the Black box approach or auditing around the computer, the auditor concentrates on input and
output and ignores the specifics of how computer processes the data or transactions. If input
matches the output, the auditor assumes that the processing of transaction/data must have been
correct. The comparison of inputs and outputs may be done manually with the assistance of the
computer. The computer assisted approach has the advantage of permitting the auditor to make
more comparisons than would be possible, if done manually.
In the White box approach, the processes and controls surrounding the subject are not only subject
to audit but also the processing controls operating over this process are investigated. In order to
help the auditor to gain access to these processes, auditing software may be used. To follow this
approach, the auditor needs to have sufficient knowledge of computers to plan, direct, supervise
and review the work performed. The auditor will also need to be satisfied that there are adequate
controls over the prevention of unauthorized access to the computer and the computerized
database. The auditor‘s task will also involve consideration of the separation of functions between
staff involved in the transaction processing and the computerized system and ensuring that
adequate supervision of personnel is administered.
Question No. 8
Universal (Pvt.) Ltd. is a trading company that imports fast moving consumer goods and
distributes them in Nepal. The company has an IT system where inventories and sales modules
are integrated. The users are provided access to the modules and can log into them using the
individual desktops provided. The company has an IT division and the following information is
provided.
 All goods received and issued are recorded in the inventory module.
 Sales invoices are generated through the system.
 The standard price database is linked to the invoicing function in the sales module.
 Sales prices are picked from the standard price database and these prices cannot be
amended /changed.
 If the quantity invoiced does not match with the sale order quantity, the system provides
an error message.
 The system does not allow raising an invoice if the required quantity of goods is not
available.
Discuss the importance of having information technology (IT) general controls and
application controls for an entity and Identify three (03) IT general controls that the company
should implement in order to ensure continuity of operations. (7 Marks, June 2019)

Answer
Importance of IT general controls and application controls for an entity
Internal controls in IT systems are essential to provide reasonable assurance that IT systems will
function as intended and fulfill their purpose effectively.
General IT controls help to create risk awareness in all IT applications. They are also necessary to
ensure that IT applications are implemented with limited risks (i.e. there will not be any
discontinuation of operations, no unauthorized access etc.)
Application controls are required to check for errors, and report (or automatically correct) errors
that are detected. Since the management wants to ensure data input, processing and output is
accurate and complete, it is essential to have IT application controls.
IT general controls to ensure continuity of operations
 Store extra copies of programs and data files off-site
 Protect equipment against fire and other hazards
 Back-up power sources
 Establish disaster recovery procedures. E.g. availability of back-up computer
facilities
 Have maintenance agreements and insurance

Chapter 12-Fraud and Auditors Liability
Question No. 1
Explain auditor‟s liability in case of unlawful acts or defaults by clients.
Answer
The auditor‘s basic responsibility is to report whether in his opinion the accounts show a true and
fair view and in discharging his responsibility he has to see as to how the particular situations
affected his position. The general thinking with regard to unlawful acts or defaults by clients
appears to be that the auditor should not ―aid or abet‖ but he is apparently not under any legal
obligation to disclose the offense. A professional accountant would himself be guilty of a
criminal offence if he advises his client to commit any criminal offence or helps or encourages in
planning or execution of the same or conceals or destroys evidence to obstruct the course of
public justice or positively assists his client in evading prosecution. A professional accountant in
his capacity as auditor, accountant, or tax representative has access to variety of information
concerning his clients. On some occasions, he may acquire knowledge that his client has been
guilty of some unlawful acts, default, fraud or other criminal offence. The duty of the
professional accountant in such case would depend upon the actual circumstances of the
situation. Due consideration should be given to the exact nature of services that a professional
accountant is rendering to his client, i.e. is he representing the client in income-tax proceedings
or is he acting in the capacity of an auditor or an accountant or a consultant.
It is in the course of the work, he comes across any unlawful acts, it is his duty to bring it to the
notice of the client as also to make a disclosure in his report in appropriate cases. An auditor
cannot disclose confidential information unless permitted by the client or unless required by the
law under the code of ethics. Each case has to be judged on its circumstances. However, in every
case he has to assess the implications of the act or default on the true and fair character of the
accounting statements. Therefore, if an auditor was aware of any unlawful act having been
committed by client in respect of the account audited by him and the unlawfulness was not
rectified by proper disclosure or any other appropriate means, the auditor has a duty to make a
suitable report. If auditor does not report, he may be held liable, if the true and fair character of
the accounts has been vitiated.
The provisions of NSA 250 " Consideration of Laws and Regulations in an Audit of Financial
Statements" must be considered by the auditor for reporting unlawful acts or defaults by clients.
Question No. 2
List steps which an auditor should take to minimize the danger of claims against him for
negligent work. (4 Marks December 2011)
Answer
Negligence, as applied to the auditor, means some act or omission, which occurs because the
auditor has failed to exercise that degree of professional care and skill, appropriate to the

circumstances of the case, which is expected of him. The steps, which an auditor should take to
minimize the danger of claims against him for negligent work, are as follows:
(i) Issue a letter of engagement in which the scope of work and the extent of the
responsibilities undertaken should be clearly set out distinguishing between audit duties
and other services.
(ii) Ensure that the firm‘s standards are continuously reviewed and monitored and that they
meet the minimum requirements set out in the Nepal Standards on Quality Control.
(iii) Carry out audit only after a thorough planning of all the key aspects of the job including
appropriate risk assessments, testing procedures, engagement quality control, reporting
etc.
(iv) Prepare well-documented, comprehensive working papers with cross referencing to the
audit conclusions as a vital means of defense against possible claims.
(v) Ensure that there is appropriate training programme for partners and staff to cope with
current changes in accounting procedures, legislation and auditing practices.
(vi) Seek specialist advice whenever in doubt over complicated issues or recommend to the
client that he should seek such advice himself.
(vii) Obtain management representation on matters material to the financial statements when
another sufficient appropriate audit evidence cannot reasonably be expected to exist.
Question No. 3
Auditor‟s liability in case of unlawful acts or defaults by clients, (8 Marks June 2009)
Answer
The auditor's basic responsibility is to report whether in his opinion the accounts show a true and
fair view and in discharging his responsibility he has to see as to how the particular situations
affected his position. The general thinking with regard to unlawful acts or defaults by clients
appears to be that the auditor should not 'aid or abet' but he is apparently not under any legal
obligation to disclose the offence. A professional accountant would himself be guilty of a
criminal offence if he advises his client to commit any criminal offence or helps or encourages in
planning or execution of the same or conceals or destroys evidence to obstruct the course of
public justice or positively assists his client in evading prosecution. A professional accountant in
his capacity as auditor, accountant, or tax representative has access to a variety of information
concerning his clients. On some occasions, he may acquire knowledge that his client has been
guilty of some unlawful act, default, fraud, or other criminal offence. The duty of the
professional accountant in such a case would depend upon the actual circumstances of the
situation. Due consideration should be given to the exact nature of services that a professional
accountant is rendering to his client, i.e. is he representing the client in income-tax proceedings
or is he acting in the capacity of an auditor or an accountant or a consultant.
The Institute of Chartered Accountants has considered the role of chartered accountants in
relation to taxation frauds by an assessee and has made the following major recommendations:
i) If the fraud relates to past years when the accountant did not represent the client, the client
should be advised to make a disclosure. The accountant should also be careful that the past
fraud does not in any way affect the current tax matters.

ii) In case of fraud relating to accounts examined and reported upon by the professional
accountant himself, he should advise the client to make a complete disclosure. In case the
client refuses to do so, the accountant should inform him that he is entitled to dissociate
himself from the case and that he would make a report to the authorities that the accounts
prepared or examined by him are unreliable on account of certain information obtained later.
In making such a report, the contents of the information as such should not be communicated
unless the client consents in writing.
iii) In case of suppression in current accounts, the client should be asked to make a full
disclosure. If he refuses to do so, the accountant should make a complete reservation in his
report and should not associate himself with the return. However, it can be argued that the
auditor has a professional obligation to ensure that the client is fully aware of the seriousness
of the offence and to seriously consider full disclosure of the matter. It has been clearly
established in various case laws that the auditor is expected to know the contents of
documents and records and ascertain whether the affairs of the client are being conducted in
an unlawful manner. It is in the course of the work, he comes across any unlawful acts, it is
his duty to bring it to the notice of the client as also to make a disclosure in his report in
appropriate cases. In this regard, one has to bear in mind the consequence of the act in
relation to the professional code to which an auditor is subjected. Under the code, an auditor
cannot disclose confidential information unless permitted by the client or unless required by
law. Each case has to be judged on its circumstances. However, in every case he has to assess
the implications of the unlawful act or default on the true and fair character of the accounting
statements. The question of liability of an auditor for unlawful acts or defaults by clients
should be considered in the light of the broad parameters given above. However, it appears
that if an auditor was aware of any unlawful act having been committed by client in respect
of accounts audited by him and the unlawfulness was not rectified by proper disclosure or
any other appropriate means, the auditor owes a duty to make a suitable report. If he does not,
he may be held liable, if the true and fair character of the accounts has been vitiated.
The provisions of NSA 250 " Consideration of Laws and Regulations in an Audit of
Financial Statements" must be considered by the auditor for reporting unlawful acts or
defaults by clients.
Question No. 4
Distinguish between Fraud and Error. (5 Marks December 2010)
Answer
a) The term fraud refers to intentional misrepresentation of financial information by one or more
individuals among management, employees or third parties. Fraud may involve manipulation,
falsification, or alteration of records or documents, or misappropriation of assets like cash
sales may not be accounted for fully, or suppression or omission of the effects of transaction
from records or document or recording of transactions with substance, or misapplication of
accounting policies.
On the other hand, the term error refers to unintentional mistakes or omissions in the financial
information. The error may involve mathematical or clerical mistakes in the underlying
records and accounting data, or oversight or misinterpretation of facts or misapplication of

accounting policies relating to measurement, recognition, classification, presentation or

disclosure.
As mentioned in NSA 240 ―The Auditors responsibility relating to fraud in an audit of
financial statement," the term fraud refers to an intentional act by one or more individuals
among management, those charged with governance, employees, or third parties, involving
the use of deception to obtain an unjust or illegal advantage. Although fraud is a broad legal
concept, the auditor is concerned with fraudulent acts that cause a material misstatement in
the financial statements. On the other hand, The term error refers to an unintentional
misstatement in financial statements, including the omission of an amount or a disclosure,
such as: a mistake in gathering or processing data from which financial statements are
prepared, an incorrect accounting estimate arising from oversight or misinterpretation of facts
and a mistake in the application of accounting principles relating to measurement,
recognition, classification, presentation, or disclosure.
Therefore, the distinguishing factor between fraud and error is whether the underlying action
that results in the misstatement in the financial statements is intentional or unintentional.
Fraud is intentional and usually involves deliberate concealment of the facts where error is
unintentional with no intention to conceal the facts.

Chapter 13 -Audit of Fair Values

Question No. 1
Fair value (5 Marks December 2016)
Answer
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date. Fair value is a market-
based measurement, not an entity specific measurement. For some assets and liabilities,
observable market transactions or market information might be available. For other assets and
liabilities, observable market transactions and market information might not be available.
However, the objective of a fair value measurement in both cases is the same – to estimate the
price at which an orderly transaction to sell the asset or to transfer the liability would take place
between market participants at the measurement date under current market conditions (i.e. an exit
price at the measurement date from the perspective of a market participant that holds the asset or
owes the liability).

Chapter 14-NAS, NFRS and IFRS
Question No. 1
a. NDC Ltd. a Road Construction Co. had incurred a sum of Rs. 8,000.00 as borrowing cost
during the finance year 2001 to 2004 for the construction of Hetauda-Kathmandu BOLT
road. Similarly, the Co. had not claimed a tax benefit of 25% on this cost i.e. Rs. 2,000.00 in
the respective years. During the financial year 2005 the Co. changed its accounting policy
with respect to the treatment of borrowing costs as revenue expenses rather than capitalizing
such cost. The Company has recorded cumulative retained earnings of Rs. 30,000.00 at the
end of financial year 2004 and a current year‟s net profit of Rs. 18,000.00 before interest of
Rs. 3,000.00 and applicable tax thereon. Here, NDC Ltd. is seeking your expertise how to
adjust such changes in the financial statements of finance year 2005.

b. ABC Co. did not adjust the decline in market value of investments, amounting to Rs. 500
million of which cost price is of Rs. 10,000 million, between the balance sheet date and the
date when the financial statements are authorized for issue. Is it necessary to adjust such
changes in the financial statements? Justify.
a. Answer
Nepal Accounting Standards 8: Accounting Policy, Change in Accounting Estimates and Error;
According to Para-14, a change in accounting policy should be made only if required by Nepal
Financial Reporting Standard (NFRS), or if change will result in a more appropriate presentation
of events or transactions in the financial statements of the enterprise.
Para-22 states that the change in accounting policy should be applied retrospectively unless the
amount of any resulting adjustment be reported as an adjustment to the opening balance of
retained earnings. Comparative information should be restated unless it is impracticable to do so.
The following should be noted in the notes to the financial statement of NDC Ltd. for the
preparation of financial statement of Finance year 2005.
During the finance year 2005 the Co. has changed its accounting policy with respect to the
treatment of borrowing costs related to the Hetauda – Kathmandu – BOLT road which is in course
of construction for use by this company. The Co. now expenses rather than capitalizes such costs.
This change in accounting policy has been accounted retrospectively. If it is possible to present a
comparative statement for the year 2004, it has to be reinstated to confirm the changed policy.
In this case, for the financial year 2004, the retained earnings and total interest to this date is
provided and it is not possible to present the comparative statement, as there is no additional
information for profit before interest and taxes and opening retained earnings of financial year
2004. Whereas an adjustment in the financial statement of financial year 2005 is noted in the
notes of the financial statement:

Particulars Rs.
Net profit before interest and taxes 18,000.00
Interest for FY 2005 3,000.00
Cumulative effect on changes in Accounting policies 8,000.00
Profit before taxes 7,000.00
Income Taxes thereon @ 25% (incl. the effects of a change in accounting 750.00
policies)
Net profit 5,250.00
Add: Cumulative profit of FY 2004 30,000.00
Retained Earnings of FY 2005 35,250.00
b. Answer
Nepal Accounting Standards 10: Events after Reporting Period;
According to para-10, an entity shall not adjust the amounts recognized in its financial statements
to reflect non-adjusting events after the reporting period.
Non-adjusting event after the reporting period is a decline in market value of investments between
the reporting date and the date when the financial statements are authorized for issue. The fall in
market value does not normally relates to the condition of the investment at the balance sheet date
but reflects circumstances that have arisen in the following period.
Therefore, an enterprise should not adjust the amounts recognized in its financial statements for
the decline in the value of investments. Similarly, the enterprise should not update the amounts
disclosed for the investments as at the reporting date, although it may need to give additional
disclosure.
As per Para-21 non-adjusting events after the reporting period are of such importance that non-
disclosure would affect the ability of the users of the financial statements to make proper
evaluations and decisions, an enterprise should disclose the following information for each
significant category of non-adjusting event after the reporting period;
- The nature of the event; and
- An estimate of its financial effect, or a statement that such an estimate cannot be made.
Question No. 2
How would you deal the followings?
i. Depreciation on amount equivalent to the revaluation of an assets.
ii. Cost of machinery purchased and installed (including incidental charges) by a
manufacturing company for the purpose of use in research and development
activities. (4 Marks December 2004)
Answer
i. NAS 16 on property, Plant and Equipment:
According to Para-35, when an item of property, plant and equipment is revalued, any
accumulated depreciation at the date of the revaluation is restated proportionately with the
change in the gross carrying amount of the asset so that the carrying amount of the assets
after revaluation equals to its revalued amount or charge the revalued amount of asset
against the revaluation reserve until the reserve is eliminated.

ii. NAS 38 Intangible Assets

Concept: If the research and development activities has succeeded, the cost of R & D is to
be capitalized and to be charged over the life of the product or to be deferred over the life
of the product.
If such research has failed, the cost of the assets is to be written off in the profit and loss
account in the year in which it is incurred.
If any machinery and equipment have been bought specially for the purpose of research
activity, the cost thereof, less the residual value should be appropriately debited to the
Research and Development Account over the period of research.
Question No. 3
Give your opinion as an auditor on the following cases with specific reference to criteria on
which your opinion is based: (5 Marks each December 2005)
a. A state-owned power generating, transmitting and distributing entity provides cash rebates
to its customers if they pay their dues within 7 days after the meter reading days. There will
be no rebate or fines if dues are paid within 8th to 22nd day and after 23rd day to 30th day a
fine of 5% is levied and so on. Income from sale of electricity is accrued once the bills are
raised.
The rebates allowed to customers are accounted for by the entity at the time of payments
against the energy bills by the customers. At the yearend no provision is made in the
accounts towards cash rebate allowed on the payments received in the subsequent year for
bills raised in the year under audit as a consistent practice.
Answer: Criteria used to form an opinion

Definition of accrual basis of accounting, matching concept and point at which the cash rebate
is allowed for revenue recognition.
According to Nepal Accounting Standards-1 Presentation of Financial Statements, an
enterprise should prepare its financial statements, except for cash flow information, under the
accrual basis of accounting. Under the accrual basis of accounting, transactions and events are
recognized when they occur (and not as when cash or its equivalent is received or paid) and
they are recorded in the accounting records and reported in the financial statements of the
periods to which they relate. Expenses are recognized in the income statement on the basis of
a direct association between the costs incurred and the earning of specific items of income
(matching).
As per the accrual basis of accounting, expenses should be recognized when they are incurred
by the enterprise. Similarly, the liabilities or provisions therefore should be recognized when
they occur. As per generally accepted accounting principles, a liability or a provision therefore
accrues when an obligation arises. In the case of cash rebates of the nature explained in the
question, the obligation of the company arises as soon as the customer makes the payment
within stipulated period. As far as ―matching concept‖ is concerned, which is an inherent
aspect of accrual; the expense of cash rebate allowed to the customers for prompt payment is
matched with the saving of interest to the enterprise due to early receipt of payment. This is
because the purpose of allowing cash rebate is to save interest on the monies which helps us
on realization of pending payment form the customers before the end of the stipulated period.

Opinion:
On the basis of the above criteria, it can said that the practice followed by the entity to account
for cash rebate for prompt payment, on settlement of bills by the customers, is in compliance
with the requirement of accrual basis of accounting and there is no need for making provisions
in the year –end accounts.
b. You are asked by your audit client to sign on a cheque leaving five cheques to be
prepared for payment to contractors who are erecting transformer but yet to be
transported to the site due to flushing out of the road, while taking cut-off at the year-
end.
Answer: Criteria used to form an opinion:

Accounting is a continuous process because the business never comes to halt. It is therefore
necessary that transactions of one period would be separated from those in the ensuring period
so that the results of the working of each period can be easily ascertained. The arrangement
that is made for this purpose is known as ―cut-off arrangement‖.
Also, as per Nepal Accounting Standards 1 – Presentation of Financial Statements, an
enterprise should prepare its financial statements, except for cash flow information; under the
accrual basis of accounting. Under the accrual basis of accounting, transactions and events are
recognized when they occur (and not as cash or its equivalent is received or paid) and they are
recorded in the accounting records and reported in the financial statements of the period to
which they relate.
Opinion
On the basis of above discussion, it is important to note that the very purpose of cutoff
procedure is to ensure that transactions are recorded under accrual basis. Hence, leaving few
cheques to be prepared for accounting the payment of work which has not been completed is
against the generally accepted accounting practices. So, the auditor should not agree for
signing the cheques leaving five cheques to be prepared for payment of contractors who are
erecting transformer but yet to be transported to the site due to flushing out of the road, while
taking cut-off at the year-end.
c. The company collects the dues in respect of sale of its products from its buyers through
cheques by post/ in person/ courier in addition to cash collected through deputation of its
representatives. At the yearend for 2061/62, the cheques bearing date 31st Ashad2062 or
before, though received and realized in the month of Shrawan 2062 are accounted for as
"cheques in hand" and presented in the financial statements of 2061/62.
Answer: Criteria used to form an opinion:
The periodicity concepts, events after the reporting period and definition of asset as provided
in the conceptual framework for the preparation and presentation of financial statements.
According to periodicity concept, an event or transaction that occur or replace to the
accounting period for which the financial statements are prepared shall be recorded in the
accounts for the period. Thus, where the accounting period ends on 31stAshad 2061 should be
reflected in the financial statements as of that date. Events occurring after the balance sheet
date should be incorporated as of that date. Events occurring after the balance sheet date
should be incorporated in the financial statements only where they assist the estimation of
amounts relating to conditions existing at the balance sheet date. Therefore, cheques that are

received after the balance sheet date should be accounted for in the period in which they are
received even though the same may be dated 31stAshad 2061 or before.
Further, according to definition given in the framework for preparation and presentation of
financial statements of Nepal Accounting Standards, an asset is a resource controlled by the
enterprise as a result of past events and from which future economic benefits are expected to
flow to the enterprise. Thus, cheques, which are not in possession or in possession of its
representatives on the balance sheet date, cannot be termed as its assets as it has no control
over the cheques on that date. Cheque in hand should be the cheques that are in the possession
of the company so that it has power to use or direct the use of those cheques for its purposes
on the balance sheet date.
Opinion
The practice followed by the company to recognize the cheques bearing the date of 31stAshad
2062 or before, though received and realized after that date as ―cheques in hand‖ in the
financial statements of 2061/62 is not correct.
The acceptable practice would be to recognize such cheques only when these are received by
the company or its representative, i.e. 2062/2063, irrespective of the date borne by the
cheques.
d. A company wants to adjust the bank balance on the balance sheet date by reversing
the entry for a cheque issued in the normal course of business and cancelled after the
year end but before the finalization of accounts. The cheque was returned on the
ground that the signature differs.
Answer: According to NAS-10: Events Occurring After the Reporting period, assets and
liabilities should be adjusted for significant events occurring after the reporting date that
provide additional evidence to make estimation of amounts relating to conditions existing
at the end of reporting period. Since the difference in signature existed at the end of
reporting date even though it is known after the reporting period, the reversal of the entry
can be made as on the reporting date if the amount is material.
Question No. 4
Answer:
NAS-1 & NSA-570(Revised)
The following are examples of factors, which might cast doubt on the going-concern status of a
company:
- Internal matters such as loss of key management, labor difficulties or excessive
dependence upon a few product lines when the market is depressed.
- External matters such as loss of key suppliers or customers or technical developments,
which render a key product obsolete.
- An excess of liabilities over assets.
- Default on terms of loan agreements.
- Significant liquidity or cash flow problems.
- Major litigation in which an adverse judgement would imperil the company‘s
- Denial of normal terms of credit by suppliers.

- Major debt repayment falling due where refinancing is necessary to the company‘s
Question No. 5
How will you distinguish a change in an accounting estimate from a change in the accounting
policy? Does a change in an accounting estimate need any disclosure? (6 Marks December
2005)
Answer:
NAS-8: Accounting Policy, Change in Accounting Estimates and Error;
A change in an accounting estimate is different from a change in the accounting policy. The
former is a routine matter in accounting, which is substantially based on estimates. An estimate is
made on the basis of facts and circumstances known at the time of making of the estimates. For
example, an estimate of bad debts is made on the basis of information in possession at the time of
making the estimate. This may change on receipt of further information at subsequent date, e.g.
insolvency of a debtor known afterwards. On the other hand, a change in accounting policy is far
less frequent and amounts to almost a permanent change in the basis of accounting in the
concerned area. For example, the accounting policy for changing depreciation may be changed
from straight – line method to written down value method or the research costs may be charged
off in the year itself, instead of being deferred as practiced previously.
Usually a change in the accounting policy has a far reaching, material and long-term effect. The
accounting picture may get substantially altered by the change in the policy, which normally does
not occur in the case with the change in accounting estimates. However, sometimes a change in
accounting estimate may have material effect on the income trend of the enterprise and in that
circumstances, there is needed to separately disclose the change and its effect on the accounts. For
example, in the case where a significantly large proportion of debtors is proved bad in the
subsequent year than it was originally estimated, then there may arise a need for separate
disclosure.
Question No. 6
Comment and give your opinion as an auditor on the following issues:
a) XYZ & Co. Ltd., a company engaged in plantation activities, raising of teak and other
forestry operations. Normally a teak tree takes 10 years to grow. In order to carry these
plantation activities till the tree is fully grown and ready for sale, the company incurred
expenditure on maintaining them and also paying lease rent to the landowners. The
company decided to treat all these costs of planting, its subsequent maintenance and lease
rent as capital expenditures and treat as long term capital receipts.
Answer:
Plantation of timber can be disclosed as "Work in progress" under "Current Assets" till it
attains maturity because the process of development of plantation from the seeding stage to
the maturity stage takes almost 10 years‘ time. Thus, the expenditure incurred in planting and
maintaining the trees cannot be treated as capital expenditure, and the timber cannot be
classified as "Fixed Assets". The plantation of Work in progress may be valued at the lower of
estimated selling price in the ordinary course of business less estimated cost to be incurred in
future for bringing the plantation to use, and the cost necessarily to be incurred in order to
make the sale. The cost of Work in progress would include all expenses for raising timber
incurred till the valuation date. The operation of the company is such that the entire plantation

of trees is going to be sold off in the year in which it would reach a maturity stage i.e. when
the trees are ready for sale. Therefore, the expenditure incurred in planting and maintaining
the trees cannot be treated as capital expenditure nor the growing timber can be classified as
Fixed Assets. Thus, the timber plantation should be disclosed as "Work in Progress" under the
head "Current Assets". However, the valuation of timber should be done at lower of cost or
net realizable value as per NAS-2, Inventories, till it attains maturity.
b) Included under Current Assets of XYZ Ltd. is inventory aggregating to Rs. 20 crores. A part
of the said inventory manufactured for export had to be sold earlier at a discounted price
offshore due to moisture content present at the time of delivery. A part of similar inventory
is included in current year's inventory balance.
Answer: A part of the inventory exported earlier had to be sold at a discounted price offshore
due to moisture content present at the time of delivery. The auditor will, therefore, have to
examine what part of the inventory is included in the inventory valued at Rs. 20 crores, a part
of which had been exported at a discounted price. He will also have to satisfy himself that
whether such part left with the company has also been damaged on account of moisture
content. If required, the auditor may obtain a certificate from an expert about the condition of
the inventory. Thereafter, it should be verified whether the principle of valuation enunciated in
NAS – 2 "Inventories" have been followed in such a case. The standard requires that the
inventories should be measured at the lower of cost and net realizable value. Accordingly,
such part of inventory which is damaged should be valued at estimated realizable value if the
same is lower than the cost. It may, however, be noted that inventories are usually written
down to net realizable value on an item-by-item basis. In some circumstances, however, it
may be appropriate to group similar or related items. This may be case with items of inventory
relating to the same product line that have similar purposes or end uses and are produced and
marketed in the same geographical area and cannot be practicably evaluated separately from
other items in that product line. It is not appropriate to write down inventories based on a
classification of inventory. Thus, the auditor should ensure that such damaged inventories
have been valued accordingly.
c) Everest Construction Ltd. commenced construction of a flyover in Rolpa in Shrawan 2061

under BOLT scheme. The same was completed in Poush 2062. Due to seasonal heavy rains
in Mangsir 2062 in the area, the work on the flyover had to be suspended for 1 month. The
company accordingly suspended borrowing costs of Rs. 1 million for that month from
capitalization.
Answer: Borrowing costs may be incurred during an extended period in which the activities
necessary to prepare an asset for intended use or sale are interrupted. According to NAS-23,
"Borrowing Costs", capitalization of such borrowing costs should be suspended during
extended periods in which active development is interrupted. The standard, however, clarifies
that capitalization of borrowing costs is not suspended when a temporary delay is necessary as
a part of the process or substantial technical and administrative work is being carried out.
Thus, the test as to whether or not to capitalize the borrowing costs depends primarily upon
the nature of interruption of activities during "extended periods".
In the instant case, it has been mentioned that the construction activity was interrupted due to
seasonal rain and hence is a regular feature. Though the rain was heavy, the period cannot be
considered as an "extended period" leading to substantial delay in suspension of construction
activities. Therefore, borrowing cost of Rs.1 million incurred by Everest Construction Ltd.

should be capitalized. Hence suspension of capitalization by the company is not a correct

treatment and statutory auditor should report accordingly.
d) The books of accounts of Sincere Ltd. show huge differences between the control accounts
and subsidiary records. The Finance Manager informs that this is common due to huge
volume of business done by the company during the year.
Answer
Difference between Control Accounts and Subsidiary Records: The huge differences found
between control accounts and subsidiary records in the books of Sincere Ltd. indicate that
there may be material misstatements requiring detailed examination by the auditor to ascertain
the cause. The contention of Finance Manager cannot be accepted simply because the
company has done huge volume of business. Such a phenomenon indicates that recording of
transactions is not being done properly or the accounting system in the company, which might
have several branches spread over the country, fails to capture all transactions in time. It
would also be interesting to see whether it is a recurring phenomenon, or such reconciliation
could not be done at a subsequent date. Having regard to all these circumstances it appears
from the facts of the case that these differences indicate the possibility of some kind of
material misstatements. As per NSA 240, "The Auditor's Responsibility to Consider Fraud and
Error in an audit of Financial Statements" when the auditor encounters circumstances that
there is material misstatement, the auditor should perform procedures to determine whether
the financial statements are materially misstated. If as a result of such examination the auditor
comes across any material information involving fraud or gross irregularity, the same shall be
reported by him appropriately.
Question No. 7
How will you distinguish a change in an accounting estimate from a change in the accounting
policy? Does a change in an accounting estimate need any disclosure?
Answer
According to NAS-8Accounting Policies, change in Accounting Estimates and error. The former is
a routine matter in accounting which is substantially based on estimates. An estimate is made on
the basis of facts and circumstances known at the time of making of the estimates. For example,
an estimate of bad debts is made on the basis of information in possession at the time of making
the estimate. This may change on receipt of further information at subsequent date, e.g.,
insolvency of a debtor known afterwards. On the other hand, a change in accounting policy is far
less frequent and amounts to almost a permanent change in the basis of accounting in the
concerned area. For example, the accounting policy for changing depreciation may be changed
from straight-line method to written down value method or the research costs may be charged off
in the year itself, instead of being deferred as practiced previously.
accounting picture may get substantially altered by the change in the policy, which normally is
not the case with the change in accounting estimates. However, sometimes a change in accounting
estimate may have material effect on the income tread of the enterprise and in those
circumstances, there is a need to separately disclose the change and its effect on the accounts. For

example, in the case where a significantly large proportion of debtors prove bad in the subsequent
year than it was originally estimated, there arise a need for separate disclosure.
Question No. 8
Define "Related Parties" and "Related Party Transactions". Explain Auditor's special
consideration and responsibility on "Transactions with Related Parties".
Answer
According to NAS-24, Related Party Disclosures,
a. Related Parties: parties are considered to be related if one party has the ability to control
the other party or exercise significant influence over other party in making financial and
operating decisions.
b. Related Party Transaction: A transfer of resources or obligations between related

parties, regardless of whether a price is charged is regarded as related party transactions.
The auditor should review information provided by directors and management for identifying
related party transactions and he/she should be alert for other material related party transactions.
When obtaining an understanding of the accounting and internal control systems and making
preliminary assessment of control risk, the auditor should consider the adequacy of control
procedures over the authorization and recording of related party transactions.
Question No. 9
Distinguish between Permanent and Timing Differences (5 Marks December 2006)
Answer
NAS-12: Income Taxes;
Tax on income is one of the significant items in the statement of profit and loss of an enterprise.
In accordance with the matching concept, taxes on income are accrued in the same period as the
revenue and expenses to which they relate. Matching of such taxes against revenue for a period
possess special problems arising from the fact that in a number of cases; taxable income may be
significantly different form the accounting income. This divergence between taxable income and
accounting income arises due to two reasons:
First, there are differences between items of revenue and expenses as appearing in the statement
of profit and loss and the items, which are considered as revenue, expenses or deductions for tax
purposes i.e. permanent difference. Such permanent differences are the difference between
taxable income and accounting income for a period that originate in one period and do not reverse
subsequently.
Second, there are differences between the amount in respect of a particular item of revenue or
expenses as recognized in the statement of profit and loss and the corresponding amount, which is
recognized for the computation of taxable income, i.e. timing difference. Such timing differences
are those differences between taxable income and accounting income for a period that originate in
one period and are capable of reversal in one or more subsequent periods.

Question No. 10
which your opinion is based. (5 Marks each December 2007)
a) M/s XYZ Ltd. acquired a fixed asset at the beginning of the year by an integral foreign
operation for FC 540,000 (FC= foreign currency) when the exchange rate of one
reporting currency (RC) was FC 10. The asset has an expected useful life of 5 years and
zero residual value. For tax purposes, the asset is written off over 3 years. The exchange
rate at the end of the financial year is RC 1 =FC 8. The chief accountant of the
company argued that there is no need to show any temporary difference in the financial
statements. Do you agree?
Answer: As per NAS-21 ―The effect of changes in foreign Exchange rates‖ and NAS-12
―Income taxes‖, the view of the chief accountant of M/s XYZ Ltd. is not correct.
A fixed asset was acquired at the beginning of the year by an integral foreign operation for FC
540,000 (FC foreign currency) when the exchange rate of one reporting currency (RC) =
FC10. The asset has an expected useful life of 5 years and zero residual value. For tax
purposes, the asset is written off over 3 years. The exchange rate at the end of the year is RC 1
=FC 8. At the end of the financial year, the temporary difference in the respective enterprise‘s
financial statements would be as follows:
Foreign Enterprise Reporting Enterprise
FC RC
Carrying Amount:
Cost 540,000/- 54,000/-
Accumulated depreciation (108,000/-) (10,800/-)
Net Book Value 432,000/- 43,200/-
Tax Base:
Cost 540,000/-
Tax depreciation (180,000/-)

360,000/- @ FC=8 45,000/-
Temporary Difference 72,000/- (1,800/-)
The tax base is measured at the year-end rate because this rate gives the best measure of the
reporting currency amount that will be deductible in future periods.
A taxable temporary difference arises in the foreign enterprise, but a deductible temporary
difference arises in the reporting enterprise. This is because, following the change in the
exchange rate from FC10 to FC 8, the foreign currency revenue required to recover the
reporting currency carrying amount of the assets is RC 43,200 * 8= FC 345,600/-, but the tax
basis of the assets remains at FC 360,000/-, This difference of FC 14,400 @ 8= RC 1,800)
gives rise to a deductible temporary difference for which a deferred tax asset should be
recognized in the financial statement of the reporting enterprise. The difference may also be

viewed as the acquisition price multiplied by the relative change in exchange rates since
acquisition. In this example, it would be 20 % of RC 54,000/- (i.e. RC 10,800).
b) The land, building and certain items of plant and machinery of an enterprise have been
revalued upward on the basis of an appraisal carried out by an independent and qualified
firm of architect. The enterprise also possesses certain obsolete items of plant and
machinery, the realizable value of which is much less than their book value. The
management insists on showing such plant and machinery at its book value while showing
land, buildings and other items of plants and machinery at the revalued amount.
Answer: According to NAS-16 ―Property, Plant and Equipment‖, when an item of property,
plant and equipment is revalued, the entire class of property, plant and equipment to which
that asset belongs should be revalued and when an asset's carrying amount is decreased as a
result of a revaluation, the decrease should be recognized as an expense but a revaluation
decrease should be charged directly against any related revaluation surplus to the extent that
the decrease does not exceed the amount held in the revaluation surplus in respect of that same
asset. Therefore, the obsolete plant and machinery should also have been revalued and written
down suitably by charging the amount of decrease as an expense in the income statement.
In the given case if the management does not show such plant and machinery at the revalued
amount which is less than its book value while showing other items of plants and machinery at
the revalued amount, a suitable qualification should be made in the report. It should also be
borne in mind that the revaluation of a class of assets should not result in the net book value of
that class being greater than its recoverable amount.
c) The company purchased a pollution controlling machinery for which the government has
announced 50% rebate in custom duty. As per the government's policy the machinery shall
be used at-least five years. Your client has credited 50% rebate provided to Income for the
year by disclosing the same in Notes to Financial Statement.
Answer: As per NAS-20 ―Accounting for Government Grants and Disclosure of Government
Assistance‖, Government grants should be recognized as income over the periods necessary to
match them with the related costs which they are intended to compensate, on a systematic
basis and should not be credited directly to shareholders‘ interest. Government grants related
to assets, including non-monetary grants at fair value, should be presented in the balance sheet
either by setting up the grant as deferred income or by deducting the grant in arriving at the
carrying amount of the asset. According to the first method, government grant is accounted as
deferred income which is recognized as income on a systematic and rational basis over the
useful life of the asset.
Whereas, according to the second method, government grant is deducted in arriving at the
carrying amount of the asset and the grant is recognized as income over the life of a
depreciable asset by way of a reduced depreciation charge. Income recognition of government
grants on a receipts basis is not in accordance with the accrual accounting assumption and
would only be acceptable if no basis existed for allocating a grant to periods other than the one
in which it was received.
Thus, as per the requirement of NAS-20, it is wrong to credit whole of the rebate received in
the year of purchase of machinery as there is a condition put forth by the government on the

company to use the machinery at-least for the 5 years. Hence, 50% rebate received on custom
duty shall be credited to income statement at-least over a 5 years' period.
Question No. 11
How do you treat the cost of internally developed software into the books of accounts?
Answer
Cost directly attributable to internally developed software can be recognized as an intangible
asset, if it meets the criteria laid down in NAS 38 on Intangible Assets for recognition. As per
Para 21 of NAS 838an intangible assets shall be recognized if and only if,
i) it is probable that the expected future economic benefit that are attributable to the
asset will flow to the entity; and
ii) the cost of the asset can be measured reliably.
According to Para 22, an entity shall assess the probability of expected future economic benefits
using reasonable and supportable assumption that represent management‘s best estimate of the set
of economic conditions that will exist over the useful life of the assets.
Hence if the cost can be reliably ascertained, the cost can be recognized, provided its useful life
carries on for more than a year If it is for sale to others then it must be treated as part of the
inventory.
Question No. 12
Distinguish between Permanent and Timing Difference. (5 Marks December 2007)
Answer
As per NAS-12: Income taxes;
There is a divergence between tax profit and accounting profit which arises due to the fact that the
amount of certain items of revenues and expense as appearing in the profit and loss account differ
from those considered as revenue, expense or deductions for tax purposes. The differences
between tax profit and accounting profit can be classified into „permanent differences‟ and
timing difference‟.
Permanent differences are the differences between taxable income and accounting income for a
period that originate in the current period and do not reverse in subsequent periods. For instance,
under many systems of taxation some donations are not an allowable deduction in determining
taxable income, however, such amounts would be deducted in determining accounting income.
Differences such as these are described as ‗permanent differences.‘
Timing difference are the difference between the taxable income and accounting income for a
period that arise because the period in which some items of revenue and expenses are included in
taxable income does not coincide with the period in which they are included in accounting
income. Timing differences originate in one period and reverse in one or more subsequent
periods. For instance, accounting policies may specify that certain revenues are included in
accounting income at the time goods or services are delivered but tax rules may require or allow
their inclusion at the time cash is collected. The total of these revenues included in accounting
income will differ. Another example is when the depreciation rate used in determining income
differs from that used in determining accounting income. These types of difference are described
as ‗timing difference‘.

Question 13
which your opinion is based. (5 Marks each June 2008)
a) M/s XYZ Ltd. wishes to bring new advancement in the manufacturing process. In order to
meet its requirement, M/s XYZ Ltd. entered into a contract with M/s ABC Ltd., a UK based
company for collaboration to acquire know-how for both manufacturing process and design,
drawing of the factory at the cost of Rs. 900 Lakhs. Design and drawing cost cover 80
percent of the total collaboration contract. Ms. Shivani, Chief Finance Officer of M/s XYZ
Ltd. capitalized the cost of design and drawing with factory building and cost of
manufacturing process with the cost of machinery.
Answer: The know-how in general is recorded in the books only when some consideration in
money or money‘s worth has been paid for it. There are generally two types of Know-how:
(i) Relating to manufacturing process; and

(ii) Relating to plans, designs and drawing of buildings or plant and machinery.
Know-how related to plans, designs and drawings of buildings or plant and machinery is
capitalized under the relevant asset‘s heads. In such cases, depreciation is calculated on the
total cost of those assets, including the cost of the know-how capitalized. Know-how related to
manufacturing processes is usually expenses in the year in which it is incurred. M/s XYZ Ltd.
should have capitalized know-how related to plant's design and drawings of factory building or
plant and machinery, under the respective asset heads. It should be ensured that such cost has
been capitalized under the relevant asset head only. Depreciation should have been calculated
on the total cost of those assets, including cost of know-how capitalized.
Furthermore, know- how expenses relating to manufacturing process should have been treated
as an expense in the year in which it was incurred. Therefore, capitalizing cost of
manufacturing process with the cost of machinery is not proper.
b) A Company had imported raw material worth US $ 5,00,000 on 25thBaisakh 2065 when the
exchange rate was Rs 62 per US Dollar. The company had recorded the transaction at that
rate. The payment for the import was made on 20thJestha 2065 when the exchange rate was
Rs 65 per US Dollar. However, on 32ndAshadh 2065 the rate of exchange was Rs 66 per US
Dollar. The company passed the entry on 32ndAshadh 2065 adjusting the cost of raw
materials consumed for the difference between Rs. 62 and Rs. 65 per US Dollar.
Answer: As per NAS 21, ―The effects of changes in foreign exchange rates‖, monetary items
denominated in a foreign currency ( for example foreign currency notes, balances in bank
accounts denominated in foreign currency, and receivables, payables and loans denominated in
a foreign currency) should be reported using the closing rates. However, in certain
circumstances the closing rate may not reflect with reasonable accuracy the amount in
reporting currency that is likely to be realized from, or required to be disbursed, a foreign
currency monetary item at the balance sheet date, e.g., where there are restrictions on
remittances or where the closing rate is unrealistic and it is not possible to effect an exchange

of currencies at that rate at the balance sheet date. In such circumstances, the relevant monetary
item should be reported to the reporting currency at the amount, which is likely to be realized
from, or required to disburse, such item at the balance sheet date. Sundry creditors are
monetary items. The NAS requires that on every balance sheet date, monetary items
denominated in foreign currency should be reported using the closing rate. In the instant case,
having regard to the fact that the inventory is not the monetary item, it should not be restated at
the closing rate.
NAS also states that effect of changes in foreign exchange rates shall be recognized as income
or loss. Thus, the treatment given by the company by restating the consumption account is
wrong. The difference between the inventory recorded at Rs.62 per dollar and payment of
respective liability at Rs.65 per dollar shall be charged off as exchange loss. If the same is not
rectified the auditor would have to consider modifying his report stating that NAS 21
requirements were not followed.
c) X Ltd. entered into a contract with Y Ltd. to dispatch goods worth Rs. 10 Lakhs every month
for six months upon receipt of entire payment on 1st Baishakh 2064. Y Ltd. accordingly made
the payment. In third month due to natural calamity, Y Ltd. requested X Ltd. not to dispatch
until the further notice. No such notice was sent till the accounts are finalized for 2063/064.
X Ltd. accounted Rs. 20 Lakhs as sales and transferred the balance to advance received
against sales.
Answer: As per NAS 18 ―Revenue‖, revenue from the sale of goods should be recognized
when all the following conditions have been satisfied;
a. The enterprise has transferred to the buyer the significant risks and rewards of
ownership of the goods;
b. The enterprise retains neither continuing managerial involvement to the degree
usually associated with ownership nor effective control over the goods sold;
c. The amount of revenue can be measured reliably;
d. It is probable that the economic benefits associated with the transaction will flow to
the enterprise; and
e. The costs incurred or to be incurred in respect of the transaction can be measured
reliably.
In this case, although conditions mentioned in iii & iv are fulfilled (full consideration was
received), it does not fully comply with conditions mentioned in i& ii (significant risks are not
transferred as goods were not relocated and X Ltd retains ownership and effective control over
the goods for which Y Ltd has paid for). If postponement of delivery schedule can be made or
allowed by the terms of the contract, the treatment given by X Ltd is correct.
d) M/s Sungava Manufacturing Co. Ltd. was making provision for nonmoving stocks based
on no issue for the past one-year upto FY 2062/63. The company hired a technical
consultant Mr. John. Mr. John submitted his technical evaluation report. As per
technical report, provision is required to be made for Rs. 4 Lakhs. The company wishes
to provide provision based on technical evaluation during the year 2063/64 instead of
provision required based on past one year.
Total Value of Stock Rs. 200 Lakhs

Provisions required based on past one-year basis Rs. 5 Lakhs

Provision required based on technical evaluation Rs. 4 Lakhs
Does this amount to change in accounting policy? Can M/s Sungava change the
method of provision?
Answer: The decision of making provision for non-moving stocks on the basis of technical
evaluation does not amount to change in accounting policy. Accounting policy of a company
may require that provision for non-moving stocks should be made. The method of estimating the
amount of provision may be changed in case a more prudent estimate can be made in line with
NAS-8. It‘s a change in estimate not an accounting policy as per NAS-8.
In the given case, the change in the amount of required provision of non-moving stock from Rs.5
Lakhs to Rs.4 Lakhs is also not material as there is difference of Rs.1 Lakh only. The disclosure
can be made for such change in the following lines by way of notes to the accounts in financial
statements for the FY 2063/64 without qualifying the report.
"The company has provided for non-moving stocks on the basis of estimate made by technical
expert unlike preceding years on which provision used to be made on period of non-moving. Had
the same method been followed as in the previous year, the profit for the year and the
corresponding effect on the year end net assets would have been higher by Rs. 1 Lakh‖.
Question No. 14
Liquidity sold some of its assets to M/s XYZ Ltd, a leasing company. M/s ABC Co. Ltd. leased
back the same assets from M/s XYZ Co. Ltd. In the notes to accounts, the Company stated,
“Assets taken on lease which is repayable in 96 installments of Rs.2,00,000 each." Comment as
an auditor of M/s ABC Company Ltd. (6 Marks June 2008)
Answer
NAS-17: Lease;
Sale and lease back of Transaction;
Under a lease agreement, the lessee acquires the right to use an asset for an agreed period of time
in consideration for payment of rent to the lessor. The legal ownership of the assets remains with
the lessor. In the instant case, the company sold assets to leasing company to meet its liquidity
crisis and took them back on lease. In the notes to the accounts it disclosed about installments
payable to leasing company, but without disclosing the true nature of the transaction. The
transaction entered into by the company is a classic case of sale and leaseback transaction. In
case of such transaction, the sale price of assets and lease rentals normally do not represent fair
value since the same are negotiated as a package.
In case such a transaction is an operating lease and rentals and sale price are established at fair
value, then in effect it is a normal sale transaction and any profit or loss is normally recognized
immediately. If the sale price is below fair value, any profit or loss is recognized immediately,
except that, if the loss is compensated by future rentals at below market price, it is deferred and
amortized in proportion to the rental payments over the useful life of the asset. If the sale price is
above fair value, the excess over fair value is deferred and amortized over the useful life of asset.

Therefore, it would be important for the auditor to determine whether the number of installments
payable is fair having regard to sale price of asset.
In case the leaseback is a finance lease, it is not appropriate to regard an excess of sale proceeds
over the carrying amount as income. Such excess is deferred and amortized over the lease term in
proportion to the depreciation of the leased asset. Similarly, it is not appropriate to regard a
deficiency as loss. Such deficiency is deferred and amortized over the lease term. Further,
disclosure shall have to be made separately of such transaction.
The auditor should, therefore, suitably qualify his report since proper disclosures have not been
made as per the requirements of Nepal Accounting Standards 17 on Leases.
Question No. 15
which your opinion is based. (5 Marks each December 2008)
a) M/s ABC TV Ltd. purchased raw material at Rs. 500/- per piece for component “A”. The
price of such component “A” which is used for production of TV is on decreasing trend the
decline. The TV market is very competitive in the country as a result the finished goods i.e.
TV in which the raw material is installed is expected to be sold at below cost. There is a stock
of 5,000 pieces of such component “A” in the stock at the year end. The replacement cost is
Rs. 400/- per piece. The Chief Accountant booked the value of stock of such component “A”
at Rs. 500/- per piece amounting to Rs. 25,00,000/-.
Answer:
As per Para-9 of NAS-2 Inventories (either FG or WIP or RM) should be measured as lower of
cost or net realizable value (NRV). So, as per of NAS 02 on Valuation of Inventories, materials
and other supplies held for use in the production of inventories are not written down below cost
if the finished product in which they will be incorporated are expected to be sold at or above
cost. However, when there has been a decline in the price of materials and it is estimated that
the cost of the finished products will exceed net realizable value, the materials are written
down to net realizable value. In such circumstances, the replacement cost of the materials may
be the best available measure of their net realizable value.
In view of above, in the given case, the stock of 5,000 pieces of component ‗A‘ will be valued
at Rs. 400/- per piece which is Rs. 20,00,000/- in total value of component ‗A‘. The finished
goods i.e. TV, if on stock, should be valued at cost or net realizable value whichever is lower.
Therefore, the valuation of the component ‗A‘ done by Chief Accountant is not correct.
b) The Management of ABC Ltd. tells you that the work in process is not valued since it is
difficult to ascertain the same in view of multiple processes involved and in any case the
value of opening and closing work in process would be more or less the same.
Answer:
As per NAS-2, inventories also include those assets which are in the process of production for
sale in the ordinary course of business apart from the finished goods and those materials or
supplies to be consumed in the production process or in the rendering of services. It is, thus,
necessary for a company to ensure that each and every component of inventory is valued
properly. The argument given by the company that it is difficult to ascertain the same in view
of the multiple processes involved is not acceptable.

The argument that the opening and closing work-in –process would be more or less the same is
also not justified because the omission of those would lead to distortion in true and fair view.
Further, cost incurred for raw materials and the overheads would normally be different and
would give rise to different value of opening and closing stocks. Therefore, in view of the
above, the auditor shall have to qualify the audit report in case the work-in-process is not
valued and shown in the financial statements.
Question No. 16
a. Human Resource Accounting (General Theory) (4 Marks December 2005)

Answer:
Human resource is perhaps the most valuable asset in an undertaking. Flamholtz defines
human resource as ―accounting for people as an organizational resource. It involves
measuring the costs incurred by the business firm and other organizations to recruit, select,
hire, train and develop human assets. It also includes measuring the economic value of people
of organizations‖.
This definition gives two methods of valuing human resources, i.e. cost and economic value.
A company may value its human resources on the cost basis, i.e. at the costs incurred by it in
procuring and developing these assets. Another method is to work out the replacement values
of persons, representing the economic value. According to Flamholtz, an individual possesses
value for an organization because he is capable of rendering future services. Theoretically,
therefore, his value to an organization is equal to the present worth of his expected future
services. Thus, an individual‘s value to an organization can be defined as the present worth of
the set of future services that the person is expected to provide during the period he is
anticipated to remain in the organization. In this connection, putting a monetary value on
human resources presents a lot of practical problems particularly from the auditor‘s viewpoint
because of element of subjectivity is inherent in the process of such valuation.
b. Cash and Cash Equivalents (4 Marks December 2006)

NAS 7 on "Statements of cash flows" deals with the provision of information about the
historical changes in cash and cash equivalents of an enterprise by means of a cash flow
statement which classifies cash flows during the period for operating, investing and financing
activities. Users of an enterprise's financial statements are interested in how the enterprise
generates and uses cash and cash equivalents. Enterprises need cash for essentially the same
reasons, however different their principal revenue-producing activities might be. They need
cash to conduct their operations, to pay their obligations, and to provide returns to their
investors. According to NAS-7―Cash Flow Statements‖, Cash comprises cash and demand
deposits and Cash equivalents comprises short term, highly liquid investments that are readily
convertible into known amounts of cash and which are subject to insignificant risk of change
in value.
Cash equivalents are held for the purpose of meeting short-term cash commitments rather
than for investment or other purposes. For an investment to qualify as a cash equivalent, it
must be readily convertible to a known amount of cash and be subject to an insignificant risk
of changes in value.

Therefore, an investment normally qualities as a cash equivalent only when it has a short
maturity of, say, three months or less form the date of acquisition. Equity investments are
excluded from cash equivalents, unless they are, in substance, cash equivalents; for example,
preference shares of a company acquired within a short period of their maturity and with a
specified redemption date.
Cash flows excluded movements between items that constitute cash or cash equivalents
because these components are part of the cash management of an enterprise rather than part
of its operating, investing and financing activities. Cash management includes the investment
of excess cash in cash equivalents.
An enterprise should disclose the components of cash and cash equivalents and should
present a reconciliation of the amounts in its cash flow statement with the equivalent items
reported in the balance sheet.
c. Contingent Assets (4 Marks December 2006)
According to NAS-37―Provisions, Contingent Liabilities and Contingent Assets‖, A
contingent asset is a possible asset 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 enterprise.
An enterprise should not recognize a contingent asset. Contingent assets usually arise from
unplanned or other unexpected events that give rise to the possibility of an inflow of
economic benefits to the enterprise. An example is a claim that an enterprise is pursuing
through legal processes, where the outcome is uncertain.
Contingent assets are not recognized in financial statements since this may result in the
recognition of income that may never be realized. However, when the realization of income is
virtually certain, then the related asset is not a contingent asset and its recognition is
appropriate.
A contingent asset is disclosed, where an inflow of economic benefits is probable.
Contingent assets are assessed continually to ensure that developments are appropriately
reflected in the financial statements. If it has become virtually certain that an inflow of
economic benefits will arise, the asset and the related income are recognized in the financial
statements of the period in which the change occurs.
d. Condensed financial statement (4 Marks December 2009)
Financial statements presented in considerably less details than complete financial statements
that are intended to present financial position, results of operations, and changes in financial
position in conformity with generally accepted accounting principles. For this reason, the
condensed financial statement should be read in conjunction with the entity's most recent
complete financial statements that include all the disclosures that are required by the
generally accepted accounting principles.
An auditor might be required to report on condensed financial statement. In such a case, the
auditor should not report on the condensed financial statement in the same manner as s/he
reported on the completed financial statement from which they are derived. To do so might

lead users to assume erroneously that all the condensed financial statements include all the
disclosures necessary for the complete financial statement.
e. Concept of Prudence (4 Marks June 2010)
Prudence is one of the major considerations in developing and applying accounting policies.
It describes the concept of prudence as that, "In view of the uncertainty attached to future
events, profits are not anticipated but recognised only when realised though not necessarily in
cash. Provision is made for all own liabilities and losses even though the amount cannot be
determined with certainty and represents only a best estimate in the light of available
information."
It is a generally accepted rule in accounting that profit is not recognised to have been earned
till it is realised in cash or a third party has legally become liable to pay the amount. Thus till
the time an amount becomes recoverable from an outsider one cannot say that a profit has
been earned. That is why accountants, taking a conservative position, refuse to record a sale
unless the third party has committed itself to paying the price and only on the happening of
this will the profit be said to have arisen. There is one exception to this rule. If it is
reasonably certain that a loss will arise on the transaction already entered into, the accountant
will take that possibility into account. Suppose goods have been produced at a cost of Rs.
100. If it is reasonably certain that the price to be realised will be less than Rs. 100, say, Rs.
97, the accountant will consider the goods to be worth RS. 97 and recognise the loss of Rs. 3
even before goods are sold.
f. Suspension of capitalization of borrowing costs (5 Marks December 2010)

Answer: NAS-23 ‗Borrowing Costs‘ prescribes the accounting treatment for borrowing
costs. The Standard specifies that the ―capitalization of borrowing costs should be suspended
during extended periods in which active development is interrupted‖. The standard amplifies
that the borrowings costs may be incurred during an extended period in which the activities
necessary to prepare the asset for its intended use or sale are interrupted. Such costs are costs
of holding partially completed assets and do not qualify for capitalization. However,
capitalization of borrowing costs is not normally suspended during a period when substantial
technical and administrative work is being carried out. The capitalization of borrowing costs
is also not suspended when there is a temporary delay that is a necessary part of the process
of getting the asset ready for its intended use or sale. For example, capitalization continues
during the extended period needed for inventories to mature or the extended period during
which high water levels delay construction of a bridge, if such high levels are common during
the construction period in the geographic region involved. Therefore, capitalization of
borrowing cost is suspended for the period for which active development had been
interrupted.
g. Related Party" as per NAS-24“Related Party Disclosures” (5 Marks December 2011)

Answer: A party is related to an entity if:
(a) Directly, or indirectly through one or more intermediaries, the party:

(i) Controls, is controlled by, or is under common control with, the entity (this
includes parents, subsidiaries and fellow subsidiaries);
(ii) Has an interest in the entity that gives it significant influence over the entity;
or
(iii) Has joint control over the entity;
(b) The party is an associate (as defined in NAS-28, ―Investments in Associates‖) of
the entity;
(c) The party is a member of the key management personnel of the entity or its
parent;
(d) The party is a close member of the family of any individual referred to in (a) or
(d);
(e) The party is an entity that is controlled, jointly controlled or significantly
influenced by, or for which significant voting power in such entity resides with,
directly or indirectly, any individual referred to in (c) or (d); or
(f) The party is a post-employment benefit plan for the benefit of employees of the
entity, or of any entity that is a related party of the entity.
h. Deferred Taxation: (4 Marks December 2009, 3 Marks June 2012)

As per NAS-12: ―Income Taxes ―Deferred tax is balance sheet item that is used to accrue tax to
the appropriate periods. It is necessary because the tax consequences of an event in the
accounts may occur in a different period from the event itself.
Deferred tax items may be assets or liabilities. Deferred tax liabilities are conceptually easy
and highly certain. They are provisions against future tax payments that relate to current (or
previous) period's profits. Deferred tax liability represents a company's liability for taxes
owed that is postponed to future periods. For example, under tax law companies can often
depreciate fixed assets at a faster rate for tax purposes than the actual use of the asset would
dictate.
Customarily tax is provided in the accounts based on the tax payable for the relevant year.
But the amount of tax provided and actually payable are never the same owing to two main
differences – Permanent difference and timing difference. Permanent difference arises when
certain incomes are tax free, e.g. tax holiday for new industrial undertakings, investment
allowance etc. and also when certain expenses are disallowed, e.g. entertainment allowance.
Timing difference arises when the period in which some income and expenses are considered
for taxation is not the same as the period in which these are recognized in accounts. To
illustrate such timing difference clearly arises when the company follows a straight-line
method of depreciation for its accounts and a written-down value method of depreciation for
tax purpose.
Deferred tax assets are usually intrinsically less certain because there may not be future
profits to claim against.

i. Intangible Assets (3 Marks June 2012)

Answer: An intangible asset is an identifiable non-monetary asset without physical
substance. It is dealt in Nepal Accounting Standard 38. Entities frequently expend resources
or incur liabilities on acquisition, development, maintenance or enhancement of intangible
resources such as scientific or technical knowledge, design and implementation of new
processes or systems, licenses, intellectual property, market knowledge and trademarks.
Common examples of items are computer software, patents, copyrights, motion picture films,
costumer lists, mortgage servicing rights, franchises etc.
j. Audit of Accounting Estimates (4 Marks December 2012)
Answer: The auditor should obtain sufficient appropriate audit evidence regarding
accounting estimates. Since accounting estimates are the responsibility of the management,
the auditor should obtain sufficient appropriate audit evidence as to whether an accounting
estimate is reasonable in the circumstances and are appropriately disclosed in the financial
statement. According to NSA 540 on Audit of Accounting Estimates, including Fair Value
accounting estimates and related disclosure, the auditor should follow either or all of the
following procedures to audit an accounting estimate:
 Review and test the process used by the management to develop the estimate
including evaluation of data and assumptions underlying the estimates, testing the
calculations involved in the estimates, comparison of estimates and actual results of
prior periods etc.
 Comparison of the managements estimate with an independent estimate.
 Review of subsequent events which confirm the estimates.
The final assessment of reasonableness of an accounting estimates would be based on the
auditors‘ knowledge of the client‘s business and its consistency with other audit evidence
obtained during the audit. If the auditor is of the opinion that the account prepared by the
management is significantly different from that assessed by him, he should request the
management to revise the same. If refused, it would be considered as a misstatement and the
auditor would be required to consider its effect on the financial statements.
k. Temporary differences (4 Marks December 2013)
Answer: As per provision contained in NAS-12 (Income tax), temporary differences can be
explained as follows;
Meaning: Temporary differences are differences between the carrying amount of an asset or
liability in the balance sheet and its tax base.
Types: Temporary differences may be either:
iii) Taxable temporary differences: That will result in taxable amounts in determining
taxable profit or tax loss of future periods when the carrying amount of the asset or
liability is recovered or settled, or
iv) Deductible temporary differences: That will result in amounts that are deductible in
determining taxable profit or loss of future periods when the carrying amount of the
asset or liability is recovered or settled.
l. Recognition of assets and liabilities under Nepal Accounting Standards/Nepal Financial

Reporting Standards. (4 Marks June 2014)

Answer: As per Conceptual Framework of NFRS recognition of assets and liabilities can be
explained as follows;
a) Recognition of assets: An asset is recognized in the balance sheet when it is probable
that the future economic benefits will flow to the entity and the asset has a cost or value
that can be measured reliably.
An asset is not recognized in the balance sheet when expenditure has been incurred for
which it is considered improbable that economic benefits will flow to the entity beyond
the current accounting period. Instead such a transaction results in the recognition of an
expense in the income statement. This treatment does not imply either that the intention
of management in incurring expenditure was other than to generate future economic
benefits for the entity or that management was misguided. The only implication is that the
degree of certainty that economic benefits will flow to the entity beyond the current
accounting period is insufficient to warrant the recognition of an asset.
b) Recognition of liabilities: A liability is recognized in the balance sheet when it is
probable that an outflow of resources embodying economic benefits will result from the
settlement of a present obligation and the amount at which the settlement will take place
can be measured reliably. In practice, obligations under contracts that are equally
proportionately unperformed (for example, liabilities for inventory ordered but not yet
received) are generally not recognized as liabilities in the financial statements. However,
such obligations may meet the definition of liabilities and, provided the recognition
criteria are met in the particular circumstances, may qualify for recognition. In such
circumstances, recognition of liabilities entails recognition of related assets or expenses.
m. Accounting Policy (4 Marks June 2014)
Answer: As per NAS-8, Accounting policies are the specific policies and procedures used by
an entity to prepare its financial statements. These include any methods, measurement
systems and procedures for presenting disclosures. Management shall select and apply an
entity‘s accounting policies so that the financial statements comply with all the requirements
of each applicable Nepal Accounting Standard. When there is not specific requirement,
management shall develop policies to ensure that the financial information satisfies the
concept of relevance and reliability. An entity shall select and apply its accounting policies
consistently for similar transactions, other events and conditions, unless a Standard
specifically requires or permits categorization of items for which different policies may be
appropriate. If a Standard requires or permits such categorization, an appropriate accounting
policy shall be selected and applied consistently to each category. Accounting policies along
with the notes is one of the components of the financial statements. Hence an entity shall
disclose in the summary of significant accounting policies used in preparation of financial
statements. Examples of accounting policies include revenue recognition, valuation of
inventories, capitalization and depreciation of fixed assets etc.
n. Non-monetary government grants and disclosures (4 Marks December 2014)
Answer: In line with the provision of NAS-20, non-monetary government grant and its
disclosure has been described as below;
Meaning: Grants that take the form of a transfer of non-monetary assets such as land or other
resources for the use of the entity from the Government is called non-monetary grant.

Recognition: Government grants, including non-monetary grants at fair value, shall not be
recognized until there is reasonable assurance that:
(a) The entity will comply with the conditions attaching to them; and
(b) The grants will be received.
Presentation: Non-monetary government grants should be recorded at fair value and shall be
presented in the balance sheet either by setting up the grant as deferred income or by
deducting the grant in arriving at the carrying amount of the asset.
Disclosure: Accounting policy adopted for Government grants including methods of

presentation adopted in the financial statements, the nature and extent of government grants
recognized, unfulfilled conditions and other contingencies attaching to Government
assistance that has been recognized are to be disclosed in the financial statements.
o. Offsetting Rules (4 Marks June 2015)

Answer: NAS-1 (Presentation of FS) states the following provision regarding the offsetting rules;
 Assets and liabilities, and income and expenses, shall not be offset unless required or
permitted by Nepal Accounting Standard.
 The standard permits the offset of revenue and costs in computing gains/losses on
disposal of non-current assets.
 It also permits netting gains and losses on a group of similar transactions, e.g., foreign
exchange gains and losses or gains and losses arising on financial instruments held for
trading. Such gains and losses are reported separately if they are material
p. Limitation of setting of Accounting Standards (5 Marks June 2017)

Answer: The major limitations of setting NAS are as follows;
i. Alternative solutions to certain accounting problems may each have arguments to
recommend them. Therefore, the choice between different alternative accounting
treatments may become difficult.
ii. There may be trend towards rigidity and away from flexibility in applying the
accounting standards.
iii.Accounting standards cannot overwrite the statute and prevailing legal provision. The
standards are required to be framed within the ambit of prevailing statutes.
q. Reserved Capital & Capital Reserve (3 Marks June 2018)

Answer: The reserved capital and capital reserve can be defined as below;
i) Reserve Capital: The portion of paid up capital which is not called up now and
retained uncalled for specific purposes in future is called reserved capital. It
shall be made by passing special resolution at AGM/EGM of the company.
For example, A limited company may, by a Special Resolution determine a
portion of its share capital not being called-up, is to be kept reserved and shall
be called-up, in the event and for the purpose of being wound-up.
ii) Capital Reserve: It is the portion of Net profit after taxes which is set aside for
specific purpose. So, it is certain amount of profit is transferred to Capital
Reserve, which is not a free reserve. It is not available to distribute as
dividend to shareholders. It is generally utilized to write-off capital losses.
For example, Profit on re-issue of forfeited shares

Question No. 17
Express your views on the followings (5 Marks June 2009)
a) Rameshwor Pvt Ltd. was under audit for the year-ended 15th July 2008. An appeal filed by
Rameshwor Pvt. Ltd. against the demand of Excise Duty of Rs. 26 crores were pending
before the Supreme Court for which neither provision was made nor was disclosed in the
notes to the financial statements. On 12th December 2008, the auditor came to know
through paper reports that the point involved in the appeal of Rameshwor Pvt Ltd. was
adjudicated by the Supreme Court in the case of some other assessee, which is in favor of
the department of Excise Duty. The auditor insisted that provisions be made of Rs. 26 crores
in the financial statements. The Management was of the view that since its own case is still
pending, no provision is called for. It was also of the view that the event does not have any
effect on the financial position of the company on the date of the Balance Sheet. Is the view
of the Management tenable?
(5 Marks June 2009)
Answer
Nepal Accounting Standard (NAS) -10 ―Events after the reporting period‖ deals with all
those significant events, both favorable and unfavorable, that occur between the end of
reporting period and the date on which the financial statements are approved by the Board of
Directors of the company for issue. As per NAS-10, those events can be identified as
adjustable events, which provide further evidence of conditions that existed at the end of
reporting period and non-adjustable events are those, which are indicative of conditions that
arise subsequent to the end reporting of reporting period.
NSA 560 on ―Subsequent Events‖ lays down that the ―auditor should consider the effect of
subsequent events on the financial statements and on the auditor‘s report‖. In the given case,
Rameshwor Pvt Ltd. had a pending demand of Rs. 26 crores made by the Excise Department
for which appeal was made in the Supreme Court. Since the issue involved in the appeal of
Rameshwor Pvt Ltd. was similar to the point in case of some other company and since the
appeal of that company was decided against that company and in favor of the Excise
Department, it is necessary for Rameshwor Pvt Ltd. to make a provision of Rs. 26 crores. The
case settled by the Supreme Court on similar point reflects significant developments affecting
the assessment about the potential risk faced by the company. The view of the management
that its own appeal is undecided or that it has no effect on the financial position as on 16 July
2008 is not at all tenable. Since the financial position is materially affected, the auditor should
express a qualified opinion, or an adverse opinion as may be appropriate.
b) Surya Industries Ltd. has a paid-up capital of Rs. 20 Crores divided into equity shares of
Rs. 10 each as on 15th July 2005. During the financial year 2005-06 it has issued bonus
shares in the ratio 1: 1. The net profit after tax for the years 15th July 2005 and 15th July
2006 is Rs. 10 crores and Rs. 15 crores respectively. The Earnings Per Share (EPS)
disclosed in the financial statements for the above two years is Rs. 5.00 and Rs. 3.75
respectively. Is the disclosure correct? (5 Marks June 2009)
Answer
NAS-33 on Earning Per Share (EPS) prescribes principles for the determination and
presentation of EPS.As per this standard, the earnings per share have to be disclosed as basic
and diluted earnings per share on the face of the statement of profit and loss for each class of
equity shares that has a different right to share in the net profit for the period. In the given

case, Surya Industries Ltd., both the basic as well as the diluted earnings per share would be
the same since there are no dilutive instruments that have been issued by the company. As per
the standard, in the case of a bonus issue, equity shares are issued to existing shareholders for
no additional consideration and thus would lead to increase in number of equity shares
without any adjustment to outstanding capital amount. Therefore, the number of equity shares
outstanding is increased without an increase in resources. The standard further requires that
the number of equity shares outstanding before the event of a bonus issue to be adjusted for
the proportionate change in the number of equity shares outstanding as if the event had
occurred at the beginning of the earliest period reported. Hence the EPS calculated as on 15
July 2005 would be Adjusted EPS and the same would be disclosed. In view of the above, the
EPS will be calculated as under:
As on 15 July 2005
EPS = Profits / (Adjusted No. of Shares)
= 100,000,000 / 40,000,000
= NRs. 2.5 per share
Where, Adjusted No. of Shares = Existing Shares + Bonus Issue @ 1:1

= (20,000,000 + 20,000,000) Shares
= 40,000,000 Shares
As on 15 July 2006
EPS = Profits / (No. of Shares)
= 150,000,000 / 40,000,000
= NRs. 3.75 per share
Since the above figures of EPS have not been disclosed, Surya Industries Ltd. did not comply
with the provisions of the standard. Therefore, the auditor would have to qualify his report.
c) Treatment of foreign currency monetary items on balance sheet date (5 Marks June 2009)
Answer
As per NAS- 21 on ―Accounting for the Effects of Changes in Foreign Exchange Rates‖ monetary
items are money held and assets and liabilities to be received or paid in fixed or determinable
amounts of money, e.g., cash, receivable, payables, etc.
Regarding foreign currency transactions, NAS 21 requires that while reporting effects of changes
in exchange rates subsequent to initial recognition, at each balance sheet date, monetary items
denominated in a foreign currency, (e.g., foreign currency notes, balances in bank accounts
denominated in a foreign currency, and receivables, payables and loans denominated in a foreign
currency) should be reported using the closing rate prevailing on balance sheet date. However, in
certain circumstances the closing rate may not reflect, with reasonable accuracy, the amount in
reporting currency that is likely to be realized from or required to be disbursed to because the rate
is unrealistic. In such circumstances, the relevant monetary item should be reported in the
reporting currency at the amount which is likely to be realized from or required to be disbursed to
at the balance sheet date.

Question No. 18
M/s X Hospital Ltd. purchased an ambulance for Rs. 30 Lakhs against which it received grant
from the Japanese Government. The company charged depreciation on the ambulance at the
prescribed rate of 15% and charged expense to Profit and Loss Account. It transferred Rs. 30
Lakhs to Capital Reserve Account. As an auditor express your opinion in this regard. (5 Marks
December 2009)
Answer
According to NAS -20, the government grant related to assets should be presented in the balance
sheet either by setting up the grant as deferred income or by deducting the grant in arriving at the
carrying amount of assets. Income is recognized over the life of depreciable assets by way of
reduced depreciation charge. Hence, in the given case it cannot be shown as equity or reserve. The
depreciation calculated at prescribed rate on ambulance purchased out of grant should be shown
as grant income in the current year and the balance amount should be booked as deferred income
in the current year. The Deferred income should be recognized as income in subsequent years as
per the depreciation charge for these years.
Question No. 19
Distinguish between Prior Period Items and Extra Ordinary Items (4 Marks June 2010)
Answer:
Prior period items are material charges or credits which arise in the current period as a result of
errors or omissions in the preparation of financial statements of one or more prior periods.
Extra-ordinary items are gains or losses which arise from events or transactions that are distinct
from the ordinary activities of the business and which are both material and expected not to
recur frequently or regularly. These would also include materials adjustments necessitated by
circumstances, which though related to previous periods are determined in the current period.
Prior period items should be separately disclosed in the current statement of profit and loss
together with their nature and amount in a matter that their impact on current profit or loss can
be perceived.
Extra-ordinary items of the enterprise during the period should be disclosed in the statement of
profit and loss as part of the net income. The nature and amount of each such items should be
separately disclosed in a manner that their relative significance and effect on the current
operating results of the period can be perceived.
Question No. 20
on which your opinion is based:
Included under Current Assets of XYZ Ltd. is inventory aggregating to Rs. 5 million. A part of
the said inventory manufactured for export had to be sold earlier at a discounted price offshore
due to moisture content present at the time of delivery. A part of similar inventory is included in
Rs. 5 million. (5 Marks June 2010)
Answer
A part of the inventory exported earlier had to be sold at a discounted price offshore due to
moisture content present at the time of delivery. The auditor will therefore have to examine
what part of the inventory is included in the inventory valued at Rs.50 lakhs, a part of which
had been exported at a discounted price. He will also have to satisfy himself that whether such
part left with the company has also been damaged on account of moisture content. If required,

the auditor may obtain a certificate from an expert about the condition of the inventory.
Thereafter, it should be verified whether the principle of valuation enunciated in NAS-2
―Inventories‖ have been followed in such a case. The standard requires that the inventories
should be valued at the lower of cost or net realizable value. NAS-2 defines the net realizable
value as the estimated selling price in the ordinary course of business less the estimated costs
of completion and the estimated costs necessary to make the sale. Accordingly, such part of
inventory which is damaged should be valued at estimated realizable value if the same is lower
than the cost. It may, however, be noted that inventories are usually written down to net
realizable value on an item-by-item basis. In some circumstances, however, it may be
appropriate to group similar or related items. This may be the case with items of inventory
relating to the same product line that have similar purposes or end uses and are produced and
marketed in the same geographical area and cannot be practicably evaluated separately from
other items in that product line. It is not appropriate to write down inventories based on a
classification of inventory, for example, finished goods, or all the inventories in a particular
business segment. Thus, the auditor should ensure that such damaged inventories have been
valued accordingly.
Question No. 21
Distinguish between Permanent Difference and Timing Difference.
(5 Marks June 2010)
Answer
NAS-12: Income Taxes;
There is a divergence between tax profit and accounting profit which arises due to the fact that the
amount of certain items of revenues and expenses as appearing in the profit or loss account differ
from those considered as revenue, expenses or deduction for tax purposes. The differences
between tax profit and accounting profit can be segregated into permanent difference and timing
difference.
Permanent differences are the differences between taxable income and accounting income for a
period that originate in one period and do not reverse subsequently. For instance, under many
systems of taxation some donations are not allowable deduction in determining taxable income,
however, such amount would be deducted in determining accounting income. These types of
differences are the permanent differences.
On the other hand, timing differences are those differences between accounting income and
taxable income for a period that originate in one period and are eligible for reversal in one or
more subsequent periods. Timing differences are the differences between the accounting income
and taxable income for a period that originate because the period in which some items of revenue
and expenses are included in taxable income does not coincide with the period in which they are
included in the accounting income. For example, accounting policies may specify that certain
revenues are included in accounting income at the time goods or services are delivered but tax
rules may require or allow their inclusion at the time cash is collected. The total of these revenues
included in accounting income will differ from taxable income. This difference is the timing
difference.

Question No. 22
Fifty sets of computerised machinery purchased by the company five years back with a
carrying value of Rs. 1,000,000 have become obsolete. On disposal of the same, the company
received Rs. 1,200,000. The company showed the excess of Rs. 200,000 as a revenue. Comment
and give your views as auditor with reasons.
(5 Marks June 2010)
Answer
NAS -16 ―Property, Plant and Equipment‖ prescribes that the entity can derecognise the carrying
value of the fixed assets on disposal or when no future economic benefits are expected from the
fixed assets. And it also states that the gains or losses arising from de-recognition of an item of
property, plant and equipment shall be included in profit or loss when an item is derecognised.
Gains shall not be classified as revenue. The auditor shall require the company to correct the
accounting treatment to show the gains separately under gain from sale of fixed assets in the
profit and loss account. If the correction is not made, the auditor shall qualify and disclose the
wrong treatment in its report.
Question No. 23
Nepal Pvt. Ltd., manufacturing garments, has valued at the year end its closing stock of packed
finished goods for which firm export contracts have been received, at realizable value inclusive
of profit and export cash incentive. As at the year end, the ownership of the goods has not been
transferred to the foreign buyers. Express your opinion as an auditor (5 Marks December 2010)
Answer
NAS-2 requires that inventories should be valued at lower of cost and Net realizable value
(NRV). A departure from the general principle can be made if the Accounting Standard is not
applicable or having regard to the nature of industry.
In the given case the sale is assumed under a forward contract, but the goods are of a nature
covered by the above NAS. Taking into account the facts the closing stock of finished goods
should have been valued at cost, as it is lower than the realizable value (as it includes profit).
Further, export cash incentives should not be included for valuation purposes.
The policy adopted by the company for valuing its closing stock of inventory of finished goods on
selling price plus export incentives is not correct. The statutory auditor should give a qualified
report.
Question No. 24
Distinguish between Depreciation and Fluctuation in Value (5 Marks December 2010)
Answer
Depreciation is a measure of the wearing out, consumption or other loss of value of a
depreciable asset arising from use, effluxion of time or obsolescence through technology and
market changes. It directly affects the earning capacity of an asset. Hence, it is a charge
against the profit of the year.
Fluctuation, on the other hand, is a temporary shrinkage or decrease and increase in the value
of an asset usually due to external causes such as rise and fall in market price of an asset. But
the fluctuation does not affect the earning capacity or working life of an asset. Hence, it is not
taken into account and no charge is made against the profit of the year.
Depreciation is only in connection with fixed assets while fluctuation is usually in connection
with current assets. Depreciation generally means fall in the value of fixed asset while

fluctuation may mean either increase or decrease in the value of any asset, current as well as
fixed. Depreciation has a significant effect determining and presenting the financial position
and results of operations of an enterprise. Depreciation is charged in each accounting period
by reference to the extent of the depreciable amount, irrespective of an increase in the market
value of the assets.
Question No. 25
Comment and give your views as an auditor with reasons in the light of Nepal Accounting
Standards and Nepal Standards on Auditing on each of the following case:
a) Assume that under normal operating conditions Ram & Sons expects to produce 100000
units of Mixing machines a year. Budgeted and actual fixed production overheads for
FY 2009-10 are Rs. 800,000.
During FY 2009-10 due to problems with the production machinery and decreased demand,
Ram & Sons produced only 80000 units of Mixing machines and allocated overheads at the
rate of Rs. 8 per unit.
What will be your answer if Ram & Sons in response to increased demand for coffee
machines its increased production shifts and produced 130000 units?
Answer:
NAS-2: Inventories
As under normal operating conditions Ram & Sons expects to produce 100000 Mixing
machines a year with budgeted and actual fixed production overheads of Rs. 800,000 during
FY 2009-10. Therefore, the fixed cost per machine based on the normal production level is
Rs.8 only.
During FY 2009-10 due to problems with the production machinery and decreased demand,
Ram & Sons produced only 80000 machines. As per NAS - 4.13, the production overheads
should be allocated based on the normal production level of 100000 (i.e. 8 per unit).
Therefore, out of the total production overheads of Rs.800,000, only Rs.640,000 (i.e. 8x80000
units) should be allocated to inventory. The remaining cost Rs. 160,000 should be recognized
as an expense during the year as incurred.
On the other hand, if during FY 2009-10 in response to increased demand for machines Ram
& Sons increased production shifts and produced 130000 units, then the amount allocated to
the inventory is limited to the actual expenditure. Therefore, if the total production overheads
remain constant at Rs.800,000, a cost of Rs.6.15 per unit (i.e. Rs.800,000/130000 units)
should be allocated to each machine.
b) ABC & Co. acquired a cooler machine at the beginning of FY 2005-06 and its useful life
was estimated to be 10 years. At the end of FY 2007-08 the carrying amount of the machine
was Rs. 100,000. At the beginning of FY 2008-09 the company revised the estimated useful
life downwards to a further two years from that date. The Company decides to depreciate
the carrying amount at the same rate as was done last year.
Answer: As per NAS 16, the useful life of an asset and the depreciation method applied
should be reviewed at least at each annual reporting date. A change in the useful life of
depreciation method is accounted for prospectively as it is a change in accounting estimate.

As ABC & Co. acquired the cooler machine at the beginning of FY 2005-06 and its useful life
was estimated to be 10 years. At the end of FY 2007-08 the carrying amount of the machine
was Rs.100,000. At the beginning of FY 2008-09 the Company revised the estimated useful
life downwards to a further two years from that date. Therefore, the carrying amount of Rs.
100,000 should be depreciated over the next two years only. In addition, the decrease in useful
life may indicate that the carrying amount of the machine is impaired.
c) Varun Traders operates an internet site from which it will sell entity Tarun‟s products.
Customers place orders directly on the internet site and provide credit card details for
payment. Varun receives the order and authorization from the credit card company, and
passes the order on to Tarun, who ships the product directly to the customer. Varun does
not take title to the products and has no risk of loss or other responsibility for the function
or delivery of the product. Tarun is responsible for all product returns, defects, and
disputed credit card charges. The product typically is sold for Rs. 175 from which Varun
receives a commission of Rs. 25. In the event that a credit card transaction is rejected,
Varun loses its margin on the sale (i.e. Rs. 25).
Varun has accounted for Rs. 175 as revenue and subsequently passes Rs. 150 to Tarun
after retaining his commission on the sale products
Answer
Varun operates an internet site from which it will sell entity Tarun‘s products. As Varun does
not take title to the products and has no risk of loss or other responsibility for the function or
delivery of the product and Tarun is responsible for all product returns, defects, and disputed
credit card charges.
As per NAS-18, Varun should recognize its fee of Rs.25 only as revenue, as it does not take
title to the product or take on any risks and rewards of ownership of the product. In addition,
its credit risk is limited to its fee of Rs.25.
Question No. 26
Company A operates an electronic payment processing service on behalf of retailers who accept
payment by credit card. One-off costs are incurred by Company A on inception of the
arrangement, in adding the retailer to its processing system.
Charges to retailers for the service comprise a set-up fee on inception of the arrangement of Rs
360,000 followed by annual charges, payable in one single instalment in advance, of Rs
240,000 per annum.
The annual charges of Rs 240,000 result in Company A making profits from the ongoing
services.
Required:
With reference to NAS please answer the following:
How should Company A recognise revenue in respect of the set-up and subsequent fees?
(7 Marks June 2011)
Answer:
NAS-18, analyses the accounting treatment of franchise fees in the context of the supply of
services. This requires that fees for the provision of continuing services, whether they are part of
an initial fee or are charged as a separate fee, are recognised as revenue as the services are
delivered.
Further, NAS-18 deals with revenue derived from initiation, entrance and membership fees. This
notes that revenue recognition depends on the nature of services provided. If an initial fee is
accompanied by an annual fee which covers ongoing services, the initial fee is recognised when

there is no significant uncertainty as to its collection. Alternatively, if the initial fee entitles the
customer to services to be provided during the period, it should be recognised on a basis that
reflects the timing, nature and value of the benefits provided.
Although the initial charge of Rs 360,000 is described as an initial set-up fee, no separate charge
is made for the provision of the first year‘s services. The amount payable from the second year
onwards for the provision of the ongoing service is Rs 240,000 per annum, indicating that this
part of the initial fee is in substance the first year‘s fee for services.
In consequence, Company A should recognise Rs 120,000 on inception of the arrangement
(provided that it meets the criterion of no significant uncertainty of collection as set out in
spreading the balance of Rs 240,000 over the first year, being the period during which services are
provided or made available.
In subsequent years, the annual fee should again be spread over the service period.
Question No. 27
Distinguish between: (5 Marks each June 2011))
i) Adjusting events and non-adjusting events
ii) Permanent Difference and Timing Difference
Answer
i) Answer
As per NAS-10 on Events after reporting period, events which occur between the end of
reporting period and the date on which the financial statements are approved for issue, may
indicate the need for adjustments to assets and liabilities as at the end of reporting date or may
require disclosure only. Adjusting events are those events that are occurred after the end of
reporting date that provide evidence of conditions that existed at the balance sheet date.
Similarly, non-adjusting events are those that are indicative of conditions that arose after the
balance sheet date.
Adjustments to assets and liabilities are required for events occurring after the balance sheet
date that provide additional information materially affecting the determination of the amounts
relating to conditions existing at the balance sheet date. For example, an adjustment may be
made for a loss on sundry debtors‘ account which is confirmed by the insolvency of a
customer which occurs after the balance sheet date.
On the contrary, adjustments of the assets and liabilities are not required for events occurred
after balance sheet date, if such events do not relate to conditions existing at the balance sheet
date. For example, the decline in the market value of investments between the balance sheet
date and the date on which the financial statements are approved. Ordinary fluctuations in
market value do not normally relate to the condition of the investments at the balance sheet
date but reflect circumstances which have occurred in the subsequent period.
Hence, an enterprise should adjust the amounts recognized in its financial statements to reflect
adjusting events after the balance sheet date and similarly, it should not adjust the amounts
recognized in its financial statements to reflect non-adjusting events after the balance sheet
date.
ii) NAS-12 Income Taxes Answer
There is a divergence between tax profit and accounting profit which arises due to the fact that
the amount of certain items of revenues and expenses as appearing in the profit or loss account
differ from those considered as revenue, expenses or deduction for tax purposes. The

differences between tax profit and accounting profit can be segregated into permanent
difference and timing difference.
Permanent differences are the differences between taxable income and accounting income for
a period that originate in one period and do not reverse subsequently. For instance, under
many systems of taxation some donations are not allowable deduction in determining taxable
income, however, such amount would be deducted in determining accounting income. These
types of differences are the permanent differences.
On the other hand, timing differences are those differences between accounting income and
taxable income for a period that originate in one period and are eligible for reversal in one or
more subsequent periods. Timing differences are the differences between the accounting
income and taxable income for a period that originate because the period in which some items
of revenue and expenses are included in taxable income does not coincide with the period in
which they are included in the accounting income. For example, accounting policies may
specify that certain revenues are included in accounting income at the time goods or services
are delivered but tax rules may require or allow their inclusion at the time cash is collected.
The total of these revenues included in accounting income will differ from taxable income.
This difference is the timing difference.
Question No. 28
Give your comments on the following
In the notes to accounts of NEW Ltd. as on 32 Ashadh 2067, notes 17 states that detention
charge of Rs. 90 million for certain machinery items lying at Birgunj custom company has
been paid upto Aswin 2067, out of which Rs. 58 million is written back during the Fiscal Year
2066/67 based on settlement with the custom authority in respect of major plant. For the
remaining equipment items, negotiations are pending and a provision of Rs. 4.4 million is
made. As such total amount of Rs. 36.4 million paid/provided on account of detention charges
have been capitalized and included in the fixed assets/capital work-in-progress. The
management is of the view that these payments are directly attributable to the acquisition of the
related Fixed Assets?
(5 Marks June 2011)
Answer: As per NAS-16 Property plant and Equipment, the cost of an item of assets comprises it
purchase price, including import duties and other non-refundable taxes or levies and any directly
attributable cost of bringing the asset to its working condition for its intended use. Generally,
detention charges represent an abnormal expenditure, as these expenditures are not directly
attributable to the cost of asset.
The auditor shall qualify the report appropriately in the paragraph stating that the balance sheet
gives true and fair view and the profit and loss account shows true and fair profit of the year
ending on 32 Ashad 2067.
The Qualification will be as follows:
Regarding the detention charges as mentioned in Notes 17 are not directly attributable to the
acquisition of related fixed assets. The said amount of Rs, 36.4 million should have been written
off in the profit and loss account. Had these expenses be written off, the profit for the year would
have been lower by the same amount, i.e. 36.4 Million and Reserve & surplus as well as fixed
assets or capital WIP would have been lower by the same amount.

Question No. 29
on which your opinion is based. (5 Marks each December 2011)
a) Surya Textiles Ltd., as part of overall cost cutting measure announced voluntary retirement
scheme (VRS) to its employees, to reduce the employee strength. During the year ended
31.03.2068, the company paid a compensation of Rs.12 million to those who availed the
scheme. The Chief Accountant has reflected this payment as part of regular salary and
wages paid by the company.
Answer: NAS 1, ―Presentation of Financial Statements‖ clearly states that if the items of
income and expenses are material, their nature and amount shall be disclosed separately. Such
a disclosure shall assist in understanding the financial performance and in assessing future
results. In the instant case the payment made to the employees on account of VRS as an
overall cost cutting measure would fall under the domain of material item. Accordingly, it is
eligible to be shown separately in the income statement of Surya Textiles Ltd., so that its
effect in the operating results of the company during the previous year can be perceived.
Therefore, clubbing of Rs. 12 million with the regular salaries and wages of the company by
the Chief Accountant is not appropriate.
Further NAS-19 states that any payment made for voluntary retirement scheme shall be
accounted as termination benefits and same shall be disclosed separately in the statement of
Profit and loss. Hence the contention of Chief accountant of Surya Textile Ltd is not in line
with the provision of Nepal accounting standards.
b) Makhan Ltd. manufactures machinery used in Iron Plants. It quotes prices in various
tenders issued by Iron Plants. As per terms of contract, full price of machinery is not
released by the iron plants, but 10% thereof is retained and paid after one year if there is
satisfactory performance of the machinery supplied. The company accounts for only 90% of
the invoice value as sales income and the balance amount in the year of receipt to the extent
of actual receipts only.
Answer: NAS-18 ‗Revenue‘, states that revenue from the sale of goods should be recognized
when the seller of goods has transferred to the buyer the property in the goods for a price or all
significant risks and rewards of ownership have been transferred to the buyer and the seller
retains no effective control of the goods transferred to a degree usually associated with
ownership and no significant uncertainty exists regarding the amount of consideration. In the
case of Makhan Ltd., the goods as well as the risks and rewards of ownership have been
transferred to the iron plants. The invoice raised by Makhan Ltd. is for the full price, but 10%
less amount is received as the same is kept as ‗Retention Money‘. In this case, therefore,
revenue has to be recognized at the full invoice price, i.e., 100% has to be accounted as Sales
Income. Depending upon the past experience of recovering the balance 10% from the steel
plants, Makhan Ltd. can, however, make a provision for sales income which is not likely to
realized. In the absence of the above, the auditor will have to qualify his report.
c) You are the manager responsible for the audit of Apple & Co. The company‟s principal
activity is wholesaling frozen fish. The draft consolidated financial statements for the
year ended 31 March 2009 show revenue of Rs67 million (PY2008 – Rs. 62.3 million),
profit before taxation of Rs. 11.9 million (PY2008 – Rs.14.2 million) and total assets of
Rs. 48 million (PY2008–Rs.36.4 million). The following issues arising during the final
audit have been noted on a schedule of points for your attention: In early 2009 a

chemical leakage from refrigeration units owned by Apple & Co. caused contamination
of some of its property. Apple has incurred Rs. 0.3 million in cleanup costs, Rs. 0.6
million in modernization of the units to prevent future leakage and a Rs. 30,000 fines to a
regulatory agency. Apart from the fine, which has been expensed, these costs have been
capitalized as improvements.
Answer: The fine of Rs30,000 is very immaterial (just 25% profit before tax). This is revenue
expenditure and it is correct that it has been expensed to the income statement.
Rs 0·3 million represents 0·6% total assets and 2·5% profit before tax and is not material on
its own. Rs 0·6 million represents 1·2% total assets and 5% profit before tax and is therefore
material to the financial statements. The Rs 0·3 million clean-up costs should not have been
capitalized as the condition of the property is not improved as compared with its condition
before the leakage occurred. Although not material in isolation this amount should be adjusted
for and expensed, thereby reducing the aggregate of uncorrected misstatements.
It may be correct that Rs 0·6 million incurred in modernizing the refrigeration units should be
capitalized as a major overhaul (NAS-16: Property, Plant and Equipment). However, any parts
scrapped as a result of the modernization should be treated as disposals (i.e. written off to the
income statement).
The carrying amount of the refrigeration units at 31 March 2009, including Rs 0·6 million for
modernization, should not exceed recoverable amount (i.e. the higher of value in use and fair
value less costs to sell). If it does, an allowance for the impairment loss arising must be
recognized in accordance with NAS - Impairment of Assets.
Question No. 30
Distinguish between “Quoted Investment” and “Trade Investment”
Answer
General Theory;
Quoted investment is an investment for which a quotation or permission to deal on a recognized
stock exchange has been granted.
Trade investment is an investment made by a company in shares or debentures of another
company not being its subsidiary, to promote the trade or business of the first company. From the
above definitions, the following points emerge:
1. Investment in subsidiary‘s shares/ debentures may be a quoted investment if the
shares/debentures are quoted on a recognized stock exchange. But investment in
subsidiary‘s shares/debentures can never be a trade investment.
2. Trade investment is necessarily investment in shares/debentures of company.
3. Quoted investment need not be share/debenture of a company. It can even be
Government securities quoted on a recognized stock exchange.
Question No. 31
The objective of NAS-10„Events after the reporting period is to prescribe the treatment of
events that occur after an entity‟s reporting period. Define the period to which the NAS-10
relates and distinguish between adjusting and non-adjusting events

Answer
Events after the reporting period are defined by NAS-10;Events after the reporting periods those
events, both favorable and unfavorable, that occur between the end of reporting date and the date
that the financial statements are authorized for issue (normally by the Board of directors and
Management).
An adjusting event is one that provides further evidence of conditions that existed at the reporting
date, including an event that indicates that the going concern assumption in relation to the whole
or part of the entity is not appropriate. Normally trading results occurring after the balance sheet
date are a matter for the next accounting period. However, if there is an event which would
normally be treated as non-adjusting that causes a dramatic downturn in trading (and profitability)
such that it is likely that the entity will no longer be a going concern, this should be treated as an
adjusting event.
A non-adjusting event is an event after the reporting date that is indicative of a condition that
arose after the reporting date and, subject to the exception noted above, the financial statements
would not be adjusted to reflect such events. The outcome (and values) of many items in the
financial statements have a degree of uncertainty at the balance sheet date.
NAS effectively says that, where events occurring after the reporting date help to determine what
those values were at reporting date, they should be taken in account (i.e. adjusted for) in preparing
If non-adjusting events, whilst not affecting the financial statements of the current year, are of
such importance (i.e. material) that without disclosure of their nature and estimated financial
effect, users‘ ability to make proper evaluations and decisions about the future of the entity would
be affected, then they should be disclosed in the notes to the financial statements.
Question No. 32
Distinguish between Reserves and Provisions (5 Marks December 2011)
Answer
Reserve denotes retained profits. In other words, certain sum or sums are set apart out of the
profits earned for specific or general purposes, and this constitutes reserve (or reserves).
These reserves are not available for dividend purposes in the year concerned. However,
subject to decision of the Board of Directors, there can be appropriation out of reserves
created in the past for dividend purposes, provided such reserves are not capital reserves. If
there is no profit, no reserve can be created and, basically, reserves are at the disposal of the
undertaking; they are not required to be maintained for meeting possible losses or expenses.
Provision, on the other hand, represents a charge for an estimated expense or loss or for a
shrinkage in the cost of an asset or the accrual of a liability. Except for provision for dividend
which is appropriation of profits, provisions are meant to meet expected losses and expenses
for which the amount is uncertain.
Question No. 33
Answer the following questions: (4 Marks each December 2011)
a) M/s Medico Alliance & Co. engaged in manufacturing pharmaceutical products has
invested in shares of M/s Western Investment Ltd. The company, after balance sheet date,
finds that the share value was declining and thus, seeking your opinion regarding recording

the losses in financial statement to comply the Nepal Accounting Standard-10, "Event after
the Reporting Period". What would be your suggestion in this regard?
Answer: NAS-10, "Events after the Reporting Period" requires an entity to adjust the amounts
recognized in its financial statements to reflect adjusting events after the end of reporting
period. However, Para 10 of the said NAS states that an entity shall not adjust the amounts
recognized in its financial statements to reflect non-adjusting events after the end of reporting
date. In the given case, the decline in market value does not normally relate to the condition of
the investments at the balance sheet date but reflects circumstances that have arisen
subsequently.
Therefore, M/s Medico Alliance & Co. should not adjust the amounts recognized in its
financial statements for the investments. Similarly, the company should not update the
amounts disclosed for the investments as at the end of reporting date, although it may need to
give additional disclosure under para-21 if non-adjusting events after the end of reporting date
are material, non-disclosure could influence the economic decisions of users taken on the
basis of the financial statements. Therefore, an entity shall disclose following for each
material category of non-adjusting event occurred after the end of reporting period;
i) The nature of the event; and
ii) An estimate of its financial effect, or a statement that such an estimate cannot be
made.
b) Avco International Limited, a public company seeks your opinion regarding the accounting
treatment of interest on loan amount taken to acquire machinery during the financial year
2067/068 in view of NAS.
Answer:
According to para-8 of NAS-23, an entity shall capitalize the borrowing cost that are directly
attributable to the acquisition, construction or production of a qualifying assets as a part of the
cost of that assets. However, an entity shall recognize other borrowing costs as an expense in
the period in which it incurs them.
Hence, in the give case, Avco International Limited shall capitalize the interest on loan taken
to acquire machinery during the fiscal year 2067/068.
Question No. 34
Answer the following questions;
a) Kantipur Publications Ltd. on 15.4.2068 imported a digital printer from Germany at a price
$ 2 million upon terms of credit that price should be settled within three months from the
date of purchase. The company capitalized the asset and created a liability for the capital
goods converting the foreign currency liability to Nepalese Rupees at a rate of exchange
prevailing as on 15.4.2067. When the company settled the liability on 30.6.2068, it had to
incur an additional amount of Rs.10,00,000 due to foreign exchange rate on the date of
settlement. It added this additional amount of exchange variation in the capital cost of the
asset and charged depreciation upon an enhanced amount of asset value from 30.6.2067.
Give your opinion about the treatment given by the company.

Answer: Nepal Accounting Standards (NAS)-21 states that the exchange differences on the
settlement of monetary items at a rate different from those at which they were translated on
initial recognition during the period or in previous financial statements shall be recognized in
profit or loss in the period in which they arise. Therefore, in view of the above, the Kantipur
Publication Ltd. Should charge the additional amount of Rs.10,00,000 to profit and loss
account in accordance with the said standard.
b) Under what circumstances can a change in an accounting policy are justified? (4 Marks
December 2011)
Answer: According to the NAS-8 ―Accounting Policies, Changes in Accounting Estimates
and Errors‖ a change in an accounting policy can be justified if the adoption of a different
accounting policy is
i) Required by Nepal Financial reporting Standards (NFRS) or
ii) If it is considered that the change would result in a more appropriate preparation or
presentation of the financial statement of an enterprise.
c) What are the points to be considered while using the work of an expert? (4 Marks
December 2011)
Answer:
During the audit, the auditor may seek to obtain, in conjunction with the client or
independently, audit evidence in the form of reports, opinions, valuations, and statements of
an expert. For examples, Valuations of certain types of assets, like, land and buildings, plant
and machinery, works of art, and precious stones, determination of quantities or physical
condition of assets, determination of amounts using specialized techniques or methods, etc.
When determining whether to use the work of an expert or not, the auditor should consider:
a) the materiality of the item being examined in relation to the financial information as a
whole.
b) the nature and complexity of the item including the risk of error therein, and
c) the other audit evidence available with respect to the item.
When the auditor plans to use the expert‘s work as audit evidence, he should satisfy himself
as to the expert‘s skills and competence by considering the expert‘s professional certification,
license or membership in an appropriate professional body and experience and reputation in
the field in which the auditor is seeking evidence.
However, when the auditor uses the work of an expert employed by him, he will not need to
inquire into his skills and competence. The auditor should also consider the objectivity of the
expert. The risk that an expert‘s objectivity will be impaired increases when the expert is
employed by the client or related in some other manner to the client. Accordingly, in these
circumstances, the auditor should (after taking into account the factors stated above) consider
performing more extensive procedures than would otherwise have been planned or lie might
consider engaging another expert.
Question No. 35
Distinguish between Deferred Tax Assets and Deferred Tax Liabilities
(4 Marks December2011)
Answer
NAS-12: Income Taxes
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of
i) deductible temporary differences,

ii) the carry forward of unused losses and

iii) the carry forward of unused tax credits.
Whereas, deferred tax liabilities are the amounts of income taxes payable in future periods in
respect of taxable temporary differences
Question: No. 36
a) You are the statutory auditor of AT Tobacco Company Limited. During the course of audit,
the management of the company informed you that the work in progress is not valued since
it is difficult to ascertain the same in view of multiple processes involved and in any case the
value of opening and closing work in progress would be more or less the same.
Answer: As per Nepal Accounting Standard-2, Inventories, inventories are assets held for sale
in the ordinary course of business. It also includes assets that are in the process of production
for such sale and those assets which are in the form of materials or supplies to be consumed in
the production process or in the rendering of services. It is thus necessary for the AT Tobacco
Company Limited to ensure that each and every component of inventory is valued properly.
The argument expressed by the company that it is difficult to ascertain the same in view of the
multiple processes involved is not acceptable. The argument that the opening and closing
work in process would be more or less the same is also not justifiable since the omission of
value of such opening and closing work in process would lead to affect the true and fairness of
the value of inventory. Further costs incurred for raw materials and the overheads would
normally be different and would give rise to different value of opening and closing stocks.
Thus, considering the above facts, I shall, as an auditor, have to qualify the audit report in case
the work in process is not valued and shown in the financial statements.
b) M/s Shandar Pollution Extinction Company Limited procured a pollution controlling

machine for which the government has provided 60% rebate in customs duty upon the
precondition that the machine should be used for at least 5 years by the same company.
During the course of audit, you found that the company has credited 60% rebate
provided to income statement for the year by disclosing the same in the Notes to
Accounts. Give your expert comments on the accounting treatment done by the
company.
Answer: As mentioned in Para 8 of NAS 20 Accounting for Government Grants and
Disclosure of Government Assistance, a government grant is not recognized until there is
reasonable assurance that the entity will comply with the conditions attaching to it, and that
the grant will be received. Receipt of a grant does not of itself provide conclusive evidence
that the conditions attaching to the grant have been or will be fulfilled. Government grants
shall be recognized as income over the periods necessary to match them with the related costs
which they are intended to compensate, on a systematic basis.
They shall not be credited directly to shareholders‘ interests. It is fundamental to the income
approach that government grants be recognized as income on a systematic and rational basis
over the periods necessary to match them with the related costs. Income recognition of
government grants on a receipts basis is not in accordance with the accrual accounting
assumption. Government grants related to assets, including non- monetary grants at fair value,
shall be presented in the balance sheet either by setting up the grant as deferred income or by
deducting the grant in arriving at the carrying amount of the asset.

Hence the NAS has provided two acceptable alternative methods of presentation in financial
statements of grants related to assets. According to the first method, the grant amount is
accounted for as deferred income which is recognized as income on a systematic and rational
basis over the useful life of the asset. Under the other alternative method, government grant is
deducted in arriving at the carrying cost of the asset and the grant is recognized as income
over the depreciable asset by way of a reduced depreciation charge.
Hence, as mentioned here above, the accounting treatment given by M/s Shandar Pollution
Extinction Company Limited to credit whole of the credit rebate amount in the year of
purchase of the machine is not appropriate since it is bound by the precondition that the
machine should be used for at least 5 years. The 60% rebate received on customs duty should
be credited to income for at least over a period of 5 years.
c) MK Traders operates internet site from which it sells Tanu‟s products. Customers place
orders directly through the internet site and provide credit card details for payment.
MK receives the order and authorization from the credit card company, and passes the
order on to Tanu, who ships the product directly to the customer. MK does not take title
to the products and has no risk of loss or other responsibility for the function or delivery
of the product. Tanu is responsible for all product returns, defects, and disputed credit
card charges. The product typically is sold for Rs. 175 from which MK receives a
commission of Rs. 25. In the event that a credit card transaction is rejected, MK loses its
margin on the sale (i.e. Rs. 25).
MK has accounted for Rs. 175 as revenue and subsequently passes Rs.150 to Tanu after
retaining her commission on the sale products.
Answer:
MK operates an internet site from which it will sells entity Tanu‘s products. As MK does not
take title to the products and has no risk of loss or other responsibility for the function or
delivery of the product and Tanu is responsible for all product returns, defects, and disputed
credit card charges, Vandana is only collecting amounts on behalf of third parties (Tanu).
As per NAS-18, MK should recognize its fee of Rs25 only as revenue, as it does not take title
to the product or take on any risks and rewards of ownership of the product and is only
collecting the amounts on behalf of the third party. In addition, its credit risk is limited to its
fee of Rs 25.
Question No. 37
Distinguish between Contingent Assets and Contingent Liabilities (5 Marks June 2012)
Answer:
As per NAS-37, Nepal Accounting Standards on Provisions, Contingent Liabilities and Contingent Assets,
A contingent asset is a possible asset 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.
A contingent liability is:
(a) 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

(b) a present obligation that arises from past events but is not recognized because:
i) it is not probable that an outflow of resources embodying economic benefits
will be required to settle the obligation; or
ii) the amount of the obligation cannot be measured with sufficient reliability.
Question No. 38
M/s Syntax & Co. engaged in manufacturing computer parts and accessories has invested in
shares of M/s Microlord Ltd. The company, after balance sheet date, finds that the share value
is declining and thus, seeking your opinion regarding recording the losses in financial
statement to comply the Nepal Accounting Standard 5, "Event after the Balance Sheet Date".
What would be your suggestion in this regard?
(5 Marks June 2012)
Answer: Nepal Accounting Standard-10, "Events after the Reporting Period" requires an entity to
adjust the amounts recognized in its financial statements to reflect adjusting events after the end
of reporting period. However, Para 10 of the said NAS states that an entity shall not adjust the
amounts recognized in its financial statements to reflect non-adjusting events after the balance
sheet date. In the given case, the decline in market value of the shares of M/s Microlord Ltd does
not normally relate to the condition of the investments at the balance sheet date but reflects
circumstances that have arisen subsequently.
Therefore, M/s Syntax & Co. should not adjust the amounts recognized in its financial statements
for the investments. Similarly, the company should not update the amounts disclosed for the
investments as at the balance sheet date, although it may need to give additional disclosure under
paragraph 21 if non-adjusting events after the balance sheet date are material, nondisclosure
could influence the economic decisions of users taken on the basis of the financial statements.
Accordingly, an entity shall disclose for each material category of non-adjusting event after the
balance sheet date:
(a) the nature of the event; and
(b) an estimate of its financial effect, or a statement that such an estimate cannot be made.
Question No. 39
Do you think that a contingent loss or a contingent gain needs to be provided in the accounts?
(5 Marks June 2012)
Answer
NAS-10 on ―Events after Reporting Period‖ provides that a contingent loss should be provided for
by a charge in the income statement if:
i. It is probable that at the date of the financial statement events subsequent thereto will
confirm that an asset has been impaired, or a liability has been incurred as at that date; and
ii. A reasonable estimate of the amount of the resulting loss can be made.
It may be noted that the provision by the way of charge in the accounts should be made if both of
the above conditions are satisfied. If either of the clauses is not satisfied then a disclosure of the
contingent loss should be made, unless the possibility of a loss is remote. Contingent gains should
not be accounted for in financial statements.
Question No. 40
Distinguish between Adjusting events and non-adjusting events (4 Marks June 2012)
Answer:

As per NAS-10 on ―Events after Reporting Period‖ , events which occur between the end of
reporting date and the date on which the financial statements are approved for issue, may indicate
the need for adjustments to assets and liabilities as at the end reporting period may require
disclosure only. Adjusting events are those events that are occurred after the reporting date that
provide evidence of conditions that existed at the end of reporting period. Similarly, non-adjusting
events are those that are indicative of conditions that arose after the end of reporting period.
Adjustments to assets and liabilities are required for events occurring after the balance sheet date
that provide additional information materially affecting the determination of the amounts relating
to conditions existing at the balance sheet date. For example, an adjustment may be made for a
loss on sundry debtors‘ account which is confirmed by the insolvency of a customer which occurs
after the end of reporting period.
On the contrary, adjustments of the assets and liabilities are not required for events occurred after
balance sheet date, if such events do not relate to conditions existing at the balance sheet date. For
example, the decline in the market value of investments between the end of reporting period and
the date on which the financial statements are approved. Ordinary fluctuations in market value do
not normally relate to the condition of the investments at the balance sheet date but reflect
circumstances which have occurred in the subsequent period.
Hence, an enterprise should adjust the amounts recognized in its financial statements to reflect
adjusting events after the balance sheet date and similarly, it should not adjust the amounts
recognized in its financial statements to reflect non-adjusting events after the balance sheet date.
Question No. 41
Distinguish between Change in an accounting policy and an accounting estimate.
Answer
NAS-8: Accounting Policy, Change in Accounting Estimates and Error;
A change in the accounting policy is different from an accounting estimate. A change in
accounting policy is far less frequent and amounts to almost a permanent change in the basis of
accounting in the concerned area. For example, the accounting policy for changing depreciation
may be changed from straight-line method to written down value method or the research cost may
be charged off in the year itself, instead of being deferred as was the past policy. On the other
hand, the latter is a routine matter in accounting which is substantially based on estimates. An
estimate is made on the basis of facts and circumstances known at the time of making of the
estimates. For example, an estimate of bad debts is made on the basis of information in possession
at the time of making the estimate. This may change on receipt of further information at
subsequent date, e.g., insolvency of a debtor known afterwards.
accounting picture may get substantially altered by the change in the policy, which normally is
not the case with the change in accounting estimates. However, sometimes a change in accounting
estimate may have material effect on the income trend of the enterprise and in those
circumstances, here is a need to separately disclose the change and its effect on the accounts.
Question No. 42
Express your opinion as an auditor on the following case: (5 Marks December 2012)

V Ltd. sold 1 lakh vacuum pumps during the year 2068-69 with a condition to make good by
repair/replacement any manufacturing defects reported within 6 months from the date of sale.
Past experience in this regard showed that there were no replacements carried out, but minor
and major repairs were necessitated to the extent of 10% and 5% respectively of the units sold.
The cost of such minor and major repairs would amount to Rs. 1,000 and Rs. 6,000
respectively. While finalizing the accounts for the year, the company does not reflect any
provision, in this regard.
Answer
As per NAS-37, ‗Provisions, Contingent Liabilities and Contingent Assets‘, a provision is a
liability which can be measured only by using a substantial degree of estimation. And a provision
should be recognized when:
i) An enterprise has a present obligation (legal or constructive) as a result of a past
event.
ii) It is probable that an outflow of resources embodying economic benefits will be
required to settle the obligation and
iii) A reliable estimate can be made of the amount of the obligation.
If these conditions are not met, no provision should be recognized. In the present case, V Ltd
fulfils all the above conditions. The sale of pumps with a warranty obligation constitutes the
present obligation as a result of past event. It is probable that some outflow will be involved in
setting the warranty obligation, satisfy the second condition. As per the details based on past
precedence reliable estimate can be made as under:
[6000*(5% of 100000) + 1000*(10% of 100000)] = Rs. 400 lakhs
Thus, V Ltd as on 31.3.07 should make a provision for warranty obligation against sale of vacuum
pumps to the extent of rupees 400 lakhs. The auditor should insist on such provision being
created. If provision is not made, he should qualify his audit report.
Question No. 43
Comment on the following cases: (5 Marks each December 2012)
a) M/s Medico Alliance & Co. engaged in manufacturing pharmaceutical products has
invested in shares of M/s Western Investment Ltd. The company finds that the share
value was declining after balance sheet date and thus, seeking your opinion regarding
recording the losses in financial statement to comply the Nepal Accounting Standard 5,
"Event after the Balance Sheet Date". What would be your suggestion in this regard?
Answer: Nepal Accounting Standard-10, "Events after the Reporting Period" requires an
entity to adjust the amounts recognized in its financial statements to reflect adjusting events
after the balance sheet date. However, Para 10 of the said NAS states that an entity shall not
adjust the amounts recognized in its financial statements to reflect non-adjusting events after
the balance sheet date. In the given case, the decline in market value does not normally relate
to the condition of the investments at the balance sheet date but reflects circumstances that
have arisen subsequently. Therefore, M/s Medico Alliance & Co. should not adjust the
amounts recognized in its financial statements for the investments. Similarly, the company
should not update the amounts disclosed for the investments as at the balance sheet date,
although it may need to give additional disclosure under paragraph 21 if non-adjusting events
after the balance sheet date are material, nondisclosure could influence the economic decisions

of users taken on the basis of the financial statements. Accordingly, an entity shall disclose for
each material category of non-adjusting event after the balance sheet date:
(a) the nature of the event; and

(b) an estimate of its financial effect, or a statement that such an estimate cannot be made.
b) Antartic & Co. acquired a freezer machine at the beginning of FY 2007-08 and its useful
life was estimated to be 10 years. At the end of FY 2008-09 the carrying amount of the
machine was Rs. 100,000. At the beginning of FY 2009-10 the company revised the
estimated useful life downwards by two years from that date. The Company decides to
depreciate the carrying amount at the same rate as was done last year. Comment.
Answer: As per paragraph 51 of NAS 16 Property Plant & Equipment, the residual value and
the useful life of an asset shall be reviewed at least at each financial year end and, if
expectations differ from previous estimates, the change(s) shall be accounted for as a change
in accounting estimate in accordance with NAS 08 Accounting Policies, Changes in
accounting estimates and errors.
As Antartic & Co. acquired the freezer machine at the beginning of FY 2007-08 and its useful
life was estimated to be 10 years. At the end of FY 2008-09 the carrying amount of the
machine was Rs100,000. At the beginning of FY 2009-10 the Company revised the estimated
useful life downwards to a further two years from that date. Therefore, the carrying amount of
Rs 100,000 should be depreciated over the next two years only. In addition, the decrease in
useful life may indicate that the carrying amount of the machine is impaired.
Question No. 44
Comment and give your views as auditor with proper reasons on each of the following cases.
a) As on 16th July 2012, there was a claim for damage from one of the customers against the
company engaged in selling of accounting software for an alleged failure to provide after
sales services in relation to the software purchased from it. Before finalization of accounts
for the year ended 16th July 2012 (the accounts were finalized on 15th October 2012), the
company won the case and had no liability whatsoever in this regard. The company has
made a provision for this contingent liability in its accounts for the year ended 16 th July
2012, which it says, will be reversed in the next year.
Answer: First and foremost, making provision of a contingent liability violates NAS-37
‗Provisions, Contingent Liabilities and Contingent Assets‘ issued by ICAN which
categorically provides that no provision should be made for a contingent liability. Only
disclosures are to be made (in the notes to the account) in respect of contingent liabilities and
even such disclosures are not required if the possibility of loss is remote. Thus, the company‘s
accounting treatment – making provision for a contingent liability violates the said standard.
The impact of post 16TH July 2012 development – This development has occurred after 16th
July 2012 but before the date of finalization of accounts (i.e. 15th October 2012). It should be
taken into account for finalization of accounts as it pertains to the conditions existing at the
balance sheet date. The impact of this development is that even disclosures (in notes to
account) [which are required to be given for contingent liabilities] are not required as it is no
longer a contingent liability. If this development had not taken place, the company would be

required to make disclosures of the contingent liability. Now that in view of the post 16 th July
2012 development it is not even a contingent liability, even disclosures in accounts are not
required. Therefore, the auditor should ask the company to rectify the accounts and reverse the
provision made as on 16th July 2012 itself and also ask the company to remove any disclosures
regarding this contingent liability in the notes to the accounts. If company does not do so, he
should qualify his opinion on the truth and fairness of accounts regarding compliance with
accounting standards.
b) T Ltd. purchased goods on credit for Rs. 5 crores for export from ABC Ltd. Upon the export
order being cancelled, T Ltd. decided to sell the same in the domestic market at a discounted
price. Accordingly, ABC Ltd. was requested to offer a price discount of 25%. ABC Ltd.
wants to adjust the sales figure to the extent of discount requested by T Ltd.
Answer: ABC Ltd. had sold goods on credit worth Rs.5 crores to T Ltd. and, as per NAS-18,
the sale was complete, and the company could recognize the revenue. T Ltd.‘s decision to sell
the same in the domestic market at a discount does not affect the amount booked under sales
by ABC Ltd. The price discount of 25% offered by ABC Ltd. at the request of T Ltd. was not
in the nature of discount given during the ordinary course of trade because otherwise same
would have been given at the time of sale itself. Now as far as ABC Ltd. is concerned, there
appears to be an uncertainty relating to collectability, which has arisen subsequent to the time
of sale. Therefore, it would be appropriate to make a separate provision to reflect the
uncertainty relating to collectability rather than to adjust the amount of revenue originally
recorded. Therefore, such discount should be written off to the profit and loss account and not
shown as deduction from the sales figure.
c) VV Ltd. had announced a voluntary retirement plan for its employees on Baisakh 1, 2068.
The scheme is scheduled to close on Ashwin 30, 2068. The scheme envisaged an initial
lump sum payment of maximum of Rs. 2 lakhs and monthly payments over the balance
period of service of employees coming under the plan. 200 employees opted for the scheme
as on Ashadh 31, 2068. The total lump sum payment for these employees would be Rs. 250
lakhs and the aggregate of future payments to them would amount to Rs. 1,500 lakhs.
However, no payment had been made to the employees under the scheme up to Ashadh 31,
2068. Nor the company made any provision in its accounts towards any liability under the
scheme.
Answer:NAS-10 on " Events After the Reporting Period', states that events occurring after the
'reporting period are those significant events, both favorable and unfavorable, that occur
between the end of reporting date and the date on which the financial statements are approved
by the Board of Directors in the case of a company and by the corresponding approving
authority in the case of any other entity. Two types of events can be identified as:
a) Those which provide further evidence of conditions that existed at the balance sheet date;
and
b) Those which are indicative (of conditions that arose subsequent to the balance sheet date).
It further states that assets and liabilities should be adjusted for events occurring after the
balance sheet date that provide additional evidence to assist the estimation of amounts relating
to conditions existing at the balance sheet date or that indicate that the fundamental
accounting assumption of going concern (i.e., the continuance of existence or substratum of
the enterprise) is not appropriate.

As per facts of the case, a condition existed at the end of reporting date (31st Ashad,2068)
regarding the liability towards the Voluntary Retirement Plan (VRP) since the management
started the VRP in the month of Baishakh, 2068 and 200 employees opted for the VRP as on
31st Ashad,2068. Since it was probable that future events will confirm that a liability has been
incurred at the end of reporting date and that the amount could be estimated on reasonable
basis, a provision for payments under the VRP would be required to be made for an
appropriate amount for the aforesaid number of employees.
d) Marushin Construction J.V. Company Limited started the construction of river bridges in
Bajura in September 2011 under BOLT scheme. The same was completed in January 2012.
Due to heavy seasonal rain in October 2011 in the construction area, the work had to be
suspended for one month and hence, company suspended borrowing costs of Rs. 5 million
for that month from capitalization.
Answer: As per NAS-23 on ‗Borrowing Costs‘, borrowing costs are interest and other costs
incurred by an entity in connection with the borrowing of funds. Under the benchmark
treatment borrowing costs are recognized as an expense in the period in which they are
incurred regardless of how the borrowings are applied. However, under the allowed
alternative treatment, borrowing costs that are directly attributable to the acquisition,
construction or production of an asset are included in the cost of that asset. Such borrowing
costs are capitalized as part of the cost of the asset when it is probable that they will result in
future economic benefits to the entity and the costs can be measured reliably. Other borrowing
costs are recognized as an expense in the period in which they are incurred.
As regards suspension of capitalization of borrowing costs, the same NAS mentions that
capitalization of borrowing costs shall be suspended during extended periods in which active
development is interrupted. Borrowing costs may be incurred during an extended period in
which the activities necessary to prepare an asset for its intended use or sale are interrupted.
Such costs are costs of holding partially completed assets and do not qualify for capitalization.
However, capitalization of borrowing costs is not normally suspended during a period when
substantial technical and administrative work is being carried out. Capitalization of borrowing
costs is also not suspended when a temporary delay is a necessary part of the process of
getting an asset ready for its intended use or sale. Thus, the test as to whether or not to
capitalize the borrowing costs depends primarily upon the nature of interruption during the
extended period.
In the given case, it has been mentioned that the construction work was interrupted due to
seasonal heavy rain in October 2011 and hence is a regular phenomenon. Though the rain was
heavy, the period cannot be considered as an ―extended period‖ leading into substantial
suspension of construction work. Thus, suspension of borrowing cost of Rs.5 million from
capitalization by Marushin Construction J.V. Company Limited cannot be treated as right
treatment. The company should capitalize the amount, if not; it should be reported by the
auditor.
Question No. 45
Y Ltd. provided Rs. 25 lakhs for inventory obsolescence in 2066-67. In the subsequent years, it
was determined that 50% of such stock was usable. The company wants to adjust the same
through prior period adjustment account as the provision was made in the earlier year. Express
your views/comments as an auditor. (5 Marks each December 2012)

Answer:
As per NAS-8 ―Accounting Policies, Changes in Accounting Estimates & Error‖, Prior period
items are income or expenses which arise in the current period as a result of errors or omissions in
the preparation of the financial statements of one or more prior periods. The write-back of
provision made in respect of inventories in the earlier year does not constitute prior period
adjustment since it neither constitutes error nor omission but it merely involves making estimates
based on prevailing circumstances when financial statements were being prepared. It is a mere
estimate process involving judgement based on the latest information available.
As per para 34 of NAS-8, an estimate may have to be revised if changes occur regarding the
circumstances on which the estimate was based, or as a result of new information, more
experience or subsequent developments. The revision of the estimate, by its nature, does not bring
the adjustment within the definitions of an extraordinary item or a prior period item. In this case,
T Ltd. provided Rs.25 lakhs for inventory obsolescence in 2066-67. In the subsequent year due to
change in circumstances, it was determined that 50% of such stock was usable. Revision of such
an estimate does not bring the resulting amount of RS.12.5 lakhs within the definition either of a
prior period item or of an extraordinary item. The amount, however, involved is material and
requires separate disclosure to understand the financial position and performance of an enterprise.
Accordingly, the accounting treatment followed by the company is not proper.
Question No. 46
As an auditor of M/S MVR Garment Co., you are required to verify whether the following
expenses of the company creates deferred tax or not? (4 Marks December 2012)
i) Being the first year of operation, first installment of the total pre-operating expenses of
Rs. 120,000 (which has to be amortized over 5 years period) has been amortized in the
financial books of accounts of the company.
ii) Provision for gratuity made for the year is Rs. 98,000 however no such fund has been
separately transferred or deposited or expensed.
iii) Donation expenses charged in the financial books amounting to Rs. 25,000 given to
local clubs.
iv) Depreciation on the fixed assets charged in the financial books is Rs. 50,000 whereas
provision allowed and claimed as per Income Tax Act is Rs. 75,000.
Answer hints
b) NAS-12 Income Taxes;
As an auditor of M/S MVR Garment Co., the following are the deferred tax calculation
verification;
i) All the pre operating expenses should be charged in first year of operation of the company by
virtue of Section 13 of the Income Tax Act 2058 and the related circular. So, there arises the
temporary difference of Rs. 96,000, assuming that one fifth of the expense has been charged
in this year in the financial books of accounts and four fifth is yet to be written off.
ii) Provision for gratuity apportioned by the company in the financial books is not deductible
expenses as per tax unless it is separately deposited in the bank account or actually expense
off. Hence there will be temporary difference of Rs. 98,000 and hence creates deferred tax
asset.

iii) Donation given to the local clubs by the company is not deductible charged as per income
tax. Also, it cannot be deferred as its permanent type of difference. Hence no deferred tax
shall be created by this head expense.
iv) There may be different rates of depreciation applied by the company in its financial books of
accounts whereas there are specified rate for depreciation for the purpose of income tax. In
the above case there is Rs. 50,000 charged as expenses as depreciation whereas there is
75,000 as per the income tax act. Hence the difference of Rs 25,000 excess claimed in the tax
audit shall be charged by the co. in the financial books in future. Hence it will create deferred
tax liability.
Question No. 47
During the course of audit of PYC Finance Company Limited, you found that the following
payments were made by the company.
i) Rs. 500,000 for purchase of five sets of computer laptop.
ii) Rs. 250,000 for purchase of computer server.
iii) Rs. 60,000 for purchase of six set of Window 7 i.e. computer operating system one
each for the laptop and computer server without which they cannot operate.
iv) Rs. 1,000,000 for „Pumori IV‟ i.e. accounting software procured from Mercantile
Operating System with the right to use for five years. The software will be installed in
the computer server.
v) Rs. 50,000 to Mercantile Operating System for training the staff of the company about
the use of „Pumori IV‟ software.
The useful life of the laptop and computer software is five years with no residual value.
Suggest the accounting treatments to PYC Finance Company Limited on above payments as
per Nepal Accounting Standard. (5 Marks June 2013)
Answer: The provision of Para 6 of NAS 16 on ‗Property, Plant and Equipment‘ defines property,
plant and equipment as tangible items that are held for use in the production or supply of goods or
services, for rental to others, or for administrative purposes and are expected to be used during
more than one period.
The provision of Para 8 of NAS-38 on ‗Intangible Assets‘ defines intangible assets as an
identifiable non-monetary asset without physical substance and Para 11 states the identifiability
criterion of the intangible assets. Para 4 of NAS-38 further states that computer software for a
computer-controlled machine tool that cannot operate without the specific software is an integral
part of the related hardware and is treated as property, plant and equipment under the provision of
NAS 16.
Similarly, the provision of Para 18 and 19 of NAS-38 specifies that the intangible assets should
be recognized at cost incurred initially to acquire or internally generate an intangible asset and
those incurred subsequently to add to, replace part of, or service it. The provision of Para 27 of
NAS 38 further elaborates that the cost of separately acquired intangible assets comprises of its
purchase price and any directly attributable cost of preparing the assets for its intended use.
In the light with above provision of NAS, the given payments made by PYC Finance Company
Ltd. should be accounted as follows:
i. The laptop and computer hardware are purchased for providing of service and
administrative purpose of the company and should be accounted as ‗property, plant and
equipment‘ in accordance with the provision of NAS 16.

ii. With regards to payment made for purchase of Window 7 software, though the software
qualifies for recognition as intangible assets under the provision of Para 9 of NAS 38, the
same should be capitalized to ‗property, plant and equipment‘ under the provision of Para
4 of NAS-38 as the same becomes integral part of the laptop and computer hardware
which cannot be operated without the software.
iii. The payment made to Mercantile Operating System for the purchase of Pumori IV. This
software will be installed in computer system that can operate independently and also not
an integral part of the computer hardware system compulsorily required for operation of
computer software, this software is treated as intangible assets. Hence, its cost qualifies
for recognized as Intangible Assets under the provision of Para 4, 9 and 13 of NAS-38.
iv. With regard to payment to Mercantile Operating System for training of staff, the payment
is not related either to the purchase of software nor for preparing the assets for its intended
staff. The payment is made for preparing the staff to operate the intangible assets. Hence,
it is not eligible for capitalization and should be charged to expenses.
Question No. 48
New Co. Ltd. charged depreciation on SLM basis. For the year ended 31.3.2069, it opted to use
WDV method. The impact of this change was Rs. 20 lakhs, being additional depreciation
charge. What are the disclosure requirements as per Nepal Accounting Standard?
(5 Marks June 2013)
Answer
As per NAS-8, the use of reasonable estimates is an essential part of the preparation of financial
statements and does not undermine their reliability.
As the New Co. Ltd has changed the depreciation method for the FY ended on 31.03. 2069,
but not changed a measurement basis, thus this change should be treated as change in
accounting estimates. As per Para 32 and 35 of NAS-8, When it is difficult to distinguish a change
in an accounting policy from a change in an accounting estimate, the change is treated as a change
in an accounting estimate. The change is accounting estimates should be applied prospectively,
that is, in the current period and in future periods if affected by the change.
A change in accounting estimate is an adjustment of the carrying amount of an asset or a liability,

or the amount of the periodic consumption of an asset, that results obligations associated with,
assets and liabilities.
Changes in accounting estimates result from new information or new developments and
accordingly, are not corrections of errors.
i. New Co. Ltd can change accounting estimate if changes occur regarding the
circumstances on which the estimate was based or as a result of new information, more
experience or subsequent developments. By its nature, the revision of the estimate does not
bring the adjustment within the definitions of an extraordinary item or a fundamental error.
0.5
ii. New Co. Ltd shall include the effect of a change in an accounting estimates in the
determination of net profit or loss in:
 The period of the change, if the change affects the period only; or
 The period of the change and future periods, if the change affects both.
Accordingly, Rs. 20 lakhs should be charged to the period ended on 31.03.2069, and this fact
should be disclosed in the notes attached with financial statements.

Question No. 49
X Limited entered into an agreement to sell its immovable property recorded in the Balance
Sheet at Rs. 10 lakhs to another company for Rs. 15 lakhs. The agreement to sell was
concluded on 15thBaishakh 2069 and the sale deed was registered on 1stShrawan 2069.
Comment with reference to NAS 5. (2 Marks June 2013)
Answer
NAS-10 deals with events occurring after the reporting period, that are those events, favorable
and unfavorable, that occur between the end of reporting period and the date when the financial
statements are authorized for issue. Specially, such events that provide adjusting and non-
adjusting the evidence of conditions that existed at the end of reporting period or not.
In the given case, we need to analyze the provision of Para-14 of NAS-18, sale of goods that
provide if all conditions are satisfied sale can be recognized in the books. NAS-18 further
provides that, in case of retail sale, the transfer of the risks and rewards of ownership coincides
with the transfer of the legal title or the passing of possession to the buyer. In other cases, the
transfer of risks and rewards of ownership occurs at a different time from the transfer of legal title
or the passing of possession.
Hence in this case NAS-10 is not applicable; transaction should be treated as sale under NAS-18,
Revenue.
Question No. 50
State the treatment of the following transactions: (3 Marks each June 2013)
i) Substantial expenditure incurred for the repair of machinery.
ii) Expenditure incurred to remove “Overburden” for purposes of facilitating mining
activities.
Answer
i) As per NAS-16, spares parts and servicing equipment‘s are generally carried as
inventory and charged to profit or loss on consumption and thus do not form part of
carrying cost of property, plant and equipment, similarly day to day service does not
involved substantial amount of money. But, when the entity incurs substantial
expenditure on repair of machinery that the future economic benefit will flow to the
entity for more than one period then such substantial expenditure shall form part of the
carrying amount of property, plant and equipment as per NAS-16.
ii) The benefit of expenditure incurred to remove the ―overburden‖ for purposes of
facilitating mining activities is that it improves access to identifiable mine deposit. Then
cost incurred for removable of the overburden should be capitalized. The capitalized
costs are depreciated or amortized on a systematic basis, usually by using the units of
production method.
Question No. 51
“Management is responsible for making estimates included in financial statements”. Explain.
(5 Marks June 2012)
Answer
AS per NAS-8: Accounting Policy, Change in Accounting Estimates and Errors accounting
estimates means an approximation of the amount of an item in the absence of precise means of
measurement.
Examples of such estimates that may be included in the financial statements are:

i) Allowances to reduce inventory and accounts receivables to their estimated realizable

value.
ii) Provisions to allocate the cost of fixed assets over their estimated useful lives.
iii) Accrued revenue
iv) Deferred Tax
v) Provision for a loss from a lawsuit
vi) Losses on construction contract in progress
vii) Provision to meet warranty claims
These estimates are often made by the management in conditions of uncertainty regarding the
outcome of events that have occurred or are likely to occur and involve the use of judgment. As a
result, the risk of material misstatement is greater when accounting estimates are involved and in
some cases the auditor may determine that the risk of material misstatement related to an
accounting estimate is a significant risk that requires special audit consideration.
As the management is responsible for establishing a process for preparing accounting estimates
and it must be requested for documentation of the process used in making estimations.
Question No. 52
What are the differences between Finance lease and Operating lease?
Answer:
Finance lease and operating lease can be distinguished as follows based on provision contained in
Nepal accounting standard (NAS)-17;
Finance lease  The lease transfers substantially all of the risks and benefits of
ownership of the leased property from the lessor to the lessee.
 Ownership of the lease asset stays with the lessor although, in some
cases, the lessee may purchase the asset from the lessor at the end of
the lease.
 For accounting purposes, the lessee records a lease asset and a lease
liability and records depreciation on the lease asset.
 For accounting purposes, the lessor replaces the tangible asset that has
been leased with a lease receivable.
 For both parties, the lease payments are treated as interest and
principal reductions against the lease liability or lease receivable.
Operating lease  The lease does not transfer substantially all of the risks and benefits of
ownership from one party to the other. The risks and benefits of
ownership remain with the lessor.
 The lessee does not record a lease asset or liability (unless there are
lease prepayments or accruals) and records the lease payments as
lease expense.
 The lessor records the lease payment as lease revenue and depreciates
the lease asset.

Question No. 53
Answer the following (4 Marks each June 2014)
a) What do you understand by Statement of Changes in Equity? Explain briefly.
b) How will you classify Current Assets and Current Liabilities as per Accounting
Standards?
Answer
a) As per NAS-1(Presentation of FS), Statement of changes in equity is an important
component of financial statements which details the change in owners‘ equity over an
accounting period by presenting the movement in reserves comprising the shareholders
equity. An entity shall present a statement of changes in equity showing on the face of the
statement:
 profit or loss for the period
 Increase or decrease in share capital reserves
 Dividend payments to shareholders
 Gains and losses recognized directly in equity
 Effect of changes in accounting policies
 Effect of correction of prior period error
A reconciliation between the carrying amount of each class of equity capital, share
premium and each reserve at the beginning and the end of the period, separately disclosing
each movement. This statement should show total comprehensive income for the period
showing separately the total amounts attributable to owners of the parent and to non-
controlling interests.
b) As per NAS 1, Current assets and current liabilities are classified as follows:
Current Assets
An entity shall classify an asset as current when:
(a) It expects to realize the asset, or intends to sell or consume it, in its normal operating
cycle;
(b) It holds the asset primarily for the purpose of trading;
(c) It expects to realize the asset within 12 months after the reporting period; or
(d)The asset is cash or a cash equivalent (as defined in standards) unless the asset is
restricted from being exchanged or used to settle a liability for at least twelve months after
the reporting period.
Current Liabilities
An entity shall classify a liability as current when:
(a) It expects to settle the liability in its normal operating cycle;
(b) It holds the liability primarily for the purpose of trading;
(c) The liability is due to be settled within twelve months after the end of the reporting
period; or
(d)The entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period.
Question No. 54
Ethics: (5 Marks December 2014)
a) You are an auditor of ABC Ltd. for the year ended 32 Ashadh 2071. The company has
earned Rs. 100 million net profit after tax during this year. On 30 Ashwin 2071, the

Company has declared dividend of Rs. 10 million to its shareholders. The financial
statements have been approved by the Board on 30 Kartik, 2071. The Company has shown
declared dividend of Rs. 10 million as an expense and the same amount was shown as
liability in the financial statement as of 32 Ashadh 2071.
Answer: Dividend payable should be recognized when the issuance of dividend is properly
authorized. No liability in respect of dividends shall be recognized where dividends are
declared after the end of the reporting period. However, if such dividends are declared before
the authorization of financial statements, they shall be disclosed in the notes in accordance
with NAS-10: Events after the reporting period.
Hence, the accounting treatment of dividend expense and liability by the company is not
correct. Dividend declared should not be shown as expense and liability instead it should be
disclosed in the notes to the financial statements as the dividend was declared before
authorization of the financial statements by the Board.
If the management fails to rectify/adjust the accounts, the auditor should qualify the report.
b) LM Ltd. has 2 divisions L and M. The finished products of division L are transferred to
division M where further processing is carried out before sale to customers. To achieve
transparency and accountability between the divisions, division L raises an invoice on
division M at cost plus normal margin. At the year end the unrealized profits on inter-
division stocks are eliminated. However, the transfers are recorded at the invoice value as
sales and purchases in the respective divisions for the purpose of preparing the Profit and
Loss Account. Suitable disclosures for this are given in the Notes to Accounts.
Answer: Revenue is defined in NAS-18 as "Revenue is a gross inflow of economic benefits

during the period arising in the course of the ordinary activities of an entity when those
inflows result in increases in equity, other than increases relating to contributions from equity
participants". Therefore, as per the definition of the term "Revenue‖ in NAS-18, revenue is
the gross inflow of cash, receivables or other consideration arising in the course of the
ordinary activities of an enterprise from the sale of goods, from the rendering of services, and
from the use by others of enterprise resources yielding interest, royalties and dividends.
Hence, the transfers within the enterprise cannot be considered as fulfilling the definition of
the term ―revenue‖. Thus, the recognition of interdivisional transfers as sales is an
inappropriate accounting treatment and is inconsistent with NAS-18. Further, in case of inter-
divisional transfers, risks and rewards remain within the enterprise and also there is no
consideration from the point of view of the enterprise as a whole. Thus, the recognition
criteria for revenue recognition are also not fulfilled in respect of inter-divisional transfers. In
the instant case, therefore, LM Ltd cannot recognize inter-division transfers from L to M as
sales and the same will have to be eliminated during finalization. If not so done, the statutory
auditor will have to qualify his report.
c) As an auditor of M/S Quest Garment Co., you are required to verify whether the following
expenses of the company create deferred tax or not?
i) Being the first year of the Co., first installment of the total pre operating expenses
of NRs. 120,000 (to be amortized over 5 years) has been charged in the Income
Statement.
ii) Provision for gratuity made for the year is Rs. 98,000. However, no such fund has
been separately transferred or deposited or expensed.

iii) Donation expenses charged in the financial books amounting to Rs. 25,000 given to
local clubs.
iv) Depreciation on the fixed assets charged in the financial books is Rs. 50,000
whereas provision allowed and claimed as per Income Tax Act is Rs. 75,000.
Answer: As per (NAS-12: Income Taxes)
i) All the pre operating expenses should be charged in first year of operation of the co.
by virtue of Section 13 of the Income Tax Act 2058 and the related circular. So, there
arises the temporary difference of Rs. 96,000, assuming that one fifth of the expense
has been charged in this year in the financial books of accounts and four fifth is yet to
be written off. Hence, there shall be Rs. 24,000 of deferred tax liability created.
ii) Provision for gratuity apportioned by the company in the financial books is not
deductible expenses as per tax unless it is separately deposited in the bank account or
actually expensed off. Hence, there will be temporary difference between carrying
amount and tax base of the gratuity provision, which creates deferred tax assets.
iii) Donation given to the local clubs by the company is not deductible charge as per
income tax act. Also, it cannot be deferred as it is permanent type of difference.
Hence, no deferred tax assets or liability shall be created by this expense.
iv) There may be different rates of depreciation applied by the company in its financial
books of accounts whereas there are specified rate for depreciation for the purpose of
income tax. In the above case there is Rs. 50,000 charged as depreciation expenses
whereas Rs.75,000 has been claimed as per the income tax act. Hence, the difference
of Rs 25,000 excess claimed in the tax return shall be charged by the company in the
financial books in future and no benefit of tax shall be enjoyed on this amount in the
future. Hence, it will create deferred tax liability of Rs. 6,250, assuming income tax
rate of 25 percent.
Question No. 55
"Both the provision and contingent liability are the present obligations from past events". Do
you agree with this statement? How do you differentiate provision and contingent liability?
Answer
NAS-37: Provisions, CLs and CAs;
Partly Yes. Both the provision and contingent liability are the present obligation that arises from
past events, but the recognition of provision is made if the following conditions are satisfied:
a. An entity has a present obligation (legal or constructive) as a result of a past event;
b. It is probable (i.e. more likely than not) that an outflow of resources embodying
economic benefits will be required to settle the obligation and
c. A reliable estimate can be made of the amount of the obligation.
However, as per Nepal Accounting Standard on Provisions, Contingent Liabilities and

Contingent Assets (NAS-37) the contingent liability is defined as:
a. 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

b. a present obligation that arises from past events but is not recognized because:
i. It is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation or
ii. The amount of the obligation cannot be measured with sufficient reliability.
Question No. 56
While doing the audit of consolidated financial statement, which current period consolidation
adjustments are to be taken into account? (5 Marks June 2015)
Answer:
Current period consolidation adjustments are those adjustments that are made in the
accounting period for which the consolidation of financial statements is done. Current
period consolidation adjustments primarily relate to elimination of intra-group
transactions and account balances. The auditor should review the memorandum records to
verify the adjustment entries made in the preparation of consolidated financial statements
to ensure:
i. Elimination of intra-group transactions relating to interest or management fees etc.
ii. Elimination of unrealized intra-group profits on assets acquired from other
subsidiaries.
iii. Elimination of intra-group indebtedness
iv. Adjustments for harmonizing different accounting policies of parent units and its
subsidiaries.
v. Adjustments for impairment loss that might exist for goodwill.
vi. Adjustments for significant events that occur between date of financial statements
of the parent and of its components when the date of financial statement of
components is different from the reporting date.
Question No. 57
Ethics:
a) XYZ Ltd. filed a lawsuit against ABC Ltd. for Rs.200 million. The management of ABC
Ltd. felt that the suit was without merit, so ABC Ltd. merely disclosed the existence of the
lawsuit in the notes accompanying the financial statements.
Answer: As per NAS 37 "Provisions, Contingent Liabilities and Contingent Assets", a
provision shall be recognized when
a. An entity has present obligation (legal or constructive) as a result of past event,
b. It is probable that an outflow of resources embodying economic benefits will be
required to settle the obligation, and
c. A reliable estimate can be made of the amount of the obligation.
NAS 37 further provides that an entity shall not recognize contingent liability but shall
disclose it unless the possibility of an outflow of resources embodying economic benefits is
remote.
NSA 570(Revised) ―Going Concern‖ requires that the auditor shall consider whether there
are events or conditions that may cast significant doubt on the entity‘s ability to continue as a
going concern. Pending legal or regulatory proceedings against the entity that may, if
successful, result in claims that the entity is unlikely to be able to satisfy is one of the
examples of such event.

When the auditor concludes that the use of the going concern assumption is appropriate in the
circumstances but a materiality uncertainty exists, the auditor shall determine whether the
financial statements adequately describe the principal events or conditions that may cast
significant doubt on the entity‘s ability to continue as a going concern and management‘s
plan to deal with these events or conditions.
In the given case, as there is no present obligation to pay, no provision shall be made.
However, the auditor shall evaluate the source data on which basis the opinion is formed and
come to the conclusion whether to disclose it as a contingent liability and evaluate the
appropriateness of use of going concern assumption.
b) During the financial year 2071-72, a company started research work with a view to the
eventual development of a new product. By 31stAshadh 2072, it had spent Rs.1.6 million
on this project. The company has a past history of being particularly successful in
bringing similar projects to a profitable conclusion. As a consequence, the assistant has
treated the expenditure to date on this project as an asset in the statement of financial
position.
Answer: The work on the new product is research with the aim of eventually moving into
development work. NAS 38 requires all research expenditure to be expensed as incurred. In
the research phase, an entity cannot demonstrate that an intangible asset exists that will
generate probable future economic benefits. Therefore, such expenses are recognized as
expense when it is incurred. Even at the development stage, it will not be possible to
capitalize the development costs unless they satisfy the NAS 38 criteria. When the criteria are
satisfied, and development costs can be capitalized. The company‘s past successful history
makes no difference to this. So, the treatment given is not correct. The amount should be
charged to statement of profit or loss as an expense for the current period.
Question No. 58
A statutory auditor is required to follow the procedures so as to identify the risk of material
misstatement associated with related parties. What are the auditor‟s duties when he identifies
related parties or related party transactions that management has not previously disclosed to
him? (8 Marks December 2015)
Answer: NSA-550 ―Related Parties‖ requires the auditor to perform procedures so as to identify
the risk of material misstatement associated with related parties. Accordingly, auditor should
perform the following:
a. Inquire the management regarding
 Identify of entity‘s Related Party, changes from prior period
 Nature of relationships between entity and Related Party.
 Type and purpose of transactions with Related Party during the period.
b. The auditor shall remain alert, when inspecting records or documents, for arrangements or
other information that may indicate, the existence of related party relationships or
transactions that management has not previously identified or disclosed to the auditor.
c. If the auditor identifies related parties or significant related party transactions that
management has not previously identified or disclosed to the auditor, the auditor shall:
i. Promptly communicate the relevant information to the other members of the
engagement team;
ii. Request management to identify all transactions with the newly identified related
parties for the auditor‘s further evaluation; and Inquire as to why the entity‘s controls

over related party relationships and transactions failed to enable the identification or
disclosure of the related party relationships and transactions;
iii. Perform appropriate substantive audit procedures relating to such newly identified
related parties or significant related parties‘ transactions;
iv. Reconsider the risk that other related parties or significant related party transactions
may exist that management has not previously identified or disclosed to the auditor, and
perform additional audit procedures as necessary; and
v. If the non-disclosure by the management appears intentional (and therefore indicative of
a risk of material misstatement due to fraud), evaluate the implications for the audit.
Question No. 59
a) Big Ltd. has borrowed Rs. 30 lakhs from Bank during the Financial Year 2071-72.
The borrowings are used to invest in shares of Small Ltd., a subsidiary company of
Big Ltd., which is implementing a new project estimated to cost Rs. 50 lakhs. As on
31stAshadh 2072, since the said project was not complete, the directors of Big Ltd.
resolved to capitalize the interest accruing on borrowings amounting to Rs. 4 lakhs
and add it to the cost of investments.
Answer: The cost of investment includes acquisition charges such as brokerage, fees and
duties. In the instant case, Big Ltd. has used borrowed funds for purchasing shares of its
subsidiary company Small Ltd. Rs. 4 lakhs interest payable by Big Ltd. to Bank cannot be
called as cost of investment. The NAS 23 on ―Borrowing Costs‖ also does not consider
investment in shares as qualifying asset that can enable a company to add the borrowing
costs to investments. In the instant case, the statutory auditor would qualify his report by
stating that the borrowing costs have been wrongly added to the cost of investments rather
than charging them to profit and loss account. The effect of the same on the profits for the
year would also have to be mentioned.
b) During the course of audit of D Co. Ltd., you as an auditor have observed that inter
corporate deposit of Rs 50 lakhs has been overdue. The D Co. Ltd. has disclosed this
in the notes to accounts stating that Rs. 50 lakhs are overdue from XYZ Co. Ltd.
and the said company is in the process of liquidation. The management is taking
steps to appoint the liquidator.
Answer: As per NAS 10 ―Events after reporting period‖ adjustments to financial
statements are required for events occurring between the end of reporting period and the
date when financial statements are authorized for issue that provide additional
information materially affecting the determination of the amounts relating to conditions
existing at the end of reporting period. If the events are only indicative, then mere
disclosure will be sufficient.
In the instant case, it appears from the note that the overdue of outstanding inter corporate
deposit may not be realizable in full. The company is in the process of liquidation, makes
it clear that at the end of reporting period, the amount of deposit is not safe and is not
likely to be realized. Therefore, as per NAS 10, necessary adjustment is required to be
made in the financial statements.
Question No. 60

a. Explain how the revenue from the following service transactions would be recognized:
(4 Marks June 2016)
i) Plant installation Fees
ii) Admission fees for Film Festival
iii) Media commission for Advertising agencies
iv) Insurance Agency Commission
b. M/s MeritaImpex is engaged in the business of manufacturing and trading of musical

instruments. A sum of Rs.5 lakhs is received from an insurance company in respect of
a claim for loss of goods in transit costing Rs. 4 lakhs. The amount is credited to the
purchase account. (4 Marks June 2016)
Answer:
a. NAS-18: Revenue;
i. Plant installation Fees: Plant installation fees are incidental to the sale of the machinery.
It should be recognized as revenue only when the machinery is installed and accepted by
the customer.
ii. Admission fees for Film Festival: Revenue from artistic performances, banquets and
other special events should be recognized when the events take place. Admission fees for
the film festival should be recognized only when the film festival has been organized.
Admission fees should be allocated to various categories of films like documentary,
information section, competition section etc., on a systematic and rational basis.
iii. Media commission for Advertising agencies: Media commission will be recognized
when the related advertisement or commercial appears before the public and the
necessary intimation is received by the agency.
iv. Insurance Agency Commission: It should be recognized on the effective
commencement or renewal of the related policies.
b. Answer
All items of income and expense which are recognized in a period should be included in
the determination of net profit or loss for the period. The claim for loss of goods in transit
is arising out of ordinary activities of the impex as a part of its normal course of business.
However, the cost of goods lost in transit is only Rs. 4,00,000 while the insurance money
received is Rs. 5,00,000. Purchases Account need not be credited since it would distort the
purchases done during the year and as also the gross profit. Therefore, entire amount of 5
lakhs needs to be taken to profit and loss account under an appropriate head. This is an
income arising from an ordinary activity of the enterprise but having regard to amount
involved and exceptional nature, a separate disclosure is made in the profit and loss
account. Such disclosure would enable the users to understand the performance of an
enterprise for the period.
Question No. 61
consideration to respective Standards, Laws and Code of Ethics: (5 Marks each June 2017)
a) During the course of the last three years, a company owning, and operating helicopters lost
four helicopters. The company management felt that after the crash, the maintenance
provision created in respect of the respective helicopters was no longer required and
decided to write back to the profit and loss account as a prior period item.

Answer: The balance amount of maintenance provision written back to Profit and Loss
Account, no longer required due to crash of the helicopters, is not a prior period item because
there was no error in the preparation of previous periods' financial statements. The term prior
period items as defined in NAS 8, "Accounting Policies, Changes in Accounting Estimates &
Error", refer only to income or expenses which arise in the current period as a result of errors
and omissions in the preparation of the financial statements of one or more prior periods. The
nature and the amount of such item should be separately disclosed in the statement of profit and
loss in a manner that its impact on current profit or loss can be perceived.
b) M Ltd. manufactures machinery used in steel plants. It quotes prices in various tenders
issued by steel plants. As per terms of contract, full price of machinery is not released by
the steel plants, but 10% thereof is retained and paid after one year if there is satisfactory
performance of the machinery supplied. The company accounts for only 90% of the invoice
value as sales income and the balance amount in the year of receipt to the extent of actual
receipts only.
Answer: NAS 18 on ‗Revenue‘, states that revenue from sale of goods should be recognized as
and when sale is made if following conditions are satisfied:
 Property in the goods has been transferred for a price
 all significant risks and rewards of ownership have been transferred, and
 seller retains no effective control of the goods associated with ownership and
 no significant uncertainty exists regarding the amount of consideration.
In the present case, the goods, as well as the risks and rewards of ownership have been
transferred to the steel plants. The invoice raised by M Ltd. is for the full price, but 10% less is
received as the same is kept as ‗Retention Money‘.
Conclusion: Under the circumstances, revenue is required to be recognized at the full invoice
price. Depending on the past experience of recovering the balance 10% from the steel plants, M
Ltd. can, make a provision for sales income which is not likely to realize.
c) X Ltd., a listed company, was incurring heavy losses since the last several years and the
industry in which it was functioning was not expected to perform better in the next few
years. While finalizing the accounts for the year ended 31/03/072, the CFO of the company
decided to create a deferred tax asset for the tax benefits that would arise in future years
from the earlier year losses that had remained unabsorbed in income tax. As the statutory
auditor, how would you deal with the situation?
Answer: NAS 12 on ―Income Taxes‖, requires that deferred tax should be recognized for all
timing differences, subject to the considerations of prudence in respect of deferred tax assets.
The standard further states that where an enterprise has unabsorbed depreciation or carry
forward of losses under the tax laws, deferred tax assets should be recognized only to the extent
that there is virtual certainty supported by convincing evidence that sufficient future taxable
income will be available against which such deferred tax assets can be realized. This implies
that there is a reasonable certainty that the carry forward losses would be recouped in the future
years.
In the instant case, looking to the fact that the industry in which the company was functioning
was not expected to perform well in the next few years, getting virtual certainty and convincing
evidence for the same would be almost impossible. Hence, in the absence of virtual certainty
for offset of the losses in future years, creating a deferred tax asset would not be possible for
the company. Conclusion: The statutory auditor would therefore have to qualify his report by

stating that deferred tax assets have been created though there is no virtual certainty for getting
the said benefit in income tax. He would also have to mention the amount by which the loss
for the year has been understated and the amount by which the reserves are overstated.
d) Mr. Madhav as a contractor has just entered into a contract with a local body for building
a flyover. As per the contract terms, Mr. Madhav will receive an additional Rs. 50 million if
the construction of the flyover were to be finished within a period of two years of the
commencement of the contract. Madhav wants to recognize this revenue since in the past
he has been able to meet similar targets very easily.
Answer: According to NAS 11 'Construction Contracts', incentive payments are additional

amounts payable to the contractor if specified performance standards are met or exceeded. For
example, a contract may allow for an incentive payment to the contractor for early completion
of the contract. Incentive payments are included in contract revenue when: (i) the contract is
successfully advanced that it is probable that the specified performance standards will be met
or exceeded; and (ii) the amount of the incentive payment can be measured reliably. In the
given problem, the contract has not even begun and hence the contractor should not recognize
any revenue of this contract.
Question No. 62
Comment and give your views with reasons of the following case, giving consideration to
a. A company is engaged in telecom business. The company is listed with Nepal stock
exchange and management of the company is provided handsome incentives based on
revenue growth. The management explains to the auditor that the revenue recognition is
fully automated and there have been no auditor‟s remark on revenue recognition for last
several years and accordingly the auditor is convinced and instructs the audit team for
not focusing on revenue audit because there is no risk of fraud on revenue recognition. (5
Marks June 2018
Answer: Fraud Risk in Revenue Recognition:
As per NSA 240: Auditors‘ responsibility relating to fraud in an audit of financial statements,
when identifying and assessing the risks of material misstatement due to fraud, the auditor
shall, based on a presumption that there are risks of fraud in revenue recognition, evaluate
which types of revenue, revenue transactions or assertions give rise to such risks. Where the
auditor concludes that the presumption is not applicable in the circumstances of the
engagement and, accordingly, has not identified revenue recognition as a risk of material
misstatement due to fraud, appropriate documentation should be made.
In the given case, since the management of the company is provided incentive based on
revenue growth, the risk of fraud in overstating revenue seems high. So, the auditor should not
accept the management‘s explanation of less risk in revenue recognition and the presumption
of high fraud risk in this case seems un-rebuttable despite the fact that there was no history of
misstatements in revenue recognition. Students may refer following provisions while
answering this question, so consider about awarding marks.
Further, Section 34 of Nepal Chartered Accountants Act, 2053 mentions that members holding
Certificate of Practice shall not certify any financial statement or give report of any type until
they or their partner or employee checks and verifies it.

NSA 330irrespective of assessed risks of material misstatement, the auditor shall design and
perform substantive procedures for each material class of transaction, account balance and
disclosures.
b. A machinery was purchased at Rs 1 crore on 1 Shrawan 2071 by a Company. The

company's policy was to charge depreciation @ 20% on reducing balance method. The
company management is of the view that straight line method of depreciation will reflect
the pattern in which economic benefits from the asset is consumed and decides to change
the policy of charging depreciation on straight line basis from 2073/74 and financial
statement of 2073/74 is yet to be signed. The chief finance officer intends to give
retrospective effect by adjusting depreciation expenses of comparative year 2072/73 and
retained earnings for the difference amount of 2072/73 and 2071/72. (5 Marks June 2018)
Answer: NAS 8 defines change in accounting estimate as ―an adjustment of the carrying
amount of an asset or a liability, or the amount of the periodic consumption of an asset, that
results from the assessment of the present status of, and expected future benefits and
obligations associated with, assets and liabilities‖. Changes in accounting estimates result from
new information or new developments and accordingly, are not corrections of errors.
So, the change in method of depreciation in the given case from reducing balance method to
straight line method is the change in accounting estimate and not the change in accounting
policy because it results into adjustment of the amount of periodic consumption of an asset.
Further, as per the said NAS, the effect of a change in an accounting estimate shall be
recognized prospectively by including it in profit or loss in:
(a) the period of the change, if the change affects that period only; or
(b) the period of the change and future periods, if the change affects both.
So, the amount of depreciation in year 2073/74 and onwards will be charged as per the new
method of depreciation (i.e. Straight line method) over the useful life of machinery and there is
no need to make retrospective adjustment (as intended by Chief Finance Officer) in the value of
machinery and depreciation expenses and retained earnings.
Question No. 63
Gajakarna News Private Limited is a media house publishing a daily newspaper named as
TajaKhabar. It also publishes a monthly magazine named as World Update covering local and
international business news. The circulation department is responsible for selling paper by
means of annual subscription (delivered by cycle boy on daily basis) and retail sales (through
stationery shops/newsstand). The annual subscription for the TajaKhabar and World Update is
Rs. 2,500 and Rs. 1,000 respectively. As on Ashadh end 2075, draft financial statements of
Gajakarna News Private Limited shows revenue of Rs. 28.20 million, receivables of Rs. 5.60
million and profit before tax of Rs. 4.80 million.
i) The Chief Finance Officer claims that the company has been recognizing
subscription income as and when cash is realized and is trying to convince the
auditor to accept the same. Suggest the CFO about the correct accounting
treatment with regard to recognition of subscription revenue.
ii) One of the advertising agencies owed an amount of Rs. 350,000 at the year end.
Testing of receivables after year end highlighted that no amounts had been paid to
Gajakarna News Private Limited from this customer as they were disputing the
quality of certain advertisement published. The Chief Finance Officer is confident

that the issue will be resolved and no allowance for receivables was made with
regards to the receivable. Describe the procedures to be followed by the audit team
to resolve this issue and its impact on the audit report if it remains unresolved.
Answer:(i)
The subscribers pay their annual subscription fee upfront to receive a daily newspaper and/or
monthly magazine and in exchange, the company promises to deliver a new issue every
day/month for 12 months.
When a business charges money for a service they intend to deliver over a long period of time,
they will need to gauge the proportion of a service that has been provided during the financial
year in order to determine the amount of revenue that may be recognized, possibly on a
percentage basis. There are revenue recognition rules that must be followed called deferred
revenue. Deferred revenue is income that you have received for goods or services not yet
delivered. From a financial reporting perspective, a business should be able to see at any given
time how much money it has collected from subscriber for subscription revenue, how much of
that money is still in a deferred revenue account, and how much of that revenue has actually been
recognized because the service has not been fully delivered.
Hence, practice followed by Gajakarna News Private Limited is not correct. Revenue should be
accrued on a daily, monthly or quarterly basis depending on the level of accuracy required.
However, it must be adjusted at least in a financial year to give a true and fair view.
Answer:(ii)
A customer of Gajakarna News Private Limited owing Rs. 350,000 at the year-end has not made
any post year-end payments as they are disputing the quality of advertisement published. No
allowance for receivables has been made against this balance. As the balance is being disputed,
there is a risk of incorrect valuation as some or all of the receivable balance is overstated, as it
may not be paid. This Rs. 350,000 receivables balance represents 1·20% (0·35/28·2m) of
revenue, 6·3% (0·35/5·6m) of receivables and 7·3% (0·35/4·8m) of profit before tax; hence this
is a material
A procedure to adopt includes:
 Review whether any payments have subsequently been made by this customer
 Discuss with management whether the issue of quality of advertisement published to the
customer has been resolved, or whether it is still in dispute.
 Review the latest customer correspondence with regards to an assessment of the likelihood
of the customer making payment.
If management refuses to provide against this receivable, the audit report will need to be
modified. As receivables are overstated and the error is material but not pervasive a qualified
opinion would be necessary.
Question No. 64
Tik and Tok Private Limited is the leading manufacturing company of Toy in Nepal. The new
accountant is confused about the valuation of stock. The details of cost and expenses are
tabulated below. (5+5=10 Marks, June 2019)

i) Normal waste of material in production process is 3%. 1,000 kg of input was processed
resulting into finished product of 950 kg. The entire quantity of finished product is at stock
at the year end. Cost of input is Rs. 100/kg. The cost of storing the final product was Rs.
6,000. The net realizable value of stock is Rs. 120/kg. The company recognized the finished
good at a value of Rs. 101,000. As an auditor suggest the management regarding the
correct valuation of stores.
ii) Subsequent to year end 2074/75 company‟s sales ledger has been corrupted by computer
virus. A new accountant was able to produce the financial statements prior to the
occurring; however, the audit team has been unable to access the sales ledger to undertake
the detail testing to revenue or year-end receivables. All other accounting records are
unaffected and there are no backups available for sales ledger. Revenue for the financial
year is Rs. 15.60 million, profit before tax is Rs. 2 million and its receivables are Rs. 3.40
million. Describe the procedures to be followed by the audit team to resolve this issue and
its impact on the audit report if it remains unresolved.
Answer:
i) As per Para 16 of NAS 2, following cost are excluded from the cost of inventories and
recognized as expenses in the period in which they incur
 Abnormal amount of waste materials, labor or other production cost,
 Storage cost, unless these costs are necessary in the production process before
further production stage
 Administrative overheads that do not contribute to bringing the inventories to their
present location and condition and
 Selling cost
In this case, normal loss is 30 kg and abnormal loss if 20 kg. The cost of 30 kg will be
included in determining the cost of finished product, whereas the cost of 20kg Rs.
2,000 and storage cost of Rs. 6,000 will be excluded from the cost and recognized as
expenses. Thus, the cost of inventories at year end will be Rs. 98,000. Whereas, the net
realizable value of the inventory is Rs. 114,000 (120*95)
As per Para 9 of NAS 2 Inventories shall be measured at the lower of cost and net
realizable value Hence the value of finished goods is Rs. 98,000.
ii) Tik and Tok Private Limited sales ledger has been corrupted by a computer virus;
hence no detail testing has been performed on revenue and receivables. The audit team
will have to see if they can confirm the revenue and receivable in an alternative
manner. If they are unable to do this then two significant balance in the financial
statements will not have been confirmed. Revenue and receivables are both higher than
the total profit before tax (PBT) of Rs. 2 million, receivables are 170% of PBT and
revenue is nearly eight times of PBT. Hence this is a very material issue.
A procedure to adopt includes:
 Discuss with management whether they have any alternative records which detail
revenue and receivable for the year.
 Attempt to perform analytical procedures, such as proof in total or monthly
comparison to last year, to gain comfort for in total for revenue and receivable.
The auditor will need to modify the audit report if they are unable to obtain sufficient
and appropriate evidence in relation to two material and pervasive areas, being
receivable and revenue. The opinion paragraph will be disclaimer of opinion and will

state that we are unable to form an opinion on the financial statements. A basis for
disclaimer of opinion paragraph will explain the limitations in relating to the lack of
evidence over revenue and receivable.
Question No. 65
c) Milan Metal Industries Ltd. had purchased during the year machinery on deferred
payment basis, payable over next ten years. The company has computed the interest
payable over these 10 years and debited Interest Suspense Account. Every year, 1/10th of
the same is written off to profit and loss account treating the same as deferred revenue
expenditure. As an auditor, give your opinions with reasons.
d) You notice a misstatement resulting from fraud or suspected fraud during the audit and
conclude that it is not possible to continue the performance of audit
a) Answer
As per NAS -08 on ―Borrowing Costs‖ enumerates the treatment of interest that interests
directly attributable to the acquisition, construction or production of a qualifying assets shall be
capitalized as part of the cost of that assets. However, interest payable on fixed assets purchased
on a deferred credit basis or on borrowed for acquisition of assets should not be capitalized after
such assets are put to use. Since the company has been following an inappropriate accounting
policy, the auditor should qualify his report as the amount involved in interest on purchased of
machinery would be material.
b) Answer
If an auditor concludes that it is not possible to continue the performance of auditing because of
misstatement resulting from fraud or suspected fraud, he should take action in accordance with
the requirement of NSA 240 in relation to the Auditor‘s Responsibility to consider Fraud and
Error:
i. He should consider the professional and legal responsibilities applicable in the
circumstances including whether there is a requirement for the auditor to report to the
person(s) who made the audit appointment.
ii. He should consider whether he has to report to the regulatory authorities.
iii. If the auditor withdraws, he should discuss with the appropriate level of management
and those who charged with the governance about the reasons for the withdrawal.
In view of the exceptional nature of circumstances and the need to consider the legal
requirement, he may also seek legal advice for determining the appropriate course of action.

Audit

Uploaded by

Copyright:

Available Formats

Audit

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Audit

Uploaded by

Copyright:

Available Formats

CHARTERED ACCOUNTANCY PROFESSIONAL III

Compilation of Suggested Answers

Paper 3: Advanced Auditing

© The Institute of Chartered Accountants of Nepal

This compilation of suggested answers is prepared by the Institute of Chartered Accountants of

b) Consideration at planning level:

 Establishing an acceptable materiality level.

c) Relationship between materiality and audit risk:

 As the time of evaluation of audit evidence.

a. Using other experts by professional accountants.

© The Institute of Chartered Accountants of Nepal 1

c. Using the work of an expert. (4 Marks December 2004)

© The Institute of Chartered Accountants of Nepal 2

© The Institute of Chartered Accountants of Nepal 3

Planning is a continuous process and changes in conditions of unexpected results of audit

© The Institute of Chartered Accountants of Nepal 4

© The Institute of Chartered Accountants of Nepal 5

© The Institute of Chartered Accountants of Nepal 6

b. Mr. A. Shrestha, a practicing Chartered Accountant, received a major professional assignment. In

© The Institute of Chartered Accountants of Nepal 7

© The Institute of Chartered Accountants of Nepal 8

ii. Substantive Procedures

© The Institute of Chartered Accountants of Nepal 9

© The Institute of Chartered Accountants of Nepal 10

© The Institute of Chartered Accountants of Nepal 11

© The Institute of Chartered Accountants of Nepal 12

Following matters may be considered in a specific engagement by the auditor.

i. General Economic Factors,

© The Institute of Chartered Accountants of Nepal 13

 Assessing risks and identifying problems,

© The Institute of Chartered Accountants of Nepal 14

© The Institute of Chartered Accountants of Nepal 15

(i) For C Unit of the Company Rs. 45,000/-

Whether Mr. Bhisma is indebted to the company and therefore disqualified?

b) Write a short note on Management Representation Letter (4 Marks December 2006)

© The Institute of Chartered Accountants of Nepal 16

© The Institute of Chartered Accountants of Nepal 17

 whether any accounting fraud has been committed in the company

i. If the Council of Institute of Chartered Accountants of Nepal decides to cancel

© The Institute of Chartered Accountants of Nepal 18

b. If the member has not completed 21 years of age.

c. If the member is declared insolvent.

a. If the member is punished on charge of criminal offence involving moral turpitude.

b. If the membership fees are not paid to the Institute.

d.If the member suffers from mental disorder.

e. If the member dies.

Question No. 22 (5 Marks each June 2007)

© The Institute of Chartered Accountants of Nepal 19

© The Institute of Chartered Accountants of Nepal 20

Question No. 23 (5 Marks each June 2007)

d) Disqualification of Auditors as per Company Act, 2063 (4 Marks December 2007)

b) According to Nepal Standards on Auditing-620, Using the Work of an Expert, an expert

© The Institute of Chartered Accountants of Nepal 21

Further Code of Ethics of Institute of Chartered Accountants of Nepal (ICAN), specifies

c) According to NSRS 4410 "Compilation Engagements" a practitioner should obtain a

© The Institute of Chartered Accountants of Nepal 22

i. A director, advisor appointed with entitlement to regular remuneration or cash benefit, a

iv. A person who has been declared insolvent;

v. A substantial shareholder of the company or a shareholder holding one percent or more

vii. A person referred to in sub-section (3) of Section 111;